Money and finance in the global economy

Money and finance in the global economy • The international monetary system is the body of rules and procedures by which different national currencies are exchanged for each other in world trade • The global financial system (GFS) refers to those financial institutions and regulations that act on the international level • The main players are private (banks, hedge funds etc) and public (central banks and government departments) and international organizations (the IMF, Bank for International Settlements etc) Money and finance in the global economy • The international monetary system is closely tied to the international finance system • Flows of international capital and FDI are conducted in money If there is a change in exchange rates they inevitably impact on the value of investment The role of the international monetary system • It requires a nation, or a group of nations, to maintain and manage it; leading nations might agree to entrust an international organization to achieve this, see IMF and World Bank • It has to determine the way to solve imbalances of national economies, by some agreed form of adjustment • It has to provide sufficient international liquidity Countries need to rely on sufficient financial reserves to meet sudden shocks The post-Bretton Wood international monetary system • Fixed exchange rates broke down in 1971 What followed were fluctuating exchange rates with no general rule on exchange rate adjustments The dollar remains the key reserve currency, although the system is based on some cooperation among the FED, the European Central Bank (the Bundesbank before 1999) and the Bank of Japan • The IMF act as regulator of the world international monetary system The post-Bretton Wood international monetary system • Many countries have chosen either to create monetary unions (the euro), or to peg their currencies to the dollar (dollar peg as in many South East Asian countries before 1997) • Some countries manage their currencies with currency reserve boards, which means relinquishing control to the IMF, which will cover their money supply with dollars (for example Hong Kong in the 1990s, and Argentina in early 2000s) The International Monetary Fund • The International Monetary Fund (IMF) oversees exchange rates and balance of payments It offers financial and technical assistance when requested • Its headquarters are located in Washington D.C and offices around the world It has currently 185 members • It came into existence in December 1945, when the first 29 countries signed its Articles of Agreement The International Monetary Fund • An unwritten rule establishes that the IMF's managing director must be European and that the president of the World Bank must be from the US • The IMF is for the most part controlled by the major Western Powers, especially the US, with voting rights on the Executive board based on a quota which reflects its monetary stake in the institution The post-Bretton Wood international monetary system • The desirable objectives of the international monetary system are • 1) exchange rate stability • 2) being able to run an independent monetary (and more broadly economic) national policy, for example a fiscal deficit when needed to boost economic growth • 3) enjoy freedom of capital flows, in order to have a more efficient financial system, international investment etc As we shall see this third point is now being challenged The post-Bretton Wood international monetary system Desirable objectives of IMS: • 1) exchange rate stability; • 2) independent monetary policy; • 3) free capital flows • The three objectives however are incompatible, only two are achievable at the same time • Under Bretton Woods there was and 2, but not • Currently most countries, have and 3, but not • The Euro means that each UE member state enjoys and 3, but not Financial crisis in Asia: debate Left wing critics: They blame the IMF for its arrogance and insensitivity and for its neo-liberal ideological approach The IMF proved to be the tool of international finance, and its prescriptions followed the wishes of the US government and Wall Street Right wing, free market critics, the IMF should not have spent so much money bailing out speculators Financial crisis in Asia: debate The IMF defence Only a strong IMF package stopped the crisis from damaging the entire world economy According to Martin Wolf the IMF was made the scapegoat, while responsibility for bad economic management rests with governments It is reasonable and consistent that the IMF should follow to a certain degree the will of its paymasters, i.e the lending nations If it were to act otherwise creditors would stop funding it and would seek to manage their relations with debtor countries bilaterally Proposals and remedies Gilpin believes that short term capital flows should be regulated A tax could be levied to discourage speculation Other observers think this solution – called the Tobin tax -both impractical and unreasonable The Asian crisis highlighted the need for better international rules Prescription on bank reserves were introduced through the Basel convention Proposals were floated for an international bankruptcy procedure It remains true that the international financial system is the weakest link in the global economy and that its governance is very weak and contested Outcome of the crisis • Of the five most affected countries, Malaysia, the Philippines, S Korea, Thailand, Indonesia, in 2001 only Indonesia had failed to recover previous GDP levels • South Korea, on the other hand, had experienced GDP growth of over 20% on its pre-crisis level The aggregate GDP level of the five was 13% higher than in 1996 • The quick recovery suggests that the crisis was mainly financial Economic fundamentals were not to blame Global finance is a factor of instability (Roderick) Argentina 2001 • Argentina had pegged its currency to the dollar, but the peso weakened and to sustain the peg it was necessary to raise interest rates, causing an economic recession • An aggravating factor was the fact that the Brazilian currency depreciated against the dollar, as did the euro, causing all kinds of problems for Argentinean exports • The peg could not be sustained, and the currency was devalued and following from that there the country defaulted on its debts The 2007-2010 crisis The origins • Long term Structural imbalances in the world economy, with USA and China • Greenspan’s two bubbles: • A) The new economy bubble (dot.com) burst in 2000 determining a sharp fall in the stock market and a domestic and international recession The Fed reacts with aggressive cuts interest rate cuts • B) The real estate bubble was a consequence of very low real interest rates after 2001 There was a boom in risky mortgage lending Dubious loans were securitized as widely traded instruments Speculative activity was fuelled by the rise in prices The 2007-2010 crisis The origins • The financial crisis in the US was centered, at least initially, not on the big commercial banks, but on the informal or shadow unregulated financial sector, (hedge funds, futures, money markets and corporate bond markets), where a huge amount of transactions was carried out The size of the informal market in 2007 amounted to various trillion dollars, much larger than the formal banking sector Also the big investment banks Goldman Sachs, JP Morgan, Lehman) were heavily involved in it • After the Great Depression, up until the 1980s, the majority of financial transactions were carried out by institutions supervised by the FED • After the 1980s, a parallel market without formal rules and no supervision, highly leveraged, had grown in size and importance The financial crisis spreads • The growth in short term capital movements has encouraged the spread of the crisis in many countries, with serious effects in some emerging economies Iceland, the Ukraine, the Baltic States all requested IMF help Other countries followed The crisis and the lessons of the past • The current crisis includes a number of features of the previous financial crises • A) the real estate bubble (Japan, end of the 1980s) • B) collapse of the financial system (Great Depression 1929-31) • C) deflationary trap in the USA and in Western Europe (Japan 1990s) • D) waves of international speculative hot money and competitive devaluations (South East Asia, 1997-1999) • What was the ERM (Exchange Rate Mechanism) and how did it work? • What is the 1987 Single European Act ? • How did the process of German unification affect the progress towards EMU? • Why were convergence criteria established by the Maastricht Treaty ? • How important has the enlargement of the EU from 15 to 25 members been for the global economy? • Was the creation of the Euro in 2002 beneficial both for the member states and for the global economy or was the Euro a flawed project from the start? .. .Money and finance in the global economy • The international monetary system is closely tied to the international finance system • Flows of international capital and FDI are conducted in money. .. Stiglitz the Asian crisis was different from the financial crises in Latin America during the 1980s Whereas in Latin America the problem had been inflation and debts in the public sector, in Asia... relinquishing control to the IMF, which will cover their money supply with dollars (for example Hong Kong in the 1990s, and Argentina in early 2000s) The International Monetary Fund • The International