The Globalization of International Finance

Interpreting Contemporary Economic Change and Globalization

• Globalization Defined: Globalization is the integration of states through increasing contact, communication, and trade, as well as increased global awareness of such integration. It is a multifaceted phenomenon encompassing interconnected material relations, the rapidity of transactions, and a shift in public perception.

• Economic Globalization: Sociologist Fran Tonkiss defines economic globalization as the increasing integration of circuits of goods, production, image, information, and money across national borders. This is characterized by high levels of trade, foreign direct investment (FDI), outsourcing, and complex financial linkages across space.

• The Shift to Geo-economics: Geo-economics refers to the relationship between geography and the economic conditions and behavior of states that define their levels of production, trade, and consumption. Many analysts suggest that geo-economics is replacing geopolitics (the distribution of military and political power) as the primary axis of international competition.

• Extent and Variability of Globalization: According to the $2015$ Index of Globalization by the KOF Swiss Economic Institute, globalization levels vary significantly by region:

  • European countries occupy $18$ of the top $20$ most globalized spots.

  • The United States ranked $34\text{th}$ with an index score of $74.81$ out of $100$.

  • The least globalized countries tend to be underdeveloped or autocratic, such as Bhutan, Liberia, and Somalia.

• Historical Impact: This era of globalization is seen as a fundamental change similar in scale to the industrial revolution or the rise of the nation-state, fundamentally altering the roles of individuals, governments, and businesses.

The Dynamics of Global Finance and Capital Flows

• International Monetary System: This consists of the financial procedures used to calculate the value of currencies and credits when capital is transferred across borders through trade, investment, foreign aid, and loans.

• Globalization of Finance: This refers to the increasing transnationalization of national markets through the worldwide integration of capital flows, leading to a unified global market where geographic location is no longer a barrier (the "end of geography").

• Scale of Financial Transactions:

  • Foreign Direct Investment (FDI): In $2014$, global FDI flows reached $1.2 \text{ trillion}$. This is ten times the amount recorded in $1980$.

  • Arbitrage: This is the selling of one currency (or product) and purchase of another to make a profit on changing exchange rates. The daily turnover in currency markets is approximately $5.3 \text{ trillion}$.

  • Comparative Scale: The amount of currency circulating globally in four days exceeds the yearly Gross Domestic Product (GDP) of the United States, which was $17.4 \text{ trillion}$ in $2014$.

  • Market Valuations ($2014/2015$):

    • Global Stock Markets: $69.5 \text{ trillion}$.

    • Global GDP: $77 \text{ trillion}$.

    • Bond Market (Debt): $175 \text{ trillion}$.

    • Derivatives Market: Estimated between $600 \text{ trillion}$ and $700 \text{ trillion}$.

• Speed of Finance: High-frequency trading (HFT) firms use computer programs to execute trades in picoseconds ($1 \text{ trillionth}$ of a second).

• Vulnerability to Information: On April $23$, $2013$, a hacked Associated Press Twitter account falsely reported explosions at the White House. The U.S. stock market plummeted $200 \text{ billion}$ in two minutes before recovering once the error was realized five minutes later.

• National Market Success: As of May $31$, $2015$, the NYSE ($19.687 \text{ trillion}$) and NASDAQ ($7.379 \text{ trillion}$) remain the largest exchanges. However, Chinese exchanges (Shanghai at $5.904 \text{ trillion}$ and Shenzhen at $4.368 \text{ trillion}$) are growing rapidly, with Shanghai overtaking the Japan Exchange Group in $2015$.

Core Concepts and Trade-offs in Monetary Policy

• Monetary Policy: Decisions made by central banks to manage the national economy and control inflation by changing the money supply and interest rates.

• Currency Functions: Money must serve three purposes:

  1. A widely accepted medium of exchange.

  2. A store of value.

  3. A standard of deferred payment for future purchasing power.

• Key Definitions:

  • Balance of Payments: A summary of financial transactions with the external world (credits minus debits).

  • Balance of Trade: Exports minus imports. A deficit occurs if imports exceed exports.

  • Inflation: A decrease in money value that increases consumer prices. Zimbabwe reached hyperinflation of over $12,000\%$ in $2010$ before adopting the dollar.

  • Central Bank: The primary monetary authority responsible for issuing currency and setting policy.

• Exchange Rate Regimes:

  • Fixed Exchange Rate: The government sets the currency value in relation to another currency or gold.

  • Floating Exchange Rate: Value is set by market forces.

  • Fixed-but-Adjustable: A government fixes the rate but may change it to reflect underlying economic shifts.

• The Impossible Trinity (Trade-offs):

  • Inflation vs. Unemployment: Expansionary policies stimulate growth but may cause inflation; restrictive policies curb inflation but may cause unemployment.

  • Strong vs. Weak Currency: A weak currency helps exporters by making goods cheaper but reduces domestic consumer spending power. A strong currency gives consumers power but hurts exporting industries.

  • Stability vs. Autonomy: In an open economy with free capital flow, a state cannot have both a fixed (stable) exchange rate and an autonomous monetary policy.

The Bretton Woods System and Its Evolution

• Origin ($1944$): Members of the Allied powers met in Bretton Woods, New Hampshire, to establish a new Liberal International Economic Order (LIEO).

• Embedded Liberalism: A compromise combining commercial liberal preferences for open markets with mercantilist desires for state intervention to ensure domestic social welfare and employment.

• Key Institutions:

  1. International Monetary Fund (IMF): Devised to maintain fixed exchange rates and provide a stabilization fund for short-term balance-of-payments problems.

  2. World Bank (IBRD): Created to provide capital for long-term development and reconstruction.

  3. GATT/WTO: Formed to encourage trade liberalization.

• U.S. Hegemony: The system relied on the U.S. dollar being pegged to gold at $35$ per ounce. The U.S. provided international liquidity through the Marshall Plan and by running deficits to supply the world with reserve currency.

• The End of Bretton Woods: By the $1960\text{s}$,