🌍Intro to International Business Unit 4 – Global Monetary System & Financial Markets

Key Concepts & Definitions

• Foreign exchange market enables currency conversion, international trade, and investment
• Exchange rate represents the value of one currency in terms of another
• Fixed exchange rate system maintains a constant rate between currencies, often backed by a country's reserves
• Floating exchange rate system allows the market to determine currency values based on supply and demand
  • Managed float involves central bank intervention to influence exchange rates
• International monetary system refers to the set of rules, conventions, and institutions that govern foreign exchange and international payments
• Balance of payments tracks a country's international transactions, including trade, investment, and financial flows
• Capital account measures the flow of capital in and out of a country (foreign direct investment, portfolio investment)
• Current account balance reflects a country's trade balance, net income from abroad, and net current transfers

Historical Context

• Bretton Woods system (1944-1971) established fixed exchange rates pegged to the U.S. dollar, which was convertible to gold
  • Created the International Monetary Fund (IMF) and World Bank to promote global economic stability and development
• Nixon Shock (1971) ended the convertibility of U.S. dollars to gold, leading to the collapse of the Bretton Woods system
• Transition to a system of floating exchange rates in the 1970s allowed market forces to determine currency values
• Plaza Accord (1985) coordinated central bank intervention to depreciate the U.S. dollar against the Japanese yen and German mark
• European Monetary System (1979-1999) aimed to stabilize exchange rates among European currencies
  • Led to the creation of the euro as a common currency for participating European Union countries
• Asian Financial Crisis (1997-1998) highlighted the risks of capital flight and the need for sound financial regulation in emerging markets
• Global Financial Crisis (2007-2009) underscored the interconnectedness of global financial markets and the importance of international cooperation

Major Global Financial Institutions

• International Monetary Fund (IMF) promotes global monetary cooperation, financial stability, and sustainable economic growth
  • Provides loans to countries facing balance of payments difficulties or financial crises
  • Conducts surveillance of member countries' economic policies and provides policy advice
• World Bank Group focuses on poverty reduction and economic development in low- and middle-income countries
  • Offers loans, grants, and technical assistance for projects in areas such as infrastructure, education, and healthcare
• Bank for International Settlements (BIS) serves as a bank for central banks and fosters international monetary and financial cooperation
• World Trade Organization (WTO) oversees the global trading system and promotes trade liberalization
• Regional development banks (African Development Bank, Asian Development Bank, Inter-American Development Bank) support economic and social development in their respective regions
• Central banks (Federal Reserve, European Central Bank, Bank of Japan) manage monetary policy and maintain financial stability in their countries or regions

Exchange Rate Systems

• Fixed exchange rate system maintains a constant rate between currencies, often backed by a country's reserves
  • Advantages: stability, predictability, and reduced transaction costs for international trade and investment
  • Disadvantages: loss of monetary policy autonomy, vulnerability to speculative attacks, and potential misalignment with economic fundamentals
• Floating exchange rate system allows the market to determine currency values based on supply and demand
  • Advantages: automatic adjustment to economic shocks, monetary policy autonomy, and reduced need for foreign exchange reserves
  • Disadvantages: volatility, uncertainty for international trade and investment, and potential for overshooting or misalignment
• Managed float involves central bank intervention to influence exchange rates, often to maintain stability or competitiveness
• Currency board is a strict form of fixed exchange rate system, where the domestic currency is fully backed by foreign reserves
• Dollarization occurs when a country adopts a foreign currency (often the U.S. dollar) as its official currency

International Financial Markets

• Foreign exchange market is the largest financial market globally, with daily trading volume exceeding $6 trillion
  • Spot market involves the immediate exchange of currencies at the current market rate
  • Forward market allows buyers and sellers to agree on a future exchange rate for a specific date
  • Currency futures and options provide tools for hedging and speculation
• International bond markets enable governments and corporations to borrow funds from foreign investors
  • Eurobonds are issued in a currency different from that of the country where they are issued
• International equity markets allow investors to buy and sell shares of foreign companies
  • American Depositary Receipts (ADRs) and Global Depositary Receipts (GDRs) facilitate cross-border investment
• Emerging markets offer higher potential returns but also carry greater risks (political, economic, and currency risks)
• Sovereign wealth funds are state-owned investment funds that invest in foreign assets for long-term returns

Global Economic Policies

• Monetary policy involves central banks adjusting interest rates and money supply to achieve economic goals (price stability, full employment)
  • Expansionary monetary policy lowers interest rates to stimulate borrowing, investment, and economic growth
  • Contractionary monetary policy raises interest rates to combat inflation and cool the economy
• Fiscal policy refers to government spending and taxation decisions to influence economic activity
  • Expansionary fiscal policy increases government spending or reduces taxes to stimulate aggregate demand
  • Contractionary fiscal policy decreases government spending or raises taxes to reduce budget deficits or curb inflation
• Trade policy encompasses tariffs, quotas, and other measures that affect the flow of goods and services across borders
  • Trade liberalization aims to reduce barriers and promote international trade (free trade agreements, WTO negotiations)
  • Protectionism seeks to shield domestic industries from foreign competition (import tariffs, subsidies)
• Capital controls are measures that restrict the flow of capital in and out of a country to manage financial stability or exchange rate volatility

Challenges & Risks

• Global imbalances arise when some countries persistently run large current account surpluses while others run deficits
  • Can lead to unsustainable debt accumulation, financial instability, and protectionist pressures
• Currency crises occur when a speculative attack on a country's currency results in a sharp depreciation or forces the central bank to defend the peg
  • Often triggered by unsustainable economic policies, external shocks, or contagion from other countries
• Contagion refers to the spread of financial crises across countries due to economic linkages, investor behavior, or market sentiment
• Sovereign debt crises happen when countries struggle to repay or refinance their government debt
  • May require debt restructuring, bailouts from international organizations, or austerity measures
• Inequality and uneven distribution of the benefits and costs of globalization can lead to social and political tensions
• Climate change and environmental degradation pose long-term risks to global economic stability and sustainable development

Future Trends & Implications

• Increasing role of emerging markets in the global economy, particularly China and India
  • Shift in economic power and influence towards developing countries
• Growing importance of digital currencies and fintech in shaping the future of international finance
  • Potential for increased financial inclusion, efficiency, and innovation, but also regulatory challenges
• Multilateralism and international cooperation will be crucial in addressing global economic challenges (climate change, inequality, pandemics)
• Demographic shifts (aging populations in developed countries, youth bulges in developing countries) will impact global savings, investment, and growth patterns
• Geopolitical tensions and trade conflicts may lead to increased fragmentation of the global economic order
  • Rise of regionalism and competing economic blocs
• Importance of sustainable finance and environmental, social, and governance (ESG) considerations in global investment decisions
• Need for resilient and adaptable economic systems in the face of increasing uncertainty and complexity in the global economy