International Political Economy (IPE)

1. International Political Economy (IPE) International College KhonKaen University Week 6 – International Monetary Relations The Global Financial System

2. International Monetary Relations • Trade is not the only form of international economic activity which has grown rapidly • International financial flows have grown even faster • Capital now flows almost effortlessly across borders • This has created increased financial interdependence among countries

3. Indicators of Modern Economic Globalization

4. International Monetary Relations • This globalization of international finance makes it difficult for governments to control fluctuations in their country’s exchange rates • The flow of investment capital is an important factor in every country’s well-being • Countries and companies have two main types of assets invested in other countries: • Foreign direct investment (FDI) • Foreign portfolio investment (FPI)

5. Global Finance - FDI • Foreign Direct Investment (FDI) is money invested directly in facilities to produce and/or market in a foreign country • FDI can be: • A greenfields investment – the establishment of a wholly new operation in a foreign country • An acquisition or merger with an existing company • Buying enough shares to control an existing company • Once a firm undertakes FDI it becomes a multinational enterprise

6. Global Finance - FPI • Foreign portfolio investment (FPI) is money used to buy shares and bonds – but not enough to control the company or to own real estate • Other forms of FPI include: loans, futures, hedge funds and derivates • Most FPI is transacted through the global capital market – a 24-hour network of commercial and investment banks that connects investors and borrowers

7. Global Finance - FDI • Both FDI and FPI have grown many times faster than world trade since 1973 • Countries compete for investment, especially FDI, because it can bring in not just money but also new technologies and skills, international networks and increases jobs • Multinational corporations account for around 80% of global FDI

8. FDI Flows : 1982-2008

9. FDI : Where is it Going? • Most FDI has historically been directed at the developed nations of the world, with the United States being a favorite target • FDI inflows remained high during the early 2000s for the United States, and also for the European Union • South, East, and Southeast Asia, and particularly China, have increased their share of inward FDI since 2008 • Latin America is also emerging as an important region for FDI

10. FDI Inflows by Region1995-2008

11. FDI : Where is it Coming From? • Since World War 2, the United States has been the largest source country for FDI • The United Kingdom, the Netherlands, France, Germany, and Japan are other important source countries • China’s investments overseas have increased rapidly as it seeks to secure the resources it needs for its rapid industrialization

13. Global Finance - FPI • But the fastest growth has been in FPI: government and company bonds, shares (stocks), loans (mainly inter-bank loans),and a vast array of precarious financial instruments • Foreign investors help to finance the budget deficits of governments • 47% of US public debt is owned by foreigners – the 3 largest are the governments of China, Japan and the UK

14. Global Financial System • The global financial system has two main functional components: • The global capital market • The foreign exchange market • And two global institutions (Bretton Woods institutions): • The World Bank • The International Monetary Fund (IMF)

15. The Global Capital Market • The function of a capital market is to bring together those who want to invest money with those who want to borrow money • Firms can list their stock on multiple exchanges, raise funds by issuing equity or debt to investors from around the world , and attract capital from international investors • An increasing proportion of global finance capital is being directed to middle income countries, especially in East Asia

16. The Global Capital Market Two main factors are responsible for the growth of capital markets: • advances in information technology – the growth of international communications technology and advances in data processing capabilities 2. deregulation by governments

17. The Global Capital Market • Individual stock exchanges, fund managers and international banks operate on a world-wide basis, 24 hours a day • To handle the huge and growing flow of international monetary transactions banks have established a world-wide, 24-hour foreign exchange market • The high speed of capital mobility has made national markets and currencies vulnerable to sudden reversals

18. The Foreign Exchange Market • The foreign exchange market is used to: • convert the currency of one country into the currency of another • Provide insurance against foreign exchange fluctuations • The foreign exchange market is a global network of banks, brokers, and foreign exchange dealers connected by electronic communications systems—it is not located in any one place

19. The Foreign Exchange Market • Foreign exchange is the “weak link” in international financial transactions because of the uncertainty of exchange rates • Governments try to provide exchange rate certainty so as to reduce foreign exchange risk for business and promote development • Changes in exchange rates can seriously affect a company’s sales, profit and strategy • The US dollar is used in around 89% of currency trades in the world

20. Exchange Rate Regimes • Since the collapse of the fixed exchange rates system in 1973, governments have followed various exchange rate regimes. In 2006: • 14% of IMF members follow a free float policy • 28% of IMF members follow a managed float system (includes Thailand) • 22% of IMF members have no legal tender of their own • the remaining countries (36% of IMF members) use less flexible systems such as pegged arrangements, or adjustable pegs

21. Exchange Rate Movement 1973-2008 Major Currencies Dollar Index

22. International Monetary Fund (IMF) • The main, original role of the IMF was to maintain the fixed exchange rate regime established in 1946 • Since that reason no longer exists, the organization’s role in the global financial system has changed • It is still the primary global organization responsible for maintaining order in the international monetary system

23. International Monetary Fund (IMF) • It maintains order by: • Promoting international monetary cooperation to facilitate the growth of international trade and investment • Providing financial assistance in the form of credits and loans to countries experiencing financial crises: • currency crises • banking crises • foreign debt crises • Provides technical assistance in the areas of fiscal and monetary policy

24. IMF Lending • By 2008, the IMF was lending to 65 countries in economic and currency crisis • All IMF loan packages require a combination of tight macroeconomic policy and tight monetary policy • However, critics worry: • the “one-size-fits-all” approach to macroeconomic policy is inappropriate for many countries • the IMF approach is dictated by lending countries without sufficient policy input by developing countries

25. World Bank • Formed initially to finance the rebuilding of Europe after World War 2 • Its focus shifted to Third World “development” in 1950’s • Lends money via bonds and loans, supporting • agriculture • education • infrastructure development • urban development • health

26. Asian Financial Crisis • The 1997 Southeast Asian financial crisis had its origins in the rapid growth of exports the previous decade, and in: • Investment boom • Cronyism and poor loans • Lack of transparency in the financial sector • Excess capacity in many sectors • Dependence on speculative capital inflows • Increasing debt service and current account deficits • Currencies and debt tied to strengthening US dollar

27. Asian Financial Crisis • The IMF provided a $17 billion bailout loan to Thailand, but with conditions: • higher taxes, public spending cuts, privatization of state-owned businesses, and higher interest rates • Speculation caused other Asian currencies including the Malaysian Ringgit, the Indonesian Rupiah and the Singapore Dollar to fall • The IMF provided a $37 billion aid package for Indonesia • The IMF provided a $55 billion aid package to South Korea