One should start by saying that before understanding the causes of consequences of global financial markets it is necessary to understand the global financial structure and its history. Global financial system or the global finance is a conglomerate of financial institutions and regulations that act on a trans-national and international level, as opposed to the financial institutions and regulations operating on local, national, district or regional levels. The major global players are certainly the World Bank, the World Trade Organization and the International Monetary Fund (IMF), national agencies and government departments as represented by the central banks (Feds), ministries of finance, and private institutions that had chosen to work on a global scale, such as hedge funds, insurance companies, and banks.
Commercial banks, Pension funds, Insurance companies, and Private Equity organizations are the most active and powerful participants in the global financial markets as clustered into Euro-zone, NAFTA, Mercosur, and CIS. In the following research paper, one will explore the issues in international economics in greater detail.
The primary International organizations as noted earlier are represented by the IMF, the WTO, and the World Bank as well as global financial markets with some short description of each presented below. The research paper will analyze each of the constituents of the global financial participants in a greater detail together with their interaction on a global scene. These members require a substantial research.
The International Monetary Fund is the organization that keeps track of all international balance of payments accounts and operations of its member-states. The IMF is a lender of the last resort for its members in cases of financial instability and distress as caused by the currency crisis, economic decline, debt defaults and other problems meeting balance of payments. The IMF membership is based on quotas, i.e., the amount of money each IMF member provides to the organization/fund relative to the country’s size of the economy and its role in the global financial system. The organization’s website is www.imf.org. This is a website of the International Monetary Fund. The IMF is an organization that was created to assist all countries of the world in times of need and crisis. The IMF provides lavish loans to most of the third world countries and thus has detailed information regarding each of them. Unlike EBRD, the IMF has enough resources about each country in the world and focuses primarily on the economic aspects of each country. IMF is the organization of 184 countries that work together for the common goal of achieving monetary cooperation, securing financial stability, facilitation of international trade, promotion of high employment and sustainable economic growth to reduce poverty (Friedman, 50). All UN member states except Cuba, North Korea, Liechtenstein, Andorra, Monaco and the island states of Tuvalu and Nauru participate in the IMF programs. To apply for membership with the IMF a country needs to fill out a formal application to be considered by the IMF executive board. Once considered and found proper, the application will be submitted to the board of directors of the IMF with the recommendation to form a membership resolution. The recommendations will then present the amount of quota in the IMF and the paid subscription to the particular country, let alone other customary terms and conditions. Then the board of governors adopts the membership resolution, and the applicant country takes necessary steps to sign the IMF agreements and fulfill pertinent obligations. The quota determines the subscription, the voting rights, and weight, let alone access to the IMF financing and special drawing rights.
The World Trade Organization is responsible for the settlement of trade disputes and negotiation of international trade agreements and pacts in the WTO rounds of talks. The most current are called Doha Round of WTO. The organization’s website is www.wto.org. The WTO oversees numerous agreements that govern the “rules of trade” between the states-members of the WTO. Before the WTO, there had been GATT(general agreement on tariffs and trade) which just like the WTO supported free trade and worked on the ways to remove or substantially reduce the trade barriers between the countries to allow them to trade smoothly and uninterruptedly. Currently, the WTO comprises over 148 countries which have most favored nation status in trade towards each other, as reflected in trade concessions granted equally to all countries that make up the WTO.
The WTO supports the following fundamental principles in trade:
- Trading must be discrimination free, i.e., all countries members of the WTO cannot discriminate against foreign products or services of other WTO member states.
- There should be as little trade barriers as possible for all members.
- The trading system of the WTO members should be predictable, i.e., no trade barriers will be raised, and no markets will be closed.
- The trading system of any country should constantly improve and become even more competitive.
- The trading system should take into account the needs of developing countries allowing them to accommodate, adjust and become more flexible on the international arena.
- The WTO serves the role of a negotiating body for discussions of trade barriers and rules and the settlement body for disputes that might arise among the member states.
In negotiations, the WTO employs the consensus mechanism which although does not require a unanimous vote of all countries on a special matter, requests them all to agree on the topic. The opponents of the WTO state that such consensus governance model although provides law-based bargaining typically favors Europe and the USA which does not lead to Pareto improvement in the trade as the organization strives to achieve.
In dispute resolution WTO, just like other organizations in the world, is unable to enforce the decisions it makes when there is a complaint. If the Dispute Settlement Body of the WTO finds in compliance with the rules, it may authorize retaliatory measures taken, yet cannot enforce them. So powerful trading blocks like the USA or the European Union can simply ignore the complaint made by smaller states, which cannot effectively hurt the economies of the EU or the USA.
The WTO comprises over 20 different agreements that need to be signed for a country to become a member of the WTO with Agreement on Agriculture, General agreement on Trade in Services (GATS), Trade-related aspects of intellectual property Rights agreement, and Sanitary and phytosanitary agreements being among the most important.
The World Bank is the organization that strives to provide funding, loans, and credits to the chosen countries and offers feasible, and favorable terms of development projects that countries around the world might choose to implement. The World Bank strives to operate in the countries where the funds for the necessary projects cannot be obtained from the private sector of the economy. The organization’s website is www.worldbank.org This is a website of the European Bank for Reconstruction and Development or the so-called World Bank. The EBRD is an organization that strives to assist the third world countries of Europe and Asia, mostly the former Soviet states. This website provides a large amount of detailed information on the countries of Europe and Central Asia and is vital for those companies who want to penetrate these new yet lucrative markets. Together with the IMF, the world bank makes up the Breton Woods Institution (Tchan, 313).
The bank relies on impoverished countries and governments around the world as major contributors of developmental finance for other nations. The World Bank strives to institute economic liberalization in these nations and thus open a way for private international investment and expansion of the capital from the first world countries to the impoverished third world nations. Currently, the World Bank focuses primarily on the issues of education, agriculture, and industry in the underdeveloped nations by providing them with loans on preferential terms in times of a difficulty. World Bank, in turn, demands these nations to develop proper means to limit corruption and foster democracy in the country. The World Bank apparently supports the western values, and economic system and some might even argue that the policies of the World Bank of a free market economy when implemented too quickly might result in the financial decay of the third world countries and the monopolization of their markets by the foreign companies (O’Mahony, 324).
The bank in its mission to fight poverty and improve the standards of living of people in the developing world provides long-term financial assistance in healthcare, education, agriculture as well as other projects related to the environment, infrastructure, road construction, etc. Furthermore, the World Bank provides economic assistance to the developing nations on how to improve their economies and standards of living. Since 1996, the World Bank would also work on the ways to combat corruption in the countries it serves despite formally having no political mandate.
In the late years, the World Bank had shifted its activity from targeting economic growth in aggregate to poverty reduction in particular thus assisting smaller states and local enterprises with funds. The bank stated that clear water, air, affordable education and sustainable economic development was essential for the economic growth of a country and thus currently supports these projects most of all (Schaechter, 73).
The global financial markets that contribute to the smooth flow of capital worldwide let alone contribute to the increased efficiency in trade and payments on a global scene. The global financial markets currently are made of the following types:
Capital markets are the markets that provide the long-term equity or debt financing opportunities for the global clients. Capital markets are made of:
- Stock markets-markets that provide equity financing, i.e. issuance of shares of common stock and the global trade of the common stock. The participants of these markets range from small private investor to pension funds, to insurance companies to mutual funds, to banks to large hedge funds that can be based anywhere (Durrie, 351). The orders of the stock market end up at the stock exchange (corporations used to facilitate the activity of the stock markets). With the rise of internet banking in the 1990s, the stock exchange witnessed the appearance of the major foreign participant on the market. The stock ownership at the stock markets varies from country to country with the Asian market’s stocks being owned primarily by large companies and corporations, in the USA or Europe, stocks are largely owned by individual investors (Kent, 44). The movement of prices in a stock market or a particular section of a stock market is measured by the movement of price indices a.k.a. Stock market indices. There are many of the in the world such as Nikkei, CAC40, S&P500, DJIA or Xetra Dax. The indices also comprise the market capitalization or the total market value of floating capital of the country weight. The weights reflect the contribution of the stock to the index (Chen, 27).
- Bond markets (credit market or debt market) -markets that provide debt financing through, i.e., issuance of bonds/debentures and long-term obligations and the global trade of these debt instruments. The participants of the bond markets are large corporations, government bodies, and investors. Since the bonds depend so much on the interest rates in the country, the common references to the bond markets, in fact, indicate the changes in the interest rates and the shape of the yield curve in the country. There can be corporate, and government bonds sold and bought on the primary or secondary markets (Mohrman, 366).
The capital markets can be primary or secondary. On the primary market one issues, sells and buys the new security. On the secondary capital market, one can sell the existing security that she/he holds or purchase it from other investors (private or institutional).
Money Markets are the markets that provide the short-term debt financing and investment opportunities for global clients and organizations. They provide the needed liquidity of money and quick access to funds. Money markets make use of short-term financial instruments such as Certificates of Deposit (CDs), and repurchase agreements (repos) as traded between the banks who are the most active participants in the money markets. The money market apparently provides medium-term liquidity to the global financial system. The derivatives present on the money market are forward rate agreements (FRAs) and short-term interest rate futures.
The trading on the money markets takes place between the bank in the so-called “money centers” as represented by New York, Tokyo, London, Sydney, Paris, Frankfurt, Hong Kong, Chicago, and Singapore. The most common instruments on the money market are the following:
- Bankers’ acceptance or a bill of exchange accepted by a reputed bank to guarantee payment of the bill (Banks, 104).
- Certificate of deposit, a special time deposit with a specified maturity date depicted on the CD with large-denomination CDs being sold prematurely.
- Commercial paper or the unsecured promissory note of an organization with maturity date ranging from one day to usually one year and sold at a discount (Burnham, 47).
- Eurodollar deposit, or the US dollar deposits made into banks outside the USA (typically Europe).
- Federal Agency notes (short term) or the short-term securities issued by the government enterprises such as Federal National Mortgage Association etc.
- Federal funds interest-bearing deposits which are held by banks at the US Fed. These funds are immediately available for borrowing or lending, typically on an overnight basis.
Municipal notes (munies) or the notes issued by specific municipalities or territories in anticipation of revenue for that municipality.
- Repos (repurchase agreements) or the short-term loans with maturity date up to 2 weeks which are arranged by selling certain securities to an investor with an agreement to buy them back at a specified price on a specified date.
- T-bills, or the US government short-term debt instruments with maturity dates ranging from 3 months to 12 months.
Derivatives markets are the markets that provide necessary instruments for the management of financial risks on a global scale. Derivatives market comprises the exchange trade derivatives and over-the-counter trade derivates. Derivatives markets are extremely important for global/international operations of virtually any company and have the following subtypes:
- Futures markets are the markets that provide either customizable futures contract on an underlying commodity or financial security or standardized contract (forwards)
- Forward markets are the markets where standardized contracts are bought and sold on a given security or underlying commodity (Hassler, 728).
- SWOPs, CAPs markets are the markets that pinpoint the needs of various financial organizations for flexibility of payment, rescheduling, and customized cash flows by working with the created SWOP and CAP contracts (Scalzi, 182).
- Options markets are the markets that provide clients with an option to either buy or sell some particular security (or sometimes commodity) at some future time (Wayner, 170). Unlike the futures/forwards market, options markets provide greater flexibility to global customers since one purchases an option rather than an obligation to buy or sell something in the future (Gupta, 43).
Futures exchanges trade standardized derivates contracts as represented by options and futures contracts on underlying products. The futures exchanges such as Chicago Mercantile Exchange (CME) is the central counterparty. So when one party goes long and buys futures, another party goes short. When a new contract is introduced to the CME, the total position in the contract results in a zero, so the sum of all long positions on the market has to be equal to the sum of all short positions. In this way, the risk gets transferred from one party to another at a profit to the risk-bearing party (Radu, 230). The total amount for all outstanding positions on the futures markets in 2004 was $54 trillion (Solomon, 120).
Over the country derivates, markets trade tailor-made derivatives which would not be traded on formal exchanges. Typically investment banks would make markets in some derivatives while hedge funds, commercial banks, and government organizations would make up the client base. The typical products to be traded over the counter are forward contracts, credit derivatives, swaps, forward rate agreements, etc. the total amount of all over-the-counter outstanding positions in 2004 was over $220 trillion (Zack, 91).
Insurance markets are the markets that allow to redistribute various existing types of risks as well as provide much liquidity in the capital and derivatives markets, themselves. Insurance market represents a form of risk management used to hedge against the risk of potential financial losses. The insurance market works by shifting the risk from one company/person to another at a profit/fee/duty of care.
The rate of losses needs to be rather predictable for insurance market to work since to set the prices/premiums the insurers need to be able to estimate the risks. If the coverage is rather unique, the insured person will have to pay a significantly higher premium. The most famous insurance company, Lloyd’s of London accepts unique coverage with insurance of Tina Turner’s legs, or Michael Jackson skin being the most famous examples (Alexander, 70).
At the same time, the losses have to be rather predictable so that the insurance company knows how much it would have to pay in the case the insurance event happens.
When the customer pays a premium, the insurance company collects these premiums and ultimately uses them for further investment typically in risk-less government securities or very low-risk municipal securities or blue-chip companies. Insurance companies in the USA alone have tremendous funds available, so they do have a powerful impact on the debt market in the USA and use it most often.
Foreign exchange markets (FOREX) are the markets that facilitate the trading of foreign currency/foreign exchange as required for all international financial operations. FOREX is believed to be one of the largest markets in the world since it involves so many different countries (Ghosh, 47).
Speaking about the market participants, one needs to remember that some of them are looking to exchange foreign currency for their own as it occurs to multinational corporations doing business abroad and expatriating profits to the homeland. Still, the largest players are represented by currency traders who speculate on the movements in exchange rates just as other people speculate on the movement of stock or bond prices. These speculators make use of small fluctuations of the exchange rate and often engage in arbitrage. Typically, 53% of all trades are done strictly between banks (inter-dealer), 33% involve a dealer (bank) and some other financial institution, while the remaining 14% are done between a dealer and a non-financial company that wants to expatriate profits from abroad or pay salaries in foreign currencies (Emerson, 150).
The FOREX makes use of the fact that the exchange rates are highly sensitive to numerous factors while a great number of participants from around the globe makes the market extremely liquid with currencies being traded 24 hours a day 5 days a week (from Friday to Sunday). in the FOREX there is very little or no insider information, so the market is believed to be extremely liquid. The exchange rates on FOREX are determined by the supply and demand interaction as well as expectations of some major macroeconomic events. The market size is huge with $600 billion in the spot, $1300 billion in derivatives.
Multinational corporations (MNC) are corporations or enterprises that manage production established at least in 2 countries around the world. Such corporations are divided into the following two distinct groups:
- Horizontally integrated corporations are companies that produce similar or same products in all foreign countries and manage production in all countries.
- Vertically integrated corporations are those that manage their production in a manner where the products coming from one country serve as inputs to the production of another branch of the company located in another company (KAHN, 50).
Diversified corporations are those corporate structures that are neither horizontally nor vertically integrated and represent a unique structure for each company.
One needs to remember that many of the large multinational corporations have budgets and financial resources that are greater than those of some third world countries. As a result of such monetary superiority, these corporations have a powerful influence in international relations due to their support of some politicians and representatives with financial resources channeled to financing PR campaigns and lobbying. Since these corporations have international reach and mobility necessary to penetrate foreign borders of chosen countries, they also compete with each other for the presence in the country and the corporate influence on the region concerning corporate lobbying, taxation, employment and economic activity (UCHITELLE, 71). Typically, many of the multinational corporations manage to obtain some tax breaks, pledges or government assistance funds, let alone relaxed labor standards and environmental requirements. Since these companies attempt to look as attractive as possible to the selected region and country to exercise later the lobbying abilities to obtain some future concessions from the region or a government, these companies are said to harm often the regions they operate in.
One should understand that many of the multinational corporations have enough resources necessary to carry out virtually any project let alone afford the best lawyers in the world to back up their actions with legitimate power. The multinationals operate on most of the markets noted earlier in the essay and assume a leading role in these markets. The multinationals obey the same rules and regulations as other market participants, yet often they have an extra ace up in their sleeve due to their connection with the major political parties or famous politicians.
Current concerns that multinational corporations take control over the country’s sovereignty are not well-grounded. The majority of these multinational corporations do not have any immunity since they are monitored by both the USA (or their country of origin) and the host country. The host country’s officials, nevertheless, often fall prey to greed and make decisions that benefit these corporations in exchange for some monetary compensations a.k.a. bribes. Still, from 1990 till 1997, there were over 900 different foreign direct investment regulations passed by over 70 different countries that govern the work of foreign companies (COLLINS, 30).
These corporations typically do not move high-paid jobs to foreign countries since often these countries lack the needed expertise and skills, thus being able to do the only low-paid routine unskilled job. In 1999 over 70% of foreign investment would go to the developed nations rather than third world countries as one might assume. The multinationals appear to be linked to the economic prosperity of the region and when looking at the areas where the presence of multinational corporations is non-existent one can observe high poverty rates.
The regulations and the role of major international organizations and legitimate bodies affect the way multinational corporations do business. For instance, from 1983 to 1999 the world figures of child labor would fall from 22% to 12%. The greatest drop in child labor took place in the middle east and north Africa where this figure changed from 15% to 6% over the past 18 years. The reduction of child labor was a sign of increased family income, which allowed families to improve their diets and the way of living let alone to have an opportunity to educate their children. The school enrollment rates thus increased from 45% to 57 for the period from 1965 to 1995, and one believes that the role of multinational companies in the region had contributed to the formation of the proper lifestyle conducive for the regional improvements (Johnston, 24).
Finally one should note that the majority of these multinational corporations would engage in the establishment of the industry codes aimed to achieve high levels of social responsibility and effectiveness. The research undertaken by the UN on the reasons why these companies selectively invest worldwide showed us that bribery, extortion and the corruption of the government officials of certain countries were the primary reasons why these countries were avoided by the foreign companies.
In conclusion, I would like to say that global financial system involves the complex interaction between the various institutions as depicted in the essay above and is typically guided by the interests of individual countries, corporations, and powerful forces behind the major organizations. While the WTO, the World Bank, or the IMF were created to promulgate democracy and fight poverty, they indeed promote the western ideas of capitalism and allow first world nations to easily penetrate foreign markets (capital, goods or labor) and exploit them to the fullest. The profit-related organizations as represented by financial markets originally were designed to accommodate the needs of individuals for a free exchange of goods or services (contracts), yet at present represent an instrument for capital to flow to the most efficient area for investment. Different markets despite having various regulations and rules typically promote freedom and liquidity and encourage participation of global players.
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