Jesus G Lopez Lozano Paper Assignment - GOV 360N

Jgl679 Professor Chapman

1
The Reality of International Finance
The XXI century has been increasingly characterized by growing
interconnectivity between people, nations and ideas. Translating this into the world
of finance, it has opened up global markets in ways never seen before. It is now
easier and widely available for any private capital owner to invest a share of their
portfolio in East Asian emerging markets, another in Chinese Government bonds,
another part in the German DAX Stock Index and a final part in American Equities.
The growth of information technology and the velocity at which information travels
from one edge of the world to the other in mere seconds has made this global
connectivity possible.

Though global integration has increased wealth and spurred economic development
it has also made domestic markets susceptible to any financial event that takes place
in the world. The interconnectivity between financial markets across the globe has
made countries interdependent. So much that any type of financial event that
happens in the world can negatively affect a nation that is nowhere close to it, even
to the point of creating a financial panic, which proves to be a problem for global
stability and the health of international markets. Additionally because of the variety
of different macroeconomic policies that countries choose to pursue, the regulation
and stability of the global markets is something that is difficult to obtain from an
institutionalized perspective. Some countries might prefer current-account deficits,
while others enjoy being a credit nation with current-account surpluses. Diverging
ideals on how markets should be approached and managed, and the belief that free
Jesus G Lopez Lozano Paper Assignment - GOV 360N
Jgl679 Professor Chapman
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markets is the best option for future development has created a space that proves
difficult to control. It is not a disorganized system, rather one that could function
better with the help of regulations and agreements. Finally, because the
international market is so prone to lending and borrowing problems, nations are
increasingly looking for ways to manage these in a way that is beneficial to their
countries without taking away capital flows. Some have made use of fiscal and
monetary policy to try and alleviate some of the burdens of international lending,
while other have had to turn to international organizations like the World Bank and
the International Monetary Fund. Yet these actions cannot be implemented without
incurring in some domestic drawbacks. In the end it looks like global finance and
investment is something that has become interconnected in a way that if China
sneezes, the US catches a cold.

International financial events pose a serious challenge to global stability
because countries have become increasingly connected financially as it has become
easier transfer funds from a capital market in one country to another. Yet, this
interconnectivity of capital flows makes global stability susceptible to any negative
financial event as it was experienced during the 2009 financial crisis. If one of the
important pillars of the global economy such as the EU, the US, or China were to
have significant financial problems, the fact that these nations are linked not only
through trade, but capital flows in terms of loans, equities and funds, will cause the
problem to spread, something that in other decades could have very well been
contained within the own nation. In the end, its the opening of global markets and
Jesus G Lopez Lozano Paper Assignment - GOV 360N
Jgl679 Professor Chapman
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the lack of capital controls that has joined nations like never before and if one takes
into account the growth of information technology over the past decade, it has not
only accelerated this, but it has magnified the impact financial events have at a
global scale. The biggest threats to global stability are speculative attacks because of
the damage these can bring. These attacks can not only erode investor confidence,
but can ultimately cause capital flight and if countries linked to that nation are not
strong enough, a crisis is even possible. In order for global stability to be possible it
is necessary to implement fail-safes to these types of financial events so they cannot
spread easily. A perfect example is the Glass-Steagall Act that was implemented in
the United States before the Clinton Administration decided to strip it down. This
act shielded certain parts of the economy if a collapse in another were to happen, in
that particular case commercial and investment banking. Open markets and capital
flows are great for development, but history has showed time and time again that
global stability cannot happen if countries are susceptible to financial events such as
the one that happened in the 80s, when the United States decided to raise their
interest rates to maintain capital flows which led to a Mexican default and an
eventual Latin American Crisis.

Although it will never be proven the United States could have prevented the
devastating effects of the financial crisis in 2009 if the above-mentioned Glass-
Steagall Act were still in place when the mortgage-backed securities market
collapsed. The question remains, why cannot countries do a better job at controlling
capital flows? The answer rests on the idea of globalization and free markets. Each
Jesus G Lopez Lozano Paper Assignment - GOV 360N
Jgl679 Professor Chapman
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nation has opened up its doors to the unrestrained flow of capital, while some
countries that act, as lenders, such as the United States, are risk-averse, there are
capital holding firms that have a high-risk tolerance and thus incur in riskier
investments with the hope of higher reward. This becomes an issue when a foreign
firm takes on a debt that it cant repay; because it not only paralyzes the firm
providing the funds it disrupts global trade. This could be resolved with a global
institution that oversees international investment and financial flows. The problem
starts to arise with the idea that because it would require a stable the foreign
exchange-rate market, it would eventually strip countries of their monetary policy
autonomy as it would have to turn to a fixed exchange rate and it will also grant this
institution a say in the way their domestic financial markets are organized, neither
of which many nations are willing to grant. Finally, every country has different
macroeconomic policies when it comes to balance of payments, while some insist on
having a current-account deficit, like the United States, others like Japan and
Germany enjoy having current-account surpluses that make them creditor nations.
As Oatley argues The determination to set macroeconomic policy independent to
foreign considerations has generated large current-account imbalances that in turn
give rise to large cross-border capital flows, disruptive exchange-rate movements,
and episodes of financial instability (226, Oatley 2009). Divergent macroeconomic
policies and lack of cooperation makes the ability of countries to regulate financial
flows nearly impossible.


Jesus G Lopez Lozano Paper Assignment - GOV 360N
Jgl679 Professor Chapman
5
Several countries have tried to protect themselves from the problems of
international lending and borrowing by enacting different tactics. One of the most
common one is to engage in concessional finance which is usually done through the
World Bank, which lends at a below-market interest rates and at times at zero
interest rate, but the amount of funds dedicated to this form of finance is often
small. On the other hand nations that are required to make service payments on
their debt might have to impose unpopular domestic measures in order to raise
money to do so. These usually come in the form of contractionary fiscal and
monetary policy in order to alter interest rates, inflation, taxes and government
spending. Such is the example of the United States and how fast their current-
account deficit widened because of their policy to maintain relatively high real
interest rates to keep capital flows; By 1984, the U.S had shifted into net debtor
status and by the end of the decade, the United States net investment position stood
at minus $260 billion (Oatley 2009, 229). Additionally, another measure that is not
very popular within nations is to draw off the International Monetary Fund (IMF) to
pay off debt requirements, but these loans from the IMF are usually conditional on
certain structural adjustments to the economic policies of the borrowing country.
Some critics have argued that instead of helping, these adjustments rather hurt the
borrowing countries as in the case of Mexico when it was forced to switch from
Import Substitution Industrialization (ISI)) and protectionism to more liberal trade
policies when it was not ready.

Jesus G Lopez Lozano Paper Assignment - GOV 360N
Jgl679 Professor Chapman
6
International finance has proven to be one of the most beneficial tools in
regards to economic development for the developing world, but not only have these
brought an increase in capital flows, but an increase in interconnectivity between
nations. It is precisely this global connectivity that has made people realize that
financial events happening on the other side of the world can now pose a threat and
cause panic in domestic markets. It has made global markets susceptible to
speculative attacks that can pose as a serious threat to financial stability in
developing countries as it was seen with Latin America and East Asia in the XX
century. Yet as these problems of market connectivity arise, the lack of proper
controls and regulations, as well as a global institution that oversees these are still
missing. The fact that institutions are not willing to give up macroeconomic policies
and engage in meaningful dialogue that will eventually lead to cooperation has
made it even more difficult to engage in comprehensive regulation. Finally,
countries have engaged in a variety of tactics to cope with the problems of
international lending and borrowing, but not without some drawbacks. Those who
have the pressure to make interest payments have often engaged in monetary and
fiscal contractionary policies to be able to keep a sustainable flow of capital, but to
the expense of interest rates, inflation and taxes. Furthermore, some have even
turned to the World Bank or the IMF for support in repaying this sort of debt
payments, but have found that the loans from these institutions are usually
conditional to certain structural adjustments such as liberalization of trade.