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Intro to International Relations
Table of Contents
Unit 7 Overview: Global Economy: Trade, Finance & Development
7.1 International Trade Theory and Policy
7.2 Global Financial System and Institutions
7.3 Economic Development and North-South Relations
7.4 Multinational Corporations and Foreign Direct Investment

The global financial system is a complex web of institutions, policies, and markets that shape the world economy. From the IMF to the World Bank, these organizations play crucial roles in maintaining stability, promoting development, and regulating international trade.

Exchange rates, monetary systems, and financial crises are key elements of this intricate system. Understanding these components is essential for grasping how global finance impacts international relations, economic growth, and the balance of power between nations.

International Financial Institutions

Key Global Financial Organizations

  • International Monetary Fund (IMF) promotes international monetary cooperation and exchange rate stability
    • Provides policy advice and financing to member countries experiencing economic difficulties
    • Monitors global economic trends and performance of member countries
  • World Bank focuses on reducing poverty and supporting economic development in low and middle-income countries
    • Offers loans, grants, and technical assistance for infrastructure projects and policy reforms
    • Consists of two main institutions: International Bank for Reconstruction and Development (IBRD) and International Development Association (IDA)
  • World Trade Organization (WTO) regulates international trade and resolves trade disputes between nations
    • Negotiates and implements global trade agreements
    • Provides a forum for member countries to address trade-related issues

Financial Regulatory Frameworks

  • Basel Accords establish international banking standards to improve financial stability
    • Basel I (1988) set minimum capital requirements for banks
    • Basel II (2004) introduced more risk-sensitive capital requirements and supervisory review
    • Basel III (2010) strengthened capital requirements, introduced leverage ratios, and enhanced liquidity standards
  • Basel Committee on Banking Supervision develops these accords
    • Consists of central bank representatives from 28 jurisdictions
    • Aims to enhance financial stability by improving the quality of banking supervision worldwide

Monetary Systems and Policies

Exchange Rate Mechanisms

  • Exchange rates determine the value of one currency relative to another
    • Floating exchange rates fluctuate based on market forces (supply and demand)
    • Fixed exchange rates are pegged to another currency or basket of currencies by central banks
  • Currency markets facilitate the buying, selling, and exchanging of currencies
    • Largest financial market in the world, with daily trading volume exceeding $6 trillion
    • Major players include commercial banks, central banks, and multinational corporations

Historical Monetary Systems

  • Bretton Woods system (1944-1971) established a fixed exchange rate regime
    • Pegged major currencies to the U.S. dollar, which was convertible to gold at a fixed rate
    • Created the IMF and World Bank to manage the system
  • Gold standard linked the value of currencies to a specific amount of gold
    • Provided stability but limited monetary policy flexibility
    • Abandoned by most countries during the 20th century due to economic pressures

Modern Monetary Frameworks

  • Fiat currency derives its value from government decree rather than intrinsic value
    • Not backed by physical commodities like gold or silver
    • Allows for greater monetary policy flexibility
  • Central banks manage monetary policy and financial stability
    • Set interest rates to influence inflation and economic growth
    • Implement quantitative easing and other unconventional monetary policies during economic crises

Global Financial Dynamics

Financial Crises and Globalization

  • Financial crises disrupt economic activities and financial markets
    • Can be triggered by various factors (asset bubbles, bank failures, sovereign debt defaults)
    • Often spread across borders due to interconnected global financial systems
  • Globalization increases economic interdependence among countries
    • Facilitates international trade and financial flows
    • Can amplify the transmission of economic shocks across borders

International Capital Movements

  • Capital flows involve the movement of money for investment purposes across national borders
    • Include portfolio investment, bank lending, and foreign direct investment
    • Can contribute to economic growth but also increase financial volatility
  • Foreign direct investment (FDI) occurs when a company establishes operations in a foreign country
    • Provides capital, technology, and expertise to host countries
    • Can stimulate economic growth and job creation in recipient countries

Sovereign Debt and Global Finance

  • Sovereign debt refers to the money a country owes to foreign lenders
    • Can be issued in domestic or foreign currencies
    • Allows governments to finance budget deficits and development projects
  • Sovereign debt crises occur when countries struggle to repay their debts
    • Can lead to currency devaluations, economic recessions, and political instability
    • Often require intervention from international financial institutions like the IMF

Key Terms to Review (23)

Sovereign debt crises: Sovereign debt crises occur when a country is unable to meet its debt obligations, leading to defaults or restructuring of its debt. These crises can have significant implications for the global financial system, as they can trigger financial instability, impact international trade, and influence the behavior of financial institutions and investors.
Foreign direct investment: Foreign direct investment (FDI) refers to the investment made by a company or individual in one country in business interests in another country, typically through acquiring assets or establishing business operations. This type of investment is significant as it allows investors to have a lasting interest and a degree of control over the foreign enterprise, influencing global economic dynamics, development strategies, and corporate behavior.
Central Banks: Central banks are national financial institutions responsible for managing a country's currency, money supply, and interest rates. They play a crucial role in the global financial system by regulating monetary policy, supervising commercial banks, and ensuring financial stability, thus influencing economic performance and international trade.
Fiat currency: Fiat currency is a type of money that has no intrinsic value and is not backed by physical commodities, such as gold or silver. Instead, its value is derived from the trust and confidence that people have in the issuing government or authority. This form of currency is essential in the global financial system, as it facilitates trade and economic stability by allowing for flexible monetary policies.
Financial crises: Financial crises are significant disruptions in the financial system that lead to severe instability, loss of asset values, and decreased credit availability. These crises often result from a combination of factors, including excessive risk-taking by financial institutions, regulatory failures, and macroeconomic imbalances. They can cause widespread economic turmoil, affecting both individual livelihoods and global economic stability.
Quantitative easing: Quantitative easing is a monetary policy used by central banks to stimulate the economy by increasing the money supply. This is achieved through the large-scale purchase of government securities and other financial assets, which lowers interest rates and encourages lending and investment. It aims to boost economic activity, especially during periods of low inflation and economic stagnation.
Fixed exchange rates: Fixed exchange rates are a type of currency exchange system where a country's currency value is tied or pegged to another major currency, like the US dollar or gold. This system is designed to maintain stable currency values and reduce the risks associated with fluctuations in the foreign exchange market, which can be crucial for international trade and investment.
Capital flows: Capital flows refer to the movement of money for investment, trade, or business production between countries. These flows can take the form of foreign direct investment (FDI), portfolio investment, or other types of financial transactions, and they play a crucial role in the global financial system by connecting economies and influencing exchange rates, economic growth, and financial stability.
Exchange rates: Exchange rates refer to the value of one currency in relation to another, determining how much of one currency can be exchanged for a unit of another. These rates are crucial for international trade, investment, and financial markets, impacting everything from import and export prices to foreign direct investment and tourism.
Basel Committee on Banking Supervision: The Basel Committee on Banking Supervision (BCBS) is an international body that provides a forum for regular cooperation on banking supervisory matters among central banks and banking regulators from various countries. Established in 1974, the BCBS aims to enhance financial stability by setting global standards for banking regulation and supervision, thereby fostering a more resilient global financial system.
Floating exchange rates: Floating exchange rates are currency values that fluctuate based on market forces without direct government or central bank intervention. This system reflects the real-time economic conditions of countries, allowing their currencies to gain or lose value relative to one another based on supply and demand. Floating exchange rates are crucial in understanding how international trade and investment work, as they can impact everything from inflation to monetary policy.
Sovereign debt: Sovereign debt refers to the money that a country's government borrows, typically by issuing bonds, to finance its expenditures and manage its budget deficits. This type of debt is often seen as a key component of a country's financial obligations and is closely tied to the global financial system, where investors, international institutions, and credit rating agencies assess the risk and creditworthiness of nations based on their ability to manage and repay this debt.
Currency markets: Currency markets are global decentralized platforms where currencies are traded against one another. They play a crucial role in determining exchange rates, which affects international trade, investments, and economic stability. These markets facilitate the buying and selling of currencies, providing essential liquidity for businesses and governments engaged in cross-border transactions.
Gold standard: The gold standard is a monetary system in which a country's currency or paper money has a value directly linked to gold. Under this system, countries agree to convert currency into a fixed amount of gold, which helps stabilize exchange rates and fosters international trade by providing a universal measure of value.
Basel III: Basel III is an international regulatory framework established to strengthen the regulation, supervision, and risk management within the banking sector following the 2008 financial crisis. This framework aims to improve the resilience of banks by increasing capital requirements, enhancing risk management standards, and introducing new liquidity requirements to ensure financial stability.
Basel Accords: The Basel Accords are a set of international banking regulations developed by the Basel Committee on Banking Supervision (BCBS) aimed at enhancing financial stability and risk management in banks globally. These accords focus on establishing minimum capital requirements, improving risk assessment practices, and promoting sound banking practices, which are essential for maintaining the integrity of the global financial system and protecting against financial crises.
Basel II: Basel II is an international banking regulation framework that was established to enhance the stability and soundness of the global financial system by ensuring that banks maintain adequate capital reserves. This framework builds upon the original Basel I agreement and introduces more comprehensive risk management measures, particularly focusing on credit, market, and operational risks. By promoting better risk assessment practices and capital adequacy requirements, Basel II aims to create a more resilient banking environment that can withstand financial shocks.
Basel I: Basel I is a set of international banking regulations established by the Basel Committee on Banking Supervision in 1988, primarily focused on maintaining adequate capital reserves for banks to protect against financial risks. This agreement aimed to create a uniform framework for bank capital adequacy, ensuring that banks hold enough capital to cover potential losses and thereby enhancing the stability of the global financial system.
World Trade Organization: The World Trade Organization (WTO) is an international organization that regulates and facilitates international trade between nations by providing a framework for negotiating trade agreements and resolving trade disputes. It plays a crucial role in shaping global trade policies and promoting free trade, which is essential for economic growth and globalization.
World Bank: The World Bank is an international financial institution that provides loans and grants to the governments of poorer countries for the purpose of pursuing capital projects. Its goal is to reduce poverty and promote sustainable economic development by providing financial and technical assistance, thus playing a critical role in shaping global economic policy and addressing issues related to inequality, development, and governance.
Bretton Woods System: The Bretton Woods System was an international monetary order established in 1944, aimed at creating a stable and cooperative global economic environment post-World War II. It introduced fixed exchange rates pegged to the U.S. dollar, which was convertible to gold, fostering international trade and investment. This system laid the groundwork for major financial institutions like the International Monetary Fund (IMF) and the World Bank, which continue to play crucial roles in global finance today.
International Monetary Fund: The International Monetary Fund (IMF) is an international financial institution established to promote global economic stability and growth by providing financial assistance, facilitating international trade, and serving as a forum for economic policy discussions among member countries. Its operations reflect the historical evolution of the international system, shaped by the need for cooperation in the face of economic crises.
Globalization: Globalization is the process by which businesses, cultures, and economies become interconnected and interdependent on a global scale. This phenomenon has transformed the way nations interact, influencing trade, finance, and the movement of people, ideas, and goods across borders. It has significant implications for state sovereignty, economic practices, and the dynamics of multinational corporations.