Intro to International Business

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

The global monetary system and financial markets form the backbone of international trade and investment. These interconnected systems enable currency exchange, facilitate cross-border transactions, and provide mechanisms for managing financial risks in the global economy. From the Bretton Woods system to today's floating exchange rates, the international monetary landscape has evolved significantly. Key players like the IMF and World Bank play crucial roles in maintaining stability, while challenges such as global imbalances and currency crises continue to shape economic policies worldwide.

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
  • 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


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© 2024 Fiveable Inc. All rights reserved.
AP® and SAT® are trademarks registered by the College Board, which is not affiliated with, and does not endorse this website.