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Globiliazation and Market integration

Integrated markets: assets sell for same price in every country
Segmented Markets: Assets sell for different prices
 

Reasons for segmentation: Transaction costs, laws, regulatory/institutional interference, informational barriers,  immobility of input factors.

Why integration has improved

Integration has improved dramatically as trade barriers have fallen.  Partially due to technology, partially due to changes in world politically, plus other reasons
 

Many groups/organizations are being formed and treaties signed to help speed demise of trade barriers.  Examples:

• WTO
• World Bank
• NAFTA-North American Free Trade Agreement
• EU- European Union
• ASEAN-Association of South-East Asian Nations
• APEC-Asia-Pacific Economic Cooperation-Southeast and Far East    Nations (incl more developed)
• Mercosour-S. America
• Andean Pact-Venezuela, Colombia, Peru, and Bolivia

Developed Nation
Less developed nation
Newly industrialized nation.
Economic Lifecycle of development

Trade "figures"

Trade Balance-refers to whether a nation is a net importer or net exporter of goods

Current Account-includes trade balance but also services, royalties, travel, pay, interest etc.
Broader than trade balance.

Financial Account-
 Concerned with inflow and outflow of "equity capital, reinvested earnings, and intercompany transactions

Portfolio Investment:  stocks, bonds, money market accounts and the like.

Exchange Rate Systems
 

1. Fixed Rate Systems-Government artificially maintains an official exchange rate.   (effectively the government is taking on exchange rate risk.)  The problems with this type of system include an inability to maintain the price and inflation worsens the economy in the nation with the higher inflation.

The inability to maintain the exchange rate is a big issue.  What often happens is that the government eventually gives up and revalues (adjusts upward) or more likely devalues (adjusts downward) the official price.  Thus the risk is still present, but it more in a jump-like manner.
 

Floating Rate System--allows currency to fluctuate according to supply and demand.  Further this allows inflation and unemployment to be largely self-correcting.   For example if inflation is high, the currency will fall which will make foreign goods more expensive (relative to domestic goods) and hence more will buy "local" which will lead to more jobs etc.

Disadvantage: constantly changing prices

From teh text: "Recognizing that no currency is truly either freely floating of fixed rate" the IMF (International Monetary Fund) classifies currencies into one of the following categories:
 

1. More Flexible-floating but with government intervantion (example most widely traded currencies, US and Japan)
2. Limited Flexibility systems-limited in terms of a single currency or group of currencies (example Europe before adoption of Euro.)
3. Pegged System-currency valuatios are fixed relative to either one another or some basket or SDR (Special Drawing Rights-units of accounts traded between central banks).

History of International Monetary System
 

Pre 1914--Gold standard.  Ended with WWI

1944 Bretton Wooods agreement (created IMF and World Bank)
  The currency of most nations was pegged to the Dollar which in turn was pegged to Gold at $35 an ounce.

In 1971 this broke down as the US acknowledged that it could no longer hold the pegged currency rate.

For the next 16 years there were several attempts to go back to a pegged system.

In 1985 the idea was finally given up.  The Plaza Accord's goal was to lower the value of the Dollar and to lower volatility in exchange rates.
 

Formed by Bretton Woods agreement to make SHORT-TERM loans to countries with temporary shortages of funds.

Has had fairly limited success as evidenced by a large number crises.

Mexican Peso Crisis of 1995

• Government had maintained an artificially high peso value.  In doing this they used up much of their foreign currency reserves.
• Commercial banks and the Mexican government borrowed $23 billion in tesebono debt (short-term DOLLAR denominated principal debt obligations.)
• Government finally admitted it could not keep peso so high and devalued the peso by 30%.  Market said that was not enough and pushed it down 50%.  Of course this lowered their reserves and increased their obligations.

The US and the IMF did step in and made loans to Mexico.  Although the economy suffered temporarily it did rebound.
 

Asian Contagion of 1997

• May 1997 the market began betting against the Thai bhat.  It was pegged to a basket of currencies.
• Speculators bet billions and outspent the government.  The government eventually gave up and allowed the currency to float.  (or sink as the case may be).    By the end of 1997 the value had fallen by 50%.
• Along with many structural problems (regulations, institutions, and high leverage), this lead to severe economic troubles.  These troubles spread quickly around the region.  Indonesia and Korea were soon suffering from the same symptoms.
• Then teh problems got serious and began to spread.  Russia defaulted.  Banks and others around the world began to get very worried that they would be next.  Feared deflation.  Economies across Asia suffered.  As investors rushed to high-quality issues,  the Long Term Capital Management Hedge fund suffered terrible losses that eventually led to a Fed-influenced bail out package and eventually the demise of hedge fund.

The immediate crisis ended as the IMF, Europe, Japan, and US came to the rescue.  (in reality the strong US economy probably played the biggest role as US consumers could afford to keep spending which arguably prevented a global recession..)

They offered loan packages tied to several conditions.  The conditions included

1. Fiscal and Monetary restraint
2. Liberalization of financial markets
3. Structural reforms (deregulation, efficiency, and transparency)

For more on the crisis, check out the following links

http://www.stern.nyu.edu/~nroubini/asia/AsiaHomepage.html
http://russia.shaps.hawaii.edu/economic/asian-crisis.html
http://www.imf.org//np/speeches/1998/062398.HTM

While the crisis was severe, it was not as bad as it could have been.   However, if that is because the IMF and others were there to lend, or if it is because the US economy was so hot at the time is debatable.  A growing school of thought is that the IMF and US actions of continually bailing out the nations (and institutions) that get into trouble is actually leading to more crises.

This theory lies to building blocks.

1. The Moral-Hazard Problem is exasperated by the bailouts.  This is the idea because the downside risk is being removed, nations (and companies) have an incentive to take on more risk.
2.  Periodic crises may force the weaker institutions out.  This would lower the likelihood of a severe crisis in the future.
http://www.cato.org/pubs/journal/cj17n3-11.html
http://www.cato.org/pubs/fpbriefs/fpb-048.pdf
 

What was learned from the crises? and the aftermath of the recent crises?

1. That no country is totally immune from the economic problems of other  nations.
2. That Central banks can not hold the line of a fixed exchange rate long term.
3. That currency devaluation can lead to serious problems if the economic infrastructure is not strong.
4. Governmental intervention in the capital markets often makes the problem more severe.  For example, capital cronyism can result whereby the lenders make loans based on an implicit government guarantee.

Very good speechs on the crisis and its aftermath include:
Speeches by US Treasury Secretary Laurence Summers
http://www.ustreas.gov/press/releases/ps212.htm
http://www2.whitehouse.gov/WH/EOP/CEA/html/19980415.html

and from the IMF
http://www.imf.org//np/speeches/1998/062398.HTM
 

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so I will be keeping these "fun" pages online.

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