Globalization and Internation Financial Crisis - Essay Example

? Globalization& International Financial Crisis of the Institute Appears Here Appears Here Table of Contents Introduction 3 Discussion 3 Conclusion & Recommendations 7 References 8 Introduction Globalization refers to the expansion, interdependence and harmonization across the world among nations, human activities, systems and policies. Globalization affects people in most areas of living since it relates to international transfer of goods, labor and knowledge. The term globalization specific to the human environment is often used to describe the economic integration across the globe and changes caused by the diffusion of information in digital form, for example with the Internet. The significance of globalization cannot be overstated since it relates to increasing global interdependence in all areas including economy, politics, culture, environment, communication, etc. This consolidation of global relationships is at the level of individuals, companies, institutions and countries (Campenhout and Cassimon, 2012). The main causes of the process of globalization are the technical progress in the communications and transportation sections, as well as, the political decisions on liberalization of world trade. The study of International Finance is of particular significance in today’s globalized financial marketplace. International finance is a branch of international economics and focuses on the monetary side of the international economy. The subject matter of international finance is useful for students of economics, finance and business studies.  It is theorized that increasing globalization has played a role in creation of a wave of international financial crises in contemporary times (Schmukler and Vesperoni, 2006). The paper critically evaluates the supposition of globalization’s role in international financial crisis and assesses the question whether international financial stability is feasible in an increasingly globalised economy. In addition, the paper critically appraises international financial crisis and ensuing policy responses to maximize economic and welfare consequences.  Discussion The degree of change brought about by the globalization of financial systems has been termed as financial globalization by several researchers. Globalization of financial systems leads to the creation of a regional market integration of external financing. According to Mishkin (2009), the financial aspect of globalization has three dimensions: geographical aspect of financial globalization refers to mobility of capital from one country to another, functional aspect of globalization relates to capital markets which are compartmentalized through shifts in money markets and stock markets. Obadan (2006) mentions that under the influence of financial globalization, global financial institutions are created, as well, like the IMF, World Bank and the European Community. Globalization’s effect on international financial markets also includes deregulation, abolition of exchange controls and restrictions on capital movements. Globalization also encourages financial innovation, disintermediation and direct access operators to funding without going through intermediaries (Cline, 2010). The impacts of globalization on the financial systems are dealt under heads: Market Development Financial globalization has facilitated the financing of companies and that the balance of payments. This has eliminated barriers to capital flows and has given an unprecedented boost to financial markets worldwide (Rose, Prasad and Terrones, 2009). Today financial information is processed and disseminated around the world, which leads to increased speculations in the financial markets and a high volatility of capital round the globe. This provides a flow of investment opportunities based on economic factors (Mishkin, 2009). These effects are sometimes seen as uncontrollable by the regional banking system and the international financial system. Disconnection between finance and production one aspect of financial globalization is that the new financial players seek liquidity and financial profitability in the short term, as companies need financial sustainability. Financial investor’s portfolio purposes have replaced direct industrial and commercial purposes in international capital flows. Some researchers observe a relationship between globalization and financial instability in the form of burgeoning systemic risk (Mendoza and Quadrini, 2010). Some financial innovations are intended to protect economic agents against volatile interest rates and exchange rates. Indeed, after the end of Bretton Woods in 1973, global financial system has moved from a fixed exchange rate system to the floating exchange causing instability in interest rates and exchange rates. In the opininog of Schmukler and Vesperoni (2006), these new financial instruments may themselves be sources of instability. Futures markets have reached a bigger size and are so much more complex that they appear uncontrollable for regulators and investment decision makers.  Excess of the above mentioned financial instruments have played a role in some recent bankruptcies and financial crisis. This impact of growing disconnection between production and finance applies especially to derivatives like futures, options, swaps, in which large corporations – for instance, insurance companies and pension funds - hedge against risk of fluctuating markets with some other derivatives. These derivative contracts facilitate financial speculation because of their leverage, representing huge potential for risk taking (Mendoza and Quadrini, 2010). Futures contracts allow financial instruments to take positions in only a small part of immobilized form of cash deposits. This is true for those options in which the premium paid is small relative to the amount of the underlying asset. Globalization has impacted financial systems around the world by creation of instruments which are used by speculators in over-the-counter markets. These markets are much less transparent than the organized markets. This implies that the fate of companies becomes less tied to their performance and more on stock market fluctuations. This situation is, of course, creates greater risk at global level. Lack of transparency some researchers have opined that globalization has reduced degree of transparency of global financial system (Bordo and Murshid, 2006). One aspect of globalization of financially systems is the existence of unpublished accounts of investors which have been termed as the "black boxes" of financial globalization (Obadan, 2006). Capital flight and corruption has increased in third-world countries because it has become possible for an investor to create undisclosed account in a foreign land.   Another aspect of globalization of financial system is that it has driven across the globe a great interdependence between investment banks and banks of deposit. Investment bankers who made bad investments have fallen into crisis taking with them all other types of banks, which are now refusing to make loans for fear of losing their money and so settles an international financial crisis.  The Emergent Role US in Global Economy Another risk factor in the current financial crisis is the world's monetary system because of the huge deposits of foreign central banks and other institutions in U.S. dollar and the corresponding debtor position of the United States (Mishkin, 2006). The present world monetary system in 1944 at Bretton Woods (USA), created in partnership with the International Monetary Fund (IMF) and the International Bank for Reconstruction and Development (World Bank). Key currency was the U.S. dollar, which was provided with the promise of the U.S. government- U.S. dollar to 1 ounce of gold in exchange. Until the mid-60s there was talk of the dollar gap that the participants would have on international trade and payments never have enough U.S. dollar to finance their international transactions (Obadan, 2006). That changed with the U.S. entry into the Vietnam War. The U.S. could not finance this war from the normal tax revenue and national saving, but it had to borrow abroad. This created a risk that shrink by Substitution of foreign dollar balances into gold, the U.S. gold reserves and eventually were able to pass into the hands of foreign central banks.  This led to flexible exchange rates and a significant devaluation of the U.S. dollar, which remained a reserve currency. At the same time this system has allowed the U.S. to borrow abroad indefinitely and maintain at its expense maintain a standard of living that was not justified by the U.S. economic performance. According to several economists, this phenomena turned out to be a source of global financial crisis which ensued. A solution will affect everyone, because a devaluation of the U.S. dollar changes the competitive position of all countries. It also requires substantial depreciation in the owners of dollar assets. A depreciation of the U.S. dollar could be countered by raising interest rates in the U.S. and the attraction of foreign capital. This would, however many dollar borrowers in the U.S. and other countries in financial difficulties. This would affect the economy not only in America but also in other economic areas. The Net Impact on International Financial Crisis from the analysis of the above mentioned impacts of globalization on financial systems, it is found that the link between globalization and financial crisis is direct. In fact, the global financial crisis of 2008 was indeed possible only because of the globalization of economic systems. This is because owing to globalization, financial systems of countries are interconnected and traders can start speculating on global financial products that are likely to have far-reaching consequences (Moshirian, 2003). It is financial globalization which has made possible to create complex financial products – for instance, the famous subprime – and sell these products to any bank in the world. Without a globalized financial system the subprime crisis would have affected only United States of America.  Globalization transformed a local financial crisis into a global economic catastrophe. Globalization has driven across the globe a great interdependence between investment banks and banks of deposit.  Investment bankers who made bad investment decisions not only got their own banks into crisis, rather took with them all other types of banks, which refused to make loans for fear of losing their money and thus spurred an international financial crisis (Rose, Prasad and Terrones, 2009). Companies can no longer access the credits had to reduce their production which caused higher unemployment levels in other economies, and lead to creation of a downward spiral. Conclusion & Recommendations The paper evaluated the impact of globalization on severity and frequency of global financial crisis. It is concluded that there is a positive connection between the process of globalization and global financial crisis both in terms of frequency and severity. Analysis of research evidence and macro-economic theory supported the thesis of the role of increasing globalization in creation of a wave of international financial crisis in contemporary times. The paper critically evaluated the supposition of globalization’s role in international financial crisis and assesses the question whether international financial stability is feasible in an increasingly globalised economy. In addition, the paper critically appraises international financial crisis and ensuing policy responses to maximize economic and welfare consequences.  It is concluded that globalization has eliminated barriers to capital flows and has given an unprecedented boost to financial markets worldwide. Another relationship between globalization and financial instability was found in the form of burgeoning systemic risk. These are the contributory factors which have played a role in some recent bankruptcies and financial crisis. The policy responses to this impact of globalization are to increase regulatory checks on the financial systems and to restrict flow of capital between countries. It is also recommended to discourage high-levels of interdependency of financial institutions on each other through regulatory means.   References Bordo, M. and Murshid, A. (2006) 'Globalization and changing patterns in the international transmission of shocks in financial markets', Journal of International Money and Finance, vol. 25, no. 4, pp. 655-674. Campenhout, B. and Cassimon, D. (2012) 'Multiple equilibria in the dynamics of financial globalization: The role of institutions', Journal of International Financial Markets, Institutions and Money, vol. 22, no. 2, pp. 329-342. Cline, W. (2010) Financial globalization, economic growth, and the crisis of 2007-09, Washington: Peterson Institute. Mendoza, E. and Quadrini, V. (2010) 'Financial globalization, financial crises and contagion', Journal of Monetary Economics, vol. 57, no. 1, pp. 24-39. Mishkin, F. (2006) The Next Great Globalization: How Disadvantaged Nations Can Harness Their Financial Systems, New York: Princeton University Press. Mishkin, F. (2009) 'Globalization and financial development ', Journal of Development Economics, vol. 89, no. 2, pp. 164-169. Moshirian, F. (2003) 'Globalization and financial market integration ', Journal of Multinational Financial Management, vol. 13, no. 5, pp. 289-302. Obadan, M. (2006) 'Globalization of finance and the challenge of national financial sector development ', Journal of Asian Economics, vol. 17, no. 2, pp. 316-332. Rose, A., Prasad, E. and Terrones, M. (2009) 'Does financial globalization promote risk sharing?', Journal of Development Economics, vol. 89, no. 2, pp. 258-270. Schmukler, S. and Vesperoni, E. (2006) 'Financial globalization and debt maturity in emerging economies', Journal of Development Economics, vol. 79, no. 1, pp. 183-207. Read More