Term Paper on "The
Survival and Climatisation of Financial Markets in Fluctuating
Economies"
Trade,
foreign investment, integrated capital markets and global or multinational firms
increasingly link the countries of the world. Technology is revolutionizing
communication. More than any other time in history, the wealth and prosperity of
nations are being determined by economic events and relationships beyond their
borders. “With today's globalization of money flows, corporations, financial
institutions, and regulations has come rapid change in technologies and quick
transfers of those technologies (both hard--e.g., computers-and soft--e.g.,
structuring of securities issues) throughout the world.” (Teresa Barger)
Technology has virtually revolutionized the way we process financial information
about asset returns and risk. The revolution has brought improvements not only
in hardware and software for computer and telecommunications technology, but
also in "brain ware" that is, advances like the theory of options. With these
innovations, there are now cheaper, easier, and more effective ways to collect
financial information, evaluate it, and manage it. In concert with this
technological revolution, attitudes toward governmental restraints on the
financial sector have undergone a revolution as well--a revolution that has led
to wide-ranging deregulation.
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The macroeconomic environment both affects and is affected by the movements in
international financial markets. Finance, of course, is not an end in itself.
Rather, it's an institutional means of facilitating the production of goods and
services. And policymakers in most countries industrial as well as emerging have
come to recognize that limiting the efficient flow of funds from savers to
investors only hinders economic growth. It seems inevitable that the account
should start with the United States of America since it plays such a dominant
role in the world economy.
The U.S. Economy Is the Key
The current international financial instability is related to the fact that
there is no country in the world capable of replacing the United States as the
locomotive for global economic growth. And even if such an option did exist, the
stability of international financial markets would heavily depend on a U.S.
economic recovery. In the years up to 2001 the United States experienced an
extraordinary period of growth. United States is typically being thought as
capable of sustainable growth at between 2 and 3 per cent. As the most advanced
economy it cannot share the experience of “catching up” which allows less
developed countries to grow more rapidly than it does.
“In 1998, the U.S. dollar served as a cushion against fluctuating U.S. bond
markets and financial market instability caused by the insolvency of several
major corporations. Thanks to the sustained strength of the U.S. dollar, the
U.S. trade deficit had previously never been much of a problem. This was due to
the fact that the U.S. trade deficit, the result of surging imports from
countries whose economies were dependent on export sales for recovery, played a
positive role for the global economy.” (Barger Teresa, 1998) From around 1994 to
2000 its average growth was closer to 4 per cent. The normal explanation for
this performance has been its ability to exploit the information technology
revolution better than any of its industrialized competitors. It was able to do
this, it is said, because its free market capitalist system provided the motives
and the means to exploit these benefits fully.
The European economies slowed down. The United Kingdom was hit by the fall in
exports and took steps, through monetary and fiscal stimulation, to boost the
growth of domestic demand. Within the euro area it was domestic demand, which
slowed down sharply. The authorities were either unwilling, or unable to provide
the kind of policy stimulus, which was introduced in the United Kingdom and the
USA. The economies of Europe, both inside and outside the euro area started the
year rather more slowly. Growth in the United Kingdom has started to pick up and
growth for the year as a whole will be at about the same rate this year as last.
Growth in the euro area could be slower than last year. In light of the problem
of the excessive capital investment situation in the United States, more time
will be needed for fresh investment to be made.
Asian Economy
Considering the economics of Asia one should never forget Asia's history. The
fact is the Asian economies are reasserting the role they have historically
played. The last couple of centuries when China has not been the world's largest
economy have been an aberration. In the first half of the 19th century the
Asia-Pacific region accounted for over 50% of the world's GDP. So, the economic
growth that we have witnessed over the last two to three decades should not be
seen as a short term phenomenon, rather it is a re-emergence, and there is an
inexorable quality to it. Japan for instance emerged from the devastation of
World War II to become the world's second largest economy. South Korea's GNP
increased from US$2.3 billion in the early 1960s to nearly US$380 billion in
1994. Put another way, per capita GNP grew from US$87 to nearly US$8,500 in just
30 years. Rural economies, heavily dependent on agriculture and primary produce
developed manufacturing sectors (including high-tech) and, in some cases,
world-class service sectors. And economic growth has been accompanied by rapid
increases in incomes and improvements in living standards.
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What had begun in July 1997 as an adverse shift in market sentiment towards a
limited number of countries in the South-East Asian region, radiated
increasingly widely over late 1997 and through 1998, affecting emerging
countries in a number of other regions and threatening global financial
stability. In Russia there was a debt moratorium after a wave of financial
market turmoil. In Brazil, confidence in the currency collapsed. In Japan,
despite numerous stimulus packages the economy fell into its deepest recession
in post-war history. With fears that the crisis would spill over into more
robust economies, investors re-assessed their risk exposures and sought comfort
in the most liquid assets - mainly US dollar denominated ones. The near collapse
of the hedge fund Long Term Capital Management raised serious concerns about
systemic risks in the financial sector and, with credit lines being sharply
curtailed, central banks in the US and Europe stepped in to increase liquidity
by adopting a more accommodative policy stance. The large adjustment to
savings-investment balances in Asia also resulted in major changes to global
current account positions.
In 1999 The Asian economies have begun to stabilize. Japan has begun to address
its long-running banking crisis, although Brazil is still widely regarded as
vulnerable and Russia's economy is still in crisis. The Asian economies most
involved in information and communication technology suffered most. Exports from
the Dynamic Asian Economies fell by nearly 10 per cent in 2001. The growth of
GDP in Hong Kong SAR, Singapore and Malaysia fell to small positive numbers or
was actually negative.
Growth has recovered in the Asian economies in 2002, particularly among those
who were seriously affected by last year’s slowdown in world trade. The Latin
American economies also suffered last year with particular problems (which have
continued this year) in Argentina. Brazil, Columbia, Mexico and Peru are
expected to do better in 2002. The emerging market economies in Europe were
relatively unaffected by world trade developments although growth in Poland and
Russia fell back significantly. They are expected to grow at about the same
speed this year. (Refer to Tables in the Appendix)
International Financial Markets
The global economy and financial system have shown enormous resilience in the
face of successive shocks. Markets have had to cope with the fall in share
prices, the attacks of September 11, the war against terrorism, the failure of
Enron, and the collapse of Argentina’s currency board. Each might have had
unpleasant economic side effects. Taken together their impact might have been
far more serious. And these events came on top of one of the worst post-war
years for world economic growth.
But the system has coped remarkably well and a recovery is in progress, led by
the United States. The financial system has responded flexibly to these recent
developments. Payment and settlement systems were even able to cope effectively
with the terrorist attack on the New York financial district. The operations of
the US equity, fixed income and repute markets were affected for a week or so
but the global system operated effectively. After the collapse of Enron, one of
the world’s largest energy traders, the energy market continued to function
normally. Markets responded more soberly to these developments than they had to
some of the events of 1998. After the collapse of LTCM (Long Term Capital
Management) and the Russian crisis there was a panic flight to liquidity. There
was no such reaction to the events of last year and this year. Credit has
continued to flow freely, although the cost has risen to less credit –worthy
borrowers. The corporate bond market was a willing provider o f funds and bond
market issues rose to record levels. Although this was a more costly source of
funding than short-term loans, the bond issues will help ease corporate concerns
for some time ahead.
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It was particularly encouraging that the serious problems in Argentina and
Turkey did not cause contagion elsewhere. As described above, this resilience to
unexpected shocks was greatly helped by a rapid and appropriate policy response,
particularly in the United States. But there were also undoubtedly benefits from
the many years dedicated to improving financial stability. In many countries
there are varied and flexible financial markets because of deregulation over
many years. The general move towards flexible exchange rates has also helped
insulate countries from problems arising elsewhere. Markets have also become
much more capable of distinguishing between the credit risks attached to
different borrowers. They have also become more risk averse. It is notable that
the banks, in particular, behaved much more sensibly and cautiously during the
1990s years of recovery than they had in the 1980s. There has also been an
improvement in the infrastructure underpinning the global financial system. Also
the associated plans for continuity and backup were vastly improved in the
previous years.
Recommendations
There is no guarantee that somewhere in the future the economy will not be
tested again by the increasing volatility of an integrated world financial
market system. It is therefore important that we shall all learn from the
experiences of the past years, and shall prepare the economy to prosper even
within the environment of volatile international capital movements.
As it is known that sound macroeconomic policies at all times make it easier to
absorb the fluctuations in the financial markets. Countries that do not apply
sound macroeconomic policies are punished more severely during times of
international currency turmoil.
As it is known that flexibility in domestic financial and other markets makes it
easier to absorb the shocks of the periodic global financial market
disturbances. In particular the prices as determined by market forces must be
allowed to respond quickly and decisively to changes in underlying market
conditions. As it is known that government policies are important, but that
government actions alone cannot solve the problem once it has infiltrated into
the markets. The disciplines of the market economy must be allowed to function
in a flexible way. It is learnt above all that sound, well managed, and healthy
banking institutions can form a major bastion against total economic collapse in
a situation of large capital outflows. In a number of East Asian countries, the
economies collapsed completely because weak banking systems could not survive in
the adverse climate of sudden large outflows of capital. The goal of financial
regulators whether in Asia or the U.S. is not to eliminate risk or failure, but
to ensure the overall stability of the financial markets. To do this, they
should balance two kinds of responsibility: One is to monitor the operations of
financial institutions and respond appropriately in times of crisis. The other
is not to impede the socially efficient operation of competitive forces.
“Diversifying in foreign markets also helps in avoiding volatility. Although
these benefits are very attractive, investors should not lose sight of the fact
that risks also exist in foreign markets. These include fluctuating currency
prices, lax regulation of exchanges, less stringent corporate financial
reporting standards, less liquidity and political instability.”(Mickey J.
Littman, 1997)
Too often, globalization is blamed for events that were largely caused by other
forces. For example, sharp swings in confidence of investors and business,
credit squeezes, and sudden movements in exchange rates had all been problems
well before the international economy became 'globalized'. One of the challenges
for governments is to find a sounder structure for international trade and
finance - one which recognizes the huge and largely irreversible increase in the
global mobility of capital and which maintains a momentum towards further gains
from trade liberalization. In particular, reforms are needed to ensure a
speedier and larger response by national and international financial authorities
when banking or foreign exchange crises hit and to improve the transparency and
prudential surveillance of short-term capital flows.
“Futures and options markets are ideally suited for a world where innovation and
competition will intensify, where demand for tailored risk management strategies
will increase, and where opportunities will rapidly appear and disappear on a
constantly changing financial horizon. Indeed, while in the coming years the
lines between exchange-traded and off-exchange traded products may become
somewhat blurred, no markets other than futures and options offer a blend of so
many credible instruments to safeguard or enhance one's assets.”(Financial
Markets In The Coming Decade, 1990)
Works Cited
Sheng Andrew. ‘Small & Medium Business Finance Challenges for the Future’ Deputy
Chief Executive (Monetary) Hong Kong Monetary Authority Address to the Hong Kong
Management Association
‘FINANCIAL MARKETS IN THE COMING DECADE’, Essay published in Futures Magazine,
November 1990.
Barger Teresa. ‘Financial Institutions’, Executive Summary. IFC Central Capital
Markets Department. (1998)
Littman, Mickey J. ‘A world of opportunity - investing in overseas markets,
(Personal Financial Planning)’ ‘Financial Inflows Cause Problems for Transition
Economies’, Laxenburg, Austria, 18 June 1997
Table1: “Key Indicators of the East Asian Financial Markets1993”, (28 September
1995), http://www.info.gov.hk/hkma/eng/speeches/speechs/andrew/speech_280995b.htm
Table2: “Net Sources of Finance 1970-1989” (28 September 1995) http://www.info.gov.hk/hkma/eng/speeches/speechs/andrew/speech_280995b.htm
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