Global Monetary System
Global monetary system today
The global financial system (GFS) is comprise of institutions and regulations that act on international level through global institutions such as the International Monetary Fund (IMF) and the Bank of International Settlements (BIS) as well as the central banks and finance ministries. According to Crane et al (1995), the function of the financial system is primarily to facilitate the allocation and deployment of economic resources across borders and time in an uncertain environment. Today, the global financial system continues to be shaky regardless of the continuous effort of the government to stimulate the entire system.
Beams (2005) noted that although the resilience of the global financial system prevails because of the continued improvement of the corporate, financial and household sectors in many countries, there are several malevolent conditions that could contribute to the downfall. This was made possible by the growth of complex financial instruments aimed at spreading risk and thereby increasing instability especially during market fluctuations. Not to mention, such instruments are dependent on quantitative mathematical models for value, assessment and pricing. Another thing, even though risk management had been strengthened and became more sophisticated, financial institutions are still heavily dependent on having ready access to liquidity during ‘market stresses’. Other danger area is the eagerness of banks and financial institutions to consider increasing risk in the search for greater profits even in the face of declining opportunities.
Shostak (2005) also suggest that the purchasing power of money cannot be established hence this speculative flow of money is causing the instability within the global financial system. The root cause of the problem now points to the paper fiat standard, directly relating with the gold standard. Originally, the premise is that the paper money was not regarded as money but just a representative of money which was gold. Various paper certificates were introduced and were claims on gold stored with the banks. This, however, opens the scope for fraudulent practices especially of banks. To avoid hyperinflation and hence avoid the collapse of banks and the financial system, this means on-going and ever growing monetary pumping of the central banks to keep the system stable. Nevertheless, this leads to persistent declines in the purchasing power of money to boom-bust cycle which in turn destabilizes the entire monetary system.
As Malliaris (2002) puts it, there is the recent challenge for economists and policymakers to create a global financial system that offers great exchange rate stability without sacrificing international capital mobility. There are three ways to do such: 1) strengthening the international financial architecture to bring stability especially to the emerging nations, 2) creating a money union in NAFTA and extending such to other countries, and 3) coordinating economic policies among the US, EU and Japan for the purpose of stabilizing key global currencies. Sharma (2009) accounts the call of UNCTAD to overhaul the global financial system through weeding out financial instruments with no social returns and improving regulation of commodity futures exchanges so that it can provide reliable price signals to producers and consumers.
Foreign exchange market
According to Pollard, the determinants of an international currency are the following: 1) size of the economy, 2) importance in international trade, 3) size, depth, liquidity and openness of domestic financial markets, 4) convertibility of the currency and 5) macroeconomic policies. While Bergsten cited five key factors that determine whether a currency will play a global role: 1) size of its underlying economy and global trade, 2) the economy’s independence from external constraints, 3) the avoidance of exchange controls, 4) the breadth, depth and liquidity of the economy’s capital and 5) the economy’s strength, stability and external position.
Pollard described that the size of the country’s economy is important because it determines the potential use of the currency in international markets. Economic size is linked with the importance of a country in international trade and the size of its financial markets. Both Pollard and Bergsten agreed with the criteria for a currency to be considered an international trade.
Specifically, the foreign exchange or what Hill (2008) referred to as the institutional arrangements that govern exchange rate. The value of a currency is determined by the interaction between the demand and supply of the currency relative to the demand and supply of other currencies. The global monetary system continues to decline when exchange rate fluctuates resulting for currency rates to go up and down. Monetary strategies are specifically important as the global economy grows providing both the opportunity for prosperity and decline of economic markets worldwide (Kelly, 2006). There is the necessity therefore to safeguard the worth of a specific currency in any other currency.
A specific scenario for this, the euro’s rise will convert an international monetary system that has been dominated by the dollar since World War 2 into a bipolar regime. Hence the structure and politics of international financial cooperation will change dramatically. The exchange rates between the euro and the dollar will pose a significant policy challenge. The United States and the rest of the world should reject any attempt by Europe to substantially undervalue the euro’s start-up rate. It would represent a blatant effort by Europe to export its high unemployment and to enable the euro to become a strong currency without any significant cost to its competitive position.
Factors that contribute to economic prosperity
With the global financial system and currency at the realm, economic prosperity depends heavily on profitability and investment while also limiting financial risks of dealing with foreign currencies. International economic compliances especially those that are mandated by WTO, World Bank and IMF could protect the interests of nation-members including aspects of stabilizing financial structures, import-export balance, access to world markets and etc. As well, the possibility of economic stagnation is relatively high for non-integrationists since the concentration of currencies are mostly inward-bounded. Nonetheless, the expanded access to international financial law and accounting firms under the agreement will strengthen structures of banks and insurance companies and the financial sector as a whole.
Further, the financial structure in general preferred to put their trust regarding money matters on governments with leaders and political systems that are not corrupt. The concept is that democratic countries must better access to monetary policies and financial systems and representation is the preference to avenues in the pursuit of favorable policies. However, the initial evaluation of the financial capability of the nation is needed. So that, that domestic financial, administrative and political capabilities will be devoted to national concerns that must be adequately address. Considering such premise, economic development that promotes economic equality and reduces poverty is brought by government efficiency that controls the overall market and the internal financial systems.
Factors that contribute to economic decline
From an econometric perspective, the economic relationship between the North and the South has transcended beyond the geopolitical blocs. Evaluating the outcomes of economic interdependence must mean to look at different parameters that separate the two. For the North, the main determinants are GDP, inflation rates, interest rates, price of primary products and strength of currency and for the South, the determinants are exports, imports, balance of payments, reserves, capital flows and the exchange rate. From this alone, we can define the extent of interdependence between the two. Notably, the economic expansion in the North is relatively felt by the South and the increase in external debts in the South affects the North – positively and negatively. For example, amplified South indebtedness has an uphill pressure on the world interest rates that will eventually devalue them. In effort to reduce cost in the North and maximize the profitability in all industries the North will resort to cheap costs of manufacturing and production which is vested on the devalued South like in the many cases of sweatshops and labor-intensive factories.
As we move into the continuum, the high interest rates will reduce aggregate supply in the North and will turn to the South for cheap labors. The decrease demand for inventories of primary products and the fall in commodity prices will follow hurting the South in terms of trading and international competence. The North will be affected as well but limited to aggregation of supply. Evidently, the interdependence in the context of North and South has beneficial effects on the North and detrimental results to the South. Though the North significantly provided for the employment, poverty, death and malnutrition, the harmful effects are far greater than the benefits. To wit, there had been no progress on the standard of living of the South and they remain poor albeit the economic agendum.
Further, the reason behind the evolution of international trade systems is axis on factor proportions followed by the input-output form of international exchange that bridge many otherwise geographically-scattered regions. The focus is on different countries’ resources endowments apparent for the choice of technology and production, consumption and trade within unified framework. Practically, production and consumption happens between dyadic constructs as the exchange of goods or trade takes place making possible the extension of economic equilibrium to international levels. Not only the concept had change, the way people define trade now consists of services and investments. The growing importance of bartering complicates the main idea that trade happen in dyadic fashion. It now enters the sphere of multi-faceted, contextual aspects and importantly yearns for set of guiding schemas thus the international trade system. Since international trading is visibly export-oriented and the fact that it is comprise of many industries and sectors, there is the growing demand for a regulating body.
Recommendations for managing global prosperity
To wit, capital flows doesn’t guarantee sound economic performance in the long run. What is needed is a ‘sound overall development strategy’ or the initiative to focus energy on the agendas that could contribute to on future plans towards global financial integration. In principle, had banks and companies in Asia’s emerging markets not been allowed to borrow freely on foreign currency, they would not have built up huge foreign currency debts, and international creditors could not have demanded repayment just as liquidity was drying up and foreign currency was becoming very expensive. Asian markets then should be well-regulated for its economy to weather strong financial markets. The country also need export earnings to support foreign debt repayments.
Impoverishment is further by other factors such as indecisive bank systems and prolonged political instability that limits national power to protect domestic endeavors from insurgency and other external financial threats. The impact of debt forgiveness or the financial bailout from richer economies could only provide for the continuum of rigidity of poorer countries. Governments will be inclined to acquire loans which are beyond their means and thus cultivate a loan-dependent environment. On capital flows, the concern is on the magnitude of the dependency of national currency as it could be influenced by the capital inflows of stronger foreign currencies. This, essentially, implicates the exchange rate and specific industries and sectors such as financial and credit and banking, respectively.
Other concerns would include protection of interests and the people, financial security, operational power and influence and bias tended on the developed nations since they are also funding sources or donors at one point.
References
Beams, N. (2005). Global financial system faces growing risks. World Socialist Website, International Committee of Fourth International (ICFI).
Crane, D. B., Bodie, Z., Froot, K. A., Mason, S. P., Perold, A. F. and Merton, R. C. (1995). The Global Financial System: A Functional Perspective. Boston, USA: Harvard Business Press.
Malliaris, A. G. (2002). The Global Monetary System: Its Weaknesses and the Role of the IMF, the EU and NAFTA. North American Journal of Economics and Finance, 13: 72-92.
Sharma, A. B. (2009). UNCTAD calls for overhaul of global monetary system. The Financial Express Online.
Shostak, F. (2005). Why the present monetary system cannot be reformed? Brookes News Bulletin, 15 August, Monday.
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