Chapter 9 – Global Finance and Business
Globalization has had its most profound influence in the way states, businesses, and individuals
deal with financial markets.
Financial integration has tremendous advantages. It offers investors and businesses access to
overseas markets to spur economic growth. It allows for the possibility of better returns on
investment for individuals investing for college tuition or retirement. But as we have witnessed
in the past two years, financial integration also carries risks. An economic crisis in one state can
quickly spread to another, then another. The spread of economic difficulties can quickly lead to a
global economic crisis affecting small and large economies alike.
About Money:
The ability to print one’s own currency is one of the hallmarks of state sovereignty. Yet, in a
globalized system of trade and finance, businesses and individuals often need other states’
currencies to do business. Because of the nature of state sovereignty, the international
economy is based on national currencies, not a world currency. One of the main powers of a
national government is to create its own currency as the sole legal currency in the territory it
controls. The national currencies are of no inherent value in another country, but can be
exchanged one for another.
For centuries, valuable metals (such as gold and silver) were used as global currencies. Gold has
long been a key power resource with which states could buy armies or other means of leverage.
In recent years gold standard is not used (except some businessmen or investors still stock piles
of gold), and international monetary system is created. Today, those kinds of metals are no
different than any other commodities, since they frequently experience fluctuations in terms of
their value.
International Currency Exchange:
Each state’s currency can be exchanged for a different state’s currency according to an exchange
rate —defining, for instance, how many Canadian dollars are equivalent to one U.S. dollar. Most
exchange rates are expressed in terms of the world’s most important currencies— the U.S. dollar,
the Japanese yen, and the EU’s euro. Thus, the rate for exchanging Danish kroner for Brazilian
reals depends on the value of each relative to these world currencies.
The relative values of currencies at a given point in time are arbitrary; only the changes in values
over time are meaningful. For instance, the euro happens to be fairly close to the U.S. dollar in
value, whereas the Japanese yen is denominated in unit closer to the U.S. penny. When the value
of the euro rises (or falls) relative to the dollar, because euros are considered more (or less)
valuable than before, the euro is said to be strong (or weak). A strong currency makes imports
more affordable, while a weak currency makes exports more competitive.
Some states do not have convertible currencies. The holder of such money has no guarantee of
being able to trade it for another currency. Such is the case in states cut off from the world
capitalist economy, such as the former Soviet Union. In practice, even nonconvertible currency
can often be sold, in black markets or by dealing directly with the government issuing the
currency, but the price may be extremely low. Some currencies are practically nonconvertible
, because they are inflating so rapidly that holding them for even a short period means losing
money. Inflation reduces a currency’s value relative to more stable (more slowly inflating)
currencies.
Extremely high, uncontrolled inflation—more than 50 percent per month, or 13,000 percent per
year—is called hyperinflation.
In contrast with nonconvertible currency, hard currency is money that can be readily
converted to leading world currencies (which now have relatively low inflation). States
maintain reserves of hard currency. These are the equivalent of the stockpiles of gold in
centuries past. (Countries like China and Saudi Arabia still have gold reserves)
Fixed exchange rates -Here governments decide, individually or jointly, to establish official
rates of exchange for their currencies.
Floating exchange rates - now more commonly used for the world’s major currencies.
Rates are determined by global currency markets in which private investors and
governments alike buy and sell currencies. There is a supply and demand for each state’s
currency, with prices constantly adjusting in response to market conditions.
Major international currency markets operate in a handful of cities—the most important being
New York, London, Zurich (Switzerland), Tokyo, and Hong Kong—linked together by
instantaneous computerized communications. These international currency markets involve huge
amounts of money—a trillion and a half dollars every day—moving around the world. They are
private markets, not as strongly regulated by governments as are stock markets.
Managed float system - National governments periodically intervene in financial markets,
buying and selling currencies in order to manipulate their value. Such government
intervention to manage the otherwise free-floating currency rates is called a managed float
system.
Why currencies rise or fall?
In the short term, exchange rates depend on speculation about the future value of currencies. But
over the long term, the value of a state’s currency tends to rise or fall relative to others because
of changes in the long-term supply and demand for the currency. Supply is determined by the
amount of money a government prints. Printing money is a quick way to generate revenue
for the government, but the more money printed, the lower its price. Domestically, printing
too much money creates inflation because the amount of goods in the economy is unchanged but
more money is circulating to buy them with. Demand for a currency depends on the state’s
economic health and political stability. People do not want to own the currency of an unstable
country, because political instability leads to the breakdown of economic efficiency and of trust
in the currency.
States often prefer a low value for their own currency relative to others, because a low
value promotes exports and helps turn trade deficits into surpluses.
Globalization has had its most profound influence in the way states, businesses, and individuals
deal with financial markets.
Financial integration has tremendous advantages. It offers investors and businesses access to
overseas markets to spur economic growth. It allows for the possibility of better returns on
investment for individuals investing for college tuition or retirement. But as we have witnessed
in the past two years, financial integration also carries risks. An economic crisis in one state can
quickly spread to another, then another. The spread of economic difficulties can quickly lead to a
global economic crisis affecting small and large economies alike.
About Money:
The ability to print one’s own currency is one of the hallmarks of state sovereignty. Yet, in a
globalized system of trade and finance, businesses and individuals often need other states’
currencies to do business. Because of the nature of state sovereignty, the international
economy is based on national currencies, not a world currency. One of the main powers of a
national government is to create its own currency as the sole legal currency in the territory it
controls. The national currencies are of no inherent value in another country, but can be
exchanged one for another.
For centuries, valuable metals (such as gold and silver) were used as global currencies. Gold has
long been a key power resource with which states could buy armies or other means of leverage.
In recent years gold standard is not used (except some businessmen or investors still stock piles
of gold), and international monetary system is created. Today, those kinds of metals are no
different than any other commodities, since they frequently experience fluctuations in terms of
their value.
International Currency Exchange:
Each state’s currency can be exchanged for a different state’s currency according to an exchange
rate —defining, for instance, how many Canadian dollars are equivalent to one U.S. dollar. Most
exchange rates are expressed in terms of the world’s most important currencies— the U.S. dollar,
the Japanese yen, and the EU’s euro. Thus, the rate for exchanging Danish kroner for Brazilian
reals depends on the value of each relative to these world currencies.
The relative values of currencies at a given point in time are arbitrary; only the changes in values
over time are meaningful. For instance, the euro happens to be fairly close to the U.S. dollar in
value, whereas the Japanese yen is denominated in unit closer to the U.S. penny. When the value
of the euro rises (or falls) relative to the dollar, because euros are considered more (or less)
valuable than before, the euro is said to be strong (or weak). A strong currency makes imports
more affordable, while a weak currency makes exports more competitive.
Some states do not have convertible currencies. The holder of such money has no guarantee of
being able to trade it for another currency. Such is the case in states cut off from the world
capitalist economy, such as the former Soviet Union. In practice, even nonconvertible currency
can often be sold, in black markets or by dealing directly with the government issuing the
currency, but the price may be extremely low. Some currencies are practically nonconvertible
, because they are inflating so rapidly that holding them for even a short period means losing
money. Inflation reduces a currency’s value relative to more stable (more slowly inflating)
currencies.
Extremely high, uncontrolled inflation—more than 50 percent per month, or 13,000 percent per
year—is called hyperinflation.
In contrast with nonconvertible currency, hard currency is money that can be readily
converted to leading world currencies (which now have relatively low inflation). States
maintain reserves of hard currency. These are the equivalent of the stockpiles of gold in
centuries past. (Countries like China and Saudi Arabia still have gold reserves)
Fixed exchange rates -Here governments decide, individually or jointly, to establish official
rates of exchange for their currencies.
Floating exchange rates - now more commonly used for the world’s major currencies.
Rates are determined by global currency markets in which private investors and
governments alike buy and sell currencies. There is a supply and demand for each state’s
currency, with prices constantly adjusting in response to market conditions.
Major international currency markets operate in a handful of cities—the most important being
New York, London, Zurich (Switzerland), Tokyo, and Hong Kong—linked together by
instantaneous computerized communications. These international currency markets involve huge
amounts of money—a trillion and a half dollars every day—moving around the world. They are
private markets, not as strongly regulated by governments as are stock markets.
Managed float system - National governments periodically intervene in financial markets,
buying and selling currencies in order to manipulate their value. Such government
intervention to manage the otherwise free-floating currency rates is called a managed float
system.
Why currencies rise or fall?
In the short term, exchange rates depend on speculation about the future value of currencies. But
over the long term, the value of a state’s currency tends to rise or fall relative to others because
of changes in the long-term supply and demand for the currency. Supply is determined by the
amount of money a government prints. Printing money is a quick way to generate revenue
for the government, but the more money printed, the lower its price. Domestically, printing
too much money creates inflation because the amount of goods in the economy is unchanged but
more money is circulating to buy them with. Demand for a currency depends on the state’s
economic health and political stability. People do not want to own the currency of an unstable
country, because political instability leads to the breakdown of economic efficiency and of trust
in the currency.
States often prefer a low value for their own currency relative to others, because a low
value promotes exports and helps turn trade deficits into surpluses.
