What is international finance?Posted on: November 1, 2021
by David Diaz
International finance – or international macroeconomics – looks at various interactions between the financial markets of countries, such as foreign direct investment and foreign exchange rates.
The international financial system is an economic arrangement between the financial institutions of different countries that allows the transferring of funds between those countries. The financial institution that represents a country is known as a central bank and it manages its currency as well as upholding economic policy.
The central bank:
- Oversees the commercial banking system
- Controls the total amount of money that can be created and within the country
- Has supervisory and regulatory powers to ensure the stability of member institutions
The pandemic has highlighted many weak points in international trade, such as supply chains, as well as exacerbating precarious political situations including Brexit and the US-China trade dispute. To add to this, the shift in people’s spending patterns and loss of profits in areas such as aviation and travel have had a major impact. All these factors have an effect on the global economy and international trade and will continue to do so. The response from central banks is key to keeping the global economy afloat.
The World Bank’s response is based upon building a resilient and inclusive recovery, as inequality has become all the more evident while Covid-19 has continued to unfold. In 2020, the International Finance Corporation (which is a member of the World Bank Group) invested $5.6 billion to support the private sector in the Middle East and Sub-Saharan Africa. This was specifically in response to the slowdown of regional economies amid lower oil prices and the Covid-19 pandemic.
As we have seen with the energy crisis and climate crisis though, there is pressure to transition to renewable energy and move away from fossil fuels. This may cause issues for the economies of countries which rely heavily on trading in gas and oil. Despite these potential problems which will need addressing, financial markets and institutions did provide vital support to the global economy when the pandemic broke out in 2020. The report The Role of Financial Markets and Institutions in Supporting the Global Economy During the Covid-19 Pandemic was released by the Financial Services Forum, the Institute of International Finance, and the International Swaps and Derivatives Association in May 2021.
What are the sources of international finance?
Commercial banks, international agencies and development banks, and international capital markets all provide loans in foreign currencies which stimulate international finance.
The International Finance Corporation (IFC) finances private-enterprise investment in developing countries all over the world. It also provides advisory services to encourage development in nations that may lack the infrastructure or liquidity for businesses to secure financial backing. Economic development to help eliminate poverty is the IFC’s tenet, but critics claim that the focus is on profit rather than on the sustainability of projects.
What is the current system of international finance?
International finance is governed by the International Monetary Fund (IMF) and the World Bank. Both of these institutions have their roots in the Bretton Woods Agreement and System. The Bretton Woods Agreement was formed after a meeting of 44 countries at the United Nations Monetary and Financial Conference in 1944. Its name is due to the fact that the conference was held in Bretton Woods, New Hampshire. The aim of this international meeting was to create a reliable foreign exchange system that would help avoid competitive devaluations of currencies as well as supporting global economic growth in the wake of World War II. While the Bretton Woods Agreement was successful in some respects, the System was dissolved in the 1970s, leaving the IMF and the World Bank to uphold its legacy as pillars of international trade.
Economist John Maynard Keynes and American Chief International Economist Harry Dexter White were instrumental in initiating and designing the Bretton Woods Agreement and System. Keynes had wanted to establish a global central bank called the Clearing Union which would use an international reserve currency called the bancor, but White wanted the US dollar to play a major role. The final agreement and system were an amalgamation of their ideas but White won out on having all currencies pegged to the value of the US dollar, which in turn was pegged to the value of gold. This is where the phrase the “gold standard” comes from, because gold tends to retain its value and its price doesn’t fluctuate too much. Unfortunately, in 1971, President Nixon devalued the US dollar in relation to gold (the “Nixon Shock”) and by 1973 the Bretton Woods System collapsed. Countries were left free to select their own exchange arrangement for pegging their currency, including allowing market forces to determine its value.
Why study international finance?
An understanding of international finance and the effect of world events on risk management has never been more important. What is playing out globally is what many of the textbooks won’t tell you about, so although daunting, there is great potential for structural change and innovative solutions in the face of challenge. The international finance sector is an exciting space to work in, and has a demand for problem-solvers and astute decision-making in a rapidly changing world. From FinTech to asset management, valuations to venture capital, an MBA Finance can help you find your niche.
Some models and theories found in the study of international finance include:
- The Mundell-Fleming Model: This model focuses on the interactions between the goods market and the money market using the assumption that price levels of the goods remain fixed.
- International Fisher Effect: A theory which assumes that nominal interest rates reflect fluctuations in the spot exchange rate between countries.
- The optimum currency area theory: This states that particular geographical territories would maximise economic efficiency if all the countries or states in the region had a single currency.
- Purchasing power parity: A measurement of prices in different places using specific goods to compare the absolute purchasing power between different currencies.
- Interest rate parity: This is an equation used by investors to manage the relationship between currency exchange and interest rates creating an equilibrium state.
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If you want to sharpen your financial management skills, a postgraduate course such as an MBA Finance from the University of Wolverhampton could be for you. The university is QAA-commended and the academic year for a 2-year part-time course starts in November. Especially designed with employability in mind, this online Master’s course from this distinguished 80-year-old business school will successfully equip you to take on senior financial services management roles in corporate finance.
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