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Financial system
FS is the system that allows the transfer of money between savers
and borrowers. It comprises a set of complex and closely
interconnected fnancial institutions, markets, instruments,
services, practices, and transactions.
Financial systems are crucial to the allocation of resources in a
modern economy. They channel household savings to the corporate
sector and allocate investment funds among frms they allow
intertemporal smoothing of consumption by households and
expenditures by frms and they enable households and frms to
share risks. These functions are common to the fnancial systems of
most developed economies. !et the form of these fnancial systems
varies widely
Global fnancial system "GFS#
It is the fnancial system consisting of institutions and regulators
that act on the international level, as opposed to those that act on a
national or regional level. The main players are the global
institutions, such as International $onetary Fund and %ank for
International &ettlements, national agencies and government
departments, e.g., central banks and fnance ministries, private
institutions acting on the global scale, e.g., banks and hedge funds,
and regional institutions, e.g., the 'uro(one.
The Evolving Global Financial System
%y Richard Vedder
A specialist in economic history and public policy, Richard Vedder is a
distinguished professor of economics at Ohio University.
During the late 19th and early 20th centuries, there was little
coordination of international fnances. That changed
substantially after World War II, and the change is continuing
today.
The prosperity of the world has been immeasurably enhanced by the
growth in international economic relations ) trading in goods and
services, and the migration of labor, capital, and ideas across the planet.
The principle of comparative advantage suggests that the wealth of
nations is enhanced by each country speciali(ing in those economic
activities for which it has low opportunity costs. !et all this economic
activity must be fnanced, and the stability of the world fnancial system
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is critical to the continued growth in world trade. This is complicated by
the fact that most nations have their own currency, and that the rules
and regulations governing fnancial transactions vary widely between
countries.
*uring the late +,th and early -.th centuries, there was little
coordination of international fnances. The world/s fnancial capital was
0ondon, and most ma1or trading nations were on the gold standard,
meaning fnancial obligations were settled in currencies redeemable in
gold. If a nation used its currencies excessively to buy imports or invest
overseas, it lost gold reserves, forcing it to restrict money supply and
credit, usually causing de2ation. This made the country/s exports more
attractive and imports less desirable, thereby correcting the balance3of3
payment imbalance problem. $any scholars believe the system worked
reasonably well between +45+ and +,+6.
7orld 7ar I involved vastly larger international capital 2ows than ever
before, as 'uropean nations such as %ritain and 8ermany went deeply in
debt, borrowing heavily from other nations, especially the 9nited &tates.
The :ersailles Treaty "+,+,# provided for punitive reparation charges
against 8ermany, which then engaged in hyperin2ationary policies that
severely damaged that nation economically. ;n attempt to restore the
gold standard in the +,-.s was short3lived< %ritain left the full gold
standard permanently in +,3+, as did the 9nited &tates two years later.
The 8reat *epression of the +,3.s resulted partially from sharply
declining international trade caused, in part, by high tari=s. %eginning in
+,36, however, nations started to reduce ruinous trade barriers, led by
the >eciprocal Trade ;greements ;ct in the 9nited &tates. ?owever,
return to normalcy in international fnance was shattered by the
outbreak of 7orld 7ar II in +,3,, the most costly war ever fought, which
disrupted world trade and led to international cooperative arrangements
to facilitate economic stability and growth.
New International Institutions
; large number of ma1or developments between +,66 and +,@.
profoundly altered the nature of the international fnancial system.
Aoncerned about huge defciencies of hard currencies to pay for goods,
services, and the reconstruction of war3torn economies, %ritain/s Bohn
$aynard Ceynes and the 9nited &tates/ ?arry *exter 7hite successfully
proposed a new international fnancial order at the %retton 7oods
Aonference in +,66. The International $onetary Fund "I$F# and the
International %ank for >econstruction and *evelopment "7orld %ank#
were created.
The I$F would help nations with balance3of3payments problems and with
diDculties maintaining reserves consistent with agreed upon fxed
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exchange rates defned in terms of gold. 7hile the fxed3rate system
broke down after +,5+, the I$F continues with expanded responsibilities.
For example, it has played a key role in averting or reducing national and
regional fnancial crises, serving as a lender of last resort to nations in
fscal stress. The 7orld %ank originally provided loans to war3torn
countries to fnance reconstruction, although by the +,E.s the bank had
moved to broader lending to fnance new development pro1ects.
;lthough both the I$F and 7orld %ank are headFuartered in 7ashington,
*.A. "given ;merica/s prominence as a global fnancial power#, these
organi(ations are truly international in orientation and control.
The most important international organi(ation, the 9nited Gations, began
in &an Francisco in +,6E. 7hile not focusing primarily on economic and
fnancial issues, those issues have been important to 9.G. agencies such
as 9GAT;* "9.G. Aonference on Trade and *evelopment# and 9G'&AH
"9.G. 'conomic, &ocial, and Aultural Hrgani(ation#. The principle of
international assistance to meet fnancial strains received a prominent
boost with the 'conomic >ecovery Irogram "$arshall Ilan# of the 9nited
&tates "+,643+,E-#, which provided aid to many 'uropean nations. The
$arshall Ilan promoted international cooperation among the recipients
of its more than J+- billion in economic assistance in the form of loans.
The Aold 7ar after +,6E led to new forms of political and economic
regional cooperation as a by3product of the creation of two military
alliances, G;TH "Gorth ;tlantic Treaty Hrgani(ation# and the 7arsaw Iact
of nations allied with the &oviet 9nion.
$ore direct forms of fnancial cooperation began, leading to the creation
of a system of international fnancial arrangements. In +,65, the 8eneral
;greement on Tari=s and Trade "8;TT# began, which provided a
framework for a series of negotiations "such as the Cennedy >ound and
the 9ruguay >ound# that over the next half century led to dramatic
reductions in barriers to international trade, especially in goods and
services.
World Economic and Financial Integration
The fnancial stress of 7orld 7ar II contributed to the hastening of an
abrupt decline in colonialism, as literally do(ens of new nations emerged.
$ost dramatic, perhaps, was India/s independence in +,65, but large
parts of ;sia and ;frica also became independent nations in the next two
decades. This greatly accelerated the need for international fnancial
organi(ations such as the I$F and 7orld %ank. 'ach new nation typically
had to establish a currency that would gain widespread international
acceptance, needed to borrow considerable sums of money from foreign
nations despite uncertain abilities to repay loans, and often had to learn
to live within the rule of law and the discipline imposed by market
conditions. Hrgani(ations such as the I$F and the 7orld %ank became
increasingly important in facilitating these factors.
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The move toward world economicKfnancial integration was advanced by
important new institutions, especially in 'urope. ; 'uropean Iayments
9nion was developed in +,E. to facilitate ways of dealing with the dollar
shortage that made international payments diDcult. The Hrgani(ation for
'conomic Aooperation and *evelopment "H'A*# began to collect
uniform economic information on ma1or industrial countries, ultimately
including nations in ;sia and 0atin ;merica as well as 'urope and Gorth
;merica. $ost important was the Treaty of >ome, signed in +,E5,
creating the 'uropean 'conomic Aommunity "Aommon $arket#, which
has grown from a six3nation customs union in +,E4 to a -53nation group
that has integrated much of its economic structure into today/s 'uropean
9nion, including a common currency covering over half the area "the
euro# and an '9 central bank.
The 'uropean e=ort has been duplicated elsewhere on a much smaller
scale, with ;sian, ;frican and 0atin ;merican nations moving to integrate
their economies more regionally. The ;sian *evelopment %ank, for
example, is an institution of about 6. nations designed to further the
creation and free 2ow of capital in one important region of the world
"making over J+. billion in loans in -..4#, while the Gorth ;merican Free
Trade ;greement "G;FT;# of +,,6 extended the customs union approach
to the ;mericas.
Four further extensions of the world fnancial system are important. In
+,,E, the 7orld Trade Hrgani(ation "7TH# replaced the 8;TT, and it was
given wide authority to enforce international standards relating to trade
and cross3border fnancial dealings. The 8roup of &even "835# was
originally a meeting of the fnance ministers of seven leading industrial
nations, but it has expanded numerically, now encompassing -. nations
"the 83-.# that meet regularly to agree on policies governing
international economic and fnancial arrangements. Hther,
nongovernmental sponsored conferences, especially in *avos,
&wit(erland, bring together corporate and fnancial leaders, often sowing
seeds for later policy reforms. Finally, a number of multilateral tax
treaties have tried to standardi(e to some extent tax treatment for those
engaged in international activities recently, small tax3haven nations
have agreed to modify bank secrecy provisions to deal with tax evasion.
Coordination Is Key
The evolving global fnancial system has been both a cause and a
conseFuence of the rapid growth in globali(ation. For most nations,
international trade comprises a larger portion of output than a
generation or two ago. International capital 2ows have grown
extraordinarily.
%eyond that, institutions such as the I$F and 7orld %ank have been
critical both in terms of fnancing long3term development needs and
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stabili(ing shaky fnancial systems. Two noteworthy examples are the
fnancial crises of +,,4 beginning in ;sia but ultimately spreading
beyond, especially to >ussia, and the -..4 worldwide crisis that has
caused signifcant stress to fnancial institutions and economies
worldwide. In both instances, the I$F and 7orld %ank made important
fnancial infusions in stressed countries such as Thailand and >ussia. The
development arm of the 7orld %ank makes LsoftM loans of around J+.
billion annually, for example. ;dditionally, large3nation central bankers
and fnance ministers have met and coordinated the provision of credit
to ease panic and the potential collapse of ma1or banks, insurance
companies, and other fnancial institutions.
;s international economic and fnancial interaction grows, the need for
coordinated rules of behavior becomes greater than ever ) uniform
accounting rules, international standards of permissible conduct,
provision for emergency loans, and the like. Go doubt existing
institutions will continue to evolve, perhaps into a new umbrella
organi(ation encompassing all facets of fnancial regulation.
This article has been taken from 9& government website and can be accessed
at http<KKwww.america.govKstKbusiness3
englishK-..,K$ayK-..,.E+3++3.63wrybakcuh..+3-@+,-.html