The last two decades has witnesses the improvement and growth in trade and development, changes in production and technology, improved innovation in telecommunication and computer application, and the general trend of liberalized markets, as well as the deregulation of markets both domestically and international. This has led to a closer interaction of international markets in the economic and finances, hence economic and financial globalization. The changes in the financial markets have led to the changes in the international business, operations, networks, as well as coming up with new challenges. The financial systems have been a subject of complete changes in both the developing and developed countries. The changes in the developing countries have been deeper since most of them were characterized by some form of repression and protectionism (Ghost, & Ortiz, p. 17). Therefore, the changes could mean a change from a highly state intervened to a market oriented or open economic situations. The financial market changes in the developing countries could thus be identified as a strategy to be used for the promotion of linkage of international financial markets, and the transition of the economies of the states to a higher economic status. It could henceforth be recognized as a way of changing the state from socialism to capitalism.
Globalization of financial markets have been rapid in the European continent, especially since the abolishment of the capital controls and the adoption of the single market program in the 1990s that was aimed at leveling the playing ground in the financial institutions (Buch, p.1). The developments fostered the integration of markets and mobility of capital in the European countries. The introduction of the euro in the European market raised the expectations of the increased market integration in the financial markets, bringing more competition in the banking sector, and the increased mobility of capital.
Globalization is thus the economic process that extends economic network across the whole world and integrates them into a synchronized economic system, destroying indigenous economies, shaking up domestic political orders, and creating regional economic blocks at the same time, (Schmidt & Hersh, p. 143).
The modern economic and financial heritage can be traced to the coming of the democratic capitalism, during the period of Adam Smith (Smith, N d. p 4). In the system, the state is not allowed to intervene in the economic affairs unnecessarily, and ensure that barriers that can prevent competition are removed as well as subsidies to favored people so as to ensure more competition in the markets, and more importantly, that the state should not discourage any person who wants to become a capitalist.
Capital mobility affects the effectiveness of fiscal and monetary policies in the area with a single currency system. “The effectiveness of monetary policy depends both on the speed with which monetary impulses are transmitted to each individual market and on the links between national financial markets”, (Buch, p. 1). In this case, the process of monetary transmission will be determined by the degree of market integration and the structure of financial markets. These activities affect the fiscal policy since the capital mobility tends to restrict the ability of the government in taxing the capital markets. There is however a different between the mobility of capital within a country and between countries. This could be due to the fact that the government can use indirect means as opposed to direct means to control the financial markets.
The current world financial markets are highly integrated with very complex transaction activities. “These phenomena are reflected in the cross-listing of securities in several countries, cross-country hedging and portfolio diversification and 24-hour trading in financial instruments at exchanges around the world”(Kester, p. 20). The changes in the financial markets have also seen the changes in the channels of financial markets changing. A major shift has been witnessed from the banks to non banks financial intermediaries, e.g. the brokerage houses, security firms, insurance companies, and the pension funds. Another shift has been from the loans to the securities and the use of foreign financial centers increasing. A surge in the use of new financial instruments (e.g. financial options, stocks, bonds & foreign currencies) has also been highly witnessed within these changes. These instruments are used to meet the needs and preferences of customers, as well as hedging their risks in the environment of fluctuating exchange rates, interest rates and stock prices. The current financial market place provides a greatly enhanced risk management properties, particularly for credit risk pool (Knight, 2006, Para 7). As Knight explained, over some few years ago, the trade in credit risk transfers e.g. credit risk swaps and asset backed securities have made it possible for the sharing of credit risk among the geographically dispersed firms and households that had never been witnessed before.
Globalization has also made the cross-boarder balance sheets to become tighter than had been in the past. This is one of the consequences of the free movement of capital markets. Many countries have come to link the globalization of financial markets with the residential property prices. The different of these countries’ and the United States’ is that the US has a bigger size and happens to be more transparency than most of the other countries (Knight, 2006, Para 28).
The financial markets have recently witnessed the frequent financial crisis. The welfare costs associated with the crisis has led to the re-evaluation of the oppressed financial systems to the international competition (Auenheimer, 2003, p. 79). In most of the industrialized countries, the financial markets are highly regulated due to various sophisticated reasons. However, the main objective of the regulation is to maintain stability of the financial markets. However, the regulations that work in the developed countries cannot work in the developing countries. This is due to moral hazard, asymmetric information and a variety of other potential markets failure. According to Auenheimer, “although there are a variety of welfare costs associated with these market failures, the dominant costs seems to be associated with financial crises”.
Capital flows has also been accelerated with the increased growth of international trade in goods and services. “Between 1970 and 2000, the value of world exports of goods and services increased twenty-five fold, accompanied by a fifty-fold increase in Foreign Direct Investment, (Rybinski, 2006, p. 2). The liberalization of financial markets enables the state to eliminate all the restrictions on the financial markets at both domestic and external markets. There have been changes in the financial services that are performed by the banks and non banking institutions. In some countries, the governments have removed or reduced the barriers that restricted the non-residents to access financial markets domestically (Rybinski, 2006, p. 6). Some of the financial changes in some countries ensued with the stability recommendations made by the World Bank and the International Monetary Fund (IMF). The consequences of these were the coming up of the “emergence markets” that have also played an important role in the global economy.
The financial globalization has led to increased financial crisis, implying that the world has shrunk due to the globalization (Mullincux & Murinde, 2003, p. 5). The origin of financial crisis was in Thailand, and then spread to the whole of East Asia, Latin America, Russia and the developed countries. Therefore, financial globalization is bound to engender worldwide, rather than local competition. In this perspective, it is expected that the banking industry in this century will be considerably more volatile than the past century. This is because with the frequently changing technology of computers, it will give the financial institutions the ability to analyze data about market changes easily and thus be able to react to the changes quickly. Furthermore, the changes in technology communications is also expected to transmit market development more quickly.
Internal rather than external finance is the major source of investment finance for both large corporate and small micro enterprises (SMEs). In all the countries, the SMEs are dependent on banks for external financial needs, and that banks are also the major financial suppliers after the non-financial business sector. The United States is the only country with a corporate bond as the alternative source of debt finance in the market. The introduction of the euro has however accelerated the development of the European corporate market. Banks remain the main supplier of debt finance in the US market, but it is only the large corporate that are capable of tapping the traditional bond markets, while the growth firms in the new technology sectors can increasingly tap the higher-risk junk bond markets (Mullineux & Murinde 2003, p. 18).
The “interaction in capitalist economies are too complex and changeable for probability distributions of future profit trends to be derivable by inference rather than subjective judgment”, (Baker, Epstein, & Pollin, 1998, p. 170). The supply side that the efficient market hypothesis taken to be the long term determinants of asset prices get deflected or reinforced with the variations in the distribution of political and market power, which affects the wage share, income distribution, and the level composition of real income. Professional traders in the financial markets have been speculating on how the other investors would react with the news about the changes in fundamentals, rather than how the changes might affect the equilibrium asset prices per se as a strategy that is more rational in the market.
This development however increases the speculative surge that increases the fragility of the banking system. The speculative positions that will be taken by the investors will augment the expected returns from debt leveraging. On the other hand, the wide swings of asset prices would increase liquid risk for long term investors, hence pushing them towards the investments with quicker payoffs. With higher leverage, faster turnover, and increased price volatility, the ability of lenders to collaterize credit effectively is weakened. The pessimistic news about financial markets can cause a selling wave and thus the fall in prices that is as a result of distress sale, settlement defaults and a drying up of liquidity as banks rise premia and cut back credit lines (Baker, Epstein & Pollin 1998, p. 170).
Another important thing about globalization and integration of international financial markets is that “there is always liquidity and appetite available…to diversify risk and invest in euros as the best alternative to dollars given that both currencies tend to be fully uncorrelated”, (Dehesa, 2005, p. 5). In the euro area countries, many countries prefer to invest in the government debt securities with a few basis points, and higher yields than those of Germany, since they know that their probability of default is zero, while Germany’s prospects are no better than those of other member countries, and that the financing costs are the same with the market liquidity.
In essence, the continued spread of globalization and deregulation in the financial services coupled with the information technology management of financial institutions are a powerful set of forces that are shaping and defining a unique way of the future of the world of financial system, as well as the national financial system. These forces thus raise various questions in the financial sector world wide. Such important question is the role of the financial institutions and more so, the role banks will have in future on the world’s financial system (Padoan, Brenton, & Boyd, 2003, p. 66). The banks have been facing stiff competition especially from the capital markets. This was experienced in the 1980’s when there were increased forces of deregulation, stiff competition, and technological changes. Furthermore, investment banks and brokerage firms were as well chasing companies and individual savers alike and propelling a formidable force in the growth of capital markets. This was thus a threat that would have ended up to the extinction of the traditional intermediary functions of banks.
Hence, the European commission has been pursuing a series of further deregulatory measures that were outlined in 1999 in the Financial Services Action Plan (FSAP), (Dunning & Boyd, 2003, p. 98). The majority of the measures are aimed at ensuring greater harmonization between the remaining national standards and regulations, although the existence of barriers to foreign investors in some countries is also a matter of concern. The introductions of the measures were primarily because of the belief that the enhanced financial development would improve the prospects of the economic growth in the region. According to Dunning & Boyd, “deregulation, technological change, globalization in the macroeconomic policies are all exerting pressure in the same direction on the structure of financial markets and the efficiency of financial institutions”.
With the increased liberalized financial markets along with the institutionalized, technological changes that have led to reduced transaction costs, and with the development of new transaction financial instruments, it has contributed to the increased level in international financial transactions. The tendency towards growing internationalization has been so far real, and forceful, but it is uneven, contradictory and certainly not linear (Went, 2000, p. 106). Another problem is that despite globalization in most other sectors, no fully integrated world economy has come into existence. According to Went, there shall be contradictions and conflicts in future between countries within countries, inside and among the trading blocs and governments and with, among and inside institutions such as the IMF, the EU, NAFTA, the World Bank, the G7, the WTO and the BIS. Furthermore, there is an increased fight that has been championed by the NGOs worldwide against the social and ecological effects of free trade and against the dictatorship of the financial markets.
The competition between the US and the Britain financial markets have led to many other countries increasing deregulation of their financial markets so as to be able to be on the same competitive edge with those countries. “This has led to prominent bodies such as the OECD and Bank for International settlements to predict that the liberalization trend is in fact increasingly threatening to undermine the dominant financial position of US and Britain”, (Boyer & Drache 1996, p. 2004). The bodies have also noted that the financial reforms in countries like Japan and Germany are likely to reduce the prominence of the dollar as the leading currency in the international finance. In the face of these developments, it is possible that the British and U.S officials will see that the financial liberalization is less favorable light. In fact some of the sentiments have already become real in the Britain’s financial circles as there is the increased competition from the European countries. As Boyer and Drache explains, “some form of co-operative regulation may begin to be perceived by the US and Britain as a way to lessen the competitive pressures on foreign financial authorities that are encouraging them to undermine British and American financial pre-eminence”.
There are two reasons that may make the US to consider such a stand in future. First, the US is the largest financial markets debtor in the world. Hence, this may encourage the United States to adopt a Tobin-style’s tax which promises to reduce the destabilization of the speculation against the dollar. Secondly, there have been increased sceptism within the US towards “free market finance”. This has been contributed by the fact that there is a belief that the free markets tradition in the US financial markets might be contributing to America’s economic decline.
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