Chapter 21. The Global Capital Market and the Gains from Trade. The global capital market Much of our discussion of international macroeconomics has taken the operation of the global capital market for granted. How does it operate? What is its structure? How has it evolved?
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The global capital market Trade.
– When we speak of the “gains from trade” we have an idea what this means in the goods market? But what does that phrase mean in the capital market?
– Why has global financial market activity vastly expanded in scale and scope since the 1960s?
– What costs and risks have been associated with that expansion, and can policymakers minimize such dangers, without also reducing the gains from trade ?
– Example: demand for US goods temporarily collapses; optimal for US agents to borrow.
– Example: when demand for GM cars collapses, demand for Toyotas rises; optimal for US agents to hold a mix of GM and Toyota stock.
The players Trade.
– Commonly take deposits and issue loans, either of which may go cross-border and be in home or foreign currency. May also make interbank deposits (“lending” to other banks, also potentially cross-border), and they may buy bonds.
– Actions depend on regulatory/legal scenario. Often more restricted at home than overseas.
– Overseas equity and debt (loan/corporate bond) issues.
– Not banks at all in the normal sense, e.g. investment banks.
– Specialize in underwriting and placing debt/equity issues of corporations and governments.
– E.g., J.P. Morgan, Goldman Sachs, Deutsche Bank; and (outside the U.S.) Citibank, Bankers Trust.
– Former are involved whenever they do ForEx intervention.
– Others are major borrowers using bonds or loans.
Risky business? inherent difficulties of international banking and systemic dangers
– Deposit insurance is impractical because of the size of typical offshore deposits (n.b. FDIC limit)
– There is no global “lender of last resort” to fulfill the role the Fed assumes in a liquidity crisis (why? there is no global currency they can print, and the reserves on hand, e.g. @ IMF, are woefully small).
– Reserve restrictions harder to police on offshore banks, and a first mover problem in imposing them (offshore banks profit from low/zero reserve requirements). Group action needed.
– Check back in 2006 or thereabouts.
– A supranational authority? Again, we expect implementation problems (e.g. Japanese banking)
– The extent of intertemporal trade?
– The extent of portfolio diversification?
– The ease with which capital can move?
– Open economies face a trilemma. Can only pick two from three (i.e., must drop one):