Term Paper on "International Capital Markets"

Term Paper 13 pages (5359 words) Sources: 15 Style: APA

[EXCERPT] . . . .

International Capital Markets

Capital markets provide the means to raise capital for all ventures. The investments in the products available in the capital markets help generate funds and stabilize interest rates. It is also an indicator pertaining to the status of the economy as also the fluctuations in the capital market and lending rates creates far reaching changes in the economy in the short run. In the eighteenth and nineteenth centuries when most countries were the colony of the European countries particularly Britain, the capital markets were institutions of international nature. After the first and Second World War, the fragmentation and independence of nations created institutions in each nation with regulators within the nation. The modern era has seen the emergence of the international capital market which is a creation of globalization, highly advanced technology and increased cooperation between nations. It has been observed that the international market in the nineteenth century was more efficient and active than the current market. The reasons along with the history of the development of the market have to be gone into before professing an opinion on the hypothesis. The integration of the capital market can be assessed in terms of interest rate arbitrage. The transaction cost levels as well as the efficiency of the arbitrage determines the state of the capital market. The interest earned by banks cannot be a measuring rod for identifying the state of the capital market because of the diversity in the institutions and interest rates.

International Capital Market in the Nineteenth Century

The international capital market was a phenomenon that existed as far back as 1700 AD. Research based on computer analysis has proved this fact. ("Review: The Rise of Financial Capitalism: International Capital Markets in the Age of Reason (Studies in Macroeconomic History)," 1993) the activity in the markets were enormous from the centre to the edges, and the London city was that centre. The British exported large shares of capital. The other countries involved were Germany, France and other countries. This increased the British commitment in the global capital market and British investments in colonies grew. Before the First war it was estimated to be over fifty percent. At that time the investments were mostly portfolio investments. Britain purchased stocks and bonds, and this was the major form of fund flow to the Americas and Australia. Direct foreign investment was made into social overheads like railways and development. During the depression of 1920 and the Second World War, the system collapsed. Post war activity was more in direct investment and the United States has emerged as a more powerful player. The post war scenario witnessed the entire capital surplus of the nineteenth and twentieth century evaporates. The capital market has come back to the operative state ever since 1972 and is growing to the state it was in the nineteenth century. The amount of capital flow in the globe in the nineteenth century shows that the market was well organized at that period. The capital market integration was also taking place within the countries that participated during the period. (O'Rourke H; Williamson, 1999) "The integration of capital markets is usually tested with an interest rate arbitrage model even though much different financial assets must be compared.." (Neal, 1985)

The history of the international financial system and the efficiency factor ought to be contrasted and viewed in the current trends after globalization. In the nineteenth century, there were no international institutions to govern the international markets. The flow of capital in the global market was then largely a result of the regulations and market flows of the capital markets of the nations, and the international flow was attempted to be regulated by the creation of central banking systems which failed. After the Second World War, the attempts to create an international capital market were revived, but there was still no consensus on its control. Having given up on the issue, insistence is now on making international fund flow transparent and in line with the globalization. These issues were also present in the nineteenth century markets and are being discussed and negotiated anew in the modern context. (Flandreau; Holtfrerich; James, 2003) the index of the progress and success of the market is the movement of the price index. The price movements in two markets in a time series must be the same. If the random walk is not observed between both the markets then there is still an interest arbitrage to be exploited. In the London and Amsterdam exchanges in the nineteenth century the shares of British companies that were traded there substantially was based on price differentials. American shares traded in the European markets were regularly traded by European market participants after the London market closed. (Neal, 1990)

Transition from the Old to the new

The transition from the capital market of the nineteenth century to the modern market came about during the Great Depression and the Second World War. The capital mobility was a requirement that has expanded globally with different exchange rates that were agreed upon by varying regimes, and the standard rates as in the Gold Standard were followed to bring about the equilibrium. The Great Depression was a significant turning event in international capital markets. Therefore all the events and machinery that was inherent with the system prior to the depression must be considered as that following the earlier market forces and the emerging market that is now current must be seen as the result of the transition that occurred at the time. (Bordo; Goldin; White, 1999)

The Post War economy and globalization

It is to be observed that may of problems in the present day world in the capital market have their origins and counterparts in the nineteenth as well as twentieth century. International mobility of capital removes the relation between investment and domestic savings and help weaker economies profit from the flow. (Bordo; Goldin; White, 1999) the changes that have come about are vast. There has been marked increased of banking institutions by foreign ownership thus creating competition among banking institutions which to some extent has raised the efficiency and optimization. (Mathieson; Schinasi, 2000) International laws are also geared to meet the globalization needs and the municipal laws of the individual nations are being changed to accommodate the changes. The Civil rehabilitation law, for example is a corporate restructuring tool. It can be viewed as a smart way of encouraging risk retaking and the introduction of market to market accounting may be taken as a progressive step forward. (Mathieson; Schinasi, 2000)

The collapse of banks was something that was inherited as a legacy from the nineteenth century international capital market. The collapse of the 'House of Baring', the oldest bank in 1995 highlights the multiple financial catastrophes that was prevalent in the pre-war market. (Davis; Gallman 2001) Three hundred years previous, the same bank was in the same critical situation and in both the situations investments were made overseas in developing countries that were at the earlier times the colonies. The bank was, in 1890 involved Latin America, "particularly Argentina and Uruguay. One hundred and five years later the newspapers reported that Barings was a "strong niche player in the emerging markets of Asia, Latin America, Africa and Eastern Europe." (Davis; Gallman 2001)

The investment patterns in both cases were the same. The fact goes to show that there is not much change in the nature of the market although the terms and the theatre of the trade have become totally different. The institutional changes that occur in the long run bar the study of the market over long periods of time. The economist therefore has to study the short-range effects in the market and therefore very little is known about "the relationship between the institutional structure and the more traditional economic variables or about the way changes in the external environment - economic, political, social, and cultural - affect the institutional structure." (Davis; Gallman 2001) Douglass North makes such an attempt and his opinion is that the economic theories assume a static nature and to understand the transition and the modern market structure dynamic models have to be constructed to understand the institutional change and its effects. (Davis; Gallman 2001)

The modern capital market is more stable and accessible on account of the international treaties, understanding and the removal of the barriers to global trade. The Evolution of the European Union and the end of the cold war has heralded a new economy on the global scale which sees capital investment flow in the same manner as in the previous nineteenth century market, but with more governing and centralized agencies like the World Bank and the International Monetary Fund. Anne O. Krueger who was the First Deputy Managing Director of IMF is of the opinion that the situation is one where we are back to square one. It is very difficult for the third world countries to integrate into the new capital market but the countries can benefit from the… READ MORE

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