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Example research essay topic: Capital Flows Developing Countries - 2,303 words

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The economic situation of the country we live in plays an important, I would say the most important, role in our every day living. It has been proved by many sociologists that even the way we think, perceive, and behave is affected by our financial status or the status of the society we live in. As everything in this world never remains static, so is the economy it constantly develops and changes. At the end of 20 th century the world economy entered a new stage of its development globalization. Unfortunately, not only it brought many benefits, like openness of virtually every national economy to others and disappearance of many trade barriers, but also its drawbacks of high exposures to various risks and global threats.

Following the rapid growth of many world economies during past 10 - 15 years, several financial crisis emerged throughout the globe. Globalization of production and investment in recent years has led to an enormous expansion of private long-term capital flows from advanced economies to developing countries, where the cost of the same type of production and its labor is much more cheaper than in the well-developed industrialized countries. There is, though, a serious disadvantage of investing in such regions high instability of local economies, and, therefore, great exposures to risks of losing the investments. While contributing greatly to economic growth and development in the countries receiving such investments, these capital flows have led to increased risks for multinational businesses, banks and the world financial system itself. The fluctuations in these flows and changes in the exchange rates of the key currencies has led to a series of disasters, which involve the economies of the countries that receive the capitals.

This crisis in turn can threaten political stability, as in the recent case of Argentina, where several prime-ministers being unable to tame the hyperinflation and panic, resigned within one week. In response, the leading industrial countries - the Great 7 - have embarked on an effort to reform the world financial system. Such reforms could reduce the disruption to trade and investment, and limit the human costs involved in the resolution of such crises. Recently there have been several proposals developed by high government officials, international currency speculators and academics on reconstructing the international financial architecture (Reforming World Finance). What was the common agreement is the need of a better control over destructive short-term capital movements.

The usual practice for this speculator y investment involves the concept of fast money. These investments usually remain in the economy only until the natural resources are available, or equipment is functioning properly. As soon as the additional investments are being required by such an environment, the investor withdraws his capital, causing a major distortion in the particular segment of the market, and a negative impact on subsequent inflows. Finally, there has been a good deal of discussion about reforming the IMF and the World Bank so that they can do a better job of preventing crises and managing them when they cannot be prevented. The problem here is in the fact that the world financial system has changed much more rapidly than the institutions that were created to help regulate it.

The world financial environment has been transformed from that of fifteen to twenty years ago by two phenomena. The first is the emergence of powerful new economic competitors in the world economy - the Asian tigers and several of the Latin American countries - with still relatively undeveloped domestic financial systems. The second is the return of the U. S. economy and financial system to a position of pre-eminence after a quarter of a century spent struggling with inflation, budget deficits and a weak currency. It must be absolutely necessary to mention the collapse of the communism regime.

After the USSR disappeared from the political map of the world, this one sixth of the earth began representing a unique economy. Though the countries, which now form the Commonwealth of the Independent States (CIS), are weak in the economic development, they still possess the potential of rapid growth. For example, along with its huge natural resources, Russia manages to play one of the leading roles in the energy market of the world. But without regulations and recommendations of the world community the country, which is in the desperate need of professional managers, it not only risks failing in its development, but also can tragically affect the rest of the economic world. The crisis of the late summer of 1998 proved that this chance is very possible. There are some - ironically including prominent currency speculator George Soros - who believe the answer lies in international regulation of global financial markets.

Contrarily, traditionalists, such as the G- 7 finance ministers, hope to make the markets more self-regulating (IMF Research Bulletin). Let us now examine the role of the two major world financial institutions (IMF and WB) in the regulation of the economy. For example, suppose the world's economies are divided into four groups: 1. the advanced industrial countries, with well-established financial markets and institutions; 2. the new economic centers (which in addition to the new OECD members includes the other Asian tigers as well as Brazil, Argentina and Chile), where banks and government financial institutions play a very large role; 3. the developing countries, the most important of which are India and China; and 4.

those countries that are not yet on a sustainable development path. For the last twenty years or so, the IMF has been involved, sometimes in a heavy-handed way, with the intermediate-term financing problems of developing countries. It has, from a macroeconomic perspective, provided economic discipline and guidance and aided in debt restructuring efforts. Occasionally, the IMF has provided short-term financing to an advanced industrial country as a means of coping with temporary balance of payments dis equilibria.

The World Bank focused its attention on long-term economic development in group 3. and 4. countries. For many years, its lending has been limited to large-scale infrastructure projects. More recently the Bank has been reaching out to fund projects that improve the environment or alleviate poverty. It borrows in advanced country markets to finance these investments.

Nevertheless, in the recent past there has been an example of the financial crisis that was not handled by any of the above-mentioned institution. Certainly none of the conferees in the Bretton Woods Conference in 1944, which founded the IMF and WB, had any idea of the enormous role private international capital flows - especially long-term ones - would be playing today. Although problems created by short-term capital movements have long been recognized, long-term capital flows and their reversals can create serious distortions as well. The crucial point is that for the new economic centers, private capital flows are all-important; and there is now an intense debate about whether monitoring them is a task that can be undertaken by a reformed IMF or whether creating new institutions is necessary. It may be, as Mr.

Soros believes, that financial markets are inherently unstable, but it matters greatly whether such instability can be self-correcting or not. It is now evident that many of the world financial crises were caused by the huge US current accounts deficit and following rises of the U. S. interest rates and associated swings in the value of the dollar.

Lets examine in more details: the low dollar (relatively to currency X) causes the increase in production and investment in the country of X, plus the rising demand for short-term borrowings in USD. When tighter money in the U. S. caused a resurgence of the dollar, there was a double problem of an increased dollar-denominated debt burden and capital outflows seeking higher interest rates. Thus, one crucial lesson from the experience of the last twenty years is that part of the answer to achieving world financial stability is to reduce the volatility of the key currencies and to mitigate the effect of swings in U. S.

interest rates. Regarding the ideas on how to prevent the financial crisis in the future, there are two distinct views Western and Japanese. The Western view emphasizes both more involvement of private investors and lenders in preventing crises and more encouragement to emerging market countries to pursue sound debt and liquidity management policies. The Japanese view, on the other hand, focuses on the need for greater exchange rate stability, international cooperation, and more control over capital flows -- especially those involving hedge funds. These differences are healthy and one can see a kind of collective evolution in thinking on the part of financial officials and observers over the last year. For example, when Japan and several ASEAN countries proposed the establishment of an Asian Monetary Fund in September 1997, U.

S. and IMF officials, who were caught by surprise and no doubt concerned about the potential challenge to U. S. leadership, responded quite negatively.

More recently, U. S. officials have softened their opposition -- perhaps recognizing that any institution that can improve dialogue between lending and borrowing countries and can mobilize substantial additional funds could contribute to the stability of the world financial system. Since much of the Asian Monetary Fund's capital would undoubtedly come from Japan, this would be consistent with the suggestion that Japan should devote part of its current account surplus to providing low-cost finance to the IMF to help countries in need of assistance. (Synnott 87).

Several practical steps have been taken since the aforementioned views been discussed. The Financial Stability Forum has brought together international institutions and national regulators and supervisors to develop guidelines for monitoring capital flows and countries' international liquidity positions. Regarding the Exchange Rate System: There is clearly a great desire in many parts of the world for greater exchange rate stability. There is no agreement, however, on how to bring this about. In the spectrum of commitment to the concept, the Japanese are most in favor of it. As Too Gotten said (IIMA Newsletter No. 9, 1999) "The United States, EU, Japan and the IMF should declare to the world that they recognize that stable exchange rates among the three major currencies - dollar, euro and yen - are vital to the global economy and that they are determined to cooperate with one another to realize this goal. " In December of 1999 Edwin M.

Truman, Assistant Secretary of the Treasury for International Affairs, quoted Article 4 of the IMF Agreement as "calling upon members to assure orderly exchange rate arrangements and to promote a stable system of exchange rates, not a stable exchange rate system" (Truman). In between Japan and the U. S. are European views that there is no ideal exchange rate regime for all countries and that currency pegs can only be useful in certain circumstances.

As the above discussion indicates, there have been quite a number of positive steps taken by governments, the IMF and market participants that should mitigate future crises. Still, greed and fear are basic human emotions and when combined with the intoxication of leverage, they are bound to lead to future booms and busts. What else can or should be done? One obvious step is to spread the lessons from the experience of these recent crises with increased communication and education. Perhaps one could build on the work of the Financial Stability Forum by sponsoring educational programs for commercial and investment bankers in both the industrialized and emerging market countries.

There is a school in Washington DC, run by the Federal Financial Institutions Examination Council (FFIEC), that could serve as a model. Another important step would be for the IMF to focus its efforts on financial problems, leaving long-term lending and concessionary financing for developing countries to the World Bank and other agencies. The essence of the proposal was for the IMF to restrict its lending to short-term loans for true emergencies and, after a five-year phase-in period, only to countries that met certain pre-conditions. This would be a radical departure from the current system where relatively long-term loans are made to developing countries, with the IMF remitting funds only as a long list of conditions are satisfied. The Meltzer Commission would get the IMF out of the business of "taking over" an economy in trouble and managing it according to the views of IMF bureaucrats.

It would also alleviate somewhat the moral hazard issue of investors putting short-term capital in a troubled country believing that the IMF would bail them out. What is critically needed is greater - not lesser - stability between the exchange rates of the key currencies - the euro, the dollar and the yen. This and continued growth in the major economies would go a long way toward ensuring that the prosperity of the U. S. "golden era" will spread to all parts of the world economy. I would like to conclude with the what Peter Drucker wrote fourteen years ago, and which is applicable even today: "From now on any country - but also any business, especially a large one - that wants to prosper will have to accept that it is the world economy that leads and that domestic economic policies will succeed only if they strengthen, or at least do not impair, the country's international competitive position. This may be the most important -- it surely is the most striking -- feature of the changed world economy" (Drucker).

Bibliography Drucker, Peter. The Changed World Economy. Foreign Affairs. April 1986: 26 - 29.

IMF Research Bulletin. 18 Nov. 2002. < web > Reforming the World Finance. Forbes Online. 19 Nov. 2002. < web > Synnott, T. W. International Monetary Reform: A Modest Proposal. New York: The Pacific Institute, 1997. Truman, Edwin M.

The Evolution of International Financial System. Remarks at the Institute for International Monetary Affairs Eighth Symposium in Tokyo. 1 Dec. 1999.


Free research essays on topics related to: monetary fund, developing countries, short term, exchange rate, capital flows

Research essay sample on Capital Flows Developing Countries

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