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VISION

V/O

SYNC

10.00.31.00

Containers/ globe graphic 995

Today's world economy is becoming increasingly financially integrated. Funds are flowing in vast amounts across the globe.

00.54

SYNC

Jack Blum, UN Consultant

In today's world, the money moves instantaneously. The money is an electron somewhere on somebody's hard drive.

01.04

People/ numbers

Text: financial globalization

A US citizen can provide funds to a foreign entity, like Sony or Toyota, by buying stocks or bonds issued by these corporations. Or a Japanese citizen can lend money to the US government by purchasing US Treasury bills. This is all feasible through financial globalization, which is the removal of restrictions on the international trade of financial assets.

01.29

Fade to black & SUPER

Financial globalization: A controversial issue

01.36

Banks/ neons

Text: trade liberalization

Financial globalization is today perhaps one of the most controversial issues within international economics. Most economists accept that trade liberalization is beneficial, (that's the elimination of barriers to international trade in good and services). But policymakers and academics are divided over the benefits of financial globalization.

02.01

Early 20^th century US archive

/stock markets

Text:1870-1913/

 financial markets

Those in favour of financial globalization often refer to the vibrant global capital market of 1870-1913 as evidence of potential benefits. They also point towards the growth of international financial markets in the last couple of decades and the menu of different assets that it provides to investors.

02.24

NATSOT Indonesian military /food riot 

Text: capital flows

But opponents of financial globalization argue that sudden capital flows in and out of a country can wreck domestic economies and their financial systems, as happened in Indonesia -where a plummeting currency and massive capital flight led to food riots.

02.42

VOX POP Julia

We are the ones who have to put food on the table and it's increasingly difficult to do that!

02.48

Indonesia riots

Text: Asian financial crisis

Opponents also claim the global capital market allows a financial crisis in one country to ricochet to other countries. This happened most recently with the Asian financial crisis in 1997 which started in Thailand and spread not only to neighboring countries such as Indonesia and Malaysia - but also to far away countries such as South Korea, Brazil and Russia.

03.13

SYNC Stanley Fischer, Former First Deputy Managing Director, International Monetary Fund

The virulence with which it spread was extraordinary. After the Hong Kong dollar got attacked in October and then you saw Korea suddenly going down and Indonesia before that and there was one day on which Wall Street went down 500 points and then it went to Brazil and then it went to Russia... that was a lot!

03.35

1928 Wall St Crash archive 

Text: Great Depression

These crises had devastating effects on these economies comparable to the Great Depression in the 1930s.

03.45

SYNC Dr. Anthony Venables, London School of Economics

What we've learned from those experiences is the importance of having some sort of regulation on capital inflows until the domestic financial system has matured to the point where it can handle large inflows.

03.59

Fade to black and SUPER

The benefits of financial globalization

04.11

text:

"inter-temporal trade /risk diversification"

Increased international capital mobility has both potential benefits and costs. Most economists agree that the two main benefits are inter-temporal trade and risk diversification.

text: "Consumption smoothing" Tracking shot sports car

Aerials Nigeria oil

Inter-temporal trade allows for smoothing spending over time. For example, during his working life a person may reduce his current income and save in order to maintain a high level of consumption during retirement. Or a student may take out a loan so he can consume comfortably today and pay back this loan by forgoing future consumption when his income is high. In a similar fashion, a poor country like Bangladesh or Nigeria can borrow funds in the global capital market in order to spend more than its current national income level and repay these funds in the future when domestic income is higher.

05.06

US skyline - statue of liberty

Rich countries on the other hand can lend funds through the global capital market so that they can maintain the high level of consumption they enjoy now into the future.

05.18

text: "Investment and growth"

Inter-temporal trade only helps to smooth consumption if the funds a country borrows or lends are invested in profitable projects that bring a higher future income. A student may take out a loan to get an education, to provide a higher future income and the means to pay back the loan. This is less likely if she squanders the money on the high life. In the same manner, funds that flow into a low income country must partly be invested in the domestic economy in a way that promotes future growth. Of course, lenders are also concerned about the soundness of these investments since they expect to be repaid.

06.04

machines/ factories

text: "diminishing returns to capital"

But why should wealthy countries provide capital to less fortunate countries? The four decades preceding WWI show why international capital should flow from rich to poor countries and highlight the benefits of inter-temporal trade. The main economic powers at that time included the United Kingdom, Germany and France. They had built up high levels of capital through industrialization, but the returns on domestic investment had tapered off. This so-called diminishing returns to capital is a natural occurrence in an economy. Consider the effects of the first machine provided to a worker, which makes him much more productive. But with each additional machine provided, the worker's additional output declines. When a worker who already operates ten machines is given an extra machine, it will not make him much more productive.

06.59

SYNC Dr. Timothy Leunig, London School of Economics

So imagine that you built a complete road network across America, building more and more roads is going to be worth ever less, because you've already got the roads, that's diminishing marginal returns to capital.

07.11

Argentine steam train

As returns on investment declined in Europe lenders started to look elsewhere. The emerging economies of the Americas such as Canada, Argentina, and the US were in dire need of funds to build railroads and ports and link agricultural production to cities. So capital flowed in vast amounts from the UK, Germany and France directly into the Americas.

07.40

SYNC Dr. Colin Lewis, London School of Economics

There's a large flow of capital and also of people from Europe to the Americas in the late 19th and early 20th century.

07.50

GRAPHIC

In 1880 the UK's net outflow of capital was about 5% of its total income, which by today's measures is very large. By 1913 it had grown to almost 10%. As a result Argentina became one of the world's richest countries where per capita income grew from 40% of that of the UK in 1870 to 75% in 1913.

08.18

SYNC Dr. Timothy Leunig, London School of Economics

And this is an era in which countries trade primarily with countries that are very different from them, so Britain trades with the 3rd world, America trades with the third world & so on.

08.27

Text: First Age of Globalization

This episode of financial integration from 1870 to 1913 is referred to as the "First Age of Globalization," and is used as an example of how inter-temporal trade led to increased world growth.

Fade down/up

08.44

text, "portfolio diversification/risk reduction"

The second benefit from financial globalization is portfolio diversification. This refers to the reduced risk to a lender who places his savings in various assets with different characteristics - "not putting all his eggs in one basket". A global capital market means savers are not restricted to domestic assets, but can diversify their portfolio by investing abroad. This makes investors less vulnerable to fluctuations in the domestic economy.

09.12

Portfolio diversification has increased dramatically since the 1970s, as many countries have reduced restrictions on cross-border capital mobility. Banks and mutual funds allow even small lenders, such as private citizens, to invest in foreign stocks and bonds.

09.30

SYNC Scott Friedman, Day Trader

It's being my own boss, it's living the American dream. I make my own decisions, I trade my own money. It's up to me.

09.42

GRAPHIC

In 2004, the US foreign assets position was valued at almost 10 trillion dollars. That figure is staggering considering it corresponds to more than 80% of total US income in 2004. Compare that to 1982, when the US foreign assets position was only around one-fourth of the country's income. Proponents of financial globalization argue this increased diversification in asset holdings has greatly reduced risk in financial markets.

10.14

Fade to black & SUPER

The costs of financial globalization

10.24

Text: capital inflows and outflows/ income inequality/ tax competition

Opponents of financial globalization see international capital mobility as a destabilizing source in the global economy. There are three main reasons for this: excessive capital inflows and outflows, worsening income inequality and international tax competition.

10.45

SYNC Dr. Wilhelmus Spanjers, Kingston University

If capital is very mobile it may leave the country very quickly for whatever reasons.  And if this happens this has a big impact on the economy of those countries.

10.58

As developing countries have liberalized their capital accounts, foreign investment has increased. But it has also led to a number of devastating financial crises due to sharp capital flow reversals. When capital inflows quickly turn into capital outflows, the domestic financial system may collapse and no longer channel funds from lenders to borrowers, slashing investment and consumption, as happened across Asia in the late 1990s.

11.28

text: "asymmetric information"

Excessive capital outflows are due to what is known as asymmetric information that exists in financial markets. A lender must assess whether a borrower represents a good or bad credit risk.

11.41

Text:cultural differences/ physical distance

The borrower knows if she is going to invest the funds in a risky project, but the lender does not. Once there are rumors that a debtor is in trouble and may default, the lack of information makes creditors worry that this is endemic among all debtors and they begin to withdraw their funds. In a global economy asymmetric information tends to worsen with cultural differences and physical distance.

12.08

Text: Mexican peso crisis

Mexico banks/ Archive bank collapses and investors withdraw money

/ Carlos Cabal

The Mexican Peso Crisis in 1995 is a perfect example of how capital flow reversal spurred by asymmetric information can be devastating. In the late 80s and early 90s Mexico's banking system was privatized. At the same time Mexico was also liberalizing its capital account. But the banking system was incompetent at risk management, and supervision from the central bank was limited. As foreign capital flowed in, these funds were channelled into bad investment projects causing an increase in non-performing loans. Bankers like Carlos Cabal were accused of making hundreds of millions of dollars worth of bad loans.

12.50

SYNC Carlos Cabal, Former Banker

That is part of a campaign of political persecution that I suffer, and they use all the press to say look, this is the guilty one for the collapse of the economy.

13.02

SYNC Victor Fuentes, journalist "Reforma" newspaper

The amount of money that was involved, he was alleged to loan close to 700 US million dollars to companies related to him or to his family.

13.12

Mexico

Cabal was never convicted. But as the world interest rate rose and investors realized Mexico might default on its debt, a sharp reversal in capital flow occurred as capital left the country causing a collapse of the financial system and widespread loss in economic activity.

13.30

Asian crisis

The Asian crisis in 1997 displayed similar features as the Mexican Peso Crisis, but also illustrated how asymmetric information in the global capital market could cause a financial crisis to spread to other countries. When a country defaults on its debt, investors may withdraw their capital from neighboring countries with similar culture or economic infrastructure because of fear of future default, allowing the crisis to spread from country to country.

14.01

SYNC Jeffrey Sachs, Columbia University

Countries that were not suffering from the usual IMF-type disease of government overspending - Asia faced a financial crisis made in the private sector. Too much private money had come in. Suddenly huge amounts of private money were stampeding out of Asia and causing a catastrophe.

14.23

text: "Income distribution/

Wage inequality"

US factory in Mexico

Financial globalization can also cause problems for developed countries experiencing capital outflows. Capital outflows make workers less productive and therefore cause wages to decline. This may be especially true in industries that employ low-skilled labor. So companies such as car producers General Motors have moved some of their production to Mexico where the wages are lower, as has electronics firm Thompson-RCA. Because the effect is less predominant among high-skilled labor, wage inequality rises.

14.57

SYNC Dick Knoph,

Thompson-RCA

We had to leave because our competitors, virtually all of them, are in Mexico today. In reality they are paying a far reduced labour rate than we have to pay in the United States.

15.10

UK health system

text: "International tax competition/ lower taxes on capital/ higher taxes on labor/ reduce welfare state"

Financial globalization also poses problems for countries with large welfare programs. These welfare programs are funded by taxing both labor and capital. Without capital restrictions, capital tends to flow where taxes on capital are low, so countries may engage in tax competition in order to attract capital. Welfare states can't afford to reduce capital and must follow suit and lower taxes on capital. In order to maintain the welfare system, the lower tax revenues from capital must be compensated with higher taxes on labor. This is a problem for many European countries with large welfare programs and high taxes on labor. Financial globalization may therefore force these countries to reduce the size of the welfare state. Britain's National Health Service, for example, founded in 1948, is funded exclusively through taxes, and provides free health care for all. But with patients now suffering long waiting lists and being denied expensive treatments, many say Britain's welfare state is creaking at the joints.

16.21

SYNC Dorothy Griffiths, cancer patient

I do feel that as far as healthcare in the United Kingdom is concerned, from my own experience, it's a third world country.

16.31

Fade to black & SUPER

International capital mobility and the impossible trinity

16.41

MONTAGE through eras/

We have now looked at the main costs and benefits of a global capital market. But what is the role of economic policy? Why was it that international capital mobility prevailed before WWI, contracted after WWII, and was revitalized in the 1970s?

16.44

GRAPHIC "the impossible trinity"

The answer lies in the way international capital mobility constrains the options facing domestic economic policy. The fundamental trade-off that faces policymakers in a global economy has been labelled "the impossible trinity", as a country cannot simultaneously pursue exchange rate stability, independent monetary policy and perfect capital mobility. They can only achieve two out of three goals at any time.

17.31

SYNC Dr. Wilhelmus Spanjers, Kingston University

If you have free capital flows, you can use monetary policy either to have independent monetary policy, or to stabilise exchange rates, but not both of them at the same time. 

17.44

Text: "relative price of currencies/ Exchange rate stability"

Sao Paulo stock exchange

The exchange rate is simply the relative price of currencies. For example, it tells you how many euros you can buy for a dollar. It is determined in the foreign exchange market where trillions of dollars worth of currency are traded each day. Because it affects the prices of goods and services sold in the world market, the exchange rate is one of the most important prices in an open economy. For instance, a US importer of TVs from Japan will have to pay more for the imports if the Yen becomes more expensive in terms of US dollars. If the exchange rate fluctuates drastically, it may reduce the incentives for international trade.

18.23

SYNC Dr. Ali Shamsavari, Kingston University

Countries may want to stabilize their exchange rate because the exchange rate is a very important price, which regulates imports and exports of a country. The more stable it is, the more stable and predictable are the levels of imports and exports.

18.43

Sweden gvs

Text: return on assets

The exchange rate also affects the price of assets. If a Swedish citizen decides to buy a US government bond, she would first have to buy dollars so that she can pay for the bond and then, once the bond has matured, she would have to buy back Swedish Kronor. If the price of the dollar depreciates (its relative value declines) before the bond matures then the return on the bond in terms of Swedish kronor decreases. The exchange rate therefore also affects the expected return on assets. For these reasons it may be attractive for countries to try to stabilize the exchange rate in order to promote international trade and attract foreign investment so that the economy can grow.

19.28

SYNC Dr. Colin Lewis, London School of Economics

Where you have a fixed exchange rate, where you have something like a convertibility plan, governments can't create credit, can't create money, they lose monetary autonomy. It's not possible to have a fixed exchange rate and monetary autonomy.

19.45

text "fiscal policy and monetary policy"

A government has two major policy tools at its disposal: fiscal policy and monetary policy. Fiscal policy concerns government expenditures and tax collection, while monetary policy affects the interest rate in the economy. By lowering the interest rate the monetary authorities can expand the economy and put upward pressure on prices.  By raising the interest rate they can contract the economy and put downward pressure on prices.

20.14

SYNC Dr. Wilhelmus Spanjers, Kingston University

These interest rates and monetary policy are set to try to stabilise the economy in the short run.  You would want to use monetary policy to do so because this has a much quicker impact on the economy than fiscal policy would have.

20.28

In a country that allows full capital mobility, monetary policy also has a direct effect on exchange rates.

20.36

SYNC Dr. Wilhelmus Spanjers, Kingston University

The increase in the interest rates make it more attractive for foreign investors to invest in this country because they get a higher reward for doing so.  As a consequence there will be a higher demand for this currency and therefore its value will increase, that is the currency will appreciate.

20.53

text: "Capital mobility and exchange rate stability"

dollars/graphic

If a country wants to stabilize its exchange rate, and use its monetary policy to stabilize the domestic economy, it has to prevent capital from moving in and out of the country. If exchange rate stability and full capital mobility are considered essential, monetary policy becomes ineffective. This is because the central bank's only objective is to stabilize the exchange rate by setting the domestic interest rate equal to the interest rate of the country to which the currency is pegged.

21.29

Mexico banks

For example in the early 1990s, the Mexican peso was fixed to the dollar. If the US interest rate was raised, Mexico's central bank had to raise the interest rate as well. Monetary policy in Mexico was therefore effectively imported from the US. By pegging the exchange rate to a country with low inflation and solid monetary policy it is possible to reduce domestic inflation.

21.58

For example, Argentina suffered hyperinflation in the late 80s and early 90s, but managed to bring it down to single digits by rigidly pegging to the US dollar.

22.10

SYNC Dr. Colin Lewis, London School of Economics

You have lots of images of people protesting on the streets, images of people not knowing what was happening to their savings, losing everything as the local countries literally fell through the floor. After that debacle of hyperinflation, governments decided to stabilize the exchange rate.

22.31

US Fed

graphic

Finally, if a country wants to keep its monetary policy independence and allow for full capital mobility, it has to sacrifice exchange rate stability. The US, for example, does not stabilize its exchange rate. Instead the US allows for full capital mobility enabling the country to invest domestically using foreign funds, but at the same time controlling monetary policy to stabilize the domestic economy.  As a consequence, the foreign exchange value of the dollar fluctuates in response to changes in monetary policy and capital flows.

23.07

Fade to black & SUPER

The evolution of the global capital market

23.17

text: "The Gold Standard"

Turn of century archive/gold

During the period 1870-1913 the world was effectively under a fixed exchange rate system called the gold standard. Every currency was redeemable in gold at a fixed price; the dollar was 1/20 of a gold ounce, the pound sterling 1/4 of a gold ounce. Of course this also meant that the relative prices of currencies were also fixed. International trade in goods and services flourished and capital flows were arguably more stabilizing than destabilizing. Funds flowed into developing countries spurring growth and increasing demand for goods and services from developed nations.

23.59

Gold/ Great Depression stills

Today, there are still policymakers arguing for a reinstatement of the gold standard because of the stabilizing effect of these counter-cyclical capital flows. Inflation could not spiral (as the money supply was connected to the gold reserves) but it also meant that monetary policy couldn't be used to stabilize the domestic economy - to control unemployment for example. The loss of monetary independence would eventually prove to be costly as the Great Depression would show.

24.29

explosions

The outbreak of WWI effectively contracted the global capital market. The gold standard was abandoned as countries needed money to finance the war, so there was no external control on governments' spending. Instead they printed money to finance their budget deficits which led to hyperinflation in countries like Germany, Austria and Hungary.

24.51

SYNC Dr. Timothy Leunig, London School of Economics

World War I had two important effects on international trade - the first one was in the short run it simply knocked out the main traders such as Britain and Germany and that allowed other countries to come in - the most obvious one of those was Japan.

25.06

Great Depression

STILLS

By 1929 most market economies were back on the gold standard. Although there was an upsurge in global capital flows at the end of the 1920s, it halted as the world economy hit the Great Depression. The economic downturn was exacerbated because the gold standard prevented countries from using monetary policy to soften it. So nations began to abandon the gold standard to focus on domestic concerns.  The Great Depression caused a stark increase in protectionism and the global capital market contracted in the 1930s and didn't recover until the 1970s.

25.44

text: "Bretton Woods"

Bretton Woods archive/ IMF boardroom/ World Bank

Text: International Monetary Fund

In the summer of 1944, while WWII was still raging, representatives of 44 countries met in Bretton Woods, US, to shape the post-war international monetary system. Because of the devastating effects of the Great Depression -caused by the inability to use domestic monetary policy - they were determined to create a system that promoted trade through fixed exchange rates but would prevent full capital mobility in order to retain monetary policy independence. The Bretton Woods agreement fixed all currencies against the US dollar which was redeemable in gold at $35 per ounce. It also established three main international institutions: firstly, the International Monetary Fund (IMF), which lent foreign currency to member countries whenever they needed to finance a trade deficit (imports exceed exports) without tightening monetary policy.

26.44

SYNC Stanley Fischer, Former First Deputy Managing Director, International Monetary Fund

What I think you would see if there was no IMF, is that countries would go into default...it would take years and years to sort it out.

26.53

Text: World Bank

Secondly, Bretton Woods established the World Bank which would rebuild devastated economies after the war and help colonial territories develop.

27.02

SYNC James Wolfensohn, former President World Bank

What we want is for developing countries and the people in them to have a chance to work their own way out of poverty.

27.11

Text: General Agreement on Tariffs and Trade/ World Trade Organization

Thirdly, Bretton Woods established the General Agreement on Tariffs and Trade, or GATT, which was the predecessor to the World Trade Organization.

27.20

SYNC Julio Lacarte-Muro, GATT-WTO, Senior Official to GATT/WTO since 1948

The GATT brought order into the world jungle of trade. Because when you have the law of the jungle, the bigger animal eats the smaller animal. And it wasn't very much different in terms of world trade.

27.42

Text: 1973/ Bretton Woods Collapsed

International capital flows were initially almost nil but as international trade expanded, the need for growth-enhancing inter-temporal trade increased. In 1973, almost 30 years after its creation, the international monetary system set up in Bretton Woods collapsed and countries allowed their exchange rates to fluctuate.

28.03

text: "The Second Age of Globalization"

Oil rigs

Since the collapse of the fixed-rate system, policymakers have struggled to balance exchange rate stability and monetary policy independence in a world of increased capital mobility. In the 1970s, there was plenty of liquidity in the global financial system seeking out investment opportunities in developing countries. This was mainly due to the increased oil revenues for oil producing countries. Unfortunately, in Latin America large portions of these inflows funded risky investments and resulted in non-performing loans.

28.40

Empty factories/ layoffs

In the beginning of the 1980s, the world interest rate rose sharply and Latin American countries could no longer service their debts. In 1982, Mexico announced it couldn't meet its external financial obligations, throwing itself and many other developing countries into a deep economic contraction.  The international capital market collapsed and capital flows to developing countries were abruptly halted. 

29.08

In the late 80s and early 90s many developing and developed countries further liberalized their capital accounts. Again, capital started to flow across the globe and developing countries regained access to foreign capital.

29.22

GRAPHIC

Text: European exchange rate mechanism/ headlines "16^th September 1992: Black Wednesday"/

"UK crashes out of ERM"

But the 90s showed that developing countries were not the only ones vulnerable to currency crises. Several European countries were committed to a fixed exchange rate system, the European Exchange Rate Mechanism (ERM), with the German Mark at its center. When the German interest rate rose in 1992, the UK and others found themselves in an economic downturn and were reluctant to follow suit. Speculators realized this and bet against the ERM. The speculative attack was successful and the ERM broke down. Although, policymakers learned a great deal from the 80s and early 90s about the anatomy of crises, nothing prepared them for the 1997 Asian crisis that spread around the world.

30.22

Fade to black

30.27

International capital mobility brings increased investment, domestic growth, and risk diversification, but can also cause sharp capital reversals followed by significant loss in economic activity.

30.42

SYNC Congressman James Leach, Chair, House Banking Committee

Well, if you take Russia as a case model, capital flight has far exceeded foreign investment and so we've seen an implosion of Russian society, where the country's actually a poorer society than it was under communism.

30.58

The financial and currency crises of the 1990's in South America, Asia and Russia have led many policymakers and academics to question the advantages of the current global financial system for individual countries and even entire regions. The debate continues...

ENDS