Capital Market Integration

1
Capital Market Integration

• Foreign Direct Investment (FDI) means the
  ownership of tangible assets in the home country
  by foreign firms or individuals. Example IBMs
  Paris operations, Ford Motor Facilities in the
  U.K. and Brazil, BMWs plants in South Carolina,
  or Nissans China operations.
• The term capital market integration means the
  liberalization of restrictions on foreign
  ownership of financial assets (including
  equities).

2
The U.S. Treasury and IMF are champions of
capital market integration. Mexico, Thailand,
Brazil, Malaysia, and the Philippines are
examples of nations that have eased restrictions
on inflows of financial capital. China and India
have resisted integration.
3
Rogoffs views1

• Capital market integration is a good thing
  because
• It allows financial capital to flow to areas
  where the rate of return of tangible capital is
  highest.
• It enables emerging economies to diversify the
  domestic output mix
• It accelerates the transfer of technology.

K. Rogoff.International Institutions for
Reducing Global Financial Instability, Journal
of Economic Perspectives, Fall 199921-42
4
The Mexican crisis

• President Zedillos decision to devalue the peso
  in Fall 1994 (apparently) precipitated a run on
  peso-denominated assets.
• The peso lost nearly 40 percent of its value
  against the dollar in the first 3 months of 1995.
  
• The Mexican government had substantial short-term
  debt denominated in dollars (tesobonos).
• U.S. Treasury Secretary Rubin spearheaded an
  effort to put together a bailout package.

5
Federal Reserve of New York
6
The Asian Flu

• This is the term used to describe the crisis of
  1997 and 1998 that involved S. Korea, Thailand,
  Malaysia, and Indonesia.
• The currencies of theses nations came under
  speculative attack, resulting in severe
  depreciation against the dollar, yen, and other
  currencies.
• The crisis choked off sources of short-term and
  long-term financing, precipitating an avalanche
  of business failures.
• Where debts were denominated in dollars or yen,
  repayment schedules measured in the home currency
  rose concomitantly.

7
Federal Reserve of New York
8
Federal Reserve of New York
9
Federal Reserve of New York
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What happened?

• The explanations proffered by economists and
  business writers included
• A banking sector captured by state enterprises
  or business oligarchies.
• Overexposure of banks to commercial real estate.
• A lack of financial transparency and conformance
  with international accounting standards.
• Cronyism, nepotism, and corruption.
• Mischief-making by the world community of foreign
  exchange speculators.
• Rogoff claims that real business cycle theory can
  partly explain the Asian slump of 1997-98.

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Proposals for Reform

• Deep pockets international lender of last
  resort.
• International financial crisis manager.
• International bankruptcy court.
• Global financial regulator.
• Global version of the FDIC.
• Movement to a single global currency.
• Controls on capital inflows.
• Controls on capital outflows.