Capital Market Integration

•Foreign Direct Investment (FDI) means the ownership of tangible assets in the home country by foreign firms or individuals. Example: IBM’s Paris operations, Ford Motor Facilities in the U.K. and Brazil, BMW’s plants in South Carolina, or Nissan’s China operations.

•The term capital market integration means the liberalization of restrictions on foreign ownership of financial assets (including equities).

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.

Rogoff’s views1

K. Rogoff.”International Institutions for Reducing Global Financial

Instability,” Journal of Economic Perspectives, Fall 1999:21-42

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.

•President Zedillo’s 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.

5.0

5.5

6.0

6.5

7.0

7.5

8.0

8.5

1/03/95 5/23/95 10/10/95 2/27/96

Pesos to the U.S. Dollar

Federal Reserve of New York

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.

25

30

35

40

45

50

55

60

7/10 8/07 9/04 10/02 10/30 11/27 12/25 1/22

Thai baht per U.S. dollar

Federal Reserve of New York

2.5

3.0

3.5

4.0

4.5

97:07 97:09 97:11 98:01 98:03 98:05 98:07 98:09 98:11

Malaysian ringgits per dollar

Federal Reserve of New York

800

1000

1200

1400

1600

1800

2000

7/28/97 10/06/97 12/15/97 2/23/98 5/04/98 7/13/98 9/21/98 11/30/98

Korean won per dollar

Federal Reserve of New York

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.

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.