How does financial integration today differ from that of a century ago? Martin Wolf, Chief Economics Commentator, Financial Times Leverhulme Centre for Research on Globalisation and Economic Policy, School of Economics, Nottingham University April 30 th, 2003

2 Financial integration then and now Why is financial integration so controversial? How has financial integration evolved? What are the big differences between the financial globalisation of the late 19 th century and today’s? What are the big issues, especially for developing countries?

3 1. Why is financial globalisation so controversial? International capital flows are unstable and associated with crises They are also associated with constraints on policy makers This is the “trilemma”: one can have only two of capital mobility, a fixed exchange rate and domestic monetary autonomy Governments want all three. Since they cannot do so, the history of the past 120 years has been one of big shifts in the two they have chosen

4 1. Why is financial globalisation so controversial?

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10 1. Why is financial globalisation so controversial?

11 1. Why is financial globalisation so controversial?

12 1. Why is financial globalisation so controversial? Extraordinary instability in capital flows Leads to many twin crises These crises are costly

13 2. How has integration evolved? The three periods of international economic integration The rise, decline and rise of capital market integration

14 2. How has integration evolved?

15 2. How has integration evolved?

16 2. How has integration evolved?

17 2. How has integration evolved?

18 2. How has integration evolved?

19 2. How has integration evolved? The stock of foreign capital is now higher than ever before, in relation to world GDP Most of the foreign capital is short term Reliance on domestic capital also seems greater than before 1914 Net capital flows across borders are relatively small

20 3. What are the big differences? Shift from UK to US as hegemon and US move into deficit Marginalisation of developing countries Rise of multi-nationals Frequency of crises Move to floating exchange rates (and the meaning of the euro)

21 3. What are the differences? The hegemon

22 3. What are the differences? The hegemon The UK’s foreign assets were three times GDP in 1914 The US’s net foreign liabilities are a quarter of GDP today The UK was the world’s largest creditor The US is the world’s largest debtor

23 3. What are the differences? Emerging markets

24 3. What are the differences? Emerging markets

25 3. What are the differences? The rise of MNCs

26 3. What are the differences? Crises

27 3. What are the differences? Crises

28 3. What are the differences? Crises Crises are more frequent, but not more severe They are more than twice as prevalent as before The chief reason, suggests Eichengreen and Bordo has been the fragility of soft currency pegs (NBER Working Paper 8716) Banking problems were rarer before 1914 – so there were fewer twin crises – because exchange rates did not collapse

29 3. What are the differences? Exchange rates

30 4. What are the big policy issues? Global macro-economics and the US deficit Exchange rate regimes - the law of the excluded middle “Original sin” and foreign currency borrowing Capital controls and prudential regulation of the financial system Sovereign bankruptcy and debt workouts