Flotte’s Outlines

International Economics

General Economics

US Economics

2008 Financial Crisis

1. History
2. Global GDP
3. Globalization
4. Foreign Investment
5. International Trade
6. International Currencies
7. Global Financial System
8. World Bank and Foreign Aid
9. WTO and Trade Disputes

History

· From the reign of Constantine I in 306 to the fall of Constantinople in 1453, the Byzantine solidus was the basis of the economy throughout the Mediterranean and the Middle East.

· 400s-500s A barter economy replaces money in most of Europe. Trade falls drastically. Estates are either self-sufficient or trade locally. Bread and beer become the standard diet; oils, spices and wine disappear. Parchment replaces papyrus. Trade with Byzantium and the East dwindles but never fully stops. The vast majority of the population live on rural estates, with towns growing slowly only in Italy, where trade continued.

· 500-1000s Agricultural Revolution. The Slavs adopt a new heavy-wheeled plow which allows farming of previously unusable land. These spread across Europe to England by the 800s. In the 700s with the new plows, common-fields appear, first with 2 fields (cereal crops and fallow), then with the introduction of beans and peas, three-field rotation. The scythe replaces the sickle, and horse-shoes and harnesses all leads to improved agricultural productivity, deforestation and an increase in population . The center of population growth moves from the Mediterranean to the North. In the south many of these changes did not occur, although new crops (rice, vegetables) and irrigation techniques were introduced by the Muslims.

· 600-800s The Merovingian Franks mint silver coins, and Charlemagne divides a pound of silver into 240 pennies (denarii)

· 800s The Vikings promote trading along with raiding

1000-1500

· 1000-1350: A period of economic growth arises from the agricultural revolution of the preceding centuries. Population in Europe rises from 40 million to 75 million in 1350, only to be lowered with the bubonic plague to 50 million, where it remained until 1500. The growth was more significant in northern Europe than in the south, as more agricultural land was developed there.

· Development of towns and trade associations: As the population and trade grow, so do towns. By 1350 Paris, Venice, Florence, and Genoa have 80,000 people, London has 30,000. Few in Germany have over 10,000. Flanders (Ypres, Ghent) and Tuscany were large textile centers. Venice and northern Italy became a banking center. As shop-keepers transform into the merchant class they form guilds and associations – combines that monopolize a trade or profession, given by a royal charter or privilege. The bourgeois – burghers or town-dwellers, gain power.

· Feudalism: By 1200 50% are English peasants are free and 50% are serfs. Serfs may gain their freedom by buying it, by a charter from their lord, or by remaining in a free borough for a year and a day. A lord could turn a village in to a borough and free all its inhabitants.

· Mediterranean trade:

· The Crusades (1096-1291) stimulate demand for Eastern luxuries – silk, pepper, cinnamon, etc. These goods travel thru Italy to Northern Europe.

· Flemish or English cloth, German or Slavic slaves, travel thru Italy or Catalonia, to North Africa, the Levant, Constantinople, or the Black sea.

· In the 1200s the first overseas trade voyage was made from Italy to Bruges (before that it had been overland).

· Insurance grows out of shipping insurance.

· The salt trade is vital for preserving food, as evidenced in the number of English towns ending in “-wich” and German towns ending in “-halle”, both words for salt.

· Banking started with goldsmiths. They initially provided safekeeping services, making a profit from vault storage fees for gold and coins deposited with them. People would redeem their "deposit receipts" whenever they needed gold or coins to purchase something, and physically take the gold or coins to the seller who, in turn, would deposit them for safekeeping, often with the same banker. Everyone soon found that it was a lot easier simply to use the deposit receipts directly as a means of payment. These receipts, which became known as notes, were acceptable as money since whoever held them could go to the banker and exchange them for metallic money.

• Then, bankers discovered that they could make loans merely by giving their bank notes to borrowers. In this way, banks began to create money – “fiat money”. More notes could be issued than the gold and coin on hand because only a portion of the notes outstanding would be presented for payment at any one time. Enough metallic money had to be kept on hand, of course, to redeem whatever volume of notes was presented for payment.
• Other financial instruments develop, such as the investment contract where investors contribute money to share risk in the transport of goods. These were probably developed by the Genoese.

· c. 1100 King Henry I of England decided to try to wrestle the power away from the Goldsmiths by inventing the "Tally Stick" system. This system lasted 726 years until 1826. Notches were carved along side a wooden stick, indicating various denominations, or amounts. Then the stick was split down the middle, with each half holding a record. Then the King would hold one-half in safekeeping to avoid counterfeiting and he would "spend" the other half into the kingdom or economy, and they would circulate as money. As a matter of fact, shares in the Bank of England were purchased with a tallystick, by at least one of it's shareholders.

· 1100s Trade associations, or hanses, form in many German towns. Lubeck and Cologne gradually lead the development of an alliance of over 100 towns known as the Hanseatic League, which dominates Scandinavia and London. The term is first used in 1344. It began to lose power in the 1400s and was dissolved in 1669.

· 1200s The bill of exchange appears along with the first bankers in Italy.

· 1200s The Champagne fairs, the first international markets, were bimonthly cloth fairs in the towns of Champagne province, France. At their height in the 13th century the Champagne fairs linked the cloth-producing cities of the Low Countries with the Italian dyeing and exporting centers. The fairs were one of the earliest manifestations of a linked European economy. From the England, Scandinavia, and the Low Countries came woolens and linen cloth. From the Italy and Spain came pepper and other spices, drugs, coinage and the new concepts of credit and bookkeeping. Italian cloth merchants were able to exploit every exchange in the process and became the great bankers of the Late Middle Ages. Historians have dated the decline of the Champagne fairs to Champagne's conquest and inclusion within the Crown of France in 1284. A sea route from the south to the north was also established, inaugurated by the first appearance of Genoese ships in Antwerp in 1277.

· 1300s The trans-Saharan gold trade from Mali relieves a bullion shortage

· 1300s Cold weather causes poor harvests and famine in Europe and trade suffers. Many trade fairs fail. Cloth production in Flanders falls by two-thirds.

· 1347-1351 The bubonic plague (Black Death) spreads from China via rats on ships, to Cyprus, then Mediterranean countries, then Central Europe. 25 to 40 millions Europeans died. 200,000 villages are wiped out. Peasant revolts followed. Wages rose 50%, hastening the end of feudalism as labor shortages allowed laborers more freedom. Population and economic growth remain anemic until 1500.

· 1401 The first modern bank was formed, Bank of Barcelona. 1407 Casa di San Giorgio, one of the first public banks, founded in Genoa.

· 1487 The first global financiers, the Fuggers in Germany, begin business

· By 1500 much of modern accounting and finance has been developed, such as double-entry bookkeeping and joint-stock companies.

1500s-1800s

· Capitalism and international trade gradually grow. Self-sufficient estates and towns become enmeshed in a trade network, and the Age of Discovery begins intercontinental trade.

· Mercantilism is the most common economic policy for European countries. It holds that countries should aim to export more than they import, in order to accumulate gold and silver. It is dominant until Adam Smith’s Wealth of Nations is published in 1776.

· The commercial center of Europe moves from Venice (which is gradually eclipsed) and Italy to the Netherlands, England, and the Baltic for several reasons: the fall of Constantinople reduces Mediterranean trade routes, the new trade routes of the Atlantic and Pacific open up, the influx of American silver, and political troubles in Italy. Antwerp, the center of the 1500s, is overtaken by London and Amsterdam in the 1600s. The Dutch originally supply salted herring to Europe, then control the Baltic, then control international trade with trading posts around the world. The English grow to rival them, initially by supplying cod caught off Newfoundland, which was eaten on Fridays in Catholic markets.

Exploration and Colonization

· Imports from the New World included: tobacco, sugar, cotton, potatoes, corn, wheat. Exports to the New World: manufactured goods, slaves. Imports from the Far East included: tea, silk, porcelain.

· Sugar cane, rice, and the banana were brought to the New World by the Spanish and Portuguese, who also introduced such Old World crops as wheat, barley, citrus fruits, wine grapes, and many vegetables to the New World. They also brought pigs, sheep, chickens, horses, cattle, goats, and donkeys to areas where there were previously no domesticated animals.  From the Americas, the Portuguese took corn to tropical Africa, where it spread remarkably fast, and to Southeast Asia. Other American food plants followed:  New World beans and squash, tomatoes, peanuts, pineapples, potatoes

· Columbus brings tobacco back to Spain on his first voyage. From there tobacco growing spreads around the Mediterranean, and by the Spanish in the West Indies.

· In the 17th and 18th centuries Europeans began to consume exotic foods in increasing volume. Tea from SE Asia Coffee originally from Ethiopia, but spread to other places in Africa by Muslims who are forbidden to drink alcoholic beverages Chocolate from Mexico/Guatemala. And an increasing desire for cane sugar to produce rum. This led to the spread of the plantation system. Rum became an important trading commodity in the Atlantic area.  Corn and potatoes had a tougher go being accepted in Europe. Even today many Europeans consider corn as animal feed.  The potato encountered great opposition in the beginning but eventually became the staple food in Ireland and Central and NE Europe

· 1441 The slave trade is begun by the Portuguese; initially slaves are sold in Lisbon. In the 1500s and 1600s the trade shifts to Brazil and North America.

· 1500s The Portuguese settle trading posts in Africa, India, China, and the Spice Islands. After supplanting the Arabs, they dominate not only European-Asian trade, but trade within Asia. They also engage in piracy of “non-Christian” vessels. By the 1550s the Portuguese have sugar plantations in Brazil run with slave labor. The Portuguese found valuable sources of pepper in West Africa

· 1536 The first trading rights are given to the French by the Ottomans, who are outside local judicial power and hold property outside the sultan’s control.

· 1610 Tea is introduced into Europe

Banks and Corporations

· 1500s Inflation develops in Europe, with prices rising 400% in 100 years, aggravated by the arrival of gold from the Spanish colonies in America. As a result rents are increased and real wages fall.

· 1531 The first modern stock exchange is established in Antwerp

· 1553 The first stock company in England, the Russia Company, is formed

· 1566 The first foreign exchange market, The Royal Exchange, is formed in London

· 1557 Genoese lenders' indulgence of Philip II of Spain's expensive taste for warfare caused not only the world's first sovereign bankruptcy but the second, third and fourth as well.

· 1600s: 1600 English East India Company established. 1602 Dutch East India Company founded. 1604 French East India Company.

· The Dutch (in Indonesia) and English (in India) supplant the Portugese in trade dominance. Trade wars become more common, as three Anglo-Dutch wars are fought (1652-1674) over Britain’s decision to restrict imports to British ships, to encourage British shipping. Colonial and trade disputes replace dysastic disputes in European diplomacy and war.

· The world's first real corporations — the Dutch and English East India Companies, West India Companies and so on — were hardly the first big business partnerships, but they were new in several ways. They were anonymous, meaning that the partners did not all have to know each other. And they separated ownership from control: elected directors made decisions, while most investors had only the choice of accepting those decisions — or selling their shares. They were permanent: if one or more partners did want out, there was no need to renegotiate the whole arrangement. Finally, they were legal entities separate from any one owner, and thus had an unlimited lifespan. In contrast, the big trading partnerships of the 16th century and earlier were created with a planned date of dissolution — sometimes at the end of one voyage, sometimes after a set number of years — at which point all the firm's holdings would be liquidated and divided among the partners. The new firms, like modem corporations, were not designed to self-liquidate. Rather, they built up their capital over the years instead of distributing it back to its separate owners.

· The Dutch East India Company was originally chartered with a finite life — it was to be liquidated in 21 years — and with compulsory high dividends. At the same time, Asian merchants who handled trade over distances almost as long apparently had no need of the corporate form. This is all the more impressive as they often continued to outcompete the Europeans on routes between the Middle East, India, Southeast Asia, Japan and China all the way through the eighteenth century.

· What made the turn to permanent life of a corporation necessary? The East India Companies were not just licensed to do trade, but to make war. Their primary target was the Portuguese, who had created fortified colonies and used their navy to claim a monopoly on trade from Asia. And, in the Americas, the West India Companies faced similar Spanish and Portuguese claims (and much stronger colonies). To compete, the Northern Europeans needed to be capable of seizing and fortifying territory, as well as arming ships to patrol the waters. But this required enormous amounts of fixed capital in forts and ships, and for working capital, such as provisions. Indeed, the founder of the Dutch East India Company's empire in Asia, Jan Pieterszon Coen, waged an almost constant battle with Amsterdam for more capital. The company was rechartered rather than liquidated after 21 years, the directors got the flexibility to lower dividends when they needed to build up capital, and Dutch investors learned to operate like shareholders today.

· The idea of companies that took care of their own protection costs did not last. As the costs of war-making soared in the 18th century, both the English and Dutch companies staggered under the burden. When they tried to earn back these costs on goods they monopolized, they found themselves very unpopular — and often undercut by smugglers. (The English East India Company's problems with tea sales in America are only the most famous example.) By the 1830s, all these companies had collapsed. Their colonies had been taken over by their home governments.

· Over the next 200 years, almost no corporations of this type were created for either manufacturing or intra-European trade. The capital needs of virtually all production at this time were small enough that people could raise the funds they needed without taking the risks of dealing with strangers. It was not until the post-1830 railway boom that there was finally an industry that required so much capital — and so long a wait before the profits started to roll in — that the corporate form became really essential.

· 1601 Sweden was the first country in Europe to have paper money

· 1600s The Bank of Amsterdam becomes an international economic force.

· 1652-1675 The English, Dutch, Spanish, and Portuguese repeatedly fight over trade issues

· 1660 The checkbook is introduced by a London Bank (it had previously be used in Arabia in the 700s)

· 1694 The Bank of England is founded. The Bank of England is the central bank of the United Kingdom, sometimes known as "The Old Lady of Threadneedle Street"

· The bank was founded by the Scotsman William Paterson. After a series of wars with France and the Netherlands, England was in dire need of money. He proposed a loan of £1.2m to the government (only 750,000 Pounds was ever received); in return the subscribers would be incorporated as The Governor and Company of the Bank of England with banking privileges including the issue of notes by Royal Charter. Public finances were in so dire a condition at the time that the terms of the loan were that it was to be serviced at a rate of 8% per annum.

· The Bank of England has issued banknotes since 1694. Notes were originally hand-written, although they were partially printed from 1725 onwards cashiers still had to sign each note and make them payable to someone. Notes were fully printed from 1855. The 1844 Bank Charter Act tied the issue of notes to the gold reserves and gave the bank sole rights with regard to the issue of banknotes.

· When the idea and reality of the National Debt came about during the 18th century this was also managed by the bank. By the charter renewal in 1781 it was also the bankers' bank. In 1870 the bank was given responsibility for interest rate policy. From 1920 to 1944, the Bank made deliberate efforts to move away from commercial banking and become a central bank. In 1946 the bank was nationalized.

· 1700s Paper currency and bank checks are spread throughout Europe

· 1773 The London Stock Exchange is formed, although stocks had long been privately traded

Pre-Industrialization

· Coal: The use of coal as a fuel dates from at least 1100 BC. However, coal was not used widely until the Middle Ages, when small mining operations in Europe began to supply it for forges, smithies, lime-burners, and breweries. The invention of firebricks in the late 1400s, which made chimneys cheap to build, helped create a home heating market for coal. Despite its drawbacks (smoke and fumes), coal was firmly established as a domestic fuel by the 1570s. By that time, production in England was high enough that exports were thriving. Some of that coal eventually went to the American colonies.

· Putting-out system: An entrepreneur would supply home-workers with raw materials and then pay them for completed work.

· 1733 The flying shuttle makes weaving much faster. 1764 The spinning jenny accelerates the spinning of thread.

· 1780s Because of mechanization, the putting-out system is replaced by factory production where workers work in a centralized location with the necessary equipment.

1800s-1945 The Industrial Revolution

· In the 1800s the population of Europe doubles, and its standard of living far exceeds the rest of the world. This is the result of improvements in medicine and agricultural productivity.

· Feudalism gradually disappears, accelerated during the Napoleonic empire, until Russia eliminates serfdom in 1861.

· Peasants become wage-earners, as industrialization causes the development of factories and cities. The percentage of population that are farmers drops

The Industrial Revolution

· Term first used by French historians in the 1830s. Began in Britain, spread to Europe and the US.

· Based on inventions in the 1700s: Flying shuttle (1733), Spinning jenny (1760s). New machines were too big to drive by hand so factories were built near rivers to utilize water-wheels.

· Iron becomes the principle material used, and coal the main fuel, both for factories and machines, and for railways

· Historians disagree whether industrialism caused worker’s standards of living to rise or fall, but it did give rise to urban squalor and much social legislation was passed in the early 1800s. The Industrial Revolution gave rise to unions and socialism. Increased production allowed for a population explosion.

· The industrial revolution lead to an increased rate of imperialism – as new markets were found for its products and new sources of raw materials were found.

· 1775 The production of steam engines by James Watt leads to factories being located near coal mines.

· 1760-1800 Work is gradually transferred from cottages to factories. Workers now rely on salaries, instead of producing their own food and clothing. Industrial towns and cities grow around the factories. But until the 1850s factories employing over 50 people only exist in the cotton mills of Lancashire (England), most people still work in small factories.

· 1792 Coal gas is used for lighting for the first time.

· 1810-1820s Development of the locomotive and steam ship allow for rapid transportation of goods and materials. The cost of shipping drops 85%.

· 1830s -1920s Resentment against Industrialization leads to socialism and communism

· By 1850 Britain is the only fully industrial nation, due to a period of peace, strong government, early technology use, early agricultural surpluses, mineral resources, population growth, overseas commerce generating capital and an existing banking and finance system. It owned half the world’s ships and railway track. It smelted 5-times more iron than the US and 10-times more than Germany. It is followed by Germany, France, Switzerland, Belgium, and the US. By 1900 the US and Germany were the world leaders.

Lassez-faire economics

· 1776 Adam Smith’s The Wealth of Nations states that people acting in their self-interest benefits all, and that the “invisible hand” of the market leads to its own efficency. This becomes known as lasses-faire economics – where government intervenes minimally in the economy

· 1815 Nathan Rothschild's messenger beat Wellington's courier to London by 20 hours to announce Napoleon's defeat at Waterloo. This news-ahead-of-the-news allowed Rothschild's agent the opportunity to bait-and-switch the bond market by beginning a panic selling spree as if Wellington lost. Once the bond market collapsed, the agent reversed course and bought up the entire debt.

· 1815-1846 Free-trade advocates in Britain, led by businessman Richard Cobden, lobby for the repeal of the Corn Laws, which they view as government interference in the economy to benefit aristocratic agricultural interests. Free-trade is in general advocated by the industrialists and resisted by the landed aristocracy.

· Although other countries experimented with free-trade based on England’s success, they generally reverted to protectionism by 1900

1860s-1910s: First era of globalization

· Britain and Europe imported raw materials from its colonies – cotton, jute, timber, minerals, cotton, rubber, wool. In turn the colonies were used as emerging markets that bought manufactured products. Britain is the main importing and exporting nation. Overall Britain and Europe were each others biggest customers, however.

· Almost all currencies are on the gold-standard, with little fluctuation in exchange rates. Freight and insurance rates, intrest rates, taxation, and food prices decreased while real wages increased.

· On a global basis, there were several waves of sovereign lending which have all followed a cyclical pattern. A period of rapid expansion of loans was followed by defaults — and then a sharp decline. The first such wave occurred in the 1820s with loans to the newly independent Latin American countries. Most Latin American countries defaulted during the first part of the 19th century, as did a number of states of the United States in the 1830s and 1840s and during Reconstruction. And so did, once again, Latin American countries, as well as eastern Mediterranean countries in the last part of the 19th century. At the end of the 19th century, it was Argentina's, Brazil's and Colombia's turn to either default or refund their loans. So did Mexico during the Mexican Revolution and Russia after the Bolshevik Revolution. All of the Latin American states, much of eastern Europe, Turkey and China defaulted on loans during the 1930s. And most recently, in the late 1970s and 1980s, it was (once again) Latin American, but also eastern European and African states that failed to meet their original loan terms. Over the last two centuries, countries have relied on a variety of foreign lenders including other states and foreign bankers with varying degrees of closeness to their own governments. Regardless of the source of funds, default or renegotiation of the original conditions of the loans has always been an issue. The private banking families that dominated European international finance during the Renaissance dealt with risk by charging high interest rates. The international lenders of the 19th century, usually banks with close relations to their own governments, often sought control of specific revenue streams (such as excise taxes on basic commodities like salt or customs revenues from major ports.) In some cases, for instance the Ottoman Empire, foreign lenders established administrative structures which resembled in some ways contemporary international financial institutions. They not only collected taxes, but also promoted institutional change. By 1910, the Ottoman Financial Authority, which was run by foreign bankers, had more employees than the Ministry of Finance. During the 19th century, lenders also relied on military force — gunboat diplomacy involved taking control of custom houses, tariffs being the main source of state revenue, if a default occurred.

· 1857 Financial crisis in Europe and U.S.

· 1860s-1890s British financing of US railroads promotes capital flow into US

· 1860 Gladstone's budget and the Anglo-French Cobden Treaty codifies and extends the principles of free trade

· 1860s Japan is opened up to international trade

· 1869 The Suez Canal is opened, constructed by a French company. Egypt sells it shares to Britain in 1875.

· 1873 Economic crisis in Europe. U.S. establishes gold standard.

· 1891 First international copyright law. No currency controls are in place. No passports required until 1914

· Crises: Argentine railroad bonds, Latvian & German bonds.

· 1890s Free trade suffers somewhat of a setback, as some countries begin imposing tariffs

· 1914-1929 The era of global economy is ended by WWI, the Russian revolution, and the Great depression

1860s-1930s: Rise of communism & socialism

· 1830s “Socialism” appears in France as a movement of people opposed to free-trade, believing that it favors the wealthy

· 1848 Karl Marx and Friedrich Engels's Communist Manifesto. Marx is a historian and political journalist. After being exiled from Cologne, Germany for publishing an anti-government newspaper. Marx meets Engles, a manufacturer in Belgium, and moves to London. There Marx becomes foreign correspondent for the New York Tribune. He and Engles write the manifesto which both explains class warfare as a Hegelian dialectic, and give a practical plan for workers to unite against capitalists. He views communism not as morally right, as the Utopian socialists did, but as historically inevitable.

· 1864 Marx founds the First International in London, and is its secretary.

· 1867 Volume I of Marx's Das Kapital

· 1870s Marx transfers the Secretariat of the International to the US

· 1889 Second (Socialist) International founded in Paris. Anarchists are expelled. Its permanent headquarters are moved to Brussels, where Germans dominate it. By this time, some (called “Revisionists”) advocate using the vote to futher socialist aims, rather than Marxism’s violent revolution. The Second International condemned Revisionism, although socialist political parties continued to use it in practice

· 1900s The Fabians, a group of intellectuals in England, including GB Shaw, Beatrice & Sidney Webb, advocate socialism

· 1919 Third International (Comintern) establishes Soviet control over international Communist movements.

1930s: The Great Depression

· 1929 On October 4 (“Black Thursday”) the US stock market crashes, beginning of the Great Depression. Unemployment near 25%, GNP decreases.

· 1931 Britain abandons the gold standard

· Encourages development of totalitarian states

1930s(-1970s): Spread of socialism & mixed economies

· John Maynard Keynes. Cambridge economics professor & successful investor. Promoted government fiscal and monentary intervention to keep economies stable.

• A product of Eton, Cambridge, and the British Treasury, he was also a member of the Bloomsbury group. A top academic and public policy polemicist, he also ran an insurance company and made a fortune in the markets.
• Keynes changed how economists study business cycles, price levels, labor markets, and economic growth. His insights have largely kept downturns in the business cycle over the past half century from turning into depressions. Keynes's lasting achievement is the invention of macroeconomics.
• Keynes can lay claim to playing a crucial role in saving capitalism during the Great Depression. Despite millions of unemployed workers in the industrial nations, economic orthodoxy demanded that government do nothing or, worse yet, tighten the purse strings. Little wonder that the totalitarian solutions of fascism and communism exerted such pull. U.S. Treasury Secretary Andrew Mellon expressed a widespread sentiment among elites when he said in 1930 that the Depression would “purge the rottenness out of the system. High costs of living and high living will come down. People will work harder, live a more moral life. Values will be adjusted, and enterprising people will pick up the wrecks from less competent people.”
• 1919: The Economic Consequences of the Peace. Said the conditions on Germany were too draconian. Made him famous.
• 1936: General Theory of Employment, Interest and Money. Stated governments should regulate economy to deliver full employment through fiscal policy (social spending, state-owned industry, taxes). He persuaded a generation of thinkers and leaders to abandon a near-theological belief in balanced budgets. He showed how economies could get trapped in recession or depression -- and argued that government could break the spiral by borrowing to finance public spending that stimulated consumer activity and restored business confidence.
• Keynes influences Harvard economists like John Kenneth Galbraith and the FDR administration during the New Deal
• Keynes champions the International Monetary Fund and the World Bank at the Bretton Woods conference in 1944

Post-World War II

The US and USSR become the principal economic forces after World War II, while Europe loses its dominance.

· 1947 Global food crisis: European wheat is production cut in half.

· 1947 The Marshall Plan is initiated to rebuild Europe while preventing the spread of communism

· 1947 The Bretton Woods Conference is held in New Hampshire with the goal to promote free trade between all countries, based on the belief that economic protectionism had led to WWII. 23 countries participate. It :

• Fixes exchange rates (pegged all currencies to gold) and institutes strict controls of capital
• Creates the International Monetary Fund and World Bank to make loans to developing countries
• Established the International Trade Organization (ITO). The ITO was rejected by the US Congress but President Truman used executive authority to implement a stopgap measure of ITO – the General Agreement on Tariffs & Trade (GATT)

· 1950s With the cold war, economic growth and a social safety net, the threat of communism recedes in Western Europe. Western Europe enjoys 5-6% GDP growth, unemployment <1%, and by 1955 it is at prewar levels of production. Defense spending due to the cold war primary is the primary engine of growth

· 1950s to 1970s Keynesian economics and socialism dominate Western Europe & US.

• Encouraged by WWII and government-directing rebuilding afterwards, governments control the economy with no effective private sector or international trade.
• Pure capitalism had been discredited by the Great Depression as morally objectionable, while the Soviet economy enjoyed economic prestige after WWII.
• 1950s-1960s Economic expansion validates Keynes, who makes the cover of Time magazine in 1965.
• 1970s The rise in oil prices sends the US and Europe into recession with rising unemployment and inflation (stagflation). In the US Nixon attempts to impose wage and price controls but they fail to control inflation or improve unemployment. This leads to downfall of Keynesianism and the end of fixed-exchange rates and controls of capital.
• In the 1970s the UK is periodically crippled by frequent labor strikes. This eventually leads to a backlash against unions.

· 1976-1980 Inflation and unemployment remain major problem during the Carter administration despite his Keynesian methods to fight them

· 1979 Paul Volcker takes over as Federal Reserve Chairman; his tight-money policy and raising of interest rates triggers a recession but he successfully lowers inflation.

· 1980s Free-market economists dominate Reagan administration and the Thatcherites in England.

• Founded on the theories of Friedrich von Hayek:

· 1919 While a student in Vienna Hayek is influenced by the libertarian economist Ludwig von Mises

· 1944 Hayek's Road to Serfdom criticizes economic planning by the state, but will influence only a minority for three decades. He writes it while at the London School of Economics.

· 1947 Hayek organizes the Mount Pelerin conference in Switzerland to combat central planning. The Institute of Economic Affairs is formed in London based on his ideas.

· 1950-1970 Hayek teaches at the University of Chicago – founding the Chicago School of economics

· 1974 Hayek wins the Nobel Prize. 1976: Milton Friedman, his student at the University of Chicago, wins the Nobel Prize

· 1974 Conservative MP Keith Joseph revives Hayek’s ideas in the UK with speeches and pamphlets. He influences Margaret Thatcher when she is a new MP.

• 1974 Deregulation of the US airline industry begins
• 1974-1975 In Chile Auguste Pinochet hires the University of Chicago economists, the "Chicago Boys", to restructure the economy in “Shock therapy”, a drastic free-market approach. The government slashes welfare programs, liberalizes trade, and deregulates the financial sector and the economy is successfully revitalized.

· 1979 Margaret Thatcher fights against striking coal miners and begins privatization of nationalized industries – eventually 2/3 are privatized

• 1980 Ronald Reagan institutes “Reganomics” supply-side economics

· 1980s The Democratization of Finance

• 1950 The credit card is introduced in the US
• Before the 1980s most large domestic and international lending had been done by big commercial or investment banks, insurance companies, etc.
• Popularization of finance began with the introduction of corporate bonds in 1960s, followed by securitization of mortgages in 1970s.
• In the 1980s mutual funds and junk bonds make investing by the middle class easier and increased the available financing of new startup companies
• 1980s Junk-bonds are popularized by Michael Milken after he showed that below investment grades companies paid 3-10% higher interest but went bankrupt only slightly more often.
• 1980s Corporate takeovers streamlined American economy for globalization

· 1980s Beginning of a global economy

· 1987 On “Black Monday” October 19 the US stock market drops 508 points (23%). By the end of October, Australia had fallen 42%, Canada 23%, Hong Kong 46%, and United Kingdom 26%.

· 1950s-1990s Neocolonialism is a term used by Marxists to describe the operations of international capitalism since the disappearance of the colonial empires.

· These critics allege that the capitalist powers, particularly the US, aim to control other countries by indirect means. In lieu of direct military-political control, they use indirect economic and cultural influences that result in de facto control over the targeted nation. It is through economic aid, multinational corporations, and through international financial agencies like the International Monetary Fund, which, it is said, gain control over economic policy in exchange for the re-financing of old loans. A variant of neocolonialist theory is "cultural colonialism," where control is through cultural means, such as media, language, education and religion, presumably for economic reasons.

International Business

Exporting

· Direct exporting: Company signs sales contract with foreign purchaser

· Indirect exporting: Company appoints foreign agent or distributor

· Foreign Manufacturing: manufacturing in foreign county

o Licensing: company license its products to be produced by foreign manufacturers

o Franchising

o Wholly owned subsidiary or joint venture

Importing

· Import controls imposed by governments include prohibitions, quotas, and tariffs

o Quotas: limits on the amounts of imported goods

o Tariffs: taxes on imports

o Dumping: selling exports at “less than fair value”, i.e. below production costs

Global GDP

Ÿ Since 2000, world GDP per capita has grown by an average of 3.2% a year, thanks to the acceleration in emerging economies. That would beat the 2.9% annual growth during the golden age of 1950-73, when Europe and Japan were rebuilding their economies after the war; and it would certainly exceed growth during the industrial revolution. Between 1870 and 1913 world GDP per capita increased by an average of only 1.3% a year. This means that the first decade of the 21st century could see the fastest growth in average world income in the whole of history.

Ÿ Over the last 100 years people of all regions of the world on average improved their standard of living. The average income of Americans and Europeans quadrupled, that of Sub-Saharan Africans doubled, and the Japanese improved their standard of living more than any other nation in the world. In particular, the number of destitute people declined during the last quarter century — the first such decline in recorded economic history.

Ÿ Developing countries continue to grow faster than high-income countries

Ÿ Developing countries will not be prepared to go on financing America’s massive current-account deficit for much longer. At some point, therefore, America’s cost of capital could rise sharply. There is a risk that the American economy will face a sharp financial shock and a recession, or an extended period of sluggish growth. This will slow growth in the rest of the world economy. But America is less important as a locomotive for global growth than it used to be, thanks to the greater vigor of emerging economies. America’s total imports from the rest of the world last year amounted to only 4% of world GDP. The greater risk to the world economy is that a recession and falling house prices would add to Americans’ existing concerns about stagnant real wages, creating more support for protectionism.

Reasons for Global GDP Growth:

Ÿ Globalization: increase in international trade

Ÿ Information Revolution/ Internet: Improved communications and efficiency

Ÿ Just-in-time inventory systems led to efficiency throughout the supply chain and huge cost savings. New inventory technologies allowed businesses to react more quickly to falloff in demand.

Regional GDPs

· The world share of the Western powers GDP declined from 53% to 43%. After 1950, Japan increased its share of world GDP from 3% to 8%. The rest of the world increased its share of world GDP from 45% to 50%.

· The economic weight of the United States did not change appreciably during the 20th century: after increasing from 19% in 1913 to 27.3% in 1950 it fell to 22% by 1998. Western Europe’s share of global GDP declined from 34% in 1913 to 20% in 1998, largely as a reflection of slow population growth. Asian countries increased their share of world output — as did China, but only slightly. Latin America increased its share by only 4%, reflecting rapid population growth. Between 1913 and 1950, the share of the former Soviet Union and Eastern Europe remained at 13% — but fell to 5% by 1998.

· In spite of China’s growth miracle, growth since the end of Mao’s era brought China’s per capita GDP back to where it was before World War I. Since 1998 however China has improved is position vis-à-vis the United States.

· During the Cold War, whole regions moved together in economic development. Now we are seeing differences within regions: Tunisia, Taiwan, Scotland, Ireland, and Finland are experiencing rapid growth compared to their neighbors.

o Also see differences within countries, “hot zones”: Shanghai & coastal China, Bangalore in India, northern Italy, Tel Aviv, Beirut, Silicon Valley, Boston (Route 128)

· Rich economies can grow only by inventing new technology or management methods. Poor countries, in theory, should find it easy to grow faster because they can boost their productivity by adopting innovations from richer ones.

Emerging Economies

· Before the steam engine and the power loom gave Britain its industrial lead in the late 19th century, China and India were the world’s two biggest economies. Estimates suggest that in the 18 centuries up to 1820 these economies produced 80% of world GDP, but by 1950 their share had fallen to 40%.

· In 2005 the combined output of emerging economies reached an important milestone: it accounted for more than half of total world GDP (measured at purchasing- power parity, at market exchange rates their share is still less than 30%). This means that the rich countries no longer dominate the global economy.

· The International Monetary Fund forecasts that in the next five years emerging economies will grow at an average of 6.8% a year, whereas the developed economies will grow only 2.7%.

· About one-third of the projected increase in the dollar value of the emerging economies’ GDPs comes from real currency appreciation rather than real growth. As countries’ relative productivity rises, their exchange rates should move closer to purchasing-power parity.

Reasons for growth

· Because they start with much less capital per worker than developed economies, they have huge scope for boosting productivity by importing Western machinery and technology. When America and Britain were industrializing in the 19th century, they took 50 years to double their real incomes; today China is achieving the same feat in nine years.

· Developing countries have also benefited from America’s consumer-spending binge, which has sucked in imports; and from historically low global interest rates, which have lowered debt-service costs.

· But favorable external factors played only a minor part in the revival of emerging economies. Much more importantly, their underlying economic health has improved. Structural reforms and sounder macroeconomic policies have made them more able to sustain robust growth and to withstand adverse shocks. Inflation has been tamed and many countries have trimmed their budget deficits; indeed, on average they are running much smaller deficits than the rich world.

· Emerging economies are also much less dependent on foreign capital than they were a decade ago, leaving them less vulnerable to the whims of investors. As a group, they are in their eighth year of current-account surplus, having been in deficit for most of the previous 20. Their average ratio of foreign debt to exports has tumbled from 174% in 1998 to an estimated 75% this year. Foreign-exchange reserves have swollen to nine months’ import cover, compared with only five months’ just before the Asian crisis in 1997. And most emerging economies no longer fix their currencies at the grossly overvalued rates that contributed to past financial crises. If anything, the currencies of China and some other Asian countries are now undervalued.

· Governments that still have large budget deficits, notably in central and eastern Europe, must wield the axe. Others, such as China, need to clean up their banking systems. Almost everywhere, governments can do more to free up markets and reduce their own meddling. In Asia, that includes allowing greater exchange-rate flexibility.

Effect on world economy and developed countries

· Emerging countries are looming larger in the world economy by a wide range of measures. Their share of world exports has jumped to 43%, from 20% in 1970. They consume over half of the world’s energy and have accounted for 80% of the growth in oil demand in the past five years. They also hold 70% of the world’s foreign-exchange reserves.

· The developing countries also have a far greater influence on the performance of the rich economies than is generally realized. Emerging economies are driving global growth and having a big impact on developed countries’ inflation, interest rates, wages and profits. Their influence helps to explain a whole host of puzzling economic developments, such as the record share of profits in national income, sluggish growth in real wages, high oil prices alongside low inflation, low global interest rates and America’s vast current-account deficit.

· The integration of China and other developing countries into the world trading system is causing the biggest shift in relative prices and incomes (of labor, capital, commodities, goods and assets) for at least a century, and this, in turn, is leading to a big redistribution of income. Because these economies’ global integration has made labor more abundant, workers in developed countries have lost some of their bargaining power, which has put downward pressure on real wages. If wages continue to disappoint, there could be a backlash from workers and demands for protection from low-cost competition. But countries that try to protect jobs and wages through import barriers or restrictions on offshoring will only hasten their relative decline.

· Emerging economies have already become important markets for rich-world: over half of the combined exports of America, the euro area and Japan go to these poorer economies. Rising exports give developing countries more money to spend on imports from richer ones. And although their average incomes are still low, their middle classes are expanding fast, creating a vast new market. Over the next decade, almost a billion new consumers will enter the global marketplace as household incomes rise.

Stock Markets

· Crises occurred in Mexico at the end of 1994, Asia in 1997, Russia in 1998, Brazil in 1999, Turkey in 2000, Argentina in 2001 and Venezuela in 2002. By 2002 the MSCI emerging-market share-price index had lost almost 60% of its 1994 value.

· The 25% drop in emerging stock markets during May and June of 2006 was a warning. Having tripled over the previous three years, share prices, fuelled by excessive global liquidity, had got ahead of themselves and a correction was overdue.

· Emerging economies still face many potential risks, from banking crises to unrest in response to widening income inequality. Some could be badly hurt by a slump in demand in America or China and a consequent fall in commodity prices. Stephen Roach of Morgan Stanley argues that the weakness of emerging economies is no longer their dependence on external finance, as in the 1990s, but their dependence on external demand.

Specific Regions

· Emerging European economies have the least healthy external balances. Hungary and Turkey have current-account deficits of 7-8% of GDP. When investors dumped emerging-market assets in May and June of 2006, these countries were hit hardest.

· Africa’s prospects look brighter than they have done for many years. In the last quarter of the 20th century real income per person in the world’s poorest region stagnated, but so far this decade Africa has put on a spurt, with GDP growth above 5% for three consecutive years, thanks largely to higher commodity prices.

· Alwyn Young, an American economist, caused a stir in the mid-1990s (just before the East Asian crisis) by suggesting that East Asia’s growth miracle was a myth. He calculated that most of the region’s faster growth was due to increased inputs of labor and capital rather than to total factor productivity growth (the efficiency with which inputs of both capital and labor are used). Paul Krugman, another American economist, summed up Mr Young’s discovery thus: “The miracle turns out to have been based on perspiration rather than inspiration.” In fact, Mr Young underestimated the growth in total factor productivity in the Asian tiger countries, which had actually been considerably faster than in rich economies. Moreover, developing economies do not need inspiration to catch up. In the early stages of development, it is enough to maintain high rates of investment and copy techniques that have proved successful elsewhere. Asia worked its miracle by creating the right conditions for high investment: a high saving rate, open markets and a good education system.

· People love to argue about whether China or India will win the economic race, yet both can prosper together. China scores higher than India on many of the key ingredients of growth: it is more open to trade and investment, has a better record of macroeconomic stability and has put more effort into education and infrastructure. It is perhaps 10-15 years ahead of India in its economic reforms. However, in the long run India might pull ahead because its population will continue to grow long after China’s has leveled off. Forecasters say that by 2030 it is likely to have more people than China.

· Brazil, Russia, India and China are the four biggest emerging economies, grouped together under the acronym BRICs, created by Goldman Sachs in 2001. These four economies account for two-fifths of the total GDP of all emerging economies. China and India are generally seen as the two giants among them. This is true in purchasing- power-parity terms, but in current dollars Brazil and Russia both produce more than India. At market exchange rates, only China and Brazil rank among the world’s top ten economies, but in purchasing-power terms all four BRICs make it.

Europe

· Europe has 19 million unemployed, and an overall youth unemployment rate of 18%

· The world’s economy is booming at an average rate of over 4%, but Europe’s growth has stagnated at an inflated 1.5%

· Deficit spending throughout the eighties and nineties has left Europe with a large public debt, in addition to the hidden liabilities accumulated in pay-as-you-go public pension schemes. Unfunded pension liabilities now average some 285% of GDP.

· The Irish economy has been booming at an annual growth rate of over 5.6% for over 20 years now. In barely 18 years Ireland has made the unbelievable jump from the 22nd to the 4th place in the OECD prosperity ranking. With 33%, the Irish overall tax burden is the most moderate of Europe. Ireland also has a unique fair-flat-tax structure, which fairly and evenly spreads the weight of the tax burden over profits, labour and consumption.

Asia

· East Asian countries have enjoyed near-miraculous growth, halving poverty rates between 1975 and 1995, thanks in part to their production of electronic goods originally invented in rich countries.

· 1997 Asian Financial Crisis

· Clan-based enterprises dominate the Asian economies (outside Japan, South Korea and China). One-third of U.S. Fortune 500 companies are family-controlled, compared to two thirds in Asia outside Japan. In Hong Kong only two major companies don’t take their orders from the head of a family. After the crisis, “family owned” became a synonym for inefficient, backward and risky. In societies with Confucian values, weak laws, limited competition and protected markets, such enterprises relied on entrenched interests of powerful families. After Suharto’s fall in Indonesia, his successors chased after the hidden billions of his family. In South Korea, 15 of the 30 largest chaebol (conglomerates) collapsed. Thailand’s takeover king, Pin Chakkaphak, flew to the U.K. to escape fraud charges. Big Asian firms, in which patriarchs once either reinvested capital in the company or siphoned it off for the family, are now far more conscious of delivering returns and dividends to shareholders. In Indonesia, the Salim family won the right to keep most companies in its stable as it settled cronyism charges with the government. Recently the Salims bought back the shares they were made to sell in Indofood, the world’s largest instant-noodle maker.

· Japan's total stockpile of foreign currency, at $817 billion, is still the largest in the world, but China, which now owns about, is catching up fast. Small groups of civil servants in Taiwan and South Korea invest foreign currency reserves of $235 billion and $193 billion, respectively.

· In recent years, U.S. generally accepted accounting principles (gaap) came to be regarded as the gold standard of accountancy. After Enron, however, gaap lost its former credibility. Today, many Asian companies and regulators are inclining instead toward implementing the rival International Accounting Standards, soon to be adopted as the European norm.

Asia’s Dollar Horde

· Asians are the biggest holders of U.S. debt, led by Japan at $720 billion, followed by China with $174 billion. Asians export far more goods in the U.S. than the U.S. exports to Asia, and they have invested their dollars in US Treasury bonds. Asian institutions are responsible for holding roughly 40 percent of the American government's public debt. Asians have little choice but to hold on because the large-scale dumping of dollars would crush the value of their remaining holdings. Shifting out of dollars could also be dangerous for the global economy, pushing the dollar even lower and triggering sharply higher interest rates in the U.S. That in turn would slow the U.S. economy and depress demand for all those imported goods, potentially triggering a worldwide recession.

· Japan's total stockpile of foreign currency, at $817 billion, is still the largest in the world, but China, which now owns about, is catching up fast. Small groups of civil servants in Taiwan and South Korea invest foreign currency reserves of $235 billion and $193 billion, respectively. For years, all four countries have held the bulk of their reserves in US Treasury bills, notes, and bonds that finance the federal budget deficit, leaving American consumers and companies free to spend more on other things and invest their spare cash in more promising ventures.

· The proportion of China's reserves held in US Treasury securities has dropped to 35%, compared with 90% of Japan's foreign currency reserves. Instead, officials in Beijing have been seeking higher yields by buying bonds backed by mortgages on houses across the US. By helping keep mortgage rates from rising, China has come to play an enormous and role in sustaining the American housing boom. Economists say that dollar-denominated securities represent a declining share of China's recent purchases, but no figures are available on how quickly Beijing may be shifting to other currency holdings.

· The central banks of Japan, China, South Korea, Taiwan, and Hong Kong together currently hold foreign currency reserves worth more than $1 trillion. Add in the foreign reserves of Southeast Asia and India, and you have a pot of more than $1.3 trillion, easily the world's largest concentration of foreign exchange reserves, a sizable percentage of which is held in U.S. dollars. For the last three and a half years, ever since the launch of the European single currency, Asian central bankers have pondered how much of this money to convert into euros to rebalance their reserves. They held off during the euro's long slide between January 1999 and October 2000, when the euro lost 30 % of its value against the dollar. Beginning in 2001 purchases of euros by Asian central banks helped fuel the euro's rise to parity with the dollar. As of then, the amounts converted had been small relative to the size of Asia's reserves. But as the dollar continued to drop, the pace of conversions increased, driving the dollar still lower. In the long run, this shift could presage the end of the dollar's hegemony as a reserve currency. Of course, the dollar has seen periods of weakness before: In 1995, it dropped below 80 yen, far below its value in mid-July 2002 of 117 yen. The difference this time is that Asian countries have greater reserves and a viable alternative reserve currency in the euro. For the United States, a shift will mean a loss of seigniorage (the revenue that accrues to issuers of reserve currencies) that could outweigh any gains a weaker currency will bring U.S. exporters.

China

· China joined the World Trade Organization only in 2001. It is having a bigger global impact than other emerging economies because of its vast size and its unusual openness to trade and investment with the rest of the world. The sum of China’s total exports and imports amounts to around 70% of its GDP, against only 25-30% in India or America. By next year, China is likely to account for 10% of world trade, up from 4% in 2000.

· China’s critics similarly argue that its growth has been driven largely by wasteful investment and cannot be sustained. In fact, total factor productivity growth in China has been even faster than in the rest of Asia. Over the past quarter century it has averaged 3% a year, accounting for roughly the same amount of GDP growth as capital investment. (Over the same period, America’s total factor productivity grew by an annual average of only 1%.) Growth will slow as China’s capital-to-output ratio rises toward rich-country levels and its excess labor dries up, but the country should still have a couple more decades of rapid growth in it.

· The ubiquitous "Made in China" label obscures an important point: Few of these products are made by indigenous Chinese companies. In fact, you would be hard-pressed to find a single homegrown Chinese firm that operates on a global scale and markets its own products abroad. China's export-led manufacturing boom is largely a creation of foreign direct investment (FDI), which effectively serves as a substitute for domestic entrepreneurship. During the last 20 years, the Chinese economy has taken off, but few local firms have followed, leaving the country's private sector with no world-class companies to rival the big multinationals. China has a large and wealthy diaspora that has long been eager to help the motherland, and its money has been warmly received. During the 1990s, more than half of China's fdi came from overseas Chinese sources. The money appears to have had at least one unintended consequence: The billions of dollars that came from Hong Kong, Macao, and Taiwan may have inadvertently helped Beijing postpone politically difficult internal reforms. For instance, because foreign investors were acquiring assets from loss-making soes, the government was able to drag its feet on privatization. China has been bold with external reforms but has imposed substantial legal and regulatory constraints on indigenous, private firms. It was not until 2000 that domestic companies were finally granted the same constitutional protections that foreign businesses have enjoyed since the early 1980s. As of the late 1990s more than two dozen industries, including banking, telecommunications, highways, and railroads--were still off-limits to private local companies. These restrictions were designed not to keep Chinese entrepreneurs from competing with foreigners but to prevent private domestic businesses from challenging China's state-owned enterprises (SOEs). Some progress has been made in reforming the bloated, inefficient SOEs during the last 20 years, but Beijing is still not willing to relinquish its control over the largest ones, such as China Telecom. In the 1990s, Chinese entrepreneurs registered their firms as nominal SOEs (all the capital came from private sources, and the companies were privately managed), only to find themselves ensnared in title disputes when financially strapped government agencies sought to seize their assets. Foreign investors have been among the biggest beneficiaries of the constraints placed on local private businesses. Bureaucrats remain the gatekeepers, tightly controlling capital allocation and severely restricting the ability of private companies to obtain stock market listings and access the money they need to grow. Compounding the problem are poor corporate governance and the absence of an independent judiciary.

· In the early 1990s, when China was registering double-digit growth rates, Beijing invested massively in the state sector. Most of the investments were not commercially viable, leaving the banking sector with a huge number of nonperforming loans--possibly totaling as much as 50 % of bank assets. At some point, the capitalization costs of these loans will have to be absorbed, either through write-downs (which means depositors bear the cost) or recapitalization of the banks by the government, which diverts money from other, more productive uses. This could well limit China's future growth trajectory.

· For years China has exported deflation to the U.S. by flooding the market with cheap goods. The U.S. and other industrialized nations have long argued that China is able to do so largely because its currency, the yuan, is grossly undervalued at its current peg of 8.28 to the dollar. Under global pressure, Chinese authorities have been discussing allowing the yuan to drift higher. Yet Beijing has signaled that it is in no great hurry to free the yuan. China needs a cheap yuan to fuel its high-speed growth and keep employment expanding. Also, clobbering the profits of exporters could be doubly damaging, since many of them are indebted to the country's already ailing Big Four state-owned banks. To maintain the currency's peg to the dollar, the Chinese have recycled their massive export earnings and capital inflows into U.S. Treasuries. Some 70% of Beijing's $400 billion in foreign currency reserves are in dollars and they are rising fast, fed by export earnings, foreign investment, and the return of funds held offshore. Such imbalances could ignite the kind of overbuilding that preceded Asia's 1997 crisis. If China opts for a basket, it may rebalance its reserves by investing in more yen and euro bonds and less in US bonds. Among the hazards on the Chinese side: a big slowdown in the mainland's export machine. That would depress China's need for imported raw materials and machinery. It also would hurt incomes, which would lower Chinese demand for imported consumer goods. On the U.S. side, a higher yuan would boost U.S. prices for everything from toys to power tools, and trigger a fall-off in Chinese purchases of U.S. Treasury securities. The money China recycles into the U.S. by buying $10 billion in Treasury bonds each month, meanwhile, is vital to keeping down interest rates and financing America's yawning current-account and federal budget deficits, which are nearing a combined $1 trillion. With saving rates dropping in Japan, Korea, and Taiwan, China is emerging as an even more vital exporter of capital. Economists say that instead of revaluing, Beijing could stop subsidizing export industries. It also could let foreign companies in China borrow yuan rather than bring in dollars. And it could allow Chinese citizens and financial institutions to buy foreign stocks. China is emerging from eight years of dropping consumer prices caused by oversupplies of everything from farm goods to TVs. Thanks to rising incomes due in part to the export boom, demand is picking up. But inflation is a meager 0.3% despite lots of fiscal stimulus from Beijing. And while Shanghai housing prices are surging, China's overall property market still hasn't recovered from a bust a decade ago. Slower Chinese demand also could hammer world trade. Even though China's politically sensitive trade surplus with the U.S. is rising, China's overall trade surplus has shrunk 70% in six months, to $6.9 billion. That's because imports have surged by 45% in the past year, to $350 billion, and are rising faster than exports. That may seem counterintuitive, since a cheap currency makes imports more expensive. But as China dismantles trade barriers, demand for luxury cars and cell phones is soaring. And to fuel its export machine, China must import electrical components, raw materials, and oil. China's steel imports soared 80% in the first seven months of this year, to 30 million tons. And China's imports of machinery leaped 50%. Beijing is already trying to soak up excess liquidity. Since late 2002, commercial banks have repatriated $60 billion from the U.S., Morgan Stanley estimates. To head off a lending binge, the government is issuing bonds. But the money supply is still growing at 20%, and China lacks a developed market for trading such paper. Beijing also is mulling a cut in tax rebates for exporters. There's even talk of letting Chinese mutual funds and insurance companies buy Hong Kong stocks, and of making it easier for Chinese companies to make foreign acquisitions.

· China has kept to structural adjustment and market-oriented reforms for 25 years and continues to lower trade and investment barriers. As a result, it has grabbed market share and foreign investment from nations that chose to reform more slowly or not at all. While other countries should be holding China up as proof that policy reforms matter, commerce officials in the United States and elsewhere are instead lambasting the country as an unfair trader. But can the motive for chastising China really be defense of free trade? No, given the hundreds of billions of dollars of agricultural subsidies in the developed world or the management of trade in steel, textiles, apparel, and maritime services, to name a few. The real motivation is fear of how competitive China has become by embracing a market-friendly recipe for reform.

· China's growth spurt over the past two decades is a marvel. But China faces a crisis because its economy is running on a primitive, corrupt financial system. There are no market mechanisms in place to prevent runaway overinvestment and the misallocation of capital. Stock and bond markets are untrustworthy. Government banks that supply most of the nation's credit direct it to well-connected party officials. Overinvestment in such sectors as steel, cement, autos, and residential real estate is rampant. Huge bailouts of the banks by Beijing are going to waste because as soon as the old bad loans are taken off their books, the banks go out and make what may well become new bad loans. Decades of Communist rule have resulted in an entrenched bureaucratic class that benefits from cronyism and outright corruption. And inefficient state-owned enterprises can't be shut down abruptly because they employ tens of millions of people. Fortunately, China's leaders understand the challenges. President Hu Jintao, Premier Wen Jiabao, and People's Bank of China Governor Zhou Xiaochuan are well-informed and capable reformers. China's leaders intend to restructure the banks so that their interest rates are set by market forces instead of fiat. Freely floating rates will help curb the economy-wide overinvestment that occurs when rates are too low. In the meantime, though, China is in danger of overheating. So as a stopgap, Beijing will need to resort to old-style command and control and impose stern penalties on those who persist in imprudent lending. The reward for the banks that whip themselves into shape will be the opportunity to list their shares on Western stock exchanges.

· China's industrial northeast was first developed by colonial Japan, and championed by Mao Zedong, who worked with his Soviet allies to build mines and factories churning out coal, chemicals, steel, trucks, ships. The region's cities were showcases of the new workers' state, with leafy parks and “cultural palaces” for opera and dance performances. Workers in the northeastern provinces were among the most favored in China, earning hefty salaries and benefits. By the 1980s the northeast accounted for nearly one-fifth of China's industrial production, although it was home to just 8% of its citizens. These days many of those factories are rusting hulks and unemployment tops 20%. As China has moved towards a market economy over the past quarter-century, the northeast has fallen behind coastal provinces such as Shanghai and Guangdong. Some 70% of production remains in the hands of the state, compared with less than 20% in Guangdong. Local companies remain saddled with pension obligations and nonproductive assets such as schools and hospitals. The political culture is among the most corrupt in China.

· A runaway China hit by a crash would have far more impact on the global economy than it would have had 10 years ago, when the mainland had its last great crisis of overheating. The Chinese economy's share of global output has doubled, to 4%, in the last decade. China is consuming 7% of the world's oil supply, and 25-30% of aluminum, iron-ore, coal, and steel. China-linked exports and industrial production accounted for about a third of the recent rebound in Japan's GDP. Trade with China kept the Korean economy from slipping into outright recession last year. Emerging-market companies in Brazil, Russia, and elsewhere have benefited from the heavily China-influenced rise in global commodity markets. And U.S. multinationals such as Motorola now rely on China for up to 10% of sales.

· The struggles of the Big Four -- Bank of China, Industrial & Commercial Bank of China, China Construction Bank, and Agricultural Bank of China -- to end decades of politically motivated lending are the most visible and best-known signs of this dysfunctional financial system. By some estimates, 45% of all bank loans remain underwater. Authorities are starting to recapitalize banks and professionalize credit operations, but it's a slow process. Local Communist Party cadres can bend the rules and get local branches of the big banks to lend when they shouldn't.

· The banks, which account for 85% of the credit created in China, might lend more sensibly if they had to compete with developed bond and stock markets for capital. But the country's 20-year-old corporate bond market has all of 24 issues listed, and daily trading is minuscule. Because interest rates are state-controlled -- and banks have always been eager to lend cheaply -- there has never been much of a need for companies to issue bonds. Only state-owned companies have bothered to issue them, and because of the implicit government guarantee they enjoy, virtually every company boasts a triple-A rating, no matter how ludicrous. The country's two domestic stock exchanges in Shanghai and Shenzhen, launched in the early 1990s, aren't much more successful at raising capital and offering an alternative to bank financing. The two bourses accounted for only 3.9% of the funds raised last year by Chinese companies.

· Through the ’70s, Beijing supported local insurgencies in Southeast Asia; more recently it has lured foreign investors away from places such as Malaysia. But now China is working with the 10-member Association of Southeast Asian Nations (ASEAN) to create the world’s largest free-trade zone. Beijing is burying its old grudges and insularity. Last year Beijing signed a vow to engage in dialogue on China Sea islands claimed by China and at least four Southeast Asian governments. Beijing is involved in an alphabet soup of organizations from the Asian Cooperation Dialogue to ASEAN plus one.

· In China's case, the errors and omissions category showed a steady flight from yuan-denominated assets from 1990 to 2001. What was happening? Many Chinese wanted to skirt China's strict currency controls and get their money out of the country, whether to give extra spending money to children studying abroad or to spirit out ill-gotten gains. Throughout the '90s, thousands of mainland Chinese literally carried suitcases of money into Hong Kong, where they converted it into Hong Kong or U.S. dollars, or Hong Kong real estate and stocks. The slow, steady leak of money indicated that even the Chinese thought their money was safer in other currencies. All told, errors and omissions added up to $136 billion flowing out of China between 1989 and 2001. But the money flow has abruptly reversed. In 2002 China recorded a net surplus in its errors and omissions cash flow of $7.8 billion. Traders say this is a sign that many expect the yuan to be revalued. Foreign banks, which were just given the right to buy stock exchange A-shares formerly restricted to mainland investors, are poised to spend billions, in part to show their commitment to China but also to take advantage of a future revaluation in the yuan. All the money rushing into China distorts the domestic economy, and that could force the government's hand. Because China limits foreign currency holdings, the central People's Bank of China must buy foreign currency from Chinese companies and individuals. They in turn spend much of the newly minted yuan on real estate, which has begun to overheat.

· The seemingly inexorable Chinese economic expansion is bootstrapping the rest of Asia out of recession. After a decade of stagnation, even Japan is showing signs of life again thanks to China, which may soon displace the United States as Japan's number one trading partner. Evidence of financial bubbles abounds. The Chinese banking system, weighed down by years of state-directed lending to profitless government enterprises, is an accident waiting to happen. China supposedly invested more than 40 % of its gross domestic product last year, and clever as the authorities may be, that money couldn't all have gone to sound, profitable projects. And don't forget the small matter of China's fixed exchange rate against the U.S. dollar. Every major international economic crisis of the past 15 years—save Brazil's in 2002—has been rooted in an exchange rate that remained too rigid for too long. China may be safe for now, partly because strict capital controls currently force Chinese citizens to deposit their savings in bankrupt domestic banks. But as international trade relentlessly expands, Chinese investors would increasingly be able to evade such regulations.

· China's economy has grown at an average rate of 10% per year for the last fifteen years, the highest growth rate in the world. China is the world's third-largest trading nation, after the United States and Germany. The ratio of trade to China's GDP was 70% last year, compared to less than 25% each for the United States and Japan.

· Between 1993 and 2000, more than 60 percent of all loans went to state-owned enterprises. Standard & Poor’s estimates that China’s banks have issued about $650 billion in bad loans, or about 40 percent of outstanding loans. If an economy growing at close to 10 percent a year generates bad loans on this scale, the misallocation of capital has to be gigantic.

· The United States is one of China's largest trading partners. In 2005 they reached an agreement to limit imports of Chinese textiles from flooding U.S. markets.

· Protectionist pressures are growing as politicians accuse China of keeping out U.S. exports while flooding the U.S. market with low-priced Chinese goods.

· Anger has been building in the United States over China's alleged manipulation of its currency. For the last decade, China had pegged the value of its currency, the renmenbi, to the U.S. dollar at what critics called artificially low rates. Manufacturers accuse China of undervaluing its currency—which makes Chinese goods cheaper in the United States and U.S. goods more expensive in China—by as much as 40 percent and say the currency rates contribute to the giant U.S. trade deficit with China. In July, mounting pressure caused China to revalue the renmenbi upward by 2.1 percent and change its peg from the dollar to a basket of international currencies.

· Asian nations are buying up dollars to keep their currencies from appreciating. So far, the IMF's pleas for Asian leaders to loosen their grip on their currencies have gone unheeded.

· Why You Should Worry About China:

o RUNAWAY CONSUMPTION: China is now devouring 7% of the world's oil supply, 30% of its iron ore output, and 27% of all steel products. The result: Rising commodity prices worldwide, which could boost inflation. And if China crashes, a global commodity bust could ensue.

o DYSFUNCTIONAL FINANCE: By some estimates, 45% of all loans are nonperforming. Yet lending is still rising fast -- and the top four banks are technically insolvent. Hiking the value of the yuan would cool things off, but it would put much-needed export jobs at risk.

o REGIONAL RISK: China demand now drives the economies of Southeast Asia and, increasingly, those of Korea, Taiwan, and Japan. A sudden slowdown in China could throw these economies into reverse.

o CORPORATE RISK: Multinationals -- from auto makers to chipmakers -- depend increasingly on domestic Chinese demand  for new growth. If Beijing has to slam on the brakes, demand could plummet, hurting earnings just as the world is recovering.

o WEAK CONTROLS: Top authorities in Beijing want to slow the economy before it's too  late, but regional Communist Party cadres  and businesses have other ideas. Credit allocation in China is still primitive -- and the authorities have a poor record of navigating soft landings in the economy.

· What's Fueling The Fire:

o OUTSIDE MONEY: Foreign direct investment and export earnings -- some $491 billion -- flood the system with foreign currency, putting upward pressure on the yuan. The central bank must buy the foreign money to lower the pressure. But that creates more yuan, which flows into the economy through the banks.

o INSIDE MONEY: Corporate earnings, personal savings, and gray-market income all rise as China prospers. Again, much of this ends up in banks, which lend cheaply since their cost of capital is so low.

o LOCAL BANKS: Besides the Big Four banks, there are more than 100 other commercial banks and 1,200 co-op lenders with tight ties to local cadres and businesses. These local bigwigs are given cheap capital, often with no regard for the quality of the borrower's finances. Central control of the Big Four's local-branch lending is also loose, though it is improving.

o UNDEVELOPED BOND MARKET: The central bank tries to soak up extra liquidity by selling government bonds, but it has not been enough to cool things off. And higher rates would just pull in more foreign money, driving up debt service for the government, putting more pressure on the yuan.

o THE YUAN: Investors all over Asia are buying property and other Chinese assets, betting on an upward revaluation of the yuan. Money smuggled out of the mainland is coming back in, too, as Chinese bet on a currency rise. That just increases the pressure to revalue and adds to the speculative froth.

India

· India has not attracted anywhere near the amount of fdi that China has. In part, this disparity reflects the confidence international investors have in China's prospects and their skepticism about India's commitment to free-market reforms. The Indian diaspora was, at least until recently, resented for its success and much less willing to invest back home. New Delhi took a dim view of Indians who had gone abroad, and of foreign investment generally, and instead provided a more nurturing environment for domestic entrepreneurs. In the process, India has managed to spawn a number of companies that now compete internationally with the best that Europe and the United States have to offer in the most cutting-edge, knowledge-based industries--software giants Infosys and Wipro and pharmaceutical and biotechnology powerhouses Ranbaxy and Dr. Reddy's Labs. In 2003 the Forbes 200 annual ranking of the world's best small companies included 13 Indian firms but just four from mainland China. India has also developed much stronger infrastructure to support private enterprise. Its capital markets operate with greater efficiency and transparency than do China's. Its legal system, while not without substantial flaws, is considerably more advanced. Although India's courts are notoriously inefficient, they at least comprise a functioning independent judiciary. Property rights are not fully secure, but the protection of private ownership is far stronger than in China. The rule of law, a legacy of British rule, generally prevails.

· India developed Fabian socialism, which aimed not to destroy capitalism but merely to mitigate the social ills it caused. It was considered essential that the public sector occupy the economy's "commanding heights," to use a phrase coined by Lenin but popularized by India's first prime minister, Jawaharlal Nehru. However, that did not prevent entrepreneurship from flourishing where the long arm of the state could not reach. For democratic, postcolonial India, allowing foreign investors huge profits at the expense of indigenous firms is simply unfeasible. Controversy erupted in the 1990s when the Enron Corporation made a deal with the state of Maharashtra to build a $2.9 billion power plant. The project proceeded, but only after several years of acrimonious debate over foreign investment and its role in India's development. During the last decade, New Delhi has backed away from micromanaging the economy. True, privatization is proceeding at a glacial pace, but the government has ceded its monopoly over long-distance phone service; some tariffs have been cut; bureaucracy has been trimmed a bit; and a number of industries have been opened to private investment, including investment from abroad. India's annual growth rate is only around 20 % lower than China's. Why isn't India's superiority reflected in the numbers? India's economic reforms only began in earnest in 1991, more than a decade after China. In addition India has had to make do with a national savings rate half that of China's and 90 % less fdi.

· Bangalore is India's Silicon Valley. Its emergence as an information technology hub has made it a magnet for young professionals from across India.

Globalization: Stimulation of global trade and investment

Causes of Globalization:

· End of the Cold War:

· During the cold war, the United States and Soviet Bloc traded mainly with its military and diplomatic allies. Now former allies are less loyal to their military patrons and the global economy has dramatically broadened.

· Spread of Free Trade Philosophy among Governments

· In the past 25 years, countries representing two fifths of the world’s 6.3 billion population have ended their self-imposed isolation: first China (population: 1.3 billion) in the late 1970s; then the former Soviet Union and Eastern bloc (roughly 400 million) in the late 1980s and early 1990s, and finally India (1.1 billion) in the early 1990s. The balance of power is shifting. In 1980 China barely traded; in 2003 it passed France as the world’s fourth largest exporter.

· Democratization of finance

· Individuals (through mutual funds, pension funds, etc) make more money available for foreign lending. Previously international lending had been done only by major banks. In 2000 50% of the US population invested in stock market.

· Securitization of international debt:

· 1989 US Treasury secretary Brady creates US-government backed “Mexico bonds” as a result of Latin American debt crisis. Value of bonds fluctuates with countries’ economic performance, political situation, etc. In 2000 16 countries have “Brady bonds”.

· Occurred with the securitization of almost everything during the 1990s - movies, personalities, credit card & consumer debt, among other things - increasing competition for capital.

· Information Revolution/Internet

· Increases information available to Western investors about foreign companies and countries. Exports increase because better communications (TV, movies etc.) allows global advertising.

· Low-cost communications, the Internet and digitalization mean that many business services can be shifted abroad. Companies have moved call centers, accounting operations and software development to offshore locations, particularly in India. Wages in India are 20 % of U.S. levels. This movement is known as outsourcing.

· English is used on 80% of the world’s 4 billion websites

· Commoditization

· Many industries (computers, telcom, brokerages) became commodities. Lower profit margins encouraged companies to explore global markets to increase market share and/or lower production costs

· Decentralization of large companies (eg IBM) due to improved communications, computers

Effects of Globalization:

Positive effects of globalization

· Economies That Are Open to Trade Grow Faster. Virtually all developing countries that have grown rapidly have done so under open trade policies.

· From the mid-1950s through the mid-1970s, industrial countries enjoyed rapid growth while dismantling their high post-World War II trade barriers. Japan offers the most dramatic example, but countries such as Denmark, France, Greece, Italy, the Netherlands, Norway, and Portugal exhibited similar patterns.

· India and China are the best recent examples of countries that started with relatively closed trade policy regimes in the 1980s but subsequently achieved accelerating growth while opening up their economies.

· During the 1960s and 1970s, India remained closed to trade, grew approximately 1% annually, and experienced no reduction in poverty

· Openness to trade promotes growth in a variety of ways.

· Entrepreneurs are forced to become increasingly efficient since they must compete against the best in the world to survive.

· Openness affords access to the best technology

· Free trade allows countries to specialize in what they do best rather than produce everything on their own. The US specializes heavily in services, which account for 80 % of total U.S. output.

· The fall of the Soviet Union was in no small measure due to its failure to access cutting-edge technologies, compete against world-class producers, and specialize in production.

· Openness to trade is not by itself sufficient to promote growth—macroeconomic and political stability and other policies are needed as well—so some countries have opened up their markets and still not seen commensurate increases in economic growth. That has been particularly true of African countries such as the Ivory Coast during the 1980s and 1990s.

· A study by the Institute for International Economics estimates that globalization is benefiting America’s economy by $1 trillion a year, equivalent to $9,000 a year for every family. But in practice the average family has not seen such a gain because much of it has gone to those at the top or into profits.

·

· Improves standards of living through GDP growth.

· Absolute poverty is falling in many countries (faster in past 50 years than previous 500). Since 1960 infant mortality & malnutrition have decreased, literacy & safe water have increased in the third world.

· Newly industrialized economies such as Hong Kong, Singapore, South Korea, and Taiwan have all been open to trade during the past four decades and have been entirely free of poverty, according to the dollar-a-day poverty line. Malaysia’s per-capita income rose from $350 to $5000 in 2 decades.

· Foreign companies pay more, create jobs faster, spend more on R&D, and export more than domestic companies (OECD study).

· Foreign investment can be a significant driver of development in poor countries. In China, India, and Mexico, foreign investors have brought not only money but technical and managerial know-how.

· Trade helps the poor through three channels: gainful employment, anti-poverty programs, and public services such as education and health.

· The current impression that the freeing of trade has failed the world's poor is partially rooted in disputable World Bank poverty figures. The bank reports that though the proportion of the poor in developing countries declined from 28% in 1987 to 23% in 1999, increased population has left the absolute number of poor unchanged at 1.2 billion.

· The time when the United States and the rest of the G7 (Britain, France, Germany, Italy, Japan and Canada) could settle major international trade and financial negotiations among themselves is quickly passing. There are more big players with their own — China, India, Brazil and Russia. In the failure of trade negotiations at Cancun, Mexico, in 2003 developing countries balked at the concessions being offered.

· The World Bank projects that eliminating government interference in trade flows would add about $287 billion to the global economy by 2015 (or $461 billion, using more generous growth assumptions), with a bit less than one-third of that going to developing countries. That translates into a 0.7 percent gain in economic output for rich countries, and a 1.5 percent boost for poor countries. Some countries -- Mexico, Bangladesh, Cameroon and Mozambique among them -- would come out losers, at least in early years

· Improves developing countries’ legal, financial, and political systems through financial pressure and increased international competition

· Encourages prudent monetary & fiscal policies by causing flight of capital if governments deviate from international norms.

· Because of the growth mutual funds and individuals investing in emerging markets, countries could no longer meet only with large banks to revise term of their loans. This made emerging markets more fiscally responsible to remain competitive.

· Moodys, Duff & Phelps, Standard & Poors rate countries based on the legal, political and economic climate. Downgrading a countries rating causes flight of capital, increased interest rates, difficulty in borrowing & paying back loans.

· Encourages: Private sector as the primary engine of growth (as opposed to government spending), low rate of inflation, balanced budget, decreased bureaucracy, eliminating tariffs, free flow of capital, foreign investment, similar rates of taxation, no quotas or government monopolies, privatizing state industries, increasing exports, deregulating capital markets, convertible currency., independent central bank, transparency, accounting standards, eliminating corruption, nepotism and “crony capitalism”. Also promotes laws in the following areas: banking, commercial, bankruptcy, securities (ie insider trading, conflict of interest), contract, property rights, intellectual property, judicial review, independent regulatory agencies.

· Foreign Corrupt Practices Act (1997) makes it illegal for US companies to pay bribes, to make business deals. (Citibank had helped the brother of the President of Mexico move out $100 million in illicit funds). In 1997 OCED adopted US anticorruption policies. Writing off bribes as tax deductions was previously legal in France & Germany (also prevalent in Japan)

· Requires a “3-legged” financial system: banks, stock & bond markets. All are available for business to raise money in case one leg (ie banks) fails. Leads to more transparency when loans are not controlled solely banks, makes cronyism more difficult

· Encourages democracy, human rights, and better working conditions to avoid protests & boycotts and attract capital.

· Capitalism decreases the power of centralized governments to control investment capital, encouraging democracy.

· Every country with per-capita income over $15,000 is liberal democracy

· Economic pressure (Internet organization) & NGOs have replaced street activism & government regulations.

· 1999: Fair Labor Association: formed by clothing companies, US government, activists & NGOs to ensure minimum workers rights, with inspections, grades, & labels on clothes in foreign-owned factories in developing countries

Negative effects of Globalization

· Increased volatility due to hedge funds’ emphasis on short-term profits and the use of leverage. Capital flows in and out of countries freely.

· 1995 Barings Bank is collapsed by single trader who lost $1.4 billion by speculating on the Singapore stock market. Barings Bank was the oldest merchant banking company in England, founded in 1762.

· International Spread of Economic Crises (see below)

· Cultural homogenization

· Weakening of the power of unions and workers in industrialized nations

• Workers in the US must compete for wages against foreign immigrant workers to the US as well as workers in US-owned companies in foreign countries (“outsourcing”)

· Foreign investment can feed corruption. For example, Angola's government, which reaps massive oil revenues, has reportedly misspent $4.2 billion in five years.

• Some corporations from rich nations to rely on bribes overseas to conduct their business. Italy reportedly has the most corrupt companies according to Transparency International.

· Globalization imposes upon the autonomy of sovereign nations. But, as seen above, this can be beneficial in the case of bad governments.

Debatable effects of Globalization

· Environmental damage

· The rapid expansion of coastal shrimp farming in several countries in Asia and Latin America in the 1980s, driven principally by the demand for exports, led to the contamination of water supplies and destruction of surrounding mangrove forests.

• Pressure from NGOs and environmental groups may lead to improvements in developing nations
• The race to the bottom hypothesis holds that more foreign investment will go to “pollution havens” and this will create incentives for lower standards everywhere. The evidence shows that this is not the case. For example the state of Sao Paulo in Brazil, FDI has increased while air pollution levels have fallen. This is also the case for Mexico City and for Chinese foreign direct investment.
• Trade protectionism often brings environmental costs: During the 1980s, the US’ quotas on Japanese small-car imports harmed the environment by reducing access to lower-pollution vehicles. Pre-1989 Eastern Europe had an extremely poor environmental record
• WTO's Doha negotiations yield environmental benefits by replacing Europe's pesticide-intensive agriculture with natural manure-intensive agriculture in developing countries.

· Widening of income gaps.

• Income for the poorest 1/5 of the population in the US dropped 21% between 1979 and 1995, that if the richest 1/5 increased 30%.
• However others argue that free-trade lifts everybody’s boat

Other effects

· A Balance of power between nations, global markets, & powerful individuals develops.

• “Supermarkets”: New York, London, Frankfurt, Hong Kong, Chicago, Buenos Aires, Paris, Singapore.
• “Individuals”: transnational corporations, hedge funds, George Soros, Osama bin Laden.

· Regional trading blocs form: EU, NAFTA, Pacific Rim. (see below)

· Increased competitiveness between countries and between companies within countries.

• The Democratization of finance and Information Revolution lowered barriers to entry, allowing more “startups”.
• The Internet is a “perfectly competitive market” - consumers can easily find low-cost producer anywhere in the world.
• The US went through downsizing, privatization, and deregulation in 1980-1990s, earlier than other countries, and became more streamlined, while the former socialist and communist countries were inefficient and unable to compete on a global scale.

· Keys to success for companies and countries: Speed (instead of size) of government approvals, investment, infrastructure; education & research; technology (instead of natural resources); openness, adaptability: (use of financial and technical.standards, immigration of skilled workers & researchers, transparency), communication between & within businesses, investors, researchers, government; ability to change management/leaders (i.e. democracy); job flexibility (being able to quickly fire or hire workers leads to increased productivity, adaptation of new technology, overall more job creation); bankruptcy laws (being able to declare bankruptcy & start again fresh leads to more innovation and risk taking); creative destruction of businesses, technology etc

· Examples: In the 1980s Brazil & Taiwan both wanted to develop fax industries. Brazil had high tariffs protecting its companies, Taiwan didn’t. Taiwan integrated technology from Japan’s Fujitsu and became leading the fax producer by 1994, Brazil’s fax industry became extinct. In 1995 Brazil rescinded tariffs. Taiwan has historically had hands-off approach to business because they anticipated returning to mainland, not running state-run industry or imposing tariffs.

· France was the only country to outlaw Internet encryption and as a result has no computer industry

Asian Financial Crisis

· Until the very eve of the crisis, Asia was the fastest growing region in the world, its progress sustained by high savings rates, a disciplined work ethic and responsible fiscal behavior on the part of the governments — though not of the private sector. What triggered the actual crisis were the factors largely out of national or regional control.

· When the IMF, backed by the United States, intervened with its standard remedies of massive austerity, a political crisis was inevitable. Thailand's democratic institutions proved resilient enough to weather it — though a 42% devaluation of the currency and interest rates as high as 40% wiped out much of the middle class. By contrast, in Korea, the U.S. Treasury — recognizing the strategic importance of the country — made available additional assistance, moderating the IMF program to one compatible with political stability. Fortunately, an election held in December 1997 brought Kim Dae Jung into the presidency. He had attacked the previous Korean administrations from the left — and was thus in a strong position politically to implement austerity. However, in Indonesia — the world's most populous Muslim country, with vast resources and a crucial strategic location — the Clinton administration, facing accusations of campaign support from Indonesian companies, chose to take no political risks. The IMF was encouraged to make assistance whether relevant to the crisis or not. It demanded the closing of 15 banks, the ending of monopolies on food and heating oil and the termination of government subsidies. Each of these measures dealt with a real problem and needed to be solved as part of a long-term program. Implemented over a period of a few weeks, however, their cumulative impact produced a political debacle. Closing banks in the middle of a crisis made a run on all other banks inevitable. Ending subsidies raised food and fuel prices, causing riots directed at the Chinese minority that controls much of the economy. As a result, Chinese money fled Indonesia in far greater quantities than the IMF could possibly offset. A currency crisis had been turned into first an economic disaster and then a political vacuum. Some may argue that the overthrow of the Suharto regime justified the decisions of the IMF, but the IMF does not have the political competence to lead political revolutions. The social upheaval of Indonesia and Asia in 1997 — repeated with comparable consequences in Russia, Brazil, Argentina, Ecuador and across Africa — occurred at a time of unprecedented growth and wealth creation in the United States and, to a lesser extent, in Europe. After decades of effort to close the gap between emerging and industrialized economies, the financial crises of the 1990s signaled a giant step backward.

· 1990s There is a rush of new capital into the emerging markets in SE Asia due to trade liberalization. The “Asian Tiger” economies were growing at 10% per year. The lifting of its citizens out of poverty into the middle class was the fastest in the world’s history.

• Finance houses borrowed heavily in dollars to finance construction – but they overborrowed and overbuilt.
• The countries had big banking systems, but lacked bond & stock markets. This lead to competition among banks to give loans, making loans for bad projects. When banks went bad companies had nowhere to go for capital.
• The companies and countries also lacked adequate financial accounting and transparency. Companies with financial problems had been audited by US big 5 accounting firms without raising red flags. US firms moved into Asia by taking over local firms that did not apply GAAP. In Dec. 1997 South Korea was reporting currency reserves of $30billion when they were actually $10billion.
• The exception was Japan, which had fallen into recession. Japanese banks had held $1 trillion in bad debt due to overlending.

· 1997 Thailand. The Thai Baht had a fixed exchange rate against the US dollar.

• May: Speculators bet against the thai baht on the presumption that the Thai economy is not as strong as reported. They force the Thai government to pay out it dollar reserves in exchange for bahts.
• July: The Thai government lacks cash reserves to protect against speculators, removes fixed rate against the dollar. The Baht falls by 30%.
• August: Thailand agrees to IMF terms for a bailout, but the bailout fails to rescue the economy. The US refuses to lend Thailand more money, thinking that its repercussions would be limited. Dec: 56 of the 58 top Thai banking houses are closed

· Spread among Pacific Rim. Thai devaluation triggers a flight of $116 billion of investment capital out of SE Asia. Currencies fall in Malaysia, Indonesia, Phillipines, Singapore, South Korea. Malaysia’s stock index falls 48%.

• First use of IMF emergency funds - $1billion for Philippines. Largest IMF bailout ever to South Korea - $57 billion in December 1997.
• Taiwan, Hong Kong, Singapore & Australia were least effected because of developed economic systems. Thailand & South Korea are democratic but with undeveloped economies – recovered quicker because people elected more democratic parties which passed anticorruption measures. The most authoritarian & corrupt countries – Indonesia & Malaysia – suffered worst.
• Asia's largest private investment bank, Hong Kong-based Peregrine Investments, files for liquidation.

· Causes political and economic reforms in SE Asia: The IMF and World Bank insist on political and economic reforms as a condition for bailouts. All countries receiving loans from the World Bank are required to use international accounting standards. South Korean unions, government and businesses reach a landmark agreement to legalize layoffs, a key condition insisted upon by the IMF. IMF insists Indonesia cut government spending and it postpones 15 major government-subsidized projects - a number of them linked to the Suharto family, agrees to eliminate state monopolies & subsidies, close banks. Causes regime change in Indonesia (Suharto steps down after 32 years), South Korea.

· Global spread: SE Asian consumption of commodities (gold, copper, aluminum, crude oil) fell, causing a fall in global commodity prices and a global stock market decline.

• 1998August: Decline in oil prices causes the Russian stock market to collapse. Russia defaults on bonds and devalues the ruble without warning and the central bank chairman resigns
• Hedge funds kept buying Russian bonds with leverage presuming IMF would bail Russia out. When it didn’t, hedge fund failures caused selling of assets in other emerging markets i.e. Brazil, Korea, Egypt, Israel, Mexico
• Russian and Asian collapse causes flight from all emerging markets. Brazil’s stock market drops 50%, requiring an IMF bailout. Brazil had to raise interest rates to 40% to attract capital. The IMF announces that the debacle in Latin American markets is "an overreaction to Russian events".
• 10/27/97: largest point loss ever (554 points) in Dow Jones Industrial Average (DJIA) on the New York Stock Exchange. Large Japanese brokers & banks go under.
• Stock market losses triggered a stampede into Treasury bonds, increasing their value
• 1998 Long-term capital management (LTCM), Greenwich, Connecticut hedge fund based on Merton & Scholes Nobel-prize winning thesis on derivatives. It directly controlled $1 billion in assets, and indirectly $1 trillion. It had bet $120billion that T-bonds would go down in value. LTCM is bailed out for $3.5 billion by banks to avoid a global meltdown

· 2000s A number of factors are behind the resurgence of emerging markets. Strong growth in the U.S. is the most important. But so is the powerful rise of China, which now ranks as the world's third-biggest importer.

· Flexible Currencies: In 1996, virtually every Asian emerging market rigidly controlled its exchange rate. The huge, sudden surges and withdrawals of dollars, as lenders and speculators arbitraged global rates led to currency crashes. Finance officials either had to spend limited foreign reserves to support their currencies or let them slide against the dollar -- making it more expensive to service foreign debt. Now most Asian and Latin nations float their currencies.

· Foreign Reserves: Emerging markets have sharply reduced dependence on short-term foreign debt and have amassed far bigger foreign reserves to shore up their currencies. Asia's central banks have amassed $2 trillion in foreign currency reserves, led by Japan's $819 billion. China is sitting on $470 billion. Even India, which in 1991 was flat broke, has $117 billion..

· Transparency and Regulation: Huge strides have been taken in cleaning up Asia's banking systems, though Beijing still needs to do more. Commercial banks in South Korea, Indonesia, Malaysia, and Thailand, hit hard by the 1997 financial crisis, now all boast capital adequacy ratios well above the 8% mandated by the Bank for International Settlements. Stronger banks mean more consumer lending for Asia's burgeoning middle class.

· Asian banks have recovered from bad loans of the 1997 crisis. Asset management companies set up by governments in Indonesia, Korea, Malaysia and Thailand have mopped up the worst bad loans. Foreign investment banks have played a big role as well. For instance, the Bank of the Philippine Islands sold $150 million in bad loans to Morgan Stanley.

• Workout Rules: Before the 1990s, debt workouts were brokered mainly by the IMF, governments, and a few money-center banks. But by the 1990s more debt rushed into emerging markets that was in the hands of mutual funds, pension managers, retail investors, speculators, and hedge-fund managers. The IMF and U.S. Treasury, among others, pushed for a new international legal framework, similar to Chapter 11 bankruptcy in the U.S., to allow shaky countries to restructure debts. Opposition by Wall Street killed the proposal. But bond issuers and traders have since embraced other crisis-prevention measures. Most new emerging-market bond issues, for example, now contain ``collective action clauses'' giving governments and as few as 75% of bondholders power to renegotiate payment terms if a country is close to default. Influential financiers are also advocating a ``code of conduct'' under which distressed countries, the IMF, and creditors would pledge to renegotiate debts.

· Asia has a booming market for the securitization of commercial and government debt. Banks and companies in Asia are bundling up credit-card receipts, commercial and residential mortgage payments and reselling them to investors. The trend strengthens banks' balance sheets, frees capital for more lucrative business, and spreads risk.

· The long drought in emerging-market debt issues is over. Developing nations are on track to raise $32 billion in foreign bonds, well below the levels before the 1997 Asia financial crisis, but more than twice as much as 2001 and 2002 combined. Spreads above U.S. Treasuries are near their lowest levels since 1998 -- around 460 basis points. Even Western banks, which since 1998 had pulled more money out of developing nations than they loaned them, are now pumping in new credit.

Foreign Investment/ Capital Flows

· Private capital flows – foreign investment by companies and individuals – rose in the early 1990s until the Mexican debt crisis, then recovered until hit by the financial crises in Asia, Russia, and Brazil in 1997-1998, then began to recover again in 2002.

· The trend in capital flows coincides with reduced debt, larger currency reserves, and institutional reforms in developing countries (especially in East Asia).

· Within developing countries, capital flows/GDP ratios have risen for middle income countries and especially for the top 10 recipients:  Brazil, China, India, Mexico, Russia.

· In the 1990s, low income countries suffered a sharp decline in their GDP growth rates along with a smaller share of capital flows compared to high-income developing countries. This suggest that capital flows tend to go where growth prospects are good and, in those settings, they further assist the growth process

· 1999 In a rebellion against the American-led drive for free markets, the finance ministers Japan and Germany have spoken about the need for tighter controls on currency movements. And late last year, a three-year-old international effort to achieve a Multilateral Agreement on Investments -- which would have promoted globalization and cross-border investments -- collapsed after France, applauded by Australia and Canada, backed out of the talks. They all worried about surrendering power to foreign companies and open markets.

· Wal-Mart Stores bought $18 billion of goods from China last year. With China's annual exports amounting to $583 billion, that means Wal-Mart ranks as its eighth-largest trading partner, ahead of Australia, Canada and Russia.

Foreign Direct Investment

· Factories, customer service centers, etc are built in foreign countries because of lower labor and capital costs, lower taxes, and avoiding tariffs. For example, Nissan or Mercedes plants in the US, US plants in India.

· FDI saw a huge increase in the late 1990s, but slowed in 2000-2005

· FDI has been directed primarily to industrial economies, especially the US. Developing-countries’ share of FDI has declined sharply since the crises.

· The concentration of capital in a few countries emphasizes the importance of a hospitable business climate in attracting FDI. High skill jobs locate in English-speaking countries: India, Pakistan, Philippines, South Africa.

International Trade

· Any imbalance in goods and services trade implies an equal and opposite imbalance in asset trade. When a country runs a trade deficit (more properly labeled a current account deficit), it is also running a capital account surplus, meaning that the country is a net seller of international assets. Capital assets may be debt (international borrowing/lending) or shares in foreign businesses or properties.

Global Trade Balances

· Europeans want the U.S. to cut its trade deficit. The U.S. wants Europe stimulate its economy, which would generate domestic demand and offset business lost to the U.S. and China because the weak dollar has made European goods so much more expensive. Both European and U.S. officials want China to revalue its yuan. The cheap yuan has begun to translate into higher inflation in China, a stronger currency would relieve some of that pressure.

Regional Trading Blocs

1950s-1960s: Formation of Common Markets

· 1949 Comecon: USSR, Albania, Bulgaria, Czechoslovakia, Hungary, Poland, Romania. Later East Germany, Mongolia, and Cuba

· 1957 European Economic Community (EEC): Belgium, France, West Germany, Italy, Luxemburg, Netherlands

· 1960 European Free Trade Association (EFTA): Austria, Britain, Denmark, Norway, Portugal, Sweden, Switzerland. Britain and Denmark left to join the EEC in 1973. Iceland joined in 1970. Finland is an associate member.

· 1960 Central American Common Market: Costa Rica, El Salvador, Guatemala, Honduras, Nicaragua

· 1961 Latin American Free Trade Association (LAFTA): Argentina, Brazil, Chile, Columbia, Ecuador, Mexico, Paraguay, Peru, Uruguay, Venezuela

· 1965 Arab Common Market: Egypt, Iraq, Jordan, Syria

· Some experts suggest that regional trade pacts are more effective than global trade deals in helping individual countries to gain access and open markets.

· 2002 The slow progress of the world trade pacts encourages countries to sign bilateral or regional trade pacts instead. The US and Latin America resumed talks on creating a Free Trade Area of the Americas. China and Japan moved towards signing a free trade pact with the members of ASEAN.

· European Union: The EU has become the most powerful trading bloc in the world with a GDP now exceeding that of the United States. The creation of the euro as a single currency for 12 EU members has led to ever closer economic links. The EU has found it difficult to shed its protectionist past based on the idea of self-sufficiency in agriculture which limits agricultural exports from the other countries. It also had to face the prospect of integrating the 10 new members from the poorer regions of Eastern Europe.

o Members: Austria, Belgium, Denmark, Finland, France, Germany, Greece, Ireland, Italy, Luxembourg, Netherlands, Portugal, Spain, Sweden, UK

· The Asia-Pacific Economic Cooperation forum is a loose grouping of the countries bordering the Pacific Ocean who have pledged to facilitate free trade. Its 21 members range from China and Russia to the United States, Japan and Australia, and account for 45% of world trade.

· ASEAN (Association of Southeast Asia Nations): Progress was seriously dented by the 1997 Asian crisis. But recently China suggested it would be interested in establishing a free-trade zone with the growing economies of South-east Asia. A trade pact between China and Asean intended to remove tariffs on merchandise by 2010, the year set by China and Asean to establish a free trade area. Asean has said it will establish an economic community by 2020. At its current pace, the trade between China and Asean could soon match the $120 billion in annual trade between Asean and the United States.

· The Cairns Group of agricultural exporting nations was formed in 1986 to lobby to free up trade in agricultural products. Highly efficient agricultural producers, including those in both developed and developing countries, want to ensure that their products are not excluded from markets in Europe and Asia. Canada, Brazil and Argentina are other leading members.

· The North American Free Trade Agreement: The United States, Canada and Mexico formed a free trade zone. Under its provisions, all barriers to trade in goods and services are to be phased out over 15 years. US unions and environmental groups argue that the safeguards are too weak. The US is negotiating with Chile to join NAFTA, but that has caused controversy with some other South American countries.

o Under the terms of the treaty, advertising and trucking were freed of restrictions immediately; all limits on bank and insurance company ownership were to be lifted by the year 2000; and duties on farm products and some 10,000 other products were to be eliminated over 15 years, and those on American-made autos over 10 years. Foreign ownership of Mexican oil fields was expressly forbidden.

o 1989 A free-trade pact between the United States and Canada takes effect

o 1990 Negotiations between Canada, Mexico, and the United States begin

o 1992 NAFTA is approved by the US Congress.

o 1994 NAFTA goes into effect.

o 1994 In a politically charged decision, the United States and Mexico announced that they had agreed to postpone indefinitely implementation of a NAFTA provision granting free access to Mexican trucks in the U.S. border states. The decision was seen as symbolic of the disenchantment that had set in in both countries since the signing of the agreement - disenchantment with recession in Mexico and with declining cross-border exports and job losses in the United States.

o 1994 Because of social unrest and assassinations, foreign capital begins to flee Mexico. An economic crisis develops due to this and government overspending. The U.S. Treasury staves off the economic crisis with a $20-billion aid program, preventing Mexico from defaulting on its international debt. Mexico bonds drop in value. US extended the loan with Mexican oil reserves as collateral. Mexico pays back the debt early. However some charge that this signals the willingness of the US Treasury Department to bail out US investors at risk from foreign debt default

o 1997 The Clinton administration declared that it would seek gradual expansion into a hemispheric free trade association.

o 1998 NAFTA is unable to be extended to Chile due to opposition from US unions

o Thousands of companies build factories in northern Mexico to export merchandise to the US – 80% of televisions sold in the US are made there

o The US plans to extend that to the rest of Latin America to create a Free Trade Area of the Americas by 2005, which would rival the EU in size and scale, but key countries like Brazil are skeptical of its benefits.

· The US is separately signing free trade agreements with Chile and the five central American countries of Honduras, Nicaragua, El Salvador, Panama, and Costa Rica.

· The regional free trade pact called Mercosur, between Brazil, Argentina, Uruguay, and Paraguay, has been put under severe strain because of currency devaluation first by Brazil, then by Argentina.

International Currencies

Foreign Currency Reserves

· The U.S. dollar remains the leading reserve currency, and its dominance appears to be increasing. In 2002, almost 65 % of the world's $3 trillion in foreign reserves was held in dollars, up from 50 % in 1990. But the euro, yen, and other currencies appear to be gaining prominence given the US’ budget deficit. A key step will be for the rest of the world to move progressively and smoothly to a multicurrency reserve system in which the U.S. dollar is no longer the single reserve currency or unit of account.

· To keep their currencies from appreciating against the dollar, Asian central banks have been accumulating massive foreign exchange reserves. Around $2 trillion now sits in the central banks of China, Japan, Taiwan, South Korea, Hong Kong, Singapore, and India.

· Manufacturers in Japan, China, South Korea and Taiwan have been selling far more to Americans than Asians have been buying from the United States. As a result, Asians have accumulated huge quantities of foreign exchange, which they have used mostly to buy American government securities. By doing so, they helped keep interest rates in the US low and the dollar relatively strong. That allowed Americans to borrow cheaply and buy goods from Asia

Currency Exchange Rates

· The exchange rate between two currencies specifies how much one currency is worth in terms of the other. For example an exchange rate of 120 yen to the US dollar means that 120 JPY is worth $1.

· Currencies can either be free-floating or pegged (fixed).

· If a currency is free-floating, its exchange rate is allowed to vary against that of other currencies and is determined by the market forces of supply and demand. Exchange rates for such currencies are likely to change almost constantly as quoted on financial markets, mainly by banks, around the world.

· A movable or adjustable peg system is a system of fixed exchange rates, but with a provision for the devaluation of a currency.

· For example, between 1994 and 2005, the Chinese yuan was pegged to the US dollar at ¥8.2768 to $1.

· The gold exchange standard was used from 1876 to 1945. The gold standard used gold to back each currency and thus prevented kings and rulers from arbitrarily debasing money and triggering inflation.

· Under the gold exchange standard, as an economy grew it would import goods from overseas until it ran its gold reserves down. As a result the country’s money supply would shrink resulting in interest rates rising and a slowing of economic activity to the extent that a recession would occur. Eventually the recession would cause prices of goods to fall so low that they appeared attractive to other nations. This in turn led to an inflow of gold back into the economy and the resulting increase in money supply saw interest rates fall and the economy strengthen. These boom-bust patterns prevailed throughout the world during the gold exchange standard years until the outbreak of World War I which interrupted the free flow of trade and thus the movement of gold.

· From the end of World War II until 1971, Western European countries all maintained fixed exchange rates with the US dollar based on the Bretton Woods system which prevented speculation in the currency markets.

· The Bretton Woods Agreement was with the aim of stabilizing international currencies and preventing money fleeing across nations.

· This agreement fixed all national currencies against the dollar and set the dollar at a rate of $35 per ounce of gold. Countries were prohibited from devaluing their currency to improve their trade position by more than 10%.

· The Bretton Woods agreement was abandoned in 1971, and the US dollar was no longer convertible to gold. By 1973, currencies of the major industrialized nations became more freely floating, controlled mainly by the forces of supply and demand.

· Prices were set, with volumes, speed and price volatility all increasing during the 1970’s. This led to new financial instruments, market deregulation and open trade. It also led to a rise in the power of speculators.

· In the 1980’s the movement of money across borders accelerated with the advent of computers and the market became a continuum, trading through the Asian, European and American time zones.

· Large banks created dealing rooms where hundreds of millions of dollars were exchanged in a matter of minutes.

· Today electronic brokers trade daily in the forex market, in London for example, single trades for tens of millions of dollars are priced in seconds.

· The market has changed dramatically with most international financial transactions being carried out not to buy and sell goods but to speculate on the market

· London has grown to become largest forex market. This arose not partially due to the creation of the Eurodollar market. The Eurodollar market was created during the 1950’s when Russia’s oil revenue, all in US dollars, was deposited outside the US in fear of being frozen by US authorities. This created a large pool of US dollars that were outside the control of the US.

· A currency will tend to become more valuable whenever demand for it is greater than the available supply. Increased demand for a currency is due to either an increased transaction demand for money, or an increased speculative demand for money.

· The transaction demand for money is determined by the amount of foreign exchange is needed by businesses to settle accounts, and is highly correlated to the country's level of business activity, gross domestic product (GDP), and employment levels.

· The speculative demand for money is much harder for a central bank to accommodate but they try to do this by adjusting interest rates. An investor may choose to buy a currency if the return (that is the interest rate) is high enough. The higher a country's interest rates, the greater the demand for that currency.

· A currency will tend to lose value if the country's level of inflation is high, if the country's level of output is expected to decline, or if a country is troubled by political uncertainty.

· For example, when Russian President Vladimir Putin dismissed his Government in 2004, the price of the Ruble dropped.

· When China announced plans for its first manned space mission, synthetic futures on Chinese yuan jumped (since China's currency is officially pegged, synthetic markets have emerged that can behave as if the yuan was floating).

· It has been argued that currency speculation can undermine real economic growth, in particular since large currency speculators may deliberately create downward pressure on a currency in order to force that central bank to sell their currency to keep it stable (once this happens, the speculator can buy the currency back from the bank at a lower price, close out their position, and thereby take a profit).

· Former Malaysian Prime Minister Mahathir Mohamad blamed the devaluation of the Malaysian ringgit in 1997 on George Soros and other speculators

· On the other hand, countries may develop unsustainable financial bubbles or otherwise mishandle their national economies, and forex speculators only made the inevitable collapse happen sooner. Mahathir Mohamad and other critics of speculation are viewed as trying to deflect the blame from themselves for having caused the unsustainable economic conditions.

· The United States has occasionally called on other countries to appreciate their currencies vis-à-vis the dollar in order to reduce foreign exports to U.S. markets. For example, Washington pushed Japan away from a much-needed depreciation of the yen during the 1990s, and it is now pressuring China to appreciate the yuan.

· Ecuador and El Salvador, in 2000 and 2001, respectively, abandoned their own currencies, adopted the dollar and placed their monetary policy in the hands of Alan Greenspan. Large countries like the United States have to tread lightly in advocating that small countries give up their currencies. In 2000, Congress considered — but did not pass — the International Monetary Stability Act, which would have provided financial assistance to countries that adopted the dollar.

· 2003-2004 The dollar fell 23% against the euro and 14% against the yen. Japan spent record amounts on intervention, buying dollars for yen in an attempt to maintain its currency's competitiveness.

· 2005 China revalued its currency, ending a decade-long peg to the American dollar and allowing the yuan to appreciate by over 2 percent, temporarily alleviating global pressure on the country to act.

· Low bond yields and the dollar’s refusal to plunge are partly due to emerging countries piling up foreign reserves.