Applied Global Money Management

This article focuses on various global money management systems and practices. Three of the featured topics include the international monetary system, the international financial system and the international capital budgeting process. There is an explanation as to why the international monetary system is necessary as well as some of the problems that are encountered in the international capital budgeting process. Finally, there is a discussion about the international financial system, especially the new international financial architecture (NIFA).

Keywords Asia Pacific Economic Cooperation; Bank of International Settlements; Basel Committee on Banking Supervision; Capital Budgeting; European Union; International Monetary Fund; International Monetary System; Money Management; North America Free Trade Agreement; World Bank

Finance > Applied Global Money Management

Overview

What is money management? Money management is the method of controlling and governing money, which can involve investing, budgeting, banking, and the implementation of taxes. This article provides a preview of how it is applied in a global economy. Some of the highlighted areas include the international monetary system, the international financial system, and international capital budgeting.

International Monetary System

The Gold Standard

The international monetary system is needed in order to better describe an ordinary form of value for the world to use as its currency. During the late 19th and early 20th centuries, the gold standard became the first international monetary system. "It has often been assumed in the international political economy literature that the classical gold standard of the late 19th century represented a turning point in monetary history because it marked the end wherein states manipulated their currency to increase their revenues" (Knafo, 2006, p. 78). One advantage of this type of system is that gold has a stabilizing influence. However, a disadvantage of the system is that it lacks liquidity. In addition, if there was an unexplainable increase in the supply of gold, prices could rise abruptly. Given the number of disadvantages, the international gold standard failed in 1914 and was replaced by the gold bullion standard during the 1920s. However, the gold bullion standard ceased to be used in the 1930s.

The Gold-Exchange Standard

The gold-exchange standard was used to conduct international trade during the period after World War II. This system encouraged countries to set the value of their currency to some foreign currency, which was set and redeemed in gold. Many countries set their currency to the dollar and maintained dollar reserves in America. The United States was seen as the leading country for currency. It was during the 1944 Bretton Woods International conference that a method of fixed exchange rates was conceived and implemented. In addition, the International Monetary Fund was established and charged with conserving stable exchange rates globally.

The Bretton Woods System

The Bretton Woods system was charged with developing and implementing the rules and regulations for global commercial and financial transactions. The International Bank for Reconstruction and Development was established as a result of this endeavor. It was the first effort at creating a system that would control monetary relationships between autonomous nation-states. The greatest accomplishments of the Bretton Woods system occurred when: Each country agreed to implement a monetary policy that would maintain the exchange rate of its currency in a fixed amount through the value of gold. They also agreed that the International Monetary Fund had the right to connect fleeting inequalities of payments. Unfortunately, the method broke down in 1971 because of Americas' suspending of conversion from dollars to gold.

The Growth of the Global Economy

According to a new report conducted by Oliver, Wyman & Company for Strategic Finance, global net revenue from money management is expected to triple to $900 billion by 2010, which is up from $277 billion in 1996 (Chernoff, 1998). The report predicts that revenue will grow at a 9% annual clip. As a result, money management will become one of the quickest spreading sectors in the global financial industry.

Chernoff (1998) alleges that growth is driven by a variety of factors such as "modest economic growth; faster wealth buildup among the affluent; continued growth in investments as a share of total financial assets: aging populations in Western countries; and an emerging middle class in developing companies" (p. 8).

Application

International Capital Budgeting

When the financial management team determines whether or not to invest in specific capital projects, the process is called capital budgeting. An organization usually has to deal with capital budgeting issues when it plans to acquire new assets or replace existing obsolete assets in order to maintain efficiency. The financial management team must determine which projects are good investment opportunities, which projects are the most desirable to acquire, and how much the organization should invest in each asset.

International capital budgeting refers to when projects are located in host countries other than the home country of the multinational corporation. Some of the techniques (i.e. calculation of net present value) are the same as traditional finance. However, "capital budgeting for a multinational is complicated because of the complexity of cash flows and financing options available to the multinational corporation" (Booth, 1982, p. 113).

Challenges Unique to Capital Budgeting for the Multinational Corporation

Capital budgeting for the multinational corporation presents many problems that are rarely found in domestic capital budgeting (Shapiro, 1978; Ang & Lai, 1989). Financial analysts may find that foreign projects are more complex to analyze than domestic projects due to the need to:

• Distinguish between parent cash flow and projects cash flow. Multinationals will have the opportunity to evaluate the cash flow associated with projects from two approaches. They may look at the net impact of the project on their consolidated cash flow or they may treat the cash flow on a stand alone or unconsolidated basis. The theoretical perspective asserts that the project should be evaluated from the parent company's viewpoint since dividends and repayment of debt is handled by the parent company. This action supports the notion that the evaluation is actually on the contributions that the project can make to the multinational's bottom line.

Some organizations may want to evaluate the project from the subsidiary's (local) point of view. However, the parent company's viewpoint should supersede the subsidiary's point of view. Multinational corporations tend to compare their projects with the subsidiary's projects in order to determine where their investments should go. The rule of thumb is to only invest in those projects that can earn a risk-adjusted return greater than the local competitors performing the same type of project. If the earnings are not greater than the local competitors, the multinational corporation can invest in the host country's bonds since they will pay the risk free rate adjusted for inflation.

Although the theoretical approach is a sound process, many multinationals tend to evaluate their projects from both the parent and project point of view because of the combined advantages. When looking from the parent company's viewpoint, one could obtain results that are closer to the traditional net present value technique. However, the project's point of view allows one to obtain a closer approximation of the effect on consolidated earnings per share. The way the project is analyzed is dependent on the type of technique utilized to report the consolidated net earnings per share.

• Recognize money reimbursed to parent company when there are differences in the tax system. The way in which the cash flows are returned to the parent company has an effect on the project. Cash flow can be returned in the following ways:
• Dividends — It can only be returned in this form if the project has a positive income. Some countries may impose limits on the amounts of funds that subsidiaries can pay to their foreign parent company in this form.
• Intrafirm Debt — Interest on debt is tax deductible and it helps to reduce foreign tax liability.
• Intrafirm Sales — This form is the operating cost of the project and it helps lower the foreign tax liability.
• Royalties and License Fees — This form covers the expenses of the project and lowers the tax liability.
• Transfer Pricing — This form refers to the internally established prices where different units of a single enterprise buy goods and services from each other.

• Anticipate the differences in the inflation rate between countries given that it will affect the cash flow over time.

• Analyze the use of subsidized loans from the host country since the practice may complicate the capital structure and discounted rate. The host country may target specific subsidiaries in order to attract specific types of investment (i.e. technology). Subsidized loans can be given in the form of tax relief and preferential financing, and the practice will increase the net present value of the project. Some of the advantages of this practice include: Adding the subsidiary to project cash inflows and discount; discounting the subsidiary at some other rate, risk free, and; lowering the risk adjusted discount rate for the project in order to show the lower cost of debt.
• Determine if the political risk will reduce the value of the investment. Expropriation is the ultimate level of political risk, and the effects of it depends on when the expropriation takes place, the amount of money the host government will pay for the expropriation, how much debt is still outstanding, and the tax consequences of expropriation and the future cash flow.
• Assess the different perspectives when assessing the terminal value of the project. Estimating the salvage value or terminal value depends on the value of the project if retained, the value of the project if purchased by outside investors and the value of the project if it were liquidated. The corporation would use the assessment that yields the highest value.
• Review whether or not the parent company had problems transferring cash flows due to the funds being blocked. An example would be when a host country limits the amounts of dividends that can be paid. If this were to occur, the multinational corporation would have to reexamine its reinvestment return and other methods in which the funds could be transferred out of the country. The blocked funds can be used to repay bank debt in the host country and allow the organization to have open lines of credit to other countries.

• Make sure that there is no confusion as to how the discount rate is going to be applied to the project.

• Adjust the project cash flow to account for potential risks. One must assume that every project has some level of risk. The risk is usually seen as part of the cost of capital. International projects tend to have more risk than domestic projects. Therefore, it is advantageous to review the risk based on the parent's and project's perspective. Each perspective has a different way of adjusting risk. For example, the parent company may propose to treat all foreign risk as a single problem by increasing the discount rate applicable to the foreign projects or incorporate all foreign risk in adjustments to forecasted cash flows of the project. The first option is usually not recommended because it may penalize the cash flows that are not really affected by any sort of risk and it may ignore events that are favorable to the organization. The four components are initial investment outlay, net cash benefits (or savings) from the operations, terminal cash flow, and net present value (NPV) technique.

Viewpoint

International Financial Systems

There was much growth and change in national and international financial systems in the 20th century. During the Post War period, many countries had the opportunity to experience economic increases, steady low unemployment and continuous deregulation in their respective economic markets. Positive steps have been taken to change the way business was done through acts such as the implementation of the European Union, the North America Free Trade Agreement and the Asia Pacific Economic Cooperation. In addition, international institutions like the World Bank, the International Monetary Fund and the Bank for International Settlements have assisted in the management of the changes that have occurred in the international financial arena. All of the efforts mentioned above have been an attempt to produce a sound international financial system that will be able to sustain over the years. "The financial system in the 21st century should provide a financial environment that is conducive to contributing to further global financial integration as well as better macroeconomic coordination" (Moshirian, 2002, p. 274).

Importance of International Cooperation

There are some key issues that may have an effect on the international financial system. Therefore, it is imperative that all of the organizations and initiatives listed above come together in order to create an international financial architecture versus working in isolation. "Globalization and increasing interdependence amongst all the nations of the world have allowed people to have a better understanding of key factors which affect the welfare and interest of all people and nations and their absence could harm both developed and developing countries. Some of these issues are sustainable development, world peace and security, sound global environmental policies, international trade, stable monetary systems, sound financial institutions, universal education and health, sound and all embracing technological changes and effective and universally accessible telecommunication" (Moshirian, 2002, p. 276).

The establishment of the International Monetary Fund and the World Bank is probably one of the most important success stories for international economic cooperation. Since the mid-twentieth century, there have been many changes in terms of the political and economic climate on a global level, which has caused the world's top international financial institutions to shift in terms of how they operate their businesses. Given the number of financial crises that have surfaced during in the twenty-first century, many scholars and practitioners in the field have called for a reform in how the international financial system is structured. These crises have exposed the weaknesses that are in the international financial system as well as highlight the fact that globalization has pros (benefits) and cons (risks).

The New International Financial Architecture

“The new international financial architecture (NIFA) was created by the G-7 countries due to the growing volatility in developing countries. Some key components of the NIFA include: The G-20, the Financial Stability Forum and the Reports on Observance of Standards and Codes, the latter involving areas such as corporate governance” (Soederberg, 2002, p. 612). The purpose of the architecture is to offer governments, businesses and individuals a mechanism (i.e. institutions, markets) to conduct economic and financial activities. The goal is to create an environment that strengthens and stabilizes the international financial system and minimizes the global exposure to financial dilemmas. Some advances have been made in order to reach these goals. The International Monetary Fund (IMF) has been instrumental in making some of these goals a reality. According to the IMF's fact sheet (2000), some of the major accomplishments include:

• Increased availability of information from governments and other institutions to the general public
• Increased usage of codes of healthy practices that are needed for an economy to function successfully
• The creation of the Contingent Credit Lines.

International Monetary Fund Improvements

IMF is working diligently to provide continuous improvements to practices that affect many sectors. For example, this body continues to:

• Stimulate the release of public information reports that detail the IMF Executive Board's evaluation of a nation’s financial state and economic policies.
• Encourage members to reveal the description of policies that the members might adhere to in order to maintain financial stability through the IMF-supported program.
• Help countries implement guidelines, such as the Reports on the Observance of Standards and Codes, that will evaluate a nation's development in practicing globally accepted standards and codes.
• Address gaps in regulatory standards through the Basel Committee on Banking Supervision.
• Encourage members to put procedures in place when they are not experiencing any problems so that they are not responding to a crisis. It's an opportunity to be proactive versus reactive.
• Aid countries in assessing their extrinsic liabilities and choosing the proper exchange rate programs.

Conclusion

The international monetary system is needed in order to better describe the shared standards of value for global currencies. During the late 19th and early 20th centuries, the gold standard became the first international monetary system. One of the advantages of this type of system is that gold has a stabilizing influence. However, a disadvantage of the system is that it lacks liquidity. In addition, if there was unexplainable increase in the supply of gold, prices could rise abruptly. Given the number of disadvantages, the international gold standard failed in 1914 and was replaced by the gold bullion standard during the 1920s. However, the gold bullion standard ceased to be used in the 1930s.

The Bretton Woods system was charged with developing and implementing the rules and regulations for global commercial and financial transactions. The International Bank for Reconstruction and Development was established as a result. It was the first effort at creating a system that would govern monetary relations among independent nation-states. The greatest accomplishments of the Bretton Woods system occurred when each country agreed to implement a monetary policy that would maintain the exchange rate of its currency in a fixed amount through the value of gold. They also agreed that the International Monetary Fund had the right to connect fleeting inequalities of payments. Unfortunately, the method broke down in 1971 when the United States suspended conversion from dollars to gold.

International capital budgeting refers to when projects are located in host countries other than the home country of the multinational corporation. Some of the techniques (i.e. calculation of net present value) are the same as traditional finance. However, "capital budgeting for a multinational is complicated because of the complexity of cash flows and financing options available to the multinational corporation" (Booth, 1982, p. 113). Capital budgeting for the multinational corporation presents many problems that are rarely found in domestic capital budgeting (Shapiro, 1978; Ang & Lai, 1989).

There was much growth and change in national and international financial systems in the 20th century. During the Post War period, many countries had the opportunity to experience economic growth, low unemployment and gradual deregulation in their respective financial markets. Positive steps have been taken to change the way business was done through acts such as the emergence of the European Union, the North America Free Trade Agreement and the Asia Pacific Economic Cooperation. In addition, international institutions such as the World Bank, the International Monetary Fund and the Bank for International Settlements have assisted in the management of the changes that have occurred in the international financial arena. All of the efforts mentioned above have been an attempt to produce a sound international financial system that will be able to sustain over the years. "The financial system in the 21st century should provide a financial environment that is conducive to contributing to further global financial integration as well as better macroeconomic coordination" (Moshirian, 2002, p. 274).

According to a report conducted by Oliver, Wyman & Company for Strategic Finance in the 1990s, global net revenue from money management was expected to triple to $900 billion by 2010, up from $277 billion in 1996 (Chernoff, 1998). In fact, by 2013, money management was a $53 trillion dollar industry (Bradford, 2013).

Terms & Concepts

Asia Pacific Economic Cooperation: A financial forum for an alliance of Pacific Rim nations to altercate over issues regarding the global and regional economy, the level of cooperation needed to function successfully, and the ins and outs of trading and investing.

Bank of International Settlements: An institution that extends its service to central banks around the world in addition to other global and national financial institutions. Individuals and businesses, however, are not allowed to deposit or otherwise receive services from this bank.

Basel Committee on Banking Supervision: A company first establishing by the central bank Governors of the Group of Ten nations. It was instilled in 1974 and joins together quarterly.

Capital Budgeting: The process by which the financial manager decides whether to invest in specific capital projects or assets.

European Union: A financial and governmental alliance created in 1993 following the ratification of the Maastricht Treaty by members of the European Community. The union - which includes Austria, Finland, Sweden, Syprus, the Czech Republic, Estonia, Hungary, Latvia, Lithuania, Malta, Poland, Slovakia, and Slovenia – increased the political scope of the European Economic Community, particularly in foreign policies and security initiatives. The union also initiated the establishment of a common European bank and central currency known as the euro.

International Monetary Fund: An institution of over 180 nations motivated to promote worldwide monetary cooperation and the wellbeing and security of the international monetary system. Every member fulfills its position by contributing to quota payments that relates directly to the nation’s size and position in the global economy. The size of the nation also determines its voting control within the IMF. The United States, for example, has a 17% voting stake. The IMF contributes to global financial gains through loan grants and technical aid directed at underdeveloped or needy countries. The institution was developed in 1944 with the help of 45 nations as a means to counter the issues raised by the catastrophic events following the stock market crash of 1929.

International Monetary System: Guidelines and policies by which differing currencies are traded for each other during global exchanges. The system is needed in order to create and impose a universal standard of value for finances across the globe.

Money Management: The process of controlling and governing finances through investing, budgeting, banking, and taxing.

North America Free Trade Agreement: An agreement that supports the implementation of free trade between Mexico, America, and Canada.

World Bank: An organization whose focus is on foreign exchange reserves and the balance of trade.

Bibliography

Ang, J., & Lai, T. (1989). A simple rule for multinational capital budgeting. Global Finance Journal, 1, 71-76. Retrieved July 5, 2007, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=6338721&site=ehost-live

Booth, L. (1982). Capital budgeting frameworks for the multinational corporation. Journal of International Business Studies, 13, 113-123.

Bradford, H. (2013). Report gives money managers pause. Pensions & Investments, 41, 2-43. Retrieved November 15, 2013, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=91756508&site=ehost-live

Chernoff, J. (1998). Global money management boom predicted. Pensions & Investments, 26, 8. Retrieved August 25, 2007, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=919587&site=ehost-live

Dent, C. M. (2013). Paths ahead for East Asia and Asia-Pacific regionalism. International Affairs, 89, 963-985. Retrieved November 15, 2013, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=89024370&site=ehost-live

Knafo, S. (2006). The gold standard and the origins of the modern international monetary system. Review of International Political Economy, 13, 78-102. Retrieved July 31, 2007, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=19125334&site=ehost-live

Moshirian, F. (2002). New international financial architecture. Journal of Multinational Financial Management, 12, 273-284. Retrieved July 28, 2007, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=7865954&site=ehost-live

Shapiro, A. (1978). Capital budgeting for the multinational corporation. Financial Management (1972), 7, 7-16. Retrieved July 5, 2007, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=5029365&site=ehost-live

Soederberg, S. (2002). On the contradictions of the new international financial architecture: Another procrustean bed for emerging markets? Third World Quarterly, 23, 607-620. Retrieved August 2, 2007, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=7484752&site=ehost-live

Suggested Reading

Appell, D. (2007). So that's where the money goes. Pensions & Investments, 35, 8. Retrieved August 26, 2007, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=24545460&site=ehost-live

Garrone, F., & Solnik, B. (1976). A global approach to money management. Journal of Portfolio Management, 2, 5-14.

Top 40 money managers. (2007). Benefits Canada, 31, 36-37. Retrieved August 26, 2007, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=25030632&site=ehost-live