Global Finance

Global finance is becoming a growing part of the financial world and the world of the investor. Global options for investing abound but require knowledge on the part of the investor and expertise on the part of the fund manager. Global finance allows emerging growth countries and economies to participate and access new markets and demand for new investments. However, the investor must weigh the cost and possible instability of global markets when investing. Portfolio diversification and strategy may suggest that a component of a well-rounded portfolio be global funds. But investors have no way of predicting the cultural and political shifts that may influence the stability of global funds. Other more secure investments may be needed to offset possible losses in global funds.

Keywords Finance; Financial Regulation; Global; Globalization; International Finance; International Monetary Fund (IMF); Securities and Exchange Commission; World Bank

Finance > Global Finance

Overview

Global finance concerns the international financial system, financial institutions and instruments. Several international institutions regulate global financial markets. These include the World Bank, the International Money Fund and the World Trade Organization. The prospect of investing in global instruments is attractive to some but worrisome to others. Tyson (2003) advised investors to be careful and often stay away from global investing. Tyson noted that the word "international" means the fund invests globally except in the United States. A fund with worldwide or global in its name includes the United States. Tyson gave two reasons for avoiding global fund investing — information and cost. He felt it was difficult for a fund manager to follow the action if it were occurring across the globe and much more difficult than following U.S. funds. Secondly, he felt that the costs associated with the operation and management of global funds would offset the yield and return an investor could anticipate.

Thinking globally means changing the view of what is important in global finance and who the primary players are. There was a time when the only markets that were deemed important were the United States and parts of Europe. The view then began to trend toward only the major industrialized nations. However, with improvements in technology and the desire of emerging growth countries to participate in global markets, the global finance landscape has changed. Poor and emerging economy countries are recognizing that they have valuable items to trade such as natural resources and labor that were previously untapped. Harnessing those resources and participating in the global economy can change the status of an emerging country and its people.

Risks of Global Finance

Some issues related to global finance are the conditions in various underdeveloped and emerging countries. There can be instability due to currency instability and political instability. There can also be war and military issues, poverty, environmental and human rights issues. Some global funds can become undesirable based on the discovery of internal turmoil in the local economy. Funds can also face a backlash when information about such instability is uncovered.

Global finance is growing with the growth and expansion of multinational corporations. Many established corporations in the United States and Europe are looking for ways to expand their customer base and increase the demand for their products and services. Some are facing saturation in developed countries and are looking for opportunities in new areas. Mergers and acquisitions are also making companies bigger with multinational interests. Many fear that the 'McDonaldslization' or 'Starbucktizing' of the world is not a good thing. This is due to the fact that when multinational firms are investing in new economies, they will likely have influence over the activity, growth and change that occurs.

Banking & Globalization

The County Monitor (2006, p. 5) noted the success of banks worldwide in reducing risk. The techniques used to do this included "statistical portfolio management, securitization, the sale of problem loans and derivatives hedging." These methods have helped banks to reduce risk and spread it around. Moody's rating service revised the way it rates banks. It contrived a five rating system from A to E to make the international ratings consistent across economies. The rating system is supposed to give investors a better idea of how credit worthy a bank is and what the true risk is in a certain economy. However, many experts believe that the rating system can only go so far, and in fact Moody's (as well as the other ratings agencies) came under sharp criticism after the 2008 global financial crisis when it was discovered that billions of dollars in bad debt, bundled into collateralized debt obligations, was given the highest rating — AAA (Fiderer, 2013).

Banks have experienced an influx of cash in the early 21st century, contributing to merger and acquisition activity. This new level of consolidation meant that mergers also began occurring across global borders. Citigroup led the way by making inroads into China, Taiwan and Turkey (Country Monitor, 2006). Other changes in global banking have occurred in the asset makeup of banks. The economies of Russia and China with "less developed financial systems" tend to have a higher ratio of corporate loans than consumer loans whereas U.S. Banks have a 50:50 ratio. In 2013 China's banks were lending at a rate of 132 percent of GDP, and of that about 85 percent was to corporations (Dobbs, Leung & Lund, 2013). The risk is lower when there are more consumer loans in the mix — spreading the risk around. With corporate loans, especially if those loans are largely to only a few institutions, the risk is greater (Country Monitor, 2006).

Role of Governments in Globalization

Dorn (2003) believed bad government policies are at fault for many global financial crises. Dorn (2003) provided examples of the Argentine government defaulting on debt in 2001 and the Brazilian crisis in 2002 as examples of how government can help devalue confidence in an economy. Dorn (2003) used these examples to indicate how important it is to find ways to deal with the crises of debt across the world combined with banking crises and currency crises. The International Monetary Fund (IMF) has stepped in to help countries in crisis but cannot remove the stigma that may remain on the credibility of investing in these regions with problems. Governments must cooperate with market forces in order to keep the flow of capital investment coming. In Europe, in the early days of the global financial crisis, Iceland partially nationalized its banks to prevent collapse, but it protected the deposits of Icelanders only; the large number of foreign depositers in the U.K. and Netherlands were bailed out by their own governments, who expected reimbursement from Iceland but were instead rebuffed. Touryalai (2011) predicted long-term repurcussions for Iceland from the global investment community. Refusing to impose austerity on its people in order to meet its credit obligations, Iceland's government instead provided mortgage relief and other measures. In contrast, Ireland, Portugal, Spain, Greece, and Italy struggled under huge debt burdens that ravaged their economies, and bailouts by the European Central Bank were conditioned on austerity measures that sparked massive protests. A fragile calm eventually ensued (though unemployment remained extremely high) and by 2013, these nations were again issuing bonds (Fontevecchia, 2013). At the same time, Iceland's economy was recovered modestly, with growth in GDP and a steep drop in unemployment; the necessity of not remaining a pariah in the foreign investment market was obvious, and the government was working toward satisfying foreign creditors and investors (Bremner & Valdimarsson, 2013). Worries remained, however, that in preserving institutions that had colossally failed, public debt had swollen to dangerous and unsustainable levels (Bilkic, Carreras Painter, & Gries, 2013).

Regard for Risk

A 1999 Federal Reserve Bank conference on "Bank Structure and Competition" (Brewer & Evanoff, 1999, para.1) suggested ways to prevent global financial crises and to resolve them when they occur. Conference discussions pursued the causes of global financial crises finding that the integration of global markets increased the dependence countries have on each other; spreading the pain around. Excessive debt, herd mentality by investors and over speculation with a "boom-bust" mentality created a gambling like atmosphere among investors. Many investors rushed into new markets without regard for risk.

Disregarding risk is a classic mistake in an unknown investment environment. Crises occurred because the governments at the center of these financial investments did not back up the liabilities incurred by financial institutions. The reason investors engage in risky investments is high yield and protection from potential losses. Other conference participants blamed the IMF for bailing out failing financial institutions as a signal to financial institutions in other countries that they would also be helped if they wanted to find relief from financial liabilities. This "moral hazard" also fueled the savings and loan crisis in the U.S. since bailout was seen as a viable option (Brewer & Evanoff, 1999, para. 8). Not only are unnecessary risks taken when bailout is assured but market prices are distorted as well. Regulation is seen as a primary vehicle to prevent excessive risk taking due to assurances of liability relief. The complexity of global finance can make it difficult for rating agencies and others to react to potential crises.

Some recommendations to avert future financial crises included restricting the IMF to bailout only if the affected country has a sound financial banking system. Sound systems would mean that private lenders would accept liability if the bank fails and foreign banks should be encouraged and allowed to fairly compete in their local markets to diversity the risk. Finally, investors would have to be compensated with a higher rate of return if failure occurs. These recommendations were felt to possibly curb the tendency for excessively risky behavior (Brewer & Evanoff, 1999). Conquering risk means regaining control and requires decision making and careful calculation (Beck, 2002).

Global Challenges

Some of the challenges with global finance are cultural and political. There may be cultural and political influences on investments that can change the risk and value associated with the investment. These factors may be unknown and it may be difficult to predict the result of cultural or political instability. Being some distance away from factors that influence investments can also give investors pause. There could be some language barriers and problems with interpretation, though many global funds have English-speaking and U.S. financial advisors.

It may be assumed that only emerging and developing countries have challenges with globalization and global finance. However, developed and highly industrialized nations must keep pace with changes in order to survive as emerging nations become stronger. The Economist (2006) reported on changes to the financial trading practices in London and its struggle to remain the capital of finance in England. Some of the changes have included infrastructure investments and transforming a formerly underutilized areas to booming economic centers as well as changing trading methods. London was a worldwide center for finance in the 1960's and 1970's and became home for international banks in the 1980's but lost many brokers to New York because of stock market trading practices. London felt a recession in the 1990s and weathered the storm of uncertainty with the euro as currency. London has followed the lead of the United States in beefing up regulatory policy to avoid financial collapses.

The integration of multiple financial systems is much more complex than it sounds. Clark (2005) found that previous attempts at understanding globalization emphasized the social aspects. Clark investigated global finance and money flow and noted that various systems are challenged by reality. The financial systems of the United States tend to be "market centered top-down systems regulated and controlled by" national and international institutions. European financial systems tend to be bottom up and loosely regulated. The argument for global financial systems calls for using the best practices of all systems (Clark, 2005, p. 101). Clark also called for research that is cross functional along the disciplines of economics, geography, sociology and finance.

Bank Stability

Ratings organizations like Moody's (Country Monitor, 2006, p. 5) have noted the improvement in the financial stability of banks. However, when considering global challenges, these ratings agencies look at "country risk, the regulatory environment, the stability of the financial system and the likelihood of government support." Country risk may include the capital inflow to an emerging economy and the stability of that inflow. Struggling governments may have no ability or desire to bail out a struggling financial institution. Debt in the United States continues to require substantial inflows and can influence interest rates in other nations. Some economies have regulatory entities that specifically look at ways to reduce risk. For example, the World Bank and European Union publish such guidelines.

Technology

Technology freed the flow of money during the dot-com era by sending money to the areas with the most innovation and productivity (Clark, 2005). Technology has done much to spur globalization and vice versa. A direct result of the increase in technology and financial markets being driven by technology is technological theft and terrorism. This new industry puts personal information about investors at risk. Investors who want to invest globally and online must heed warnings of scams and should deal with reputable entities regardless of the claims of high returns.

Time Zone Differences

Time zones can present challenges for global investors. One market may be active while another market is asleep. This presents challenges in tracking investments and making decisions about them. Freed (2006, p. 20) reported on a company called "Recerche" — a team of 30 analysts based in India who have high speed Internet access and tools for performing research on demand for global investment clients. Fund managers use services like this because analysts are literally working on investment issues while the fund manager sleeps.

Internal Security Threats

The Computer Security Update (2005) reported that for the first time there is an increase in internal security threats on financial institutions that now overtake external threats. Easy access to the Internet has made these attacks possible. Bogus emails and phishing scams are most popular. Financial institutions are engaging in awareness training for staff and information security strategies. A study of financial institution security officers noted that Europe, the Middle East and Africa lead the way in adopting security standards and have information security strategies in place. Asian countries had the highest awareness level and commitment to training on these issues. Latin America and Caribbean countries had the lowest level of programming for managing privacy compliance. More than half of Canadians responding reported actual experience with security breaches. Along with the United States, Canada has committed adequate funding to address these issues (Computer Security, 2005).

Clark (2005, p. 105) compared the characteristics of global finance to the characteristics of the substance mercury. One characteristic is that mercury "runs together at speed." Global finance can do the same thing due to the ability to communicate instantly across the globe. Similarly, mercury "forms in pools." A distinct advantage of global finance is to shift pools of money to demand where it exists. Pooling transactions also reduces cost.

Viewpoints

Benefits & Dangers of Global Investing

There can be benefits in investing globally. Investors can tap into profits and have alternatives to only investing domestically. At the same time, policies must exist to ensure risk is limited and that countries can share in the benefits of globalization. In no way can the individual investor alone participate in this policy making nor can the investor predict the movement and changes in policy. The effect of policy cannot be determined in advance.

An understanding of globalization can also help investors determine how and where to invest. The International Monetary Fund (IMF) (2002, para. 13) found that there were four components of globalization including:

• Trade

• Capital Movements
• Movement of People
• Spread of Knowledge and Technology

Trade

The percentage of trade by developing countries increased 19% from 1971 to 1999 with Asian countries benefiting from this trend primarily in the area of manufacturing. Accompanying this trend has been a change of opinion of these countries. In prior years, the countries were laughed at and assumed to produce inferior goods. Once the manufacturing techniques improved, some countries were seen as dangerous competitors and the source of many high paying manufacturing jobs leaving the United States. Many have resigned themselves to the fact that the Japanese dominate automotive manufacturing and the Chinese dominate manufacturing of toys, electronics and other consumer goods. Others have used these events as a rallying cry for a boycott of non-American made products or to push the government to intervene. The IMF supports government policy to retrain workers.

Capital Movements

Capital flow into developing companies has increased primarily due to expansion by multinational corporations. The migration of people for the purposes of better employment has primarily been concentrated to developing countries with limited movement back to developing countries to share knowledge and skill. Finally, investment in developing countries requires an increase in the local knowledge and technology. However, it is noted that poverty is not positively impacted by globalization. Instead the rich countries continue to get rich while poorer countries get poorer. Similarly, within countries the gap between rich and poor continues to increase.

Increased Portfolio Stability

One reason to invest globally is to reduce fluctuation in your portfolio. The reduction in fluctuation occurs because not every country's investment vehicle is going up or down at the same time as another country. In addition, only investing domestically can limit opportunities that may only exist in other countries. Finally, investments tend to act in cycles and investing outside of one's country can help the investor's portfolio by tapping into positive cycles of fast growth internationally that may not be taking place domestically. This action can reduce fluctuation in an investor's portfolio. Financial advice is important, especially with foreign investment. The investor should also be prepared for long term investment and understand the overall equity returns or how domestic currency performs against foreign currency over the long haul (Khosrow & Salvatore, 1993).

Complexity

Some disadvantages to global investing include complexity. There may not be adequate information about investment practices or regulatory policies. Understanding tax liability may also be difficult. In developing countries, there is unlikely to be an organization like the Security and Exchange Commission (SEC) providing regulatory guidance so some risk is inherent. Another information problem is that global investing may require getting information from other parts of the world that are not on the same schedule and it may result in delays in getting updated financial statements or communicating with someone in real time (Khosrow & Salvatore, 1993).

Diversification

Jenks & Eckett (2002) believed that there were several advantages to global investing for the small investor such as diversification as a risk amelioration strategy for investors. They suggest splitting a portfolio among various areas of the world making sure different industries, asset types and a mix of developing versus emerging countries is selected. It is also suggested that investors become more familiar with risk terms and the meaning of volatility measures in order to better select a global investment. All types of risk including political and regulatory risk have to be balanced against any possible return on a global investment. Global investors should avoid investing in countries which have correlating stock relative to the investor's home country. Not following this advice could lead to losses and defeats the purpose of diversification. International markets may not have the sophistication of U.S. markets and the advantage to the U.S. investor is greater knowledge of how investments work applied to the international opportunity.

Crises & Regulatory Fallout

A constant danger in the global markets is that of a crisis and regulatory fallout and analysis of crises. Most crises are unforeseen events and have far-reaching consequences. Hoguet (2001) examined a 1999 global financial crisis caused by a default crisis in Russia, devaluation in Brazil, capital controls in Malaysia and the 1998 collapse of Long Term Capital Management hedge fund. Hoguet (2001, p. 46) noted several reasons given by analysts for these crises. The reasons included:

• Shrinkage in bank lending
• Macroeconomic policies in specific countries
• Deficits as a percentage of Gross Domestic Product
• Excessive money supply growth
• "herd" behavior of investors
• IMF policies that adversely affected specific countries
• Prosperous countries taking advantage of less prosperous ones
• "Misallocation" of capital by corporate managers and lenders

Hoguet (2001, p. 47) felt that international equity investors and fund managers play a substantial role in "stabilizing the global economy." In addition, Hoguet believed that U.S. pension funds are the key because of their size (60% of the world's pension fund assets at $13+ trillion) and because over "11% of these assets are invested in foreign equities." U.S pension funds are expected to grow and can provide balance to corporate asset allocation. Hoguet (2001) accurately described increasing global investment as inevitable with the entry of China into the global economy. Hoguet (2001) suggested a number of policy guidelines to manage communication with emerging markets for investment. One of the most important ideas to communicate would be the international global finance guidelines as well as emphasizing the benefit of experienced U.S. fund managers. Hoguet (p.47) felt that the best reasons for increasing investments in emerging global markets are "diversification, return enhancement and a broader investment opportunity set". Hoguet's views are not unlike most others in the reasons to invest. The individual investor must create a portfolio that can withstand the volatility and potential for crisis that the global finance market offers.

Conclusion

Global investing is an opportunity for investors to capitalize on fast growth that takes place in other countries. It also provides a way to diversify a portfolio and guard against risk. However, just as in domestic investing, the investor will need to be armed with substantial knowledge about investing as well as knowledge about the possibilities in various regions throughout the world. Technology has made it easier to get information but the lure of high profits may cause investors to hurry into an investment without adequate preparation. The many dangers of global investing include unstable governments and currencies as well as the lack of country regulatory bodies that protect the investor. Novice investors should probably avoid risky global investments and stick with those that provide diversity in industry and region.

Terms & Concepts

Finance: The study of managing money.

Financial Regulation: Rules that govern financial institutions.

Global: Pertaining to worldwide, including multiple countries around the world.

Globalization: Refers to the movement since the 1990s toward integration of worldwide markets. Technology has accelerated globalization.

International Finance: The study of international economics, investment and money transfer.

International Monetary Fund (IMF): An international organization located in Washington, D.C. made up of 185 member countries. It monitors economic activity, advises on policy and responds to financial crises.

Securities and Exchange Commission: The United States regulatory agency for the securities industry.

World Bank: An international organization providing advice and assistance to developing countries. The goal of the World Bank is to improve living conditions and reduce poverty worldwide.

Bibliography

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Dobbs, R., Leung, N., & Lund, S. (2013). China's rising stature in global finance. Mckinsey Quarterly, , 26-31. Retrieved November 15, 2013, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=88395262&site=ehost-live

Dorn, J.A. (2003). International financial crises: What role for government? CATO Journal, 23, 1-9. Retrieved September 16, 2007, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=10690353&site=ehost-live

Fiderer, D. (2013). Moody's CEO Is Wrong, We Need Rating Agency Reform. Asset Securitization Report, 13, 7. Retrieved November 15, 2013, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=88842737&site=ehost-live

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The global finance function: Five focal points. (2013). Journal of Accountancy, 216, 20-21. Retrieved November 15, 2013, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=92022844&site=ehost-live

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Tyson, E. (2003). Personal finance for dummies. Indianapolis: Wiley Publishing.

Suggested Reading

Kazemi, H. & Sohrabji, N. (2006). The role of the IMF on global financial institutions and markets. International Advances in Economic Research, 12, 141. Retrieved September 16, 2007, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=22930215&site=ehost-live

SAS of N.C. revamps anti-launder product. (2006). American Banker, 171, 10. Retrieved September 16, 2007, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=20069698&site=ehost-live

Sohn, I. (2005). Asian financial cooperation: The problem of legitimacy in global financial governance. Global Governance, 11, 487-504. Retrieved September 16, 2007, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=19097714&site=ehost-live

The $350b outsourcing market. (2003). Siliconindia, 7, 15. Retrieved September 16, 2007, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=9221752&site=ehost-live

The politics of spending overseas. (2004). Bank Technology News, 17, 14. Retrieved September 16, 2007, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=12696997&site=ehost-live