International Financial Markets

International financial markets encompass a network of exchanges where foreign currencies, currency-linked derivatives, and international bonds are traded. This system took shape after the collapse of the Bretton Woods Agreement in the early 1970s, which had previously tied various currencies to the U.S. dollar and gold, promoting stability in international trade. With currencies now allowed to float, markets like the foreign exchange (FX) market, Eurocurrency market, and Eurobond market developed, facilitating global commerce.

The FX market operates as a decentralized platform where traders buy and sell currencies worldwide, with major trading hubs including the U.S., U.K., and Japan. The Eurocurrency market allows deposits in one country's bank to be denominated in another country's currency, offering a fluid and often unregulated source of capital. Meanwhile, the Eurobond market involves bonds issued in a currency different from the country of sale, allowing for diverse international financing opportunities.

As globalization continues to evolve, these markets are crucial for businesses operating across borders, as they influence the purchasing power of currencies and, consequently, the cost of goods and services worldwide. However, the nature of these markets has raised concerns, especially in developing nations, about the vulnerability of their currencies to external factors and the need for potential regulatory measures.

Published in: 2021

By: Tucker, Michael

Subject Terms

International Financial Markets

Abstract

The term "international financial markets" is generally, albeit not always, applied to the various exchanges of foreign currency and currency-linked derivatives, plus the international bond market. These markets emerged after the Bretton Woods system collapsed in the early 1970s. The Bretton Woods system had pegged most free market currencies to the United States dollar, which in turn had been linked to gold. However, once currencies were allowed to float in value relative to one another, it was possible to trade them and derivatives based on them (futures, spots, etc.) in much the same way that other commodities may be traded. These new international markets include the foreign exchange (FX) market, the Eurocurrency market, and international or Eurobond market (among others). Basic knowledge of these markets is, thus, vital to anyone doing business either internationally or, given the increasingly globalized nature of commerce, within a single nation.

Overview

The term "international financial markets" is generally applied to the various exchanges of foreign currency and currency-linked derivatives, plus the international or Eurobond market. It should be noted, though, that this nomenclature, while common, is not universal, and some writers will use the term to mean anything from the world's stock exchanges to the money changers of third world villages. That said, "international financial markets" will be used in this article to mean the global foreign exchange (FX), Eurocurrency, and Eurobond markets.

Foreign Currency Exchange. The foreign currency exchange (FX) market can be broadly defined as the decentralized network in which currency traders located across the world buy and sell the money of different nations.

Eurocurrency Market. The Eurocurrency market is the similarly decentralized market for "Eurocurrency," that is, deposits in a bank in one country which are denominated in the currency of another country.

Eurobond Market. The Eurobond market, finally, is the market for Eurobonds, that is, bonds denominated in the currency of a particular nation, but which are not sold in that nation. Thus, a Eurobond might be issued in American dollars, but by a bank outside of the United States, and sold exclusively in Asia.

These markets are vitally important to anyone doing business, anyplace, in the world today. In an age when raw material suppliers and final customers are almost certainly located in different nations, and when a "single" product may contain parts from many different countries, the reality is that all trade is multinational trade. The price of any one item in any one location will then be dependent on the purchasing power of the currency used to pay for it. That purchasing power, in turn, will depend on the currency's standing in the international financial markets.

Discussion. While international financial markets have existed in some form since merchants discovered there was a profit to be made in buying and selling the coinages of different weights and purities issued by different princes, they developed their present form only quite recently—literally less than two generations ago, with the demise of the Bretton Woods system in the early 1970s. The Bretton Woods system was brought into existence in the aftermath of World War II by the Western Allied powers, chiefly the United States and the United Kingdom. At that time, the world's major powers, or at least those involved in the free market economy, were particularly concerned with stability. The recent world war and the Great Depression before it seemed to prove that some form of currency regulation was necessary to keep national economies from spiraling into debt, crisis, inflation, and ultimately, dictatorship and war.

Bretton Woods Agreement. The Bretton Woods agreements (so called because they were drawn up at a conference held in Bretton Woods, New Hampshire in 1944) specified that free market world currencies would be pegged to the dollar, which in turn would be pegged to gold. In effect, this allowed British pounds, U.S. dollars, West German marks, Japanese yen, and so on, to be freely convertible with one another, thus facilitating international trade. But, because these were all ultimately linked to gold, their value was more or less stable (Cohen, 2001).

The Bretton Woods system worked chiefly because at the time, the U.S. economy was enormously strong compared to every other on the planet, raw materials (and particularly oil) were relatively cheap, and the volume of international trade was relatively small. In the late 1940s and early 1950s, no one could have possibility foretold that German and Japanese cars and electronics, Chinese textiles, and South American low-cost labor would someday compete with America's factories and mills. Moreover, if anyone had suggested that gasoline would be more costly than distilled water, that person would surely have been dismissed as an alarmist.

Failure of the Bretton Woods System. By the 1970s, all those things had come to pass. The American dollar was under enormous inflationary pressure, oil prices had skyrocketed, and international trade was now far too large for any one economy to act as a sort of world lender of last resort. Thus, by 1973, the Bretton Woods system had been largely dismantled. The dollar was no longer pegged to gold, and individual currencies floated in value against one another.

Development of the Foreign Currency Exchange Market. As a result, de facto market mechanisms soon took the place of those official mechanisms of Bretton Woods. The FX market was perhaps the first to draw the attention of the public. Roughly defined, it is the large (not to say enormous), decentralized, amorphous, high risk, and high volume market in which currency traders located across the world buy and sell the money of different nations. It has no one central point and no one predominant physical location. In other words, it has no equivalent to Wall Street or the City of London, but rather exists chiefly in what might be called economic cyberspace. In effect, it is the Internet of the financial world, which makes a certain sense, given that both the Internet and the modern FX market developed at roughly the same time and were similarly based on electronic communications. However, if the FX market has no one location, it does have geographic capitals where the participants are more often based than not—that is, the traditional banking centers, such as the United States, the United Kingdom, Germany, Japan, Singapore, Hong Kong, Switzerland, and so on. In addition, China and India have become ever more aggressive players in the market.

The FX market can be thought of, then, as a network whose individual nodes are traders, brokers, banks, governments, pension funds, multinational corporations, speculators and more. All of these may also be "market makers," i.e., people or companies who offer to buy currencies at one price and to sell them at another (Grabbe, 1996, p. 88). Such market makers, who attempt to profit from the difference between the bid and the offer, tend to be the predominant players in FX, and it is them that one usually thinks of when one says "currency trader."

In theory, traders could deal in any of the world's many currencies, and to a certain extent, they do. However, the reality is that there is relatively little trade in the less well-known currencies. It is a rare trader who will, for example, specialize in the North Korean won. Thus, while almost all of the world's currencies are traded, the currencies which are traded the most are the euro, the British pound, the Swiss franc, the Canadian dollar, the Australian dollar, and the U.S. dollar. These currencies may be treated directly, as they are, or they may be traded in a variety of other forms, that is, as derivatives.

Indeed, the FX market was revolutionized in the 1980s by the discovery that currency could and perhaps should be thought of as simply one more commodity among many. As a result, trading tools and concepts from Chicago's commodity pits were soon transferred successfully to FX. Perhaps first among these was "futures," which here means the sale and purchase of some item (in this case, money) at a specific price today for delivery at some point in the future, even though at that time the actual market of the commodity may have risen or fallen. A speculator in futures is, obviously, either buying on the assumption that prices will rise in the near term so that today's price is a bargain, or selling on the assumption that they will fall, so that today's price is inflated. Either way, there is a profit to be had and a loss to be avoided.

There are several future-oriented devices in FX. In a spot transaction, for example, the buyer and seller agree on a price for currency with delivery scheduled within a very short period, usually two days at most. In a forward transaction, delivery is scheduled for a later date, say, two weeks after the purchase. In a swap agreement, meanwhile, the buyer will agree to purchase a certain amount of currency at a certain time, but to then sell it back to the seller at another specified price. The buyer might do this if it had a short-term need for a specific currency—say, for a unique project in a particular country—but did not need that sum in the long run, and might indeed believe that the value of the currency in question might soon decline. In addition, there are FX options, in which traders exchange the right to buy or sell specific currencies at some time in the future, though they are not required to do so when that time comes. Again, all of these derivatives have their direct analogs in other financial markets (stocks, commodities, etc.), and more are being constantly invented, refined, and revised.

The Eurocurrency Market. Beyond the FX market is the Eurocurrency market. This, too, is a large, potent, high value, high risk, and amorphous entity without a geographic center. The term "Eurocurrency" refers to a deposit in a bank in one country that is denominated in the currency of another country. Thus, a U.S. dollar–denominated account in a Swiss bank would be a Eurocurrency account. But, the term "euro" here does not mean that the bank is necessarily in Europe. Rather, it is a holdover from the 1950s, when some European banks developed the practice of foreign currency denominated accounts. Ergo, "Eurocurrency" means here simply that there is a difference between the nationality of the bank and the nationality of the cash it contains, and an account denominated in Turkish lira in a bank in Hong Kong would still, technically, be Eurocurrency.

The Eurocurrency market, in turn, is the business of using the FX stored in the various banks. For example, a company in Russia may need dollars for some purchase. Perhaps, it attempts to get them from U.S. sources, but finds that difficult for reasons ranging from price to politics. So, it can turn to a bank in Hong Kong, which already has dollars available, and is perhaps willing to loan them at a lower rate than the Russian company can get in New York. Thus, Eurocurrency becomes a kind of stateless money, easily accessible, fluid, and largely beyond the controls (however feeble) of the governments and central bank that minted the cash in the first place.

The Eurocurrency market is important because it is a vital source of much needed capital for the funding of projects the world over. However, it is has been the subject of some concern in Washington (and most Eurocurrency accounts remain, for the moment, also Eurodollar accounts) as well as in other capitals. Given that Eurocurrency is so fluid, and so far removed from central bank controls, many a government has begun to wonder exactly what their yen, pounds, or dollars are doing beyond their borders. There have long been, therefore, calls for some form of international regulation of the Eurocurrency markets. However, to date, those calls seem to have elicited few responses.

The Eurobond Market. The Eurobond market, meanwhile, has likewise raised a few red flags. A Eurobond, like Eurocurrency, is something of a misnomer. It is a bond, like any other, which happens to be denominated in the currency of a particular nation, but which is not sold in that nation, nor is it subject to the controls of that nation (Giddy, 1975). Thus, a Eurobond might be issued in Japanese yen, but by an agency outside of Japan, and sold exclusively in, for example, Africa or the Arab world.

Again, Eurobonds are important to finance worldwide and are increasingly seen as an important tool to fund all manner of projects. The Eurobond market (that is, the trade in Eurobonds by individuals and institutions) have made them accessible to investors and companies. But, again, the fact that they tend to be beyond the control of the central banks has made governments a bit uneasy. The United States, beset with problems of drug smuggling and money-laundering, has been particularly concerned by the fact that they have traditionally been bearer bonds, and so have given a distressing anonymity to their owners.

Still, the world's appetite for Eurobonds seems insatiable and they continue to be issued by the score. Thus, in 2007, Brazil, China, India, and Russia were all four moving eagerly into the Eurobond business, and bankers were more than happy to be of service (Attwood, 2007). Meanwhile, Ireland, a more traditional source of Eurobonds, has been offering American lawmakers some satisfaction by moving its offerings away from the bearer model (Hurley and Heuston, 2007).

Quite simply, then, the Eurobond market joins the Eurocurrency and FX markets as permanent fixtures on the international scene. There is every reason to believe that they will be as much a part of the financial future as are stock and commodity exchanges.

Yet, one should exercise at least a little caution in the matter. The three international markets are not universally loved. In particular, developing nations have felt that the three have put their currencies at the mercy of traders in places far away and in nations with very different cultures. As a result, particularly outside the West, various governments have attempted to impose renewed currency controls from time to time. Often, such attempts yield mixed results, but in the 1997 currency crisis, the government of Malaysia did seem to successfully defend its currency against foreign traders. Indeed, after 1997, many Islamic nations considered a Bretton Woods–like joint trading currency, the gold dinar, which would be based on precious metals, and so beyond the reach of the FX market (Evans, 2007).

Conclusion

To restate, the "international financial markets" include the foreign exchange (FX) market, the Eurocurrency market, and the Eurobond market. These markets developed in the ruins of the Bretton Wood system in the 1970s. In effect, all three exploit the concept of currency as a commodity, which can be traded and sold like any other.

These markets are relevant not only because of their size, but because they affect anyone buying or selling anything in the world today. No matter how small the purchase, nor how local the transaction, any commercial exchange is governed by the purchasing power (or lack thereof) of a currency. In a globalized and globalizing world, any currency's purchasing power is directly impacted by its standing on world markets. Thus, whether the customer is a multinational corporation making a trillion-dollar investment, or a child buying a gum ball from a machine, the cost of the purchase is at least partly governed by the movements of bonds and valuations of traders, in offices and suites that may be half a world away.

Terms & Concepts

Bretton Woods system: A defunct economic system which specified that free market world currencies would be pegged to the dollar.

Eurocurrency: A term for deposits in a bank in one country which are denominated in the currency of another country.

Eurobond: A bond denominated in the currency of a particular nation, but is not sold in that nation.

Foreign exchange (FX) market: This market can be broadly defined as the decentralized network in which currency traders located across the world buy and sell the money of different nations.

Forward: A transaction in which the buyer and seller agree on a price for currency with delivery scheduled for a later date, say, two weeks after the purchase.

Future: The sale and purchase of some item at a specific price today for delivery at some point in the future, even though at that time the actual market of the commodity may have risen or fallen.

International financial markets: A term which sometimes refers to the FX Market, the Eurobond Market, and the Eurocurrency Market considered as a whole.

Spot: A transaction in which the buyer and seller agree on a price for currency with delivery scheduled within a very short period, usually two days at most.

Swap: An agreement where-by the buyer will contracts purchase a certain amount of currency at a certain time, but to then sell it back to the seller at another specified price.

Bibliography

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International Financial Markets

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Subject Terms

International Financial Markets

Abstract

Overview

Conclusion

Terms & Concepts

Bibliography

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