Emergence of financial globalization: 1870–1914 laid to connect North America and Europe , a steamship which laid the transatlantic cable beneath the ocean The world experienced substantial changes in the late 19th century which created an environment favorable to an increase in and development of
international financial centers. Principal among such changes were unprecedented growth in capital flows and the resulting rapid financial center integration, as well as faster communication. Before 1870,
London and
Paris existed as the world's only prominent financial centers. Soon after,
Berlin and
New York grew to become major centres providing
financial services for their national economies. An array of smaller international financial centers became important as they found
market niches, such as
Amsterdam,
Brussels,
Zürich, and
Geneva. London remained the leading international financial center in the four decades leading up to
World War I. The first modern wave of
economic globalization began during the period of 1870–1914, marked by transportation expansion, record levels of
migration, enhanced communications, trade expansion, and growth in capital transfers. The standardization of international passports would not arise until 1980 under the guidance of the
United Nations'
International Civil Aviation Organization. From 1870 to 1915, 36 million Europeans migrated away from Europe. Approximately 25 million (or 70%) of these travelers migrated to the
United States, while most of the rest reached
Canada,
Australia and
Brazil. Europe itself experienced an influx of foreigners from 1860 to 1910, growing from 0.7% of the population to 1.8%. While the absence of meaningful passport requirements allowed for free travel, migration on such an enormous scale would have been prohibitively difficult if not for technological advances in transportation, particularly the expansion of railway travel and the dominance of
steam-powered boats over traditional
sailing ships. World railway mileage grew from 205,000 kilometers in 1870 to 925,000 kilometers in 1906, while steamboat cargo
tonnage surpassed that of sailboats in the 1890s. Advancements such as the
telephone and
wireless telegraphy (the precursor to
radio) revolutionized
telecommunications by providing instantaneous communication. In 1866, the first
transatlantic cable was laid beneath the ocean to connect London and New York, while Europe and
Asia became connected through new
landlines. Economic globalization grew under
free trade, starting in 1860 when the
United Kingdom entered into a
free trade agreement with
France known as the
Cobden–Chevalier Treaty. However, the golden age of this wave of globalization endured a return to
protectionism between 1880 and 1914. In 1879, German Chancellor
Otto von Bismarck introduced
protective tariffs on agricultural and manufacturing goods, making
Germany the first nation to institute new protective trade policies. In 1892, France introduced the
Méline tariff, greatly raising customs duties on both agricultural and manufacturing goods. The United States maintained strong protectionism during most of the nineteenth century, imposing customs duties between 40 and 50% on imported goods. Despite these measures,
international trade continued to grow without slowing. Paradoxically, foreign trade grew at a much faster rate during the protectionist phase of the first wave of globalization than during the free trade phase sparked by the United Kingdom.), with the greatest share of foreign assets held by the United Kingdom (42%), France (20%), Germany (13%), and the United States (8%). The
Netherlands,
Belgium, and
Switzerland together held foreign investments on par with Germany at around 12%.) in gold.
Interwar period: 1915–1944 with German troops along the French border in August 1914 Economists have referred to the onset of World War I as the end of an age of innocence for
foreign exchange markets, as it was the first
geopolitical conflict to have a destabilizing and paralyzing impact. The United Kingdom declared war on Germany on August 4, 1914 following Germany's
invasion of France and Belgium. In the weeks prior, the
foreign exchange market in London was the first to exhibit distress. European tensions and increasing
political uncertainty motivated investors to chase
liquidity, prompting
commercial banks to borrow heavily from London's discount market. As the money market tightened, discount lenders began rediscounting their
reserves at the
Bank of England rather than
discounting new pounds sterling. The Bank of England was forced to raise discount rates daily for three days from 3% on July 30 to 10% by August 1. As foreign investors resorted to buying pounds for
remittance to London just to pay off their newly
maturing securities, the sudden demand for pounds led the pound to appreciate beyond its gold value against most major currencies, yet sharply depreciate against the
French franc after French banks began liquidating their London accounts. Remittance to London became increasingly difficult and culminated in a record
exchange rate of US$6.50/GBP. Emergency measures were introduced in the form of moratoria and extended
bank holidays, but to no effect as financial contracts became informally unable to be negotiated and export embargoes thwarted gold shipments. A week later, the Bank of England began to address the deadlock in the foreign exchange markets by establishing a new channel for transatlantic payments whereby participants could make remittance payments to the U.K. by depositing gold designated for a Bank of England account with Canada's
Minister of Finance, and in exchange receive pounds sterling at an exchange rate of $4.90. Approximately US$104 million in remittances flowed through this channel in the next two months. However, pound sterling liquidity ultimately did not improve due to inadequate relief for
merchant banks receiving sterling bills. As the pound sterling was the world's
reserve currency and leading
vehicle currency, market illiquidity and merchant banks' hesitance to accept sterling bills left currency markets paralyzed.
Smoot–Hawley tariff of 1930 U.S.
President Herbert Hoover signed the
Smoot–Hawley Tariff Act into law on June 17, 1930. The tariff's aim was to protect agriculture in the United States, but
congressional representatives ultimately raised tariffs on a host of manufactured goods resulting in average duties as high as 53% on over a thousand various goods. Twenty-five trading partners responded in kind by introducing new tariffs on a wide range of U.S. goods. Hoover was pressured and compelled to adhere to the
Republican Party's 1928 platform, which sought protective tariffs to alleviate market pressures on the nation's struggling
agribusinesses and reduce the domestic
unemployment rate. The culmination of the
Stock Market Crash of 1929 and the onset of the
Great Depression heightened fears, further pressuring Hoover to act on protective policies against the advice of
Henry Ford and over 1,000 economists who protested by calling for a
veto of the act. Exports from the United States plummeted 60% from 1930 to 1933. The international ramifications of the Smoot-Hawley tariff, comprising protectionist and discriminatory trade policies and bouts of
economic nationalism, are credited by economists with prolongment and worldwide propagation of the Great Depression.
Formal abandonment of the Gold Standard throughout the
Great Depression as viewed from an international perspective. Triangles mark points at which nations abandoned the gold standard by suspending gold convertibility or devaluing their currencies against gold. The classical gold standard was established in 1821 by the United Kingdom as the Bank of England enabled redemption of its
banknotes for gold
bullion. France, Germany, the United States,
Russia, and
Japan each embraced the standard one by one from 1878 to 1897, marking its international acceptance. The first departure from the standard occurred in August 1914 when these nations erected trade embargoes on gold exports and suspended redemption of gold for banknotes. Following the end of World War I on November 11, 1918,
Austria,
Hungary, Germany, Russia, and
Poland began experiencing
hyperinflation. Having informally departed from the standard, most currencies were freed from
exchange rate fixing and allowed to
float. Most countries throughout this period sought to gain national advantages and bolster exports by depreciating their currency values to predatory levels. A number of countries, including the United States, made unenthusiastic and uncoordinated attempts to restore the former gold standard. The early years of the Great Depression brought about bank runs in the United States, Austria, and Germany, which placed pressures on
gold reserves in the United Kingdom to such a degree that the gold standard became unsustainable. Germany became the first nation to formally abandon the post-World War I gold standard when the
Dresdner Bank implemented
foreign exchange controls and announced bankruptcy on July 15, 1931. In September 1931, the United Kingdom allowed the pound sterling to float freely. By the end of 1931, a host of countries including Austria, Canada, Japan, and
Sweden abandoned gold. Following widespread
bank failures and a hemorrhaging of gold reserves, the United States broke free of the gold standard in April 1933. France would not follow suit until 1936 as investors fled from the franc due to political concerns over
Prime Minister Léon Blum's government. This arrangement is commonly referred to as the Bretton Woods system. Rather than maintaining fixed rates, nations would peg their currencies to the U.S. dollar and allow their exchange rates to fluctuate within a 1% band of the agreed-upon parity. To meet this requirement, central banks would intervene via sales or purchases of their currencies against the dollar. Members could adjust their pegs in response to long-run fundamental disequilibria in the balance of payments, but were responsible for correcting imbalances via
fiscal and
monetary policy tools before resorting to repegging strategies. The adjustable pegging enabled greater exchange rate stability for commercial and financial transactions which fostered unprecedented growth in international trade and foreign investment. This feature grew from delegates' experiences in the 1930s when excessively
volatile exchange rates and the reactive protectionist exchange controls that followed proved destructive to trade and prolonged the
deflationary effects of the Great Depression. Capital mobility faced de facto limits under the system as governments instituted restrictions on capital flows and aligned their monetary policy to support their pegs. An important component of the Bretton Woods agreements was the creation of two new international financial institutions, the
International Monetary Fund (IMF) and the
International Bank for Reconstruction and Development (IBRD). Collectively referred to as the Bretton Woods institutions, they became operational in 1947 and 1946 respectively. The IMF was established to support the monetary system by facilitating cooperation on international monetary issues, providing advisory and technical assistance to members, and offering emergency lending to nations experiencing repeated difficulties restoring the balance of payments equilibrium. Members would contribute funds to a pool according to their share of
gross world product, from which emergency loans could be issued. Member states were authorized and encouraged to employ
capital controls as necessary to manage payments imbalances and meet pegging targets, but prohibited from relying on IMF financing to cover particularly short-term capital hemorrhages. The creation of these organizations was a crucial milestone in the evolution of the international financial architecture, and some economists consider it the most significant achievement of multilateral cooperation following
World War II. Since the establishment of the
International Development Association (IDA) in 1960, the IBRD and IDA are together known as the
World Bank. While the IBRD lends to middle-income
developing countries, the IDA extends the Bank's lending program by offering concessional loans and grants to the world's poorest nations.
General Agreement on Tariffs and Trade: 1947 In 1947, 23 countries concluded the General Agreement on Tariffs and Trade (GATT) at a UN conference in Geneva. Delegates intended the agreement to suffice while member states would negotiate creation of a UN body to be known as the
International Trade Organization (ITO). As the ITO never became ratified, GATT became the
de facto framework for later multilateral trade negotiations. Members emphasized trade reprocity as an approach to lowering barriers in pursuit of mutual gains. GATT was centered on two precepts: trade relations needed to be equitable and nondiscriminatory, and
subsidizing non-agricultural exports needed to be prohibited. As such, the agreement's most favored nation clause prohibited members from offering preferential tariff rates to any nation that it would not otherwise offer to fellow GATT members. In the event of any discovery of non-agricultural subsidies, members were authorized to offset such policies by enacting countervailing tariffs. The agreement's initial round achieved only limited success in reducing tariffs. While the U.S. reduced its tariffs by one third, other signatories offered much smaller trade concessions. Following these woes surrounding the U.S. dollar, the dollar price of gold was raised to US$38 per ounce and the Bretton Woods system was modified to allow fluctuations within an augmented band of 2.25% as part of the
Smithsonian Agreement signed by the
G-10 members in December 1971. The agreement delayed the system's demise for a further two years. The second amendment to the articles of agreement was signed in 1978. It legally formalized the free-floating acceptance and gold demonetization achieved by the Jamaica Agreement, and required members to support stable exchange rates through macroeconomic policy. The post-Bretton Woods system was decentralized in that member states retained autonomy in selecting an exchange rate regime. The amendment also expanded the institution's capacity for oversight and charged members with supporting monetary sustainability by cooperating with the Fund on regime implementation.
European Monetary System: 1979 Following the Smithsonian Agreement, member states of the
European Economic Community adopted a narrower
currency band of 1.125% for exchange rates among their own currencies, creating a smaller scale fixed exchange rate system known as the
snake in the tunnel. The snake proved unsustainable as it did not compel EEC countries to coordinate macroeconomic policies. In 1979, the European Monetary System (EMS) phased out the currency snake. The EMS featured two key components: the
European Currency Unit (ECU), an artificial weighted average market basket of
European Union members' currencies, and the
Exchange Rate Mechanism (ERM), a procedure for managing exchange rate fluctuations in keeping with a calculated parity grid of currencies' par values. The parity grid was derived from parities each participating country established for its currency with all other currencies in the system, denominated in terms of ECUs. The weights within the ECU changed in response to variances in the values of each currency in its basket. Under the ERM, if an exchange rate reached its upper or lower limit (within a 2.25% band), both nations in that
currency pair were obligated to intervene collectively in the foreign exchange market and buy or sell the under- or overvalued currency as necessary to return the exchange rate to its par value according to the parity matrix. The requirement of cooperative market intervention marked a key difference from the Bretton Woods system. Similarly to Bretton Woods however, EMS members could impose capital controls and other monetary policy shifts on countries responsible for exchange rates approaching their bounds, as identified by a divergence indicator which measured deviations from the ECU's value. The
Uruguay Round of GATT
multilateral trade negotiations took place from 1986 to 1994, with 123 nations becoming party to agreements achieved throughout the negotiations. Among the achievements were trade liberalization in agricultural goods and textiles, the
General Agreement on Trade in Services, and agreements on intellectual property rights issues. The key manifestation of this round was the
Marrakech Agreement signed in April 1994, which established the World Trade Organization (WTO). The WTO is a chartered multilateral trade organization, charged with continuing the GATT mandate to promote trade, govern trade relations, and prevent damaging trade practices or policies. It became operational in January 1995. Compared with its GATT secretariat predecessor, the WTO features an improved mechanism for settling trade disputes since the organization is membership-based and not dependent on consensus as in traditional trade negotiations. This function was designed to address prior weaknesses, whereby parties in dispute would invoke delays, obstruct negotiations, or fall back on weak enforcement.
Financial integration and systemic crises: 1980–present , 1945 to 1971. This analysis is similar to Figure 10.1 in Rogoff and Reinhart (2009). Financial integration among industrialized nations grew substantially during the 1980s and 1990s, as did liberalization of their capital accounts. Accompanying financial integration in recent decades was a succession of
deregulation, in which countries increasingly abandoned regulations over the behavior of financial intermediaries and simplified requirements of disclosure to the public and to regulatory authorities. These crises differed in terms of their breadth, causes, and aggravations, among which were
capital flights brought about by
speculative attacks on fixed exchange rate currencies perceived to be mispriced given a nation's fiscal policy,
Birth of the European Economic and Monetary Union 1992 In February 1992, European Union countries signed the
Maastricht Treaty which outlined a three-stage plan to accelerate progress toward an Economic and Monetary Union (EMU). The first stage centered on liberalizing capital mobility and aligning macroeconomic policies between countries. The second stage established the
European Monetary Institute which was ultimately dissolved in tandem with the establishment in 1998 of the
European Central Bank (ECB) and
European System of Central Banks. Key to the Maastricht Treaty was the outlining of
convergence criteria that EU members would need to satisfy before being permitted to proceed. The third and final stage introduced a common currency for circulation known as the
Euro, adopted by eleven of then-fifteen members of the European Union in January 1999. In doing so, they
disaggregated their sovereignty in matters of monetary policy. These countries continued to circulate their national legal tenders, exchangeable for euros at fixed rates, until 2002 when the ECB began issuing official Euro coins and notes. , the EMU comprises 17 nations which have issued the Euro, and 11 non-Euro states.
Eurozone crisis In 2009, a newly elected government in Greece revealed the falsification of its national budget data, and that its fiscal deficit for the year was 12.7% of GDP as opposed to the 3.7% espoused by the previous administration. This news alerted markets to the fact that Greece's deficit exceeded the
eurozone's maximum of 3% outlined in the Economic and Monetary Union's
Stability and Growth Pact. Investors concerned about a possible sovereign default rapidly sold Greek bonds. Given Greece's prior decision to embrace the euro as its currency, it no longer held monetary policy autonomy and could not intervene to depreciate a national currency to absorb the shock and boost competitiveness, as was the traditional solution to sudden capital flight. The crisis proved contagious when it spread to Portugal, Italy, and Spain (together with Greece these are collectively referred to as the
PIGS). Ratings agencies downgraded these countries' debt instruments in 2010 which further increased the costliness of
refinancing or repaying their national debts. The crisis continued to spread and soon grew into a European sovereign debt crisis which threatened economic recovery in the wake of the Great Recession. In tandem with the IMF, the European Union members assembled a €750 billion
bailout for Greece and other afflicted nations. Additionally, the ECB pledged to purchase bonds from troubled eurozone nations in an effort to mitigate the risk of a banking system panic. The crisis is recognized by economists as highlighting the depth of financial integration in Europe, contrasted with the lack of fiscal integration and political unification necessary to prevent or decisively respond to crises. During the initial waves of the crisis, the public speculated that the turmoil could result in a disintegration of the eurozone and an abandonment of the euro. German
Federal Minister of Finance Wolfgang Schäuble called for the expulsion of offending countries from the eurozone. Now commonly referred to as the Eurozone crisis, it has been ongoing since 2009 and most recently began encompassing the
2012–2013 Cypriot financial crisis. ==Implications of globalized capital==