International finance (also referred to as international monetary economics or international macroeconomics) is the branch of

financial economics Financial economics, also known as finance, is the branch of economics characterized by a "concentration on monetary activities", in which "money of one type or another is likely to appear on ''both sides'' of a trade". William F. Sharpe"Financia ...

broadly concerned with

monetary Money is any item or verifiable record that is generally accepted as payment for goods and services and repayment of debts, such as taxes, in a particular country or socio-economic context. The primary functions which distinguish money are ...

and

macroeconomic Macroeconomics (from the Greek prefix ''makro-'' meaning "large" + ''economics'') is a branch of economics dealing with performance, structure, behavior, and decision-making of an economy as a whole. For example, using interest rates, taxes, an ...

interrelations between two or more countries. International finance examines the dynamics of the

global financial system The global financial system is the worldwide framework of legal agreements, institutions, and both formal and informal economic actors that together facilitate international flows of financial capital for purposes of investment and trade finan ...

international monetary systems An international monetary system is a set of internationally agreed rules, conventions and supporting institutions that facilitate international trade, cross border investment and generally the reallocation of capital between states that have d ...

balance of payments In international economics, the balance of payments (also known as balance of international payments and abbreviated BOP or BoP) of a country is the difference between all money flowing into the country in a particular period of time (e.g., ...

exchange rates In finance, an exchange rate is the rate at which one currency will be exchanged for another currency. Currencies are most commonly national currencies, but may be sub-national as in the case of Hong Kong or supra-national as in the case of ...

foreign direct investment A foreign direct investment (FDI) is an investment in the form of a controlling ownership in a business in one country by an entity based in another country. It is thus distinguished from a foreign portfolio investment by a notion of direct c ...

, and how these topics relate to

international trade International trade is the exchange of capital, goods, and services across international borders or territories because there is a need or want of goods or services. (see: World economy) In most countries, such trade represents a significa ...

. Sometimes referred to as multinational finance, international finance is additionally concerned with matters of international

financial management Financial management is the business function concerned with profitability, expenses, cash and credit, so that the "organization may have the means to carry out its objective as satisfactorily as possible;" the latter often defined as maximizin ...

. Investors and

multinational corporation A multinational company (MNC), also referred to as a multinational enterprise (MNE), a transnational enterprise (TNE), a transnational corporation (TNC), an international corporation or a stateless corporation with subtle but contrasting senses, i ...

s must assess and manage international risks such as

political risk Political risk is a type of risk faced by investors, corporations, and governments that political decisions, events, or conditions will significantly affect the profitability of a business actor or the expected value of a given economic action. ...

and

foreign exchange risk Foreign exchange risk (also known as FX risk, exchange rate risk or currency risk) is a financial risk that exists when a financial transaction is denominated in a currency other than the domestic currency of the company. The exchange risk arises ...

, including transaction exposure, economic exposure, and translation exposure. Some examples of key concepts within international finance are the

Mundell–Fleming model The Mundell–Fleming model, also known as the IS-LM-BoP model (or IS-LM-BP model), is an economic model first set forth (independently) by Robert Mundell and Marcus Fleming. Reprinted in Reprinted in The model is an extension of the IS–LM ...

, the

optimum currency area In economics, an optimum currency area (OCA) or optimal currency region (OCR) is a geographical region in which it would maximize economic efficiency to have the entire region share a single currency. The underlying theory describes the optimal cha ...

theory,

purchasing power parity Purchasing power parity (PPP) is the measurement of prices in different countries that uses the prices of specific goods to compare the absolute purchasing power of the countries' currencies. PPP is effectively the ratio of the price of a bask ...

interest rate parity Interest rate parity is a no-arbitrage condition representing an equilibrium state under which investors interest rates available on bank deposits in two countries. The fact that this condition does not always hold allows for potential opportuniti ...

, and the

international Fisher effect The international Fisher effect (sometimes referred to as Fisher's open hypothesis) is a hypothesis in international finance that suggests differences in nominal interest rates reflect expected changes in the spot exchange rate between countries. T ...

. Whereas the study of international trade makes use of mostly

microeconomic Microeconomics is a branch of mainstream economics that studies the behavior of individuals and firms in making decisions regarding the allocation of scarce resources and the interactions among these individuals and firms. Microeconomics fo ...

concepts, international finance research investigates predominantly

concepts. The foreign exchange and political risk dimensions of international finance largely stem from sovereign nations having the right and power to issue currencies, formulate their own economic policies, impose taxes, and regulate movement of people, goods, and capital across their borders.

History

China and fiat currency

The idea of

fiat currency Fiat money (from la, fiat, "let it be done") is a type of currency that is not backed by any commodity such as gold or silver. It is typically designated by the issuing government to be legal tender. Throughout history, fiat money was some ...

was established just over a thousand years ago in China during the Yuan,

Tang Tang or TANG most often refers to: * Tang dynasty * Tang (drink mix) Tang or TANG may also refer to: Chinese states and dynasties * Jin (Chinese state) (11th century – 376 BC), a state during the Spring and Autumn period, called Tang (唐) ...

Song A song is a musical composition intended to be performed by the human voice. This is often done at distinct and fixed pitches (melodies) using patterns of sound and silence. Songs contain various forms, such as those including the repetiti ...

and

Ming The Ming dynasty (), officially the Great Ming, was an imperial dynasty of China, ruling from 1368 to 1644 following the collapse of the Mongol-led Yuan dynasty. The Ming dynasty was the last orthodox dynasty of China ruled by the Han pe ...

dynasties. In the Tang Dynasty (618-907) there was a high demand for metallic currency that exceeded the supply of precious metals. The people were already familiar with the use of credit notes, and they rapidly began accepting pieces of paper or paper drafts. A shortage of coins forced these people to change from coins to notes. During the Song Dynasty (960-1276), there was a booming business in the

Sichuan Sichuan (; zh, c=, labels=no, ; zh, p=Sìchuān; alternatively romanized as Szechuan or Szechwan; formerly also referred to as "West China" or "Western China" by Protestant missions) is a province in Southwest China occupying most of t ...

region that led to a shortage of copper money. This led to traders issuing private notes covered by a monetary reserve. This was considered to be the first ever

legal tender Legal tender is a form of money that courts of law are required to recognize as satisfactory payment for any monetary debt. Each jurisdiction determines what is legal tender, but essentially it is anything which when offered ("tendered") in ...

Paper money A banknote—also called a bill (North American English), paper money, or simply a note—is a type of negotiable promissory note, made by a bank or other licensed authority, payable to the bearer on demand. Banknotes were originally issued ...

became the only legal tender in the Yuan Dynasty (1276-1367) and issuing of notes was conferred to the Ministry of Finance during the Ming Dynasty (1368-1644). Fiat money can serve as a good currency if it can handle the role that a nation's economy needs of its monetary unit: storing value, providing a numerical account, and facilitating exchange. It also has excellent

seigniorage Seigniorage , also spelled seignorage or seigneurage (from the Old French ''seigneuriage'', "right of the lord (''seigneur'') to mint money"), is the difference between the value of money and the cost to produce and distribute it. The term can be ...

, meaning it is more cost-efficient than a currency directly tied to produce than a currency directly tied to a commodity. On the International stage fiat currencies were not truly relevant until the US removed its currency from the

gold standard A gold standard is a monetary system in which the standard economic unit of account is based on a fixed quantity of gold. The gold standard was the basis for the international monetary system from the 1870s to the early 1920s, and from th ...

in 1971. At this point other nations followed suit creating an environment where an infinite amount of money could be created. Before this, a nation's currency—which was unaccredited by precious metals—would not be accepted in exchange for goods and services outside of the host country where it was produced.

Bretton Woods Conference

The Establishment of the

International Monetary Fund The International Monetary Fund (IMF) is a major financial agency of the United Nations, and an international financial institution, headquartered in Washington, D.C., consisting of 190 countries. Its stated mission is "working to foster glo ...

(IMF) and the

World Bank The World Bank is an international financial institution that provides loans and grants to the governments of low- and middle-income countries for the purpose of pursuing capital projects. The World Bank is the collective name for the Inte ...

are one of the most significant turning points in the History of international finance. Through Decades of negotiation between international powers and the persistence of economic superpowers no single event inspired unity of determining the fair rules of trade and monetary policy than the Second World War. In

Bretton Woods, New Hampshire Bretton Woods is an area within the town of Carroll, New Hampshire, United States, whose principal points of interest are three leisure and recreation facilities. Being virtually surrounded by the White Mountain National Forest, the vista from B ...

, delegates from 44 nations gathered to determine what would be the rules for international trade after the war. After the Bretton Woods Conference was completed the framework for the IMF and World Bank were laid out and begun to be developed. As a result, international trade skyrocketed since exchange between countries and between continents finally had a measurable way to determine

exchange rate In finance, an exchange rate is the rate at which one currency will be exchanged for another currency. Currencies are most commonly national currencies, but may be sub-national as in the case of Hong Kong or supra-national as in the case of t ...

s and fair value of currency. Individual countries' banks were no longer the determining factor in determining a fair exchange rate, removing inconsistencies between individual countries' monetary systems. The Bretton Woods system did not last very long, as after WW2 the United States was the physical owner of most of the world's gold supply. This meant countries' currencies were supposed to be pegged to a resource over which the US had a near monopoly. This state of affairs only lasted around 20 years as most notably in 1971 the French who were skeptical of the US dollar being the world's reserve currency reclaimed most of their gold that they exported to the US for protection. This action was inherently a destabilizing force to the US dollar since at any time before this individuals or businesses were able to exchange their US dollars for gold. Many other nations followed suit in a metaphorical “Gold Rush'' to get gold from the US by exchanging dollars. The result of this action was the world's reserve currency, the US dollar, no longer being pegged to gold from 1971, with Richard Nixon removing the convertibility factor of the US dollar. This fundamentally changed international finance as no longer was the world's currency based on anything physical, it transitioned into a fiat currency.

N. Gregory Mankiw Nicholas Gregory Mankiw (; born February 3, 1958) is an American macroeconomist who is currently the Robert M. Beren Professor of Economics at Harvard University. Mankiw is best known in academia for his work on New Keynesian economics. Mankiw ...

(2014). Principles of Economics. p. 220.

ISBN The International Standard Book Number (ISBN) is a numeric commercial book identifier that is intended to be unique. Publishers purchase ISBNs from an affiliate of the International ISBN Agency. An ISBN is assigned to each separate edition a ...

978-1-285-16592-9. fiat money: money without intrinsic value that is used as money because of government decree

Notes and references

External links

Historical documents on international finance
available on FRASER {{Authority control Financial economics

de:Weltwirtschaft es:Economía Internacional

History

China and fiat currency

Bretton Woods Conference

See also

Notes and references

Further reading

External links