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

macroeconomic Macroeconomics is a branch of economics that deals with the performance, structure, behavior, and decision-making of an economy as a whole. This includes regional, national, and global economies. Macroeconomists study topics such as output/ GDP ...

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 agent (economics), economic action that together facilitate international flows of financial capital for purposes of investme ...

, international monetary systems, balance of payments, exchange rates,

foreign direct investment A foreign direct investment (FDI) is an ownership stake in a company, made by a foreign investor, company, or government from another country. More specifically, it describes a controlling ownership an asset in one country by an entity based i ...

, 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 significan ...

. Sometimes referred to as multinational finance, international finance is additionally concerned with matters of international financial management. Investors and

multinational corporation A multinational corporation (MNC; also called a multinational enterprise (MNE), transnational enterprise (TNE), transnational corporation (TNC), international corporation, or stateless corporation, is a corporate organization that owns and cont ...

s must assess and manage international risks such as political risk and foreign exchange risk, including transaction exposure, economic exposure, and translation exposure. Some examples of key concepts within international finance are the Mundell–Fleming model, the optimum currency area theory,

purchasing power parity Purchasing power parity (PPP) is a measure of the price of specific goods in different countries and is used to compare the absolute purchasing power of the countries' currency, currencies. PPP is effectively the ratio of the price of a market bask ...

, interest rate parity, and the international Fisher effect. Whereas the study of international trade makes use of mostly microeconomic 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 is a type of government-issued currency that is not backed by a precious metal, such as gold or silver, nor by any other tangible asset or commodity. Fiat currency is typically designated by the issuing government to be legal tender, ...

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

Song A song is a musical composition performed by the human voice. The voice often carries the melody (a series of distinct and fixed pitches) using patterns of sound and silence. Songs have a structure, such as the common ABA form, and are usu ...

and Ming 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 is a province in Southwestern China, occupying the Sichuan Basin and Tibetan Plateau—between the Jinsha River to the west, the Daba Mountains to the north, and the Yunnan–Guizhou Plateau to the south. Its capital city is Cheng ...

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 Standard of deferred payment, courts of law are required to recognize as satisfactory payment in court for any monetary debt. Each jurisdiction determines what is legal tender, but essentially it is anything ...

Paper money Paper money, often referred to as a note or a bill (North American English), is a type of negotiable promissory note that is payable to the bearer on demand, making it a form of currency. The main types of paper money are government notes, which ...

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 (), is the increase in the value of money due to money creation minus the cost of producing the additional money. Monetary seigniorage is where government bonds are exchanged for newly create ...

, 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 backed currency, monetary system in which the standard economics, 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 ...

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 funded by 191 member countries, with headquarters in Washington, D.C. It is regarded as the global lender of las ...

(IMF) and the

World Bank The World Bank is an international financial institution that provides loans and Grant (money), grants to the governments of Least developed countries, low- and Developing country, middle-income countries for the purposes of economic development ...

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, 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 ...

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

(money without intrinsic value that is used as money because of government decree). N. Gregory Mankiw

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