UNIT 4.

GLOBAL MONETARY SYSTEM

Introduction
Engaging in international trade requires the use of a medium of exchange. Today’s
international trade uses international currencies to facilitate these transactions. Funds are a
necessity in financing these activities and a global monetary system is currently in place and is
constantly evolving to adapt to changing realities in the market. Systems. This unit shall
concentrate on these systems and mechanisms that describes today’s global monetary system
that governs international trade activities.

Unit Learning Objectives

By the end of this unit, the students should be able to:

1. Describe nature of the foreign exchange market; and
2. Explain the impact of the global capital market in global business and trade.

GLOBAL MONETARY SYSTEM

When you do business locally or within your country, you would normally use the local
currency. But when you engage in international trade, most transactions may use their own
currency and other foreign currency as a medium of payment. Let us consider this example,
Country A wants to sell its lumber to Country B. What if Country B would import these 1,000
pieces of lumber at a total price of B$ 1000 (1000 in Country B’s own currency). However,
Country A will claim that its own currency (A$) is more valuable compared to that of (B$)
internationally. Both countries may agree that an exchange rate (for example A$ 1 is equal to B$
1.25) should be established and considered for a particular time period. Thus, Country A could
agree to sell its lumber instead of B$ 1000, it will pay for B$ 1,250 following the recognized
currency exchange agreement.

In a larger scope, trade happens under such currency exchange agreement. There is an
international mechanism that governs and regulates the trading of different international
currencies. Here, we have the foreign exchange market.

4.1. FOREIGN EXCHANGE MARKET

The foreign exchange market is a market for converting the currency of one country into that
of another country (Hill, 2012). According to investopedia.com, the foreign exchange market
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(also known as forex, FX or the currency market) is an over-the-counter (OTC) global
marketplace that determines the exchange rate for currencies around the world
(investopedia.com, 2020). Here, those that participate are able to buy, sell, exchange and
speculate on currencies for different purposes. Different banks, foreign exchange/currency
dealers, commercial companies, central banks, investment management firms, hedge funds,
retail forex dealers and even investors make up the foreign exchange markets.

How does the foreign exchange market help international trade?

The foreign exchange market has two main functions:

1) Converting the currency of one country into the currency of another.

2) Provide some insurance against foreign exchange risk, or the adverse consequences
of unpredictable changes in exchange rates.

The major foreign exchange markets that exist are: (shodhganga, 2020)

1. Spot market refers to the transactions involving sale and purchase of currencies for
immediate delivery. In practice, it may take one or two days to settle transactions.
2. Forward market transactions are meant to be settled on a future date as specified in the
contract. Though forward rates are quoted just like spot rates, but actual delivery of
currencies takes place much later, on a date in future.
3. Futures market is a localized exchange where derivative instruments called 'futures'
are traded. Currency futures are somewhat similar to forward, yet distinctly different.
4. Options are derivative instruments that give a choice to a foreign exchange market
operator to buy or sell a foreign currency on or up to a date (maturity date) at a specified
rate (strike price).
5. Swaps, as the term suggests, are simply the instruments that permit exchange of two
streams of cash flows in two different currencies.

4.2. INTERNATIONAL MONETARY FUND

What is the International Monetary Fund (IMF)

The International Monetary Fund (IMF) is an organization of 189 countries, working to

foster global monetary cooperation, secure financial stability, facilitate international trade,
promote high employment and sustainable economic growth, and reduce poverty around the
world (imf.org, 2020).

Purpose of the IMF

According to the organization’s website, The IMF's primary purpose is to ensure the
stability of the international monetary system—the system of exchange rates and international
payments that enables countries (and their citizens) to transact with each other. The Fund's

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mandate was updated in 2012 to include all macroeconomic and financial sector issues that bear
on global stability.

Moreover, its fundamental mission is to ensure the stability of the international monetary
system. It carries out this mission through (imf.org, 2020).

1. Economic Surveillance

The IMF oversees the international monetary system and monitors the economic and financial
policies of its 189 member countries. As part of this process, which takes place both at the global
level and in individual countries, the IMF highlights possible risks to stability and advises on
needed policy adjustments.

2. Lending

The IMF provides loans to member countries experiencing actual or potential balance of
payments problems to help them rebuild their international reserves, stabilize their currencies,
continue paying for imports, and restore conditions for strong economic growth, while correcting
underlying problems.

3. Capacity Development

The IMF works with governments around the world to modernize their economic policies and
institutions, and train their people. This helps countries strengthen their economy, improve
growth and create jobs.

How does the IMF assist or facilitate international trade?

In the area of trade, the IMF’s mandate includes facilitating the expansion and balanced
growth of international trade, promoting exchange stability, and providing the opportunity for
the orderly correction of countries’ balance of payments problems (imf.org, 2020).

Moreover, the IMF seeks to mitigate the negative effects of globalization on the world
economy in two ways: by ensuring the stability of the international financial system, and by
helping individual countries take advantage of the investment opportunities offered by
international capital markets, while reducing their vulnerability to adverse shocks or changes in
investor sentiment (imf.org, 2020).

4.3. GLOBAL CAPITAL MARKET

A global capital market is the interlinking of various investment exchanges around the
world that enable individuals and entities to buy and sell financial securities on an international
level (timesofindia.indiatimes.com, 2017).

The interlinking of these various exchanges results in the emergence of an informal, but
never-the-less structured global capital market. Spurred by the decoupling of exchange controls
and foregoing of adjustable peg exchange rates from individual capital markets, in addition to
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technological advances that have facilitated the movement of capital around the world,
investors have increasingly sought investments in multiple currencies.

As a financial market, capital markets allow the selling of long-term debt (over a year)
or equity-backed securities to be bought and sold (Michael Wills, 2020). This is beneficial to
companies and countries that lack sufficient financing for international trade. Companies
may raise funds by issuing additional shares, bonds, and other securities through the capital
market intermediaries such as banks as well as stock markets. Capital markets make the
wealth of savers available to companies or governments who can put it to long-term
productive use as long-term investments.

Functions of the capital markets

According to wallstreetmojo.com, here are the popular functions of capital markets

(wallstreetmojo.com, 2020)

1. It makes trading of securities easier for investors and companies.

2. It assists the transaction settlement in time.
3. It helps minimize transaction costs and information costs.
4. It mobilizes the savings of parties from cash and other forms to financial markets.
5. It offers insurance against market risk.

Securing needed funds through the global capital markets is a great challenge to any
international firm. William R. Cline in his article “Challenges Facing Global Financial
Markets” presents these challenges. Please see this article in Appendix A.

Unit Summary

The global monetary system is that which assists in the smooth and successful flow
of international trade. Engaging in trade requires money in every transaction. The foreign
exchange markets allow international traders to secure needed currencies for trade at
universally acceptable regulated exchange rates. Funding trade requires capitalization and
this global system encourages the existence of capital markets to help international traders.
International organizations such as the IMF is part of this global financial system as it exist
to facilitate trade and financing needs.