How Does the U.S. Economy Affect Global Financial Markets? Alan Greenspan (1999)

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 financing. The system has evolved substantially since its emergence in the late 19th century during the first modern wave of economic globalization, marked by the establishment of central banks, multilateral treaties, and intergovernmental organizations aimed at improving the transparency, regulation, and effectiveness of international markets. From the late 1800s to early 1900s, the world experienced rapid growth in human migration, transportation, and communication. Coupled with weak passport requirements, innovations in transportation such as steamships and railway growth accelerated world migration while enhancements in communication technology accelerated the sharing of information. These developments facilitated unprecedented growth in international trade and investment which drove early financial globalization. As the United Kingdom entered World War I in August 1914, the foreign exchange markets became stressed as the money market in London tightened. As investors met increasing difficulty in their remittances to London, the pound remained illiquid and the markets grew paralyzed. Political pressure following stock market turmoil in 1929 prompted the United States to enact protective tariffs on agricultural and manufacturing imports. This spurred a chain reaction as trading partners successively introduced similar tariffs. World trade virtually halted by 1933, worsening the effects of the worldwide Great Depression. In 1934, the United States reversed its trade protectionism and began negotiating reciprocal trade agreements and tariff reductions. From 1934 to 1947, the U.S. entered into 29 such agreements. The legislation's neutrality favored no particular countries and had the effect of equalizing tariffs from trade agreements and reducing tariffs worldwide. The Bretton Woods system emerged in 1944 as the outcome of efforts to revamp the international monetary system after World War II and address issues underpinning the Great Depression and the unsustainability of the international gold standard in the 1930s. The system's improved exchange rate stability facilitated record growth in worldwide trade and investment. It ultimately succumbed to overwhelming market pressures in the 1970s as central banks who needed to hold more U.S. dollars in reserve relied on the United States' consistent dollar deficits. Investors realized the currency was overvalued and speculative investments drove the value of the United States' gold reserves downward to such a degree that the exchange of dollars for gold was suspended in 1971. Investors began selling U.S. dollars in anticipation of adjustments in other nations' currency values, giving rise to large capital influxes that pressured central banks to choose among inflation, questionably effective capital controls, and flexible exchange rates. A culmination of currency devaluations and oil crises led other countries to allow their exchange rates to fluctuate, marking the de facto demise of the Bretton Woods system. The world economy became increasingly financially integrated throughout the 1980s and 1990s as nations liberalized capital accounts and deregulated financial sectors. With greater exposure to volatile capital flows, a series of financial crises in Europe, Asia, and Latin America had contageous effects on other countries. In the 2000s, financial institutions became increasingly large with a more sophisticated range of investment activities. During 2007 and 2008, the United States experienced a financial crisis characteristic of earlier systemic crises, which quickly propagated among other nations. It became known as the global financial crisis and is recognized as the catalyst for the worldwide Great Recession. Following revelations of Greece's falsified fiscal data in 2009, financial markets began to adjust to the realization that Greece was no longer in compliance with the European Economic and Monetary Union. The crisis spread to other European nations experiencing sovereign debt problems and became known as the Eurozone crisis. A country's decision to operate with an open economy and globalize its financial capital carries monetary implications captured by the balance of payments, which can indicate the degree to which a nation is living within its means and can reveal the composition of a nation's wealth as well as its economic competitiveness. Globalized financial capital also carries exposure to systemic risks unique to international finance, such as political deterioration, regulatory changes, foreign exchange controls, and legal uncertainties for foreign investments and property rights. http://en.wikipedia.org/wiki/Global_financial_system