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 financing. The system has evolved substantially since its emergence in the late 19th century during the first modern wave of economic globalization.^[1] The change is marked by the establishment of central banks, multilateral treaties, and intergovernmental organizations aimed at improving the transparency, regulation, and effectiveness of international markets.^[2]:74[3]:1

From the late 1800s to early 1900s, weak passport requirements and innovations in transportation 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.^[2]:75–76 As the United Kingdom entered World War I in August 1914, the foreign exchange markets became stressed while 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 in a neutral manner which had an ultimate effect of reducing tariffs worldwide.

The Bretton Woods system emerged in 1944 from efforts to revamp the international monetary system after World War II and address issues underpinning the Great Depression and 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 eventually succumbed to overwhelming market pressures in the 1970s as foreign central banks relied on the United States' consistent dollar deficits to acquire dollar reserves. Realizing the currency was overvalued, speculative investors 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 foreign currency values, giving rise to large capital influxes that pressured central banks to choose among inflation, dubious capital controls, and flexible exchange rates. A culmination of currency devaluations and oil crises led most 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. During 2007 and 2008, the United States experienced a financial crisis characteristic of earlier systemic crises, which quickly propagated throughout other nations. It became known as the global financial crisis and is recognized as the catalyst for the worldwide Great Recession. Revelations of Greece's falsified fiscal data in 2009 caused financial markets to adjust to the realization that Greece was no longer in compliance with its monetary union. The crisis spread to other European nations already experiencing sovereign debt problems and became known as the Eurozone crisis.

A country's decision to operate 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 reveal the composition of a nation's wealth as well as its economic competitiveness. Globalized 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. Numerous groups and individuals participate in the global financial system. Economic actors such as general consumers and international businesses undertake consumption, production, and investments. Governments and intergovernmental organizations participate as investors and as purveyors of international trade, economic development, and crisis management. Regulatory bodies such as government agencies and multilateral institutions establish financial regulations and legal procedures, while independent self-regulatory associations coordinate standard practices and facilitate industry supervision. Professional associations, policy think tanks, and research institutes collect and analyze data, publish reports and policy recommendations, and facilitate public discourse on global financial affairs.

While the global financial system is edging toward greater stability, governments must deal with differing regional or national needs and policies. Various nations are trying to orderly discontinue unconventional monetary policies installed to alleviate systemic pressures and cultivate recovery, while others are expanding their scope and scale. Policymakers in emerging market countries face a challenge of precision as they must carefully institute more sustainable macroeconomic policies during extraordinary market sensitivity without provoking investors to retreat their capital to stronger markets. Nations' inability to align interests and achieve international consensus on matters such as banking regulation has perpetuated exposure to the risk of future global financial catastrophes.