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Economics 244 International Finance
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A detailed summary of all the content covered in the international finance portion of Economics 244.
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Economics 244International Finance
Lecture 1
Context is important with international finance. What is happening in the global economy has an
effect on financial market, which has an effect on investor sentiment. This is why it is important to
know what is happening in the markets.
2020 is an unprecedented year. We have not seen a pandemic of this size globally in history, and a
big factor in this is globalization and the fact that people can travel between countries so quickly and
so efficiently. Along with this, we have also not seen this kind of economic devastation before. We
are in the deepest recession that we have seen in decades, and many economists say it is almost
worse than the great depression, and that we are most likely heading towards a great depression.
This is significant because there are very few people alive who had lived through the great
depression, so there are very few of us alive today who have seen this kid of economic devastation
before.
What is happening in the world determines what is happening in international trade and
international finance. As previously stated, we are in currently in a recession, but a depression is
likely to follow. This has a greater effect on developing economies – they are more susceptible to
this external shock than developed countries. Countries that have been hit the hardest by the
pandemic are those that rely heavily on external financing (financial flowing into an economy,
resultantly affect foreign reserves, balance of payments, and exchange rate), tourism, commodity
exporting, global trade etc. A lot of these factors play a big role in South Africa’s economic growth,
meaning that we have been hit hard by these economic impacts of the pandemic. The biggest issue
in South Africa, as is with many developing countries, is the fact that we do not have a lot of savings.
So we are reliant on other countries, and foreign investors to bring money into the country. This is
done by them loaning money to us. This refers to portfolio investment (shares or derivatives bought
in a country) which results in very quick movements of the exchange rate. This is because it all
happens very quickly which is different to exports.
While exports are important for financial flows, they are very slow. When there is an increase in
exports, purchases and payments do not happen immediately – it takes time. So if you are looking at
the effects on reserves of exports, there is a lag effect. For example, the rand is relatively weak at the
moment because of covid and there is a risk off environment. “Risk off” refers to how investors are
feeling about what is happening in the world, and due to the pandemic, investors are very weary.
When there is a risk off sentiment, investors will stick to investing in safe investments, such as dollar
based financial assets, or gold. While the return yielded might be lower, it is a safer investment.
Investments in emerging markets are higher risk, and while you get a better return off of these,
some investors are very skeptical at the moment, and are worried about the future.
The Context – Economic Curves
A lot of covid information focuses on China. This is because of a lot of factors, but ultimately because
China has such a large, active economy. They have the biggest import and export volume of all
economies. Due to context, this means that what is happening in China will affect the rest of the
world. However it could also be because they were the first country hit, which means that they have
had the most exposure to the virus. The saying “when the US sneezes, the rest of the world catches
a cold” can also be applied to China.
, There were already concerns (unrelated to covid) about a recession in 2019, and the concern of
many economists was the fact that China’s growth was slowing. This meant that China was no longer
in a position to rescue the rest of the world. During the global financial crisis, China rescued a lot of
countries because they were still in a strong enough position to be able to assist other countries and
buy from other countries. While their growth was just slowing and was not negative, it was still a
concern because of the power that the country’s economy holds. Global supply chains rely on China.
The graph on real estate floor space sales in China indicate a major decline around February. This is
because people were not buying or investing in real estate. The graphs also show a large decrease in
power plant coal consumption, air pollution and traffic congestion. These are good for the
environment and are one of the few positive effects that came out of the covid lockdown. However
in terms of economic activity, we say major drops: an example in the graphs was the almost non-
existence of box office administration from February.
The Recession Induced by the Pandemic Containment Policy
It is very important to know that we are currently in the deepest recession that has occurred in four
decades. This is very important and will be reiterated throughout the section of international
finance. Due to this induced recession, global supply chains have been interrupted and lower
migration. Migration is important for financial flows because of remittances. A remittance is when
somebody works abroad, and they send money – foreign income – bank to their home country.
Remittances form the biggest financial flow into Africa. There are four categories of financial flow
(which will be discussed in more detail later on): remittances; official development assistance
(charitable help, grants and donations); portfolio investment or other short-term flows; foreign
direct investment.
Diagnosing the Nature of the Macroeconomic Shock
A macroeconomic/external shock is one that happens outside of your economy but effects your
economy in a major way. They normally occur on a large scale. The recession we are currently living
through is not a normal recession, and it is not a financial recession. It is an induced recession, and
we say this because it was induced by an exogenous health cause resulting in the containment
policy. The containment policy refers to the lockdown, and without this containment, we would
have seen an incredibly high death toll. There is a lot of debate around whether or not the lockdown
should have happened regarding economic impacts, but this is regarded as normative economics.
Countries had the choices of: not implementing containment polices, having a high death toll but
entering a shallow recession, or, implementing containment policies, having a low death toll, but
entering a severe and persistent recession. In the case of implementing containment policies,
developed countries were in a better financial position to subsidies citizens for loss of income etc.
that developing countries, such as South Africa, can’t really afford to do. South Africa has a very
small tax base so there isn’t enough tax revenue to fund initiatives like this. The lockdown further
decreases SARS’ tax revenue in terms of personal taxes and sin tax.
Small Business Recession Curve in US Cities
The graph shows that at the worst point of the lockdown, around 90% of hourly wages earners were
not working/earning an income in the States. This is a dramatic difference to what it was at the
beginning of the year (around 5-10% of workers). These people were earning less money, which
ultimately means they had less money to spend, which effects the rest of the economy.
The Pandemic-Induced Recession
A lot of shops experienced a shortage of many supplies during the initial hard lockdown, and this
was as a result of interrupted supply chains. Firms were experiencing interrupted supply chains,
supply of workers and revenue from sales, while households were experiencing interrupted
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