E-Book Glossary
The Marshall Plan
Between 1948 and 1951 the U.S. provided about 13 billion dollars in cash, goods and services to help Europe rebuild its war torn economies. Under the plan, the U.S. provided aid to prevent starvation in major war areas and to repair the economy. The goal was to rebuild the economies of Europe as quickly as possible. The plan was aimed at preventing the spread of communism in Western Europe and at stabilizing the international order in a way favorable to the development of political democracy and free market economies.
Neoclassical theory
For an excellent description and analysis of neoclassical economics, see http://william-king.www.drexel.edu/top/prin/txt/Neoch/Eco111s1.html.
Chile
Looking at absolute figures, one might be tempted to conclude that Chile's predicament in 1982 was mild compared to other Latin American debtor countries. In 1982, Brazil, Mexico, and Argentina, the three major debtor countries in terms of absolute levels of foreign debt, carried total foreign debt of approximately $92.2 billion, $86 billion, and $43.6 billion, respectively. Chile, on the other hand, carried only $17.3 billion of foreign debt in that year. In relative terms, however, Chile suffered one of the most severe debt burdens in all of Latin America. In 1982, for example, Chile had the highest foreign debt relative to its GDP: 130 percent, compared to 50 percent in Brazil and 75 percent in Argentina. Moreover, Chile owed eighty-five percent of its debt to foreign commercial banks, compared to a range of forty percent to sixty percent for other Latin American countries.
Law and Development
During the Cold War, funding from the U.S. government, private foundations such as the Ford and Rockefeller Foundations, and international organizations enabled scholars to write about and advise on non-communist strategies to modernize "Third World" nations through legal reform. Inspired by the work of Max Weber, scholars believed that an autonomous, consciously designed, and universal legal system could help replicate the development path of Western industrialized societies. However, by the early 1970s, scholars began to doubt the utility of the "liberal legalist model." In a soul searching article titled Scholars in Self-Estrangement: Some Reflections on the Crisis in Law and Development Studies in the United States, David Trubek and Marc Galanter despairingly observed:
Law and development studies are in crisis because some scholars have come seriously to doubt the liberal legal assumptions that "legal development" can be equated with exporting United States institutions or that any improvement of legal institutions in the Third World will be potent and good. They have come to see that legal change may have little or no effect on social economic conditions in Third World societies and, conversely, that many legal "reforms" can deepen inequality, curb participation, restrict individual freedom, and hamper efforts to increase material well-being.
The law and development "movement" subsequently subsided. Interest in legal reform rose somewhat in the 1980s as a result of U.S. funding to improve criminal justice systems in developing countries.
World Bank and Gender
The World Bank now works on improving the status of women in developing countries. One way that the Bank is seeking to improve the lives of women throughout the world is through education. The Bank believes that an education is crucial to success in a modern economy. Additionally, there are special benefits for women who are less prone to have large families. When women bear fewer children, they are healthier, live longer, and their children are healthier. To achieve this goal, the Bank has begun a systematic evaluation of gender issues in the design and preparation of projects, especially in education and health care projects. This analysis has been extended to projects that traditionally were not seen as involving gender issues, such as transportation and irrigation projects.
NGOs
NGOs have made their presence felt earlier in this century. They participated in multilateral conferences and the implementation of treaties. Their participation was noted in the League of Nations, which was created by the Allies after World War I to prevent further international conflicts through dispute resolution. During World War II, many private groups demonstrated their usefulness to states and NGOs were accepted with greater regularity as legitimate partners in international law-making. Historically, governments relied upon NGOs when they needed information or policy advice. However, when these governments developed a sense of certainty with regard to their policies, they no longer turned to NGOs for additional insight or assistance.
Environmental Treaties
NGO's first significant participation in environmental treaties was their contribution to the creation of the Declaration of the United Nations Conference on the Human Environment in Stockholm in December of 1972. The Declaration proclaimed the fundamental right of people to inhabit an environment "that permits a life of dignity and well-being." Another important breakthrough for NGOs was the 1987 Montreal Protocol on Substances that Deplete the Ozone Layer, the most widely recognized environment treaty. The treaty recognized as an observer any body or agency--whether national or international, governmental or non-government--qualified in fields relating to the protection of the ozone layer, provided that no party objected.
In 1994, NGO lobbying brought about the creation of the Commission on Environmental Cooperation (CEC), formed by the North American Commission on Environmental Cooperation (NACEC) and the North American Free Trade Agreement (NAFTA). NGOs may submit to the CEC assessments of member countries that have failed to enforce their domestic environmental laws.
Information Disclosure
For a discussion concerning "information disclosure" by the World Bank, see http://www.worldbank.org/html/extdr/faq/qa_sp98-11.htm.
World Bank Rules
Requesters for an inspection must demonstrate several things to the Panel. The requesters must show that they live in a project area or represent people who live in a project area. They must also prove that they are or are likely to be affected adversely by the activities of the project. The requesters must believe that the actual or potential harm results from a neglect of the bank to follow its own policies and procedures. Further more, the requesters must have previously presented their concerns to the management of the Bank and must have been dissatisfied with the Bank's response.
In processing requests for inspection, the Panel follows a set procedure. First, it decides if the request is an acceptable one. Then, it submits the request to Bank management, which provides it with a response to the allegations of the requesters. The Panel then prepares a preliminary review of the request, conducts an independent assessment of the merits of the response of the Bank management and recommends to the Board of the Bank whether or not the request should be investigated. An investigation proceeds if the Board approves a Panel recommendation for investigation. Upon the completion of an investigation, the Panel presents its findings to both Bank management and the Board. Bank management has up to six weeks to submit its recommendation to the Board as to the actions the Bank should undertake as a result of the findings of the Panel. Based upon the Panel's findings and the recommendations of bank management, the Board then makes the final decision on appropriate action.
Inspection Panel
See Nancy Dunne, Threat to Powers of World Bank Watchdog, Fin. Times, March 3, 1999, p. 6. See also Second Review of the Inspection Panel: 1998 Clarification of Certain Aspects of the Resolution, http://www.worldbank.org/html/extdr/ipwg/report.htm.
Zapatistas
On January 1, 1994, the day NAFTA became effective, the Zapatista National Liberation Army (EZLN), comprised of more than 1000 armed Mayan Indians, occupied several cities and villages in Chiapas, one of the poorest states in Mexico. Composed of peasants and indigenous peoples, the Zapatistas began their struggle to secure greater economic and political rights in the face of wealthy land owners who control the vast majority of land upon which these peasants and indigenous peoples live and farm. The Zapatistas have refused to disarm. Negotiations between the Zapatistas and the Mexican government have stalled. See Zapatista National Liberation Army, http://www.ezln.org.
Council
See http://www.oecd.org/daf/nocurruption/whatsnew.htm. For the text of the Convention and the Recommendation by the Council, see http://www.oecd.org/daf/nocurruption/20nov1e.htm and http://www.oecd.org/daf/nocurruption/tax98.HTM#annex.
Central Banks
A crucial point to understand about the foreign exchange market is government intervention. Central banks (government institutions responsible for the aggregate, or total, amount of money and credit supplied in the economy of a given country) make international financial transactions to manipulate exchange rates. This is known as foreign exchange intervention. A managed float regime, also called a dirty float, allows exchange rates to change up and down on a daily basis. The regime attempts to influence the fluctuations by buying and selling currencies.
How do central banks do this? First, they have holdings known as international reserves; these are bundles of assets denominated in currencies other than their own. Using basic supply and demand principles, the banks can influence the values of their own currencies. By purchasing domestic currency with the international reserve currencies, the central banks are "buying up" the domestic money supply. This causes a scarcity of the domestic currency, driving up the value of the suddenly rare currency.
The opposite effect occurs when a central bank sells domestic currency to purchase international assets. In that situation, more domestic currency is in the marketplace, outpacing demand, and driving the value of the domestic currency down.
Borrowing
The nineteenth and early twentieth centuries saw bank-offered bonds as the principal tool in the international capital markets. Latin America made great use of the London capital market to finance its industrial revolution. One of the dangers of debt instruments is the ongoing obligation of the borrower to maintain a consistent payment stream. Failing to make the requisite payments, or defaulting, makes future lenders more wary when lending, such that lenders would demand prohibitive interest rates or perhaps not even make the loans at all.
Transaction Costs
Transaction costs are those expenses incurred in the purchase or sale of an investment. For example, if an investment requires an electronic transfer of funds, someone has to pay for the transfer, or when an investor uses a broker, the investor often must pay a commission to the broker. When the costs are close in value to the investment, their effects are greater. For example, if one stock trade has a transaction cost of $10 and if one investor makes ten trades, then the investor is out $100 due to transaction costs. If the investor is in a pool with 99 other investors then this cost is reduced. Given the same ten $10 trades, the indvidual investor only pays 1/100 of the $100 of transactions costs—a savings of $99!
Floating Currency
When a currency "floats," its value is determined by the market forces of supply and demand. If traders of a given currency think that it should trade at a certain value, then that is the price of the currency. When a country’s economic conditions change, the currency traders will assess the value of that country’s currency independent of what that government might desire as a value for its currency. By contrast, when a currency is "pegged," the government sets the trading value of its currency with respect to some other currency (often the United States dollar). The currency traders do not get to adjust the trading value of the currency—unless there is a speculative attack and the country devalues the currency to restore equilibrium between the value of the currency and the country’s underlying economic fundamentals.
Negotiations
In response to Mexico’s growing inability to meet its debt obligations, negotiations began among the Mexican government, the IMF and the World Bank, the United States government, and hundreds of commercial bank creditors around the world via Bank Advisory Committees ("BACs" ) or Steering Committees. In these negotiations, the commercial banks agreed to provide balance of payments financing in the form of "new money loans’ and to postpone payments of principal. This allowed Mexico to pay its interest obligations, while deferring the principal obligations to a later date, at which time a stronger Mexican economy would put Mexico in a better position to make such payments. In exchange for this "new money," Mexico also agreed to "structural adjustment programs" supervised by the IMF and the World Bank.
U.S. Expansion
The United States has a very low savings rate compared to the countries of Europe and Japan. It has financed its economic expansion over the last 20 years by accessing the savings of other countries. The best example is the U.S. method of financing its government deficit. Until 1998, the U.S. government always spent more than it collected in taxes. It made up the difference by borrowing in the form of issuing bonds. When the government sells bonds, the purchasers give the government a lump sum of, say, $1,000 in exchange for 10 years of interest payments on the $1,000 and repayment of the full $1,000 at the end of 10 years. Because U.S. Treasury bonds are considered a safe and reliable investment for citizens, corporations, and governments all over the world, the U.S. government is able to issue the bonds at a far cheaper price (interest rate) than if it had to rely solely on U.S. purchasers of the bonds.
Classic
The result is classic in that it has been the result of almost every major speculative assault against a currency peg. Refer back to the previous section on the Mexican Crisis of 1995 for a particularly timely example. Other pegs that fell victim to the remarkable power of the foreign currency markets to " correct" misaligned exchange rate pegs include: Great Britain and Italy in 1992 (part of the ERM crisis), and, arguably, the U.S. dollar peg to gold in the old Bretton Woods System. In every such episode, the government that attempted to defend the peg defiantly insisted, often up to the very day of the surrender, that under no circumstances would the government devalue. Thailand was no different. On June 30, 1997, two days before the devaluation (or more precisely the announcement of the float which caused the devaluation), the Thai Prime Minister, Chavalit Yonchaiyudh, assured the nation in a televised address that there would be no devaluation of the baht.
Intervening
A government intervenes in a currency market to defend its currency by making huge purchases of its own currency. Here is how it is supposed to work. You are the head of the Central Bank of Thailand. You see the value of the baht falling against the dollar. You then sell your bank’s dollars (or dollar reserves) in exchange for a set amount of baht. The effect of this transaction is two-fold. You have removed baht from the market (because people have come in with their baht to exchange them for the dollars you were selling), reducing the supply of baht, and thereby increasing its value. You also hope that you have simultaneously signaled to the market that the demand for the domestic currency is high (because someone, in this case the government, is buying a whole lot of it), which should increase the value of the currency. Another way of looking at this is to imagine yourself as the head of the Thai Central Bank in a room with 10 billion dollars. This 10 billion represents all of Thailand’s dollar reserves. In essence you have 10 billion dollars with which to convince the world that the value of the baht is really, honestly 5:1. If the currency market speculators think the real value is closer to 10:1, and have more than 10 billion dollars to spend testing how long you will purchase them at 5:1, then you are in serious trouble. The currency markets will continue to purchase 1 dollar with 5 baht, until you run out. The lesson is that governments cannot significantly influence the desired price for a currency by intervening in the market. The simple truth is that there is more money in the global currency markets that any one country could hope to have.
Currency
When Indonesian investors purchased "rupiah futures" they purchased the right to sell rupiah at a set price in the future. For example, let’s say an Indonesian investor purchases a bank CD for 10,000 rupiah, which will earn 20% interest in one year. At the end of one year, the investor will have 12,000 rupiah. When he makes his original purchase of the CD, he might also purchase a rupiah futures contract, which will allow him to sell 12,000 rupiah for $1,000 in one year. He would do this if he thinks, at the time of the CD purchase, that the rupiah will be worth less than 12:1 dollar. If he is right, and at the end of the year the exchange rate is 15:1, he will have saved himself 3,000 rupiah.
When investors purchase futures to guard against currency risks, it is called "hedging." Hedging is generally regarded as a prudent means of protecting the integrity of investments. However, when several million people who are not investors, but are merely holders of the currency, make bets that the rupiah will lose value, it signals to the markets that there is a lack of confidence in the stability of the pegged exchange rate. In this case, the cumulative effect of these purchases was that it triggered investors to abandon their rupiah denominated investments before the devaluation everyone was apparently betting on actually materialized.
Chaebols
A good example of a "chaebol" that collapsed in the wake of the Asian financial crisis is the Korean conglomerate known as the Halla Group. Halla was involved in everything from manufacturing auto-parts and aerospace electronics, to operating hotels and ship construction. Halla was the 12th largest chaebol in Korea before it sank into bankruptcy in December of 1997. At the time it was saddled with $5.3 billion in debt, stemming largely from its unsuccessful effort to enter the already bloated shipbuilding sector. Halla was able to accumulate such an enormous amount of debt because of its close cooperation with Korea Exchange Bank, a Halla "member." And when even this friendly bank was reluctant to lend, as it was with regards to the shipyard, Halla was able to persuade smaller merchant banks to borrow money abroad (a product of financial globalization) and then to re-lend the foreign money to Halla. This type of activity eventually saddled Halla with an enormous debt burden denominated in a foreign currency. When the crisis hit Korea and the won lost much of its value against foreign currencies, Halla was unable to service its debts, and it collapsed into bankruptcy.
Liquidity Crisis
Chances are you have personally faced a liquidity crisis at least once in your life. A borrower has a liquidity crisis when he says he "has the money, but just not on me." A borrower goes bankrupt if he defaults on a loan when his debts far exceed his assets. In contrast, a borrower is in a liquidity crisis when he has sufficient assets to cover his debts, but the assets are not sufficiently liquid (or transferable) to service the debt. A liquid asset is something that can easily flow from one owner to the next. Cash flows quite nicely¾ it is the most liquid asset you own. If you own your home, it is an asset, but it is not very liquid, because the property will probably have to be sold before it can be used to pay off a debt. In the Korean example, the companies and banks that were in trouble had considerable wealth in terms of the amount of their assets. The problem was that their supply of liquid assets was insufficient to service their debt payments, which had to be made in dollars, because the won’s depreciation had robbed those liquid assets of nearly 25% of their value relative to the dollar.
GAAP
Generally accepted accounting practices (GAAP) are standards for continuously tracking and reporting the values of a company’s, individual’s, or government’s assets and liabilities. To a very large extent, they are the standards that have been developed by the accounting profession in the United States. The relevance of this provision in the IMF and Korean Agreement is that if Korean firms conform to these accounting standards, much more information will be made available to the investment community, and the information will be more frequently produced. Korea and several other countries have resisted adopting these standards in the past because the frequency of the disclosures arguably skews company management toward short-term gain. The IMF and others respond, however, that if Korean firms disclose financial statements that conform to GAAP, than investors will "know what they are getting into" and will lend and invest more wisely.