Hi there. In the last video, we looked at the growth of foreign direct investment and we examined some of the factors that explained its growth and its distribution. Well, in this video, we're going to trace the growth of international financial markets. We'll try to split it into different categories and keep the explanations simple, which is not always easy. And then, we'll look at some of the explanations for its growth, before turning to try to estimate its current size. Now, what are financial markets? Well, so far, we've looked at transactions in goods and services. And by implication, the cash that changed hands to effect the change in ownership. We've also looked at transactions to acquire increased business assets abroad, and again, by implication the cash that's changed hands. Our financial market cover cash transactions for what is left. But what is left? Well, there are four main category. The first of these are bonds. These are fixed income, fixed term loans, usually issued by governments, both national and local, but occasionally also by business. The second category are equities. Equities refer to the ownership of assets, including company stocks and shares. The third category is referred to as derivatives. These are financial contracts that derive, note the word, derive their value from the performance of another asset. So these might take the form of futures, options, and swaps. Many of them involve some sort of insurance against future price changes. And finally, we have foreign exchange transactions. Simply the buying and selling of currencies. Now, it's generally agreed that financial markets have expanded rapidly, especially since the 1970s. But there's little consistent data to measure exactly when and how this occurred. It's a general agreement, however, that it's grown fast. Much faster than world GDP, much faster than world trade, much faster even than world FDI. And in my opinion, if there's a radical departure from the previous period of globalization at the end of the 19th century, it lies precisely in the growth of the international financial market. Persistent skeptics of globalization would respond to this in two ways. They'd say that most bonds and equities are still traded nationally, and that much international financial trading is largely regional, or at the most, shared among the richer nations of the world. But they, too, would agree that it's grown explosively. Now, there are many factors that help explain this growth, but we'll generalize about them in four categories, the available currency, government policy, technology, and innovation. Well first, you need an international currency to become available. Traditionally, most foreign exchange used to be held by national banks. Although some international companies might hold on to some as trading reserves. After the Second World War when dollars were scarce, any surplus dollars earned from the United States were used to replenish the foreign exchange reserves of national banks. By the end of the 1950s, most European national banks held sufficient dollars. But still, the American balance of payments deficit continued to pump money into the world economy. Right up to today, the U.S. is still running a deficit. So these reserves, then, were accumulated in private banks and other financial institutions, where they were used for international transactions. Now, the second category, increasing in the 1980s, governments began to remove controls over financial markets, allowing foreign banks and other financial institutions to establish branches in and to trade in each other markets. The IMF also used its leverage in bailing countries out of financial crises to insist on increased deregulation in this area as well. And third, this was the era of increased speed in international communications. The one sector that's been utterly transformed by the increasing computer speed and transmission times is financial institutions. And finally, with all that cash available, with lax regulation, even laxer supervision and virtually no enforcement, and with the means of almost instantaneous communication throughout the world, financial institutions derived new products which they could sell, and nowhere was this more apparent than the market for derivatives. So how big is the financial sector? Well, basically we're dealing with very, very large numbers. So let's have a look at the trillion. 1,000 billion. And don't forget that a billion is 1,000 million. So a trillion is one followed by 1, 2, 3, 4, 5, 6, 7, 8, 9, 10, 11, 12 noughts. Okay, well let's run through some of the numbers. Bonds if you remember are fixed interest, fixed term loans. The size of the international bond market, in other words the total accumulated value of all bonds at the end of 2013 stood at $22.8 trillion. Net issues, that's the balance of new issues in 2013 were half a trillion. Equities refers to the ownership of assets, stocks and shares. In January 2014, the total monthly traded value for equities, domestic and international, on the main stock markets in the world was $4.6 trillion. If that level were maintained over a year, we get a total in the region of $50 trillion. Derivatives, financial contracts whose value depends on the performance of another asset, the total turnover in nominal value of derivatives in 2013 was $1,886 trillion. Now the problem here lies in the fact that when you have a derivative, you only pay a small percentage of its probable future value. So the actual money changing hands is much less than this. And then we have foreign exchange transactions, the buying and selling of currencies. And since 1989, we've had data on this from the Bank for International Settlements. In April 2013, the daily value of currency transactions was $5.3 trillion. If we multiply this by 350, allow the traders a few holidays, we get an annual value again of $1,855 trillion. Now, again you could argue this isn't really the true value of transaction. Much of this is simply a swap, a like for like exchange. But nevertheless, a dollar is not a euro, so there is a transfer of real ownership. These are all huge number, but what do they mean? The question we have to ourselves is how does all of this relate to the rest of the world economy? And this is the question that we're going to answer in the next video. So let's recap on what we've done in this video. We've divided the financial market into four types of transaction. We've examined its growth and we've tried to explain it, and we've attached some numbers to its current estimated size.
