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THE GLOBAL CAPITAL MARKET: The Integration of Global Capital Markets 2

Given the benefits of a global capital market, why was the market still so fragmented and limited in scope a full generation after the end of War II? It had not always been so. Until World War I, a vibrant, free-wheeling capital market linked financial centers in Europe, the western hemisphere, Oceania, Africa, and the Far East. A nineteenth-century reader of the Economist magazine could track investments in American railroads, South African gold mines, Egyptian government debt, Peruvian guano, and much more. The laying of the trans-Atlantic cable in 1866 reduced the settlement time for intercontinental transactions from roughly ten days (the duration of a steamship voyage between Liverpool and New York) to only hours (Officer 1996, p. 166). This enormous communications advance of the era was perhaps more significant than anything that has been achieved since.

The international financial market broke up during World War I, made a brief comeback between 1925 and 1931, and then withered in the Great Depression. At that time, governments everywhere limited the scope of domestic financial markets as well, imposing tighter regulation and prohibiting myriad activities outright. World War II cemented the demise of the global capital market. As late as 1950, the world’s major economies remained linked only by the most rudimentary, and typically bilateral, trade and financial arrangements. However, private capital movements began to return in the 1960s, grew rapidly in the 1970s, and then grew even faster in the 1980s (though global capital largely bypassed the developing countries mired in that decade’s debt crisis). The worldwide trend of financial opening in the 1990s has restored a degree of international capital mobility not seen since this century’s beginning.

Table 1. Size of Net Capital Flows since 1870 (mean absolute value of current account as percentage of GDP, annual data)

Period Argentina Australia Canada Denmark France Germany Italy Japan Norway Sweden U.K. U.S. All
1870-89 18.7 8.2 7.0 1.9 2.4 1.7 1.2 0.6 1.6 3.2 4.6 0.7 3.7
1890-1913 6.2 4.1 7.0 2.9 1.3 1.5 1.8 2.4 4.2 2.3 4.6 1.0 3.3
1914-18 2.7 3.4 3.6 5.1 11.6 6.8 3.8 6.5 3.1 4.1 5.1a
1919-26 4.9 4.2 2.5 1.2 2.8 2.4 4.2 2.1 4.9 2.0 2.7 1.7 3.1
1927-31 3.7 5.9 2.7 0.7 1.4 2.0 1.5 0.6 2.0 1.8 1.9 0.7 2.1
1932-39 1.6 1.7 2.6 0.8 1.0 0.6 0.7 1.0 1.1 1.5 1.1 0.4 1.2
1940-46 4.8 3.5 3.3 2.3 3.4 1.0 4.9 2.0 7.2 1.1 3.2a
1947-59 3.1 3.4 2.3 1.4 1.5 2.0 1.4 1.3 3.1 1.1 1.2 0.6 1.9
1960-73 1.0 2.3 1.2 1.9 0.6 1.0 2.1 1.0 2.4 0.7 0.8 0.5 1.3
1974-89 1.9 3.6 1.7 3.2 0.8 2.1 1.3 1.8 5.2 1.5 1.5 1.4 2.2
1989-96 2.0 4.5 4.0 1.8 0.7 2.7 1.6 2.1 2.9 2.0 2.6 1.2 2.3

These developments can be documented through data on international financial flows and asset prices.1 Table 1 shows data on one such measure, the current account balance from 1870 through the present, for 12 countries, reported as the absolute value of the current account divided by gross domestic product. The current account balance, of course, is the difference between national saving and domestic investment: if positive, it measures the portion of a country’s saving invested abroad; if negative, the portion of domestic investment financed by foreigners’ savings. The final column of the table presents the average over the 12 countries for different time periods. While international investment flows commonly topped 3 percent of GDP before 1914, they slumped to half that level in the 1930s and only after 1970 began to move decisively upward. The relatively high imbalances during wars represent government rather than private borrowing. Even today, the average level of current account balances has not quite attained the magnitude that was common before World War I.