monetary system and this has resulted in a highly volatile capital flow and exchange rates and interest rates.

**Persistent Payments Imbalances and Volatile Capital Flows.** International capital markets virtually disappeared after the widespread debt defaults caused by the Great Depression.  Capital movements in the interwar period mainly took the form of hot-money. The disappearance of private capital flows was assumed to be more or less permanent when the design of the World Bank and the IMF was being finalized at the Bretton Woods negotiations in 1944. The size of official assistance and lending soon would be dwarfed by the rapid revival of FDI in the 1950s and the subsequent reemergence of a market in financial capital.<sup>39</sup> Financial flows primarily took the form of floating-interest bank loans rather than the fixed-interest rate bond finance that had been prevalent in the pre-War period.<sup>40</sup> In the following 30 years, there was an explosive growth in bank lending, some of it in the shape of recycling of the so called petro-dollars following the oil price shocks of the 1970s.

International financial integration accelerated after the Asian financial crisis in 1997-98. The gross cross-border flows rose from 5 percent of world GDP in the mid-1990s to around 20 percent by 2007, and international financial openness (external assets plus liabilities) rose sharply from 150 percent to 350 percent of world GDP in the same period.41 In fact, the gross cross-border flows dwarfed net flows, and they flowed in the opposite direction of what would be implied by countries’ current account deficits and surpluses. For example, for the US the cumulative current account deficits between 2002 and 2007 amounted to $4.8 trillion while it experienced even larger gross outflows, amounting to more than $5.8 trillion- excluding outflows related to financial derivatives. These, however, were financed by around $10 trillion in gross inflows.<sup>42</sup> Financial innovation and development in both advanced countries and emerging economies further accelerated global financial integration. The rising share of cross-border ownership of financial institutions, together with increased funding from international capital markets, further enhanced international financial integration. As a result, the value of external assets and liabilities of banks doubled as a share of GDP from around 30 percent in the early 1990s to about 60 percent in 2007.<sup>43</sup> Rapid growth of world trade also contributed to the increased global financial integration through increased trade credits and export insurance. Nevertheless, international capital flows rose about three times faster than international trade as a result of financial liberalization and innovations, though they fell sharply in 2008 as a result of the economic and financial crisis. Emerging markets participated in this globalization process as they increased their share in international capital markets from 7 percent in 2000 to 17 percent 2007.

> 39 By 2011, net flows from official creditors to developing countries amounted to $50 billion (mainly due to increased support during the global crisis) compared to $554 billion in net FDI flows to these countries (Global Economic Prospects, Jan. 2012, World Bank).

> 40 Williamson (1990) and Obstfeld and Taylor (2004).

> 41 OECD Economic Outlook, Paris, 2011.

> 42 These inflows into the US economy were distributed as follows: about $3 trillion in US official assets, including US Treasuries, $1 trillion in FDI, $1.4 trillion in stocks and $1.7 trillion in corporate bonds and $2.6 billion in other assets, including real estate, as reported by US based banks and brokerage firms – source:  Economic Report of the Presisent: 2011 Report Spreadsheet tables B-103: http://www.gpoaccess.gov/eop/tables11.html. US Bureau of Economic Analysis, International Investment Position of the United States at Yearend: http://www.bea.gov/international/ai1.htm#BOPIIP

> 43 BIS Annual Report, Basel, 2010.

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