Applied Global Money Management
This article focuses on various global money management systems and practices. Three of the featured topics include the international monetary system, the international financial system and the international capital budgeting process. There is an explanation as to why the international monetary system is necessary as well as some of the problems that are encountered in the international capital budgeting process. Finally, there is a discussion about the international financial system, especially the new international financial architecture (NIFA).
Keywords Asia Pacific Economic Cooperation; Bank of International Settlements; Basel Committee on Banking Supervision; Capital Budgeting; European Union; International Monetary Fund; International Monetary System; Money Management; North America Free Trade Agreement; World Bank
Finance: Applied Global Money Management
What is money management? Money management is the method of controlling and governing money, which can involve investing, budgeting, banking, and the implementation of taxes. This article provides a preview of how it is applied in a global economy. Some of the highlighted areas include the international monetary system, the international financial system, and international capital budgeting.
International Monetary System
The Gold Standard
The international monetary system is needed in order to better describe an ordinary form of value for the world to use as its currency. During the late 19th and early 20th centuries, the gold standard became the first international monetary system. "It has often been assumed in the international political economy literature that the classical gold standard of the late 19th century represented a turning point in monetary history because it marked the end wherein states manipulated their currency to increase their revenues" (Knafo, 2006, p. 78). One advantage of this type of system is that gold has a stabilizing influence. However, a disadvantage of the system is that it lacks liquidity. In addition, if there was an unexplainable increase in the supply of gold, prices could rise abruptly. Given the number of disadvantages, the international gold standard failed in 1914 and was replaced by the gold bullion standard during the 1920s. However, the gold bullion standard ceased to be used in the 1930s.
The Gold-Exchange Standard
The gold-exchange standard was used to conduct international trade during the period after World War II. This system encouraged countries to set the value of their currency to some foreign currency, which was set and redeemed in gold. Many countries set their currency to the dollar and maintained dollar reserves in America. The United States was seen as the leading country for currency. It was during the 1944 Bretton Woods International conference that a method of fixed exchange rates was conceived and implemented. In addition, the International Monetary Fund was established and charged with conserving stable exchange rates globally.
The Bretton Woods System
The Bretton Woods system was charged with developing and implementing the rules and regulations for global commercial and financial transactions. The International Bank for Reconstruction and Development was established as a result of this endeavor. It was the first effort at creating a system that would control monetary relationships between autonomous nation-states. The greatest accomplishments of the Bretton Woods system occurred when: Each country agreed to implement a monetary policy that would maintain the exchange rate of its currency in a fixed amount through the value of gold. They also agreed that the International Monetary Fund had the right to connect fleeting inequalities of payments. Unfortunately, the method broke down in 1971 because of Americas' suspending of conversion from dollars to gold.
The Growth of the Global Economy
According to a new report conducted by Oliver, Wyman & Company for Strategic Finance, global net revenue from money management is expected to triple to $900 billion by 2010, which is up from $277 billion in 1996 (Chernoff, 1998). The report predicts that revenue will grow at a 9% annual clip. As a result, money management will become one of the quickest spreading sectors in the global financial industry.
Chernoff (1998) alleges that growth is driven by a variety of factors such as "modest economic growth; faster wealth buildup among the affluent; continued growth in investments as a share of total financial assets: aging populations in Western countries; and an emerging middle class in developing companies" (p. 8).
International Capital Budgeting
When the financial management team determines whether or not to invest in specific capital projects, the process is called capital budgeting. An organization usually has to deal with capital budgeting issues when it plans to acquire new assets or replace existing obsolete assets in order to maintain efficiency. The financial management team must determine which projects are good investment opportunities, which projects are the most desirable to acquire, and how much the organization should invest in each asset.
International capital budgeting refers to when projects are located in host countries other than the home country of the multinational corporation. Some of the techniques (i.e. calculation of net present value) are the same as traditional finance. However, "capital budgeting for a multinational is complicated because of the complexity of cash flows and financing options available to the multinational corporation" (Booth, 1982, p. 113).
Challenges Unique to Capital Budgeting for the Multinational Corporation
Capital budgeting for the multinational corporation presents many problems that are rarely found in domestic capital budgeting (Shapiro, 1978; Ang & Lai, 1989). Financial analysts may find that foreign projects are more complex to analyze than domestic projects due to the need to:
- Distinguish between parent cash flow and projects cash flow. Multinationals will have the opportunity to evaluate the cash flow associated with projects from two approaches. They may look at the net impact of the project on their consolidated cash flow or they may treat the cash flow on a stand alone or unconsolidated basis. The theoretical perspective asserts that the project should be evaluated from the parent company's viewpoint since dividends and repayment of debt is handled by the parent company. This action supports the notion that the evaluation is actually on the contributions that the project can make to the multinational's bottom line.
Some organizations may want to evaluate the project from the subsidiary's (local) point of view. However, the parent company's viewpoint should supersede the subsidiary's point of view. Multinational corporations tend to compare their projects with the subsidiary's projects in order to determine where their investments should go. The rule of thumb is to only invest in those projects that can earn a risk-adjusted return greater than the local competitors performing the same type of project. If the earnings are not greater than the local competitors, the multinational corporation can invest in the host country's bonds since they will pay the risk free rate adjusted for inflation.
Although the theoretical approach is a sound process, many multinationals tend to evaluate their projects from both the parent and project point of view because of the combined advantages. When looking from the parent company's viewpoint, one could obtain results that are closer to the traditional net present value technique. However, the project's point of view allows one to obtain a closer approximation of the effect on consolidated earnings per share. The way the project is analyzed is dependent on the type of technique utilized to report the consolidated net earnings per share.
- Recognize money reimbursed to parent company when there are differences in the tax system. The way in which the cash flows are returned to the parent company has an effect on the project. Cash flow can be returned in the following ways:
- Dividends — It can only be returned in this form if the project has a positive income. Some countries may impose limits on the amounts of funds that subsidiaries can pay to their foreign parent company in this form.
- Intrafirm Debt — Interest on debt is tax deductible and it helps to reduce foreign tax liability.
- Intrafirm Sales — This form is the operating cost of the project and it helps lower the foreign tax liability.
- Royalties and License Fees — This form covers the expenses of the project and lowers the tax liability.
(The entire section is 3977 words.)