How and why are the world’s financial markets so deeply connected? And what does it mean for your investments?
These days when Spain catches a cold, Australia sneezes. When Japan has a sore leg, the UK limps. And when economic giants China and the USA have even the slightest itch, the rest of the world scratches. The interconnectivity of international financial markets is a reality, which creates both risks and opportunities to investors.
Illiquidity and losses in markets translate increasingly quickly into global asset re-composition, according to the International Monetary Fund (IMF).1 In other words, when the global economic environment senses a problem, it shifts assets around to make up for, and protect against, that problem. There is little that local administrators can do to avoid or control these changes.
The benefits of a globally connected system mostly involve those of scale, including efficient systems and pooling of risk. Globally connected systems mean upswings translate into profit more quickly, but downturns are also just as quick to be transmitted. The fact that the market has remained on high alert, and is therefore quite jittery, since the GFC has also meant negative events on the global financial scene are often amplified as they flow through the system.
But why now? Is it simply to do with technology, or are there other forces at play? The IMF report says the situation we see today is a result of several unique influences.
In the last three decades, for instance, the external assets and liabilities of nations as a share of GDP has increased over six-fold. So there is a lot more money in the pot than there ever used to be. At the same time there has been enormous increase in financial interconnectedness between nations, financial institutions and corporations. So there is more money moving around between more territories and via more systems.
But individual agents, whether they be nations or corporations etc, typically fail to take into account the effects of their actions on others, the report says. The systems and the environment have changed rapidly, but the individual mindsets are slower to catch up, meaning the potential for systemic risk is greater.
The IMF is now mapping the global financial market, figuring out which countries and institutions are at the centre of the action and how those on the outskirts are affected by various shifts. But what does it all mean for you and your investment portfolio?
The effects the global market can have on value of any type of investment must be accepted as both a risk and a benefit. Your financial adviser is always available to help you understand the make-up of your investments and how it may need to adjust to your changing circumstances.
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