Question

International capital movements can bring major gains both to the lending or investing countries and to the borrowing countries, through intertemporal trade and through portfolio diversification for the lenders/investors. But international lending and borrowing is not always well-behaved—financial crises are recurrent. Discuss.

Answer 1

The international lending and borrowing cannot well behaved always. The international capital flows mean that the stock of wealth of two countries or investor lent this between the two countries. When there is no international lending, then countries with wealth to the domestic investment opportunities creates less rate of return or interest rate. With the international capital flows the low rate country can invest in high rate interest countries. So this will benefit both the countries. With the shadow financial crisis the lending country trying to stop lending and trying to repay the benefits as quickly as possible, but the borrower is unable to pay the benefits leads to crisis. It is called over lending and over borrowing.

Another problem is exchange rate risk, which means that devaluation or revaluation of home currency will adversely affect both the lending and borrowing countries. Another issue is the massive increase in the short term debt of foreigners. This all leads to both lending and borrowing cannot well behaved.