International Financial System

International financial system refers to the system for the flow of funds between nations. The need for the flow of funds on account of two reasons. First, trade between the nations often requires international transfer of funds. Since trade rarely assumes the form of barter, there is either a surplus or a deficit in the balance of trade of a country. This will transfer of funds between the countries. A second category of transfer of funds from one country to another involves long-term capital flows. These may be at both the government and the private levels.

The need for international finance of two kinds: 1)Long term  and 2) Short term

The balance of payments of almost all countries are invariably in disequilibrium. This implies that there is either a surplus or a deficit in the balance of payments. This would require flow of short-term funds from a surplus to a deficit country. 

On the other hand, flow of long-term capital between the countries is guided by two factors: 

1) the foreign capital needs of developing countries and

 2) the investment opportunities available abroad, Now let us detail about short-term requirements and requirements separately.

Short  Term Flow of Funds:

As discussed earlier, the need for short flow of funds at their level arises from the disequilibrium in the balance of payments of the various countries. 

But what does this disequilibrium mean? The balance of payments of a country refers to the net claims of a country against the rest of the world arising from the transactions over a certain period. these claims are positive, the balance of payments is said to be while if these claims are negative the balance of payments is termed as In order to follow this statement, it is necessary to understand the book-keeping of the balance of payments. In Table 14.1 given below, accounts of a country's balance of have presented in a summary form.

The balance of payments of a country involves double entry book keeping and is, thus, always in balance. This implies that total receipts are equal to total payments. If you  look at Table 14.1 carefully, you will observe that both credit and debit sides have the same total, that is $2,000. Still the balance of payments of this country may not be in equilibrium and may require flow of short-term funds between this country and the rest of the world. This is really a paradoxical situation and it deserves careful attention. Since this is a somewhat complex situation, it is necessary for us to consider each item of the balance of payments account separately.