““Capital flows’’–international movements of investment funds –are the Achilles’ heel of the world economy. As investors shift funds among countries, they foster booms and busts. Asia’s crisis represents the third global episode since 1980. Major Latin economies stagnated in the 1980s from their debt crisis: too many bank loans. In 1994 Mexico suffered an outflow of funds that caused a deep recession (gross domestic product plunged 6.2 percent in 1995). The question now is how bad Asia’s bust will be and how much it will hurt the rest of the world. No one knows, but the aftershock could be surprisingly large.
In the 1990s the world’s poorer countries have received vast, private foreign investment. In 1990 the inflow was $44 billion, reports the World Bank. By 1996 this was $244 billion. Over the seven-year period, inflows totaled $938 billion. Of this, about half was direct investment: multinational companies building factories or offices; another fifth went into local stock markets; most of the rest came through bank loans or bonds. China was the largest overall recipient ($217 billion), but Mexico ($112 billion), Brazil ($76 billion), Malaysia ($60 billion), Indonesia ($50 billion) and Thailand ($48 billion) all got huge inflows.
In theory, the capital is a boon. It helps reduce poverty and raise living standards. But the theory doesn’t always work smoothly. Countries mismanage the inflows. Banks can be rife with favoritism or incompetence; bad loans get made. Or multinationals build too many factories. Or speculation propels stock prices to unrealistic heights. And ample foreign exchange–the dollars or yen provided by overseas investors–finances a spending spree on imports.
If capital inflows slow or reverse, the boom can collapse. Precisely this happened in Thailand, where the present crisis started. Construction halted on unneeded office buildings. Bad loans mushroomed at finance companies and banks. The stock market dived. Similar problems afflict other Asian economies, and the losses extend to their foreign trading partners and investors.
Japan is one loser, because other Asian economies absorb about half its exports and because Japanese banks have suffered more loan losses. Jeff Uscher, editor of the newsletter Grant’s Asia Observer, reports that 68 percent of Thailand’s overseas debt is held by Japanese lenders. Japan’s economy may grow only 1 to 2 percent in 1998. Some other Asian economies will fare much worse. Gregory Fager of the Institute of International Finance expects Thailand’s GDP to shrink 1.5 percent in 1998, compared with growth of 6.4 percent in 1996; the Philippines’ GDP, he thinks, will grow a meager 0.5 percent, down from 5.7 percent in 1996.
What’s worrying is the prospect that the crisis might spread beyond Asia. Competitive devaluations are one danger. By devaluing its currency–making it cheaper in terms of other currencies–a country gains an export advantage, because its products become less expensive on world markets. Mexico’s sharp peso depreciation (about 50 percent) in late 1994 was one reason that its slump, though deep, was short. Surging exports enabled Mexico to grow more than 5 percent annually in 1996 and 1997.
If only one or two countries devalue, it’s not especially threatening. But the more countries devalue, the more other nations may want–or be forced–to follow suit. Otherwise, they risk losing export markets. ““Currencies are weakening all around you, and you can’t keep your currency in place,’’ says economist Desmond Lachman of Salomon Brothers. And lots of Asian countries have now devalued. Since July the Thai, Indonesian and Philippine currencies are down 35 to 40 percent. Little wonder there’s pressure on Hong Kong; Lachman thinks it could move to India. Latin America, Eastern Europe and even China aren’t immune.
All that global capital compounds the pressure. Suppose you’re a mutual-fund manager invested in, say, Brazil. You sold dollars to buy Brazil’s currency (the real) to buy Brazilian stocks. But if you fear a devaluation (meaning you’d get fewer dollars for Brazilian currency), you’d try to avoid the loss. You’d sell your Brazilian stock and convert the proceeds back into dollars before the devaluation occurred. This is how stock-market collapses and currency depreciations (and the fear of them) feed on each other and can become self-fulfilling. Not surprisingly, both Brazil’s currency and its stock market were hit last week.
What’s clear–as with the Latin debt crisis–is that the providers of global capital follow the crowd. First they supply too much capital; then they withdraw it too abruptly. ““One implication of globalization is that [investment managers] have a portfolio of many countries,’’ says economist Guillermo Calvo of the University of Maryland. ““It’s hard to know what’s going on in any individual country. If you hear a rumor . . . you take your money out.''
Developing countries (including China, the former Soviet Union and Eastern Europe) represent nearly half of the global economy. If capital flows to them slow sharply, their imports from richer countries might stagnate or drop. They would try to spur their economies by exporting more. But how much can the rest of the world absorb? The U.S. economy is in its seventh year of expansion; Americans have already bought lots of cars and VCRs. Japan resists imports. Europe’s economic improvement is partly based on higher exports. All countries cannot export their way to growth. Here lie the seeds of a broader crisis. It is hardly certain. But it’s possible–and chilling.
