We are being reminded once again that erratic shifts of global monies–called “capital flows”–are the curse of the world economy. As investors, bankers and currency traders seek the highest returns, their flights in and out of countries and currencies amplify booms and busts. Japan is the latest example: Capital is fleeing from recession, a stagnant stock market and low interest rates (barely above 1 percent on government bonds). Yen are sold and dollars bought as investors shift into dollar deposits, bonds or stocks. As a result, the yen’s value has sunk below 144 to the dollar, the lowest since 1990.
All this deepens Asia’s economic collapse and imperils the American and world economies. Consider how. Japan and South Korea compete in cars, computer chips and steel. As the yen depreciates (making Japan’s exports cheaper), Korea’s exports lose competitiveness. So the Korean won tends to drop as currency traders anticipate the erosion. This may help Korea’s exports; but each won is now worth less in dollars. It becomes harder for South Korea to repay interest or principal on its overseas dollar debts–the legacy of earlier capital flows.
The debt burden in turn keeps Korea depressed. Interest rates must stay high to suppress spending and imports–so that the trade surplus (mostly in dollars) can be fattened further. This is the only way for Korea to service the foreign debt. But high interest rates raise unemployment, bankruptcies and social unrest. Most Asian nations face the same grim prospect. They are all trying to export their way out of crisis. They can’t export more to each other (30 to 40 percent of their usual markets), and continuing currency depreciations increase the debt burden.
It is wrong to blame Asia’s crisis exclusively on rampaging capital flows. For example, Japan’s recession reflects its dependence on export-led growth. In the 1990s, exports (and related business investment) weakened; unfortunately, no other source of demand has emerged to replace them. But Japan was shoved from stagnation into slump by Asia’s present crisis, which started with the fickle flows of foreign capital into Thailand, South Korea, Indonesia and other Asian countries.
First came floods of money that could not all be wisely invested. Then capital inflows halted as it became clear they were being invested in unneeded plants and offices. Countries were left with huge overseas debts.
The free flow of capital should, in theory, benefit everyone. Poor countries get funds to modernize; investors in wealthy countries (through banks, mutual funds and multinational companies) earn high profits. But theory and practice have diverged. For the theory to succeed, at least three conditions must be met: 1) Economic information must be accurate; otherwise, poor investments will be made; 2) risk and reward must be aligned; if investors don’t fear possible losses, too much money will go into the riskiest investments (which promise the biggest profits); and 3) there must be some financial “safety net” because without it, speculative excesses could trigger a financial panic.
All these conditions are weak in global financial markets, as a study by Morris Goldstein of the Institute for International Economics in Washington makes clear. Good information? It was spotty. Japanese, European and U.S. banks were lending to Thai and Korean banks. But these banks were much weaker than official government reports indicated.
Bad information was compounded by the belief–shared by many investors–that they would be protected against losses. So they made too many risky investments. Some individual investors actually did suffer huge losses. But the Japanese, European and U.S. banks that made bad loans have largely escaped losses. They have been protected by emergency loans organized by the International Monetary Fund. These loans have partly repaid foreign banks; many other debts have been renegotiated on terms favorable to the banks.
The main reason that the IMF has shielded banks, says Goldstein, is the fear of a panic. If banks suffer losses in Asia, they might call in loans to other poorer countries. The danger is genuine. At year-end 1997, banks in rich countries (mainly Europe, the United States and Japan) had almost $1 trillion in loans to poor countries (their banks, firms and governments), estimates the Bank for International Settlements. A general flight of foreign capital could plunge Latin America and Eastern Europe into the same desperate condition as Asia.
To paraphrase Ross Perot, what we are hearing is the sucking sound of money leaving Asia. It is fleeing depression and recession. Only the brave (or the foolish) see investment opportunities. There is a spreading implosion of economic activity. Too many countries face high interest rates and scarce capital. Too many strive to recover by exporting to the same markets. Expansion of the world economy depends more than ever on the U.S. boom. How long this can continue is a worrying question.
