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The global economy's weak spot

It's easy to be a global capitalist these days. You just put some savings into one of the 766 mutual funds that invest everywhere from Bangkok to Buenos Aires. Millions of Americans have done just that, pouring more than $350-billion into such funds (as of August). But their enthusiasm for overseas investing has had an unintended consequence: It helped trigger the turmoil in world stock markets and now casts an immense cloud over the global economy.

"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 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. Between 1990 and 1996, inflows totaled $938-billion, reports the World Bank. 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 enables poorer countries to 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. This happened in Thailand, where the present crisis started. Construction halted on unneeded office buildings. Bad loans mushroomed. 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. Japan's economy may grow only 1 percent to 2 percent in 1998. Some other Asian economies will fare much worse.

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 to other exporting countries. But the more countries devalue, the more other exporting nations may want _ or be forced _ to follow suit. Otherwise, they risk losing export markets. And lots of Asian countries have now devalued. Since July the Thai, Indonesian and Philippine currencies are down 35 percent to 40 percent. Little wonder there's pressure on Hong Kong. Latin America, Eastern Europe and even India and 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 would try to avoid the loss. You would 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.

What's clear is that the providers of global capital (banks, investment managers, multinationals) follow the crowd. First they supply too much capital; then they withdraw it too abruptly. 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? 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.

Robert J. Samuelson is a columnist for Newsweek.

Washington Post Writers Group

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