A fascinating but little-noted aspect of the recent financial turmoil is how much it’s been an international event. It started with doubts about China’s economy, symbolized by a tumbling stock market and a surprise devaluation of the renminbi. But the worry quickly spread to all major stock markets, along with a growing unease that the global economy suddenly faced new — though not well-defined — perils.
Some connections between China and the wider world are apparent. As I argued last week, one is commodities — the minerals, grains and fuels that China consumes in prodigious quantities. China’s needs dominate these markets. Economist John Mothersole of IHS Global Insight reports that China’s share of world consumption for five major industrial metals (aluminum, copper, lead, nickel and zinc) is now 48 percent, up from 13 percent in 2000.
If China’s demand for commodities falls below expectations, the ripple effects are widely felt. Commodity surpluses result, depressing prices and profits. New mining projects are canceled. Commodity-exporting countries — the likes of Brazil, Indonesia — suffer slower growth. That’s what happened. Although China’s economy is still expanding, it’s expanding less rapidly than predicted.
Oil is a special case but similar: Consumption disappointed. The International Energy Agency forecasts that China’s oil demand will grow 3 percent this year and next, “well down [from] the double-digit percentage point gains seen only a few years back.” The shortfall — along with U.S. shale oil — has created the massive crude surpluses that have sent prices down from more than $100 a barrel last year to $40 or less now.
But these links between China and the rest of the world are well known. By themselves, they don’t seem to explain why China’s problems suddenly precipitated an international financial firestorm. The answer, I think, lies in what economists call “capital flows.” Huge amounts of money can shift in a digital instant among countries, currencies and various financial markets.
In our mind’s eye, “globalization” evokes images of exports, container ships and supply chains. This physical globalization does not operate at warp speed. It takes time to deliver a cargo or construct a supply chain.
By contrast, financial globalization can operate at warp speed. With a few keyboard strokes, investors can dump stocks in one country and buy in another or do the same for bonds and currencies. Since the 1980s, this type of globalization has spread. Most countries have dismantled the restrictions that limited or prevented individuals and companies from moving money across borders. After World War II, these “capital controls” were widespread.
As a result, large and unexpected events can trigger panic buying and selling around the world, as traders react to what they think other traders will do. China’s unexpected devaluation, coupled with its stock market decline, apparently constituted this sort of trigger. But the effects of financial globalization go further.
In a new paper, economists at the Bank for International Settlements argue that the internationalization of finance has diminished many countries’ influence over their long-term interest rates. Especially affected are emerging-market countries such as Brazil. If companies in these countries don’t like domestic interest rates in local currencies, many can borrow in dollars at lower rates, the BIS economists say.
By early 2015, borrowing in U.S. dollar bond markets by non-bank foreigners totaled an eye-popping $4.5 trillion. “Dollar bond markets [have gone] global,” they write. Aside from weakening government central banks, this creates new economic vulnerabilities. One is a currency mismatch: Companies that borrow in dollars must repay in dollars; but if they earn most of their revenue in local money (say, the peso for Mexico), a depreciating currency will make repayment harder.
Globalization has also punished the United States. From 2004 to 2006, the Federal Reserve raised short-term interest rates by 4.25 percentage points, believing that long-term rates on bonds and mortgages — which affect the economy more — would follow. They didn’t. If they had, would the 2008-2009 financial crisis have been avoided or softened? Then-Fed Chairman Ben Bernanke later argued that a “global savings glut” of dollars — flooding into bonds — kept long-term rates down.
It’s not that this sort of globalization is entirely new. Greg Ip, the Wall Street Journal’s chief economic commentator, usefully recalls that the Asian debt crisis of 1997-1998 stemmed from excessive capital inflows (mostly bank loans) to countries such as Thailand and South Korea. But since then, cross-border money movements have grown and become more complex. These flows are too great to be bottled up; we can’t revert to widespread capital controls.
Still, globalization is quietly rewriting the economic rules in ways that suggest we may be losing control over events. We are not entirely at the whim of international markets — but we’re drifting in that direction. Not a comforting thought.
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