Global Markets’ Massive Extraterritorial Power

The film “Independence Day” depicts gigantic and terrifying spaceships appearing over the key capitals of the world. Large enough to block the sun, they hover, silently, just above the tallest buildings. Confused and frightened citizens pitifully try to befriend them. But the alien vessels unleash blinding rays of terrible force, obliterating the cities in minutes.

Over the past six months, global financial markets have similarly trained their fire on the capitals of East Asia. One by one, from Bangkok to Seoul, they have crushed previously stable currencies. In their wake, they left soaring interest rates, tottering banking systems and slowing economies. Many of the governments have been destabilized. The previously muscular “Asian tigers” have been crippled, and India may be next.

This devastation suggests world financial markets have emerged as a form of supra-national government for the 21st century. They are not elected and do not convene. But as virtually all nations join the global economy, their finances are subject to the markets’ rulings. Their currencies, which must be reasonably stable to promote national growth, are always on trial. So is their access to international borrowing markets to finance exports and infrastructure. When these markets’ verdict is negative, changes in national economic policies are forced and entire governments can be powerless.

Increasingly, the International Monetary Fund is the only governmental counterweight. It alone can assemble the resources necessary to financially rescue decimated nations. It alone has the political and territorial independence to demand tough financial reforms from the victim nation. But questions now are being raised about whether even the IMF can withstand such overwhelming financial forces.

How much power do these markets have and how did they get it? Are any regions exempt? Is the emergence of such power a positive or negative development for the world community?

The most recent demonstration of these markets’ awesome power began last summer. For years, the leading nations of East Asia had been lionized as icons of growth. Their typical blend of high savings and investment with relatively autocratic economic and political rule had been hailed as the ideal recipe for developing nations. And, their gross-domestic-product growth rates, 6%-8% annually in recent years, had been remarkable.

But in July, the foreign-exchange markets became disenchanted with this region, beginning with Thailand. Waves of selling battered its currency, which fell an astounding 40% against the dollar in three weeks. This made it hugely expensive for the country and its private borrowers to pay off their vast, dollar-denominated borrowings. The cost of imports soared. The central bank exhausted its reserves trying to defend the currency and Thailand, in effect, went bankrupt. Its government fell, and the IMF stepped in with a $17-billion package of emergency financing, conditioned on austerity measures.

As they invariably do, the markets had grasped what no one else had yet seen. That Thailand was financially sick. Thais had been running up huge debts, mostly in dollars, and depending on the stability of their own currency to repay them. In particular, urged on by the political leadership, banks were shoveling loans into unprofitable and crony-controlled ventures. All this made the statistics on investment and growth look good, but the result was a financially troubled country that would ultimately fail. The currency was overvalued, therefore, and the markets took it down.

The global markets next turned thumbs down on Malaysia, Indonesia and the Philippines in quick succession. They saw similar flaws in these economies. They drove the currencies and stock markets to drastically lower levels. Interest rates were raised sky-high to persuade global investors to stick with local securities, but those efforts mostly failed. The impact on Indonesia was particularly vivid, as powerful President Suharto reluctantly accepted a $40-billion bailout.

Then, like a spreading storm, this market opprobrium descended onto South Korea, the biggest East Asian economy other than China. It was the same syndrome of falling currencies and stock markets--and the same initial denials of crisis. As financial analysts looked more closely, they saw that the famous Korean conglomerates and their banks were earning little or no money amid widespread corruption. This time, the total bailout, from the IMF and individual governments, totaled $60 billion.

Six months ago, East Asia appeared as a glittering example of sound policy and exceptional growth. Today, it is facing economic contraction, widespread bankruptcies, social austerity and unstable politics. The markets flexed their muscles and the tigers were turned into goats.

This awesome power stems from profound changes in technology, global liquidity and the culture of investment performance. Technology now permits information to be disseminated instantaneously worldwide and transactions to be executed electronically from any fully equipped terminal. In addition, there are huge capital flows coursing the world, driven by global trade and investment patterns. These monies are professionally managed for maximum investment results. The result often is mass capital movements, favoring a nation or abandoning it, and fostering prosperity or hard times. Their verdicts cannot be appealed.

No nations are truly protected against these market rulings. As far back as 1979, President Jimmy Carter submitted a long-awaited budget that displeased the global currency markets. The dollar collapsed and, within two weeks, Carter retreated and submitted a new, tighter budget to Congress. Otherwise, U.S. inflation and interest rates would have risen, triggering an economic slowdown.

Then, five years ago, British Prime Minister John Major, facing jittery markets, stood defiantly outside 10 Downing Street and vowed Britain would not delink its pound from the key European currencies. Within days, after world markets crushed the pound, he reversed course in humiliating fashion.

These global markets are mostly unregulated today, and that isn’t likely to change. While the domestic activities of larger U.S. and European financial institutions are supervised by central banks and other agencies, their international trading and investment businesses are largely unconstrained. Moreover, the armies of mutual funds and other investment vehicles are largely unregulated. But, more to the point, there is nothing illegal or unfair about their decisions.

The right focus, instead, is on the IMF. It is the emergency financier for faltering governments and the architect of austerity measures for their financial recovery. But the IMF should develop a better early-warning system for detecting incipient crises. In the Mexican collapse of 1995 and this year’s East Asian crisis, it issued no warnings to the nations involved. The industrialized world must also ensure that the IMF has the necessary financial resources, however large, to prevent full-fledged collapses. Otherwise, the entire global financial system could be at risk.

The emergence of this huge, quasi-governmental force carries profound implications for the world. Possibly, it is a plus for democracy and economic modernization. Global markets can topple despots in ways local citizens cannot. They also have no tolerance for regimes that stifle enterprise and growth for the sake of political preservation. For example, China is still relatively closed. But its growth and income aspirations can be achieved only if it fully enters the global economy. To do this, it needs a convertible currency and lower barriers to capital flows. This will inevitably mean a more democratic and decentralized state, because financial markets will force it.

But this can also be destabilizing. The sheer momentum of markets often causes them to overshoot. Right now, their disaffection for developing nations extends beyond Asia to Brazil, now in the midst of a long-term recovery. The risk, therefore, is that a downward cycle spins out of control and threatens the world financial system. There was a hint of this in the chain-reaction global stock-market declines we saw three weeks ago.

In “Independence Day,” the U.S. president personally leads a fighter squadron to destroy the alien ships. But that only happens in the movies. Global financial markets are invisible, beyond the reach of political leaders and far more powerful.