- The free unhindered flow of capital across the world
- The concentration of hundreds of billions of dollars in the hands of very few large funds looking for maximum short term return
- The lack of liquidity in many of the markets that are attracting this money
- The herd mentality of these investors
- Market linkages.
- A systemic need to increase the volume of speculative investments as opportunities for easy profits decrease.
Let us look at these six factors more closely.
(1) Free global capital flow is a completely new concept, only a few years old, never seen in previous times, and completely contrary to the ideas of classical economics. It is a concept designed to enrich the forces promoting globalization, which I call “shareholder protectionism”, primarily the owners of the transnational corporations. A key concept is that no demands are made on investors. All the advantages accrue to the shareholders. All the problems accrue to everyone else.
(2) Specialization in the intricacies of international investment has resulted in available investment capital flowing to a relatively small number of enormous specialist firms, over 3000 so-called “hedge funds” that invest in “anything that moves” as well a number of gigantic equity funds and pension funds, mostly American, and a few very large international banks. They tend to think alike. They are all looking for the maximum short term return on their funds, wherever that may be. In practice, this means primarily looking for the most attractive equity markets anywhere in the world, and getting the “hot money” out when something better appears on the horizon. They have no loyalty to any country, to their employees, nor to the local communities where they operate, nor do they have any regard for the cultural traditions of their host countries, for the environment, nor to anything else besides money.
(3) These investors insist on free capital movement so they can extract their capital quickly when they see a more advantageous opportunity elsewhere. In theory. In practice, only the largest and most liquid markets can absorb the kind of short term pressures on stock prices and currencies that can result from such a decision to suddenly pull out of a market. They tend to get in slowly and get out all at once. This is the crux of the problem. Furthermore, in a panic situation, even the largest markets, USA, Japan, and the new Euroland will probably not be able to handle the pressures of a sudden repatriation of funds.
(4) The herd mentality is a critical part of the problem also. A fundamental axiom of the managers of these mammoth funds is that you don’t get fired for doing the same thing as everyone else. This becomes the single most important investment criterion – not expected return, not risk, but doing what everyone else is doing. We see it at work in the way they all herd into Mexico, then Russia, then China, then Brazil, then Korea, then Malaysia, etc. etc. We see it at work the way the US stock market reaches unrealistic heights because no big fund manager is silly enough to risk his job by going against the crowd, and all hope they will be among the first to get out when the panic selling starts. We see the problem on the front pages when they all try to rush out of some market at the same time. That is when the risk of meltdown comes nearer.
(5) It used to be a prudent dictum to diversify your equity holdings by investing in many different stock markets at the same time, because they were relatively independent. That was true in the good old days when I was advising these same fund managers — about 20 years ago, before the free capital flow regime of the 1990’s took firm root. It is no longer true. Today all markets are closely linked, as anyone who follows the markets must have observed. They are now highly correlated. This has dramatically increased the risks of global equity investment.
(6) One of the effects of globalization is to decrease the buy/sell spreads in many markets due to the sophisticated arbitrage between markets made possible by the latest information technologies. This has the effect of transferring profits from inefficient local monopolies to the TNCs — not so good for the local financial community, not a bad thing for the small local businessman, and great for the TNC arbitrageurs, at least until the game becomes known to everyone. However, as arbitrage opportunities are eliminated one after one, where will this kind of speculative money go? The answer is that it will go to lower margin, more speculative, larger and riskier operations. And that is a recipe for disaster. Nasser Saber makes the interesting point that there is a systemic need for speculative capital to constantly increase in size in order to maintain profit growth in an environment with falling spreads — very much in line with the claims of Karl Marx, as he points out.
We saw a prelude to the “hot money” phenomenon in Mexico in 1994. We saw it again in Asia in 1997-98, where Malaysia and Indonesia were hardest hit. I believe it is inevitable that such a crisis, sooner or later will lead to a total meltdown unless fundamental reforms of the globalization paradigm are made. In a meltdown, everyone gets hurt, including shareholders, as stock and bond markets crash across the world. A meltdown means, in practice, very widespread bankruptcies of many major companies and even nation states, and of course many smaller companies and individuals as well. It may even mean issue of a new currency in some countries. This will be followed by global depression, and many countries reinstating foreign exchange and investment controls, as Malaysia did in the 1997-98 crisis.