Some Americans may take quiet satisfaction from the euro’s slide. After all, this is a case of private Europeans (corporations, institutional and personal investors) voting with their money in favor of the United States. In 1999 Europeans bought about $200 billion worth of U.S. stocks and bonds. Corporate takeovers of U.S. firms added to the total. Many Europeans see America as an economic and technological wonderland. They want in on the action.
American smugness, though understandable, would be shortsighted. Unpredictable capital flows–the fancy term for global money movements–loom as a constant threat to world economic stability. The last major disturbances occurred in 1997 and 1998, when capital flight out of Asia and Russia caused local depressions. The United States is not immune to this disruptive process. The flows that now favor America could someday slacken or reverse, with damaging consequences (higher inflation or a recession).
Few Americans realize the size of foreign money flows. Consider some numbers. In 1999 all foreigners bought $332 billion worth of U.S. stocks and corporate bonds and spent $276 billion on direct investment in the United States–buying American companies, building factories, shopping malls or office complexes. The foreign enthusiasm for U.S. economic assets has exploded since the mid-1990s, and the cumulative effects are now sizable. Here is what foreign investors owned in March 2000, says the International Monetary Fund:
Because Europe provided much of this money, the euro has suffered. The mechanism is (again) simple. European investors who want U.S. stocks sell euros and buy dollars. With the dollars, they then purchase American stocks. On foreign exchange markets, the low demand for euros–and high demand for dollars–weakens the euro’s value. What’s magnified the effects are doubts about the euro itself. Will the new currency survive? Can the European Central Bank (Europe’s Federal Reserve) reconcile the different interests of the 11 euro countries? In currency trading, the drift has been to sell euros. On Sept. 28, Denmark votes on whether to adopt the euro; if the Danes say no, selling pressures may intensify.
So far, none of this has done much economic damage. Quite the opposite. The euro’s fall has enhanced Europe’s economic growth, even while wounding its pride. The currency’s decline improved export competitiveness. A European widget priced at one euro would have cost $1.16 when the currency was introduced; now the cost is between 85 and 90 cents, depending on the daily exchange rate. “If you ask a company in Germany or Italy about the euro, they’d say “Don’t touch it’,” says one European leader. (Last week the ECB, the Federal Reserve, the Bank of Japan and the Bank of England intervened in foreign exchange markets to halt the euro’s slide. They bought euros and sold other currencies.)
Similarly, the United States has benefited from large capital inflows. They have bolstered the demand for stocks and, presumably, boosted prices. The strong dollar–the mirror image of weak currencies elsewhere–has suppressed inflationary pressures. It has made imports cheap, holding down U.S. prices. Meanwhile, the ravenous American appetite for imports has helped Asia recover from the 1997-98 financial crisis as well as benefiting Latin America, Japan and Europe. In 2000 the U.S. current account deficit–the broadest measure of foreign commerce, including travel–will exceed $400 billion, more than 4 percent of our national income (gross domestic product). This is a modern record.
Why worry? Well, all these wonderful trends might stop. Capital flight is a grim phrase that Americans associate only with corrupt Third World countries or creaky Europe. But it could happen here. Foreigners could slow new U.S. investments–or even withdraw funds. What triggered capital flight from Asia and Russia was disappointment. Investors didn’t get what they expected. America, too, could disappoint. Profits might slow. The stock market might stagnate or drop. Then the benign cycle (strong capital inflows, high dollar, low inflation) could unravel. Every 10 percent depreciation of the dollar adds a percentage point to inflation, says Fred Bergsten of the Institute for International Economics.
Small changes in capital flows or exchange rates, especially if they occurred gradually, might not matter much. Lost jobs or profits could be negligible. But market moods and exchange rates can shift abruptly, and that would be another matter. Capital outflows could worsen a stock slump. Confidence would decline in the United States and elsewhere. World economic growth has been dangerously lopsided, with two of the three major economies (Europe, Japan) running sizable current-account surpluses. A severe U.S. slowdown (or recession) could hurt almost every major economy.
The magnitude of capital inflows into the United States ought to give us pause. They could reflect America’s genuine strengths–or represent speculative excess. We have ventured into unexplored territory. Hardly anyone truly understands today’s rapidly changing world of global finance. Even for the United States, what goes around could come around.
