Who Sank, or Swam, in Choppy Currents of a World Cash Ocean

By Nicholas D. Kristof, with Edward Whatt, The New York Times, 15 February 1999

Mary Jo Paoni stood contentedly in her front yard, as firmly planted in Middle America as any of the cornstalks out back.

I wouldn’t invest in Asia, she said, shaking her head decisively. A 59-year-old secretary with big, sparkling eyes, a plaid shirt and no pretensions, she added, Investing in Asia frightens me.

Her husband, George, a retired meat cutter, was standing beside her as the sun set over Cantrall, Ill., a farm town about 130 miles southwest of Chicago. He was equally adamant. If I’m going to gamble, he said, I want to sit down with my friends.

Yet Mrs. Paoni, who has never traveled outside the United States, is in fact invested in Asia and all over the world, although she does not know it.

After retiring in April from her job as a secretary with the state government, she will rely on a pension fund that has large investments abroad, giving her indirect ownership of stocks in Indonesia and Russia and Brazil. And the cash she tucked away in an A.G. Edwards money market account was funneled to big banks, which helped build elegant hotels and office towers from Argentina to Vietnam.

Millions of Americans have become, like the Paonis, the unknowing financiers of developing countries, as money swishes around the world today from Cantrall to Russia to Brazil to China, connecting the most unlikely people. Among them are Mrs. Paoni and an Indonesian rickshaw driver named Salamet, a 27-year-old with a drooping mustache, an angry wife and three hungry children.

For Mrs. Paoni and most Americans, these are still good times economically. But elsewhere in the world, hundreds of millions of people like Salamet are still caught in a severe crisis, one that has recast lives and will haunt a generation in the East just as the Great Depression shaped a generation in the West.

It is still not clear that the financial upheavals, which began in Thailand in July 1997, will ever damage the United States. But the collapse of Brazil’s currency in January and the jolt it gave markets worldwide underscored the continuing risks of the most serious financial crisis in half a century, as President Clinton called it in his State of the Union address.

The worldwide financial crisis over the last 20 months has toppled some governments and hobbled others. The crisis has turned Salamet’s life upside down without affecting Mrs. Paoni at all—but it illustrates how globalization increasingly stitches lives all over the world into a single economic quilt.

In the new economic landscape that has emerged in recent years, the pool of international investments has grown to dwarf the sums that governments can muster, and money zips around the globe far faster than ever before. The result is a world more prosperous, but also perhaps more wobbly.

More and more people are asking whether the international financial system as it has operated for most of the 1990s is basically unstable, Ian McFarlane, governor of Australia’s central bank, said at a recent conference in Singapore. And I think by now the majority of observers have come to the conclusion that it is.

Salamet, the Rickshaw Man alamet, a burly man with an expression as hard as his biceps, knows nothing of finance, but he understands that his world is falling apart.

As he sat on the porch of his little white house in a remote corner of Indonesia, his thoughts were on his mother. He sat brooding, his stomach tying itself in knots, as his mother’s gasps filtered through the curtain from the next room.

She was lying on the floor, dying of cancer, a huge tumor growing inside her breast. What gnawed at Salamet each waking moment was not just her gasps but also his guilt at the knowledge that he could help her but had decided not to.

The doctor had prescribed a painkiller costing $2 a month, a sum that Salamet earns in two days and could afford. But as his wife, Yuti, reminded him sharply, if he were to buy the painkiller, he would get further behind in making payments on his rickshaw, meaning that it might be seized and he would lose his livelihood.

Or he would have to stop paying school fees, meaning that his son Dwi might be forced to leave the second grade and never get an education.

Although Salamet has always been poor, the financial crisis has deepened the desperation in his home and countless others. Indeed, if Dwi drops out, he will have plenty of company: The Asian Development Bank estimates that 6.1 million children have left school in Indonesia in recent months because of the economic crisis.

Salamet contemplated his options as he sat, stony-faced, beneath the mango trees of Mojokerto, a midsized town 400 miles east of the Indonesian capital, Jakarta. He is quiet by nature, and when his wife scolds him for not earning enough money, he does not shout at her or hit her, as other men in the neighborhood might.

Instead, he just sulks, said Mrs. Yuti, a slim woman with high cheekbones; an embarrassed grin spread across her face and was mimicked by the baby she was carrying in her arms.

Salamet, who like his wife and many other Indonesians uses only one name, pondered the bleak options in a flat voice, weighing what flexibility he might have. Would the school really expel Dwi if he got further behind on the school fees? How long could he delay payments before the rickshaw would be seized? How little pain reliever could he get away with giving his mother to ease the worst of her agony?

Tired of this calculus, he shook his head.

If it were like before and I had money, he growled, of course I would buy her more painkillers. But now I can’t spare the cash for her.

From Speculation to Crisis

The initial impulse in the United States as the crisis erupted was to see the problems as an outgrowth of Asian corruption and cronyism. These probably made the situation worse, but a growing body of evidence suggests that there was nothing uniquely Asian about these countries’ problems, and that the catastrophe was worsened by folly and hubris in the United States and Europe.

It was bankers and investors in Moscow and the Thai capital, Bangkok, who speculated wildly on stocks and real estate and thus built up catastrophic bubble economies. But it was U.S. officials who pushed for the financial liberalization that nurtured the speculation (even if developing nations themselves welcomed it).

And it was U.S. bankers and money managers who poured billions of dollars into those emerging markets. Then, when the crisis hit, U.S. officials insisted on tough measures like budget cuts and high interest rates, which many economists argue made things worse.

The failure in January of the $41.5 billion bailout of Brazil demonstrates that the West still has not found a reliable formula for dealing with these crises. Experts continue to worry about the danger of a global recession or worse, and about the risk that economic woes may tear apart countries like Indonesia and even China.

Resentment at U.S. policies—and perhaps at the United States’ economic success—has also led to a sense in many countries that the global economy is at an ideological turning point. In particular, there is a growing backlash against what some nations regard as an American model of laissez-faire capitalism, which rescues Connecticut hedge funds but sacrifices Indonesian children.

Particularly in Tokyo and Paris, where markets have always been regarded as something like ornery oxen—best when firmly yoked and even then prone to leave messes—there is talk of sturdier harnesses to guide capital flows, speculators and markets themselves.

What does all this portend? And how can it be that, as David Hale, chief economist of the Zurich Group, describes the financial upheaval of the last year and a half, a real-estate crisis in Bangkok set in motion something that has no parallel in human history?

Early Gains for Salamet

The saga begins in places like Salamet’s riverside neighborhood in Indonesia, then a poor country that had not yet taken on the glitter of an emerging market.

For countless generations, Salamet’s ancestors have been agricultural laborers, owning little or no land, struggling to survive and often not even managing that. When Salamet was 10, his father fell to his death from a palm tree he was pruning.

Salamet’s mother remarried, and the boy and his new stepfather labored side by side each day, lugging sacks of sand from riverbanks to sell to cement factories. It was backbreaking work, but it was accompanied by breathtaking progress.

As foreign investments poured into Indonesia, the town of Mojokerto thrived in the general prosperity. Salamet and his stepfather, Pirso, rented rickshaws and began driving them—a business that boomed as people made a bit more, and as mud paths were paved to make rickshaw travel feasible.

Indonesian families are usually close-knit, and Pirso sent some of the money to help his own mother, Mariyam, in the town of Kediri several hours’ drive to the south.

Mrs. Mariyam, a thin and energetic gray-haired woman, was sitting one day recently in her store-bought wooden chair, beside her nicely finished bureau, on which rested a black Deluxe All Transistor Radio that in English pledged INSTANT SUPERB SOUND.

The floor was concrete, the roof was tile, the walls were covered with tattered wallpaper, and a curtain covered the bedroom next door. It had become a genuine house, no longer a hut, and outside was a pump and outhouse-cum-bath built five years ago by Pirso.

It’s a big improvement, she said, because the river was far away. And it’s nice, because I can bathe without everybody seeing. It’s supposed to be that if you’re bathing in the river, people stay away. But some of the men are naughty.

These gains over the years have been enormous, and so far they have proved reasonably durable. The deprivation and hunger are serious, but as yet there is little evidence that the financial crisis has sent Asia 20 or 30 years backward or that it has destroyed the middle class.

Third World Is Renamed

raditionally, Mrs. Paoni’s savings would have stayed far from any place where people have to bathe in rivers. Her money would have remained where she still thinks it is, entirely in nice and safe American communities like hers. Mrs. Paoni and her husband have invested in stocks, but they say they have stuck to blue chips like Coca Cola and Disney.

She wants security above all. Risk is acceptable when confined to her Mary Higgins Clark mysteries and Stephen King horror novels, but she is counting on safe investments and her pension income when she and her husband pull up stakes this year and move, perhaps to Florida.

Income in retirement will come from the Illinois state pension fund, which like most pension funds has the same deeply conservative instincts as Mrs. Paoni.

But even that is slowly changing, as fund managers seek higher returns. In 1980 less than 1 percent of pension-fund assets in the United States was invested abroad, but by 1997 that figure had risen to 17 percent. And so, as part of the process bandied about as globalization, Mrs. Paoni has tiny financial stakes in dozens of countries around the world.

One reason Americans like her and her pension-fund managers used to be unwilling to invest in places like Indonesia was the description Third World markets, which had an ominous ring. In the mid-1980s the International Finance Corp. of the World Bank was trying to drum up support for a Third World investment fund, when one listener complained about the terminology.

No one wants to put money into the Third World investment fund, the man protested. You’d better come up with something better.

So in just a few days officials dreamed up an alternative—emerging markets—and it proved a winner. The first emerging-markets fund came out in 1986, and the craze was born.

Emerging markets quickly produced emerging gurus. One of the most prominent is Mark Mobius, 62, who is instantly recognizable at investment conferences with his shaven head and stern, lean look.

Templeton Funds recruited Mobius in 1987 to figure out the small markets of the world, and under him the Templeton Emerging Markets Fund was a success almost immediately. In 1988 the fund gained 37 percent, and then it soared 98 percent in 1989. After a small dip in 1990, it rocketed 112 percent in 1991 and after another dip soared 100 percent in 1993.

The 1987 crash was very bad for emerging markets, Mobius said. But in 1988-89 the recovery came, and the ball started rolling as people started waking up to the tremendous returns that were possible.

The bullishness was, in part, self-fulfilling. The stock markets in small countries were tiny, and modest investments by Westerners tended to bid up prices, thus attracting more investors.

The result was that hubris increased more rapidly than the caliber of most investment research. Bright young men and women who could barely read a spreadsheet moved to Asia and ended up getting hired as research analysts by investment banks. They sometimes made hundreds of thousands of dollars a year picking stocks in countries whose languages they could barely speak.

The Capital Starts to Flow

ven more than pension funds and mutual funds and other stock purchasers, banks were piling into emerging markets—particularly banks from Europe and Japan. Investors bought $50 billion worth of stocks and bonds in emerging markets in 1996, but that year international banks poured $76 billion into those countries.

From Mrs. Paoni’s money market account at A.G. Edwards, the American brokerage company, cash flows to major U.S. banks, like J.P. Morgan and Chase Manhattan. There is no risk to Mrs. Paoni, but from the big banks some portion of her savings journeys abroad.

All this capital made a spectacular difference to emerging-market countries.

When history books are written 200 years from now about the last two decades of the 20th century, Deputy Treasury Secretary Lawrence Summers said recently, I am convinced that the end of the Cold War will be the second story. The first story will be about the appearance of emerging markets—about the fact that developing countries where more than 3 billion people live have moved toward the market and seen rapid growth in incomes.

Countries like Chile, Egypt, Russia and Vietnam became enmeshed in the international economy. In Moscow, tycoons dripping with gold and diamonds began to drop hundreds of dollars at trendy new restaurants, and in the early 1990s more Mercedes 600 SEL sedans were selling in Moscow, at $130,000 apiece, than in New York City. In the Russian city of Volgograd, one wealthy citizen plunked down $300,000 to buy two stretch limousines.

In Brazil’s biggest city, Sao Paulo, homeless children slept under billboard advertisements for mutual funds, and farther south, in Argentina, cash machines spat out U.S. dollars and televisions offered 50 cable channels.

And in the ancient Chinese lakeside city of Hangzhou, two dakuan, or fat cats, got into a contest to see who was wealthier. They began burning real currency to show off, and in a blink they had each burned $400.

In one sense, today’s crisis fits neatly into a long history of financial manias and panics. Emerging markets have been risky ever since the 1320s, when England, then a developing country, defaulted on loans to banks in the Italian city-state of Genoa. In the 19th century, states like Mississippi defaulted on debts just as Russia did last year.

Yet for all the parallels with the past, new elements are at work to make the global economy very different from that of a century ago, or even a decade ago. Most fundamentally, finance and technology have exploded in importance and now dominate the economic horizon.

In a typical day, the total amount of money changing hands in the world’s foreign exchange markets alone is $1.5 trillion—an eightfold increase since 1986 and an almost incomprehensible sum, equivalent to total world trade for four months.

It’s no longer the real economy driving the financial markets, said Marc Faber, a prominent fund manager in Hong Kong, but the financial markets driving the real economy.

Already, a 15 percent increase in U.S. stock prices bolsters American wealth by $1.7 trillion, which is considerably more than the value of all the manufacturing that takes place in a year in the entire United States. This capacity for wealth creation has delighted Americans, but there is also a converse: A 15 percent drop in the market erases wealth equivalent to the entire annual output of all U.S. factories.

Economists are still charting this new global economic landscape, but they point out some of its features:

— The amount of investment capital has exploded. By 1995, mutual funds, pension funds and other institutional investors controlled $20 trillion, 10 times the figure of 1980. The global economy is no longer dominated by trade in cars and steel and wheat, but rather by trade in stocks, bonds and currencies.

— Far more wealth than ever before is stateless, circulating wherever in the world the owner can find the highest return. Thus spending by investors in industrialized countries on overseas stocks increased 197-fold between 1970 and 1997, and each nation’s capital market is beginning to merge into a global capital market.

— New technologies have vastly reduced the importance of physical distance. In 1930 a three-minute telephone call from New York to London cost $245. Now it runs 36 cents. In cyberspace, every market is next door.

— Investments are increasingly leveraged, using borrowed money so that a $1 million bet becomes a $5 million bet, or they are channeled through complex financial instruments known as derivatives to multiply the potential profits. Derivatives have grown exponentially, with those traded in 1997 valued at $360 trillion, a figure equivalent to a dozen times the size of the entire global economy, and they bring important benefits but also new risks of turbulence.

— Public funds are increasingly used to bail out losers, like banks. The latest crisis has forced an international rescue on a scale like nothing before, with roughly $175 billion in public money raised so far for the various international bailouts. At least some of that public money has gone to rescue bankers and politicians from their own mistakes.