Money, go home

Editor's column for The Times

It would seem that it is too early to worry about the next financial crisis. But even in the current bleak circumstances, Wall Street is buying up assets from "transition countries" that are growing faster and bringing in higher, more stable profits....

It would seem that it is too early to worry about the next financial crisis. But even in the current bleak circumstances, Wall Street is buying up assets from "transition countries" that are growing faster and bringing in higher, more stable returns. Financial regulators and legislators in these countries should pay attention to this.

The Institute of International Finance, which lobbies the interests of large banks, estimates that $825 billion will be invested in the economies of developing countries this year, 42% more than in 2009. The volume of investment in the debt obligations of countries with economies in transition will increase three times - to $ 272 billion.

While developing countries may benefit from foreign investment, large capital inflows complicate the macroeconomic situation.

Investment increases the exchange rate, which boosts imports and hurts exports, and accelerates credit expansion—which can lead to inflation, create asset bubbles, and usually end up in a pile of bad loans.

Such money leaves the country at the first sign of problems, causing a crisis in the country.

This is what was behind the Mexican tequila crisis of 1994, the Asian crisis of 1997, the Russian crash of 1998, the Brazilian fiasco of 1999, and the Argentine collapse of 2002. The mortgage "bubble" that burst in America in 2008 was painfully similar to them with unwise investments and a sudden exit from the market.

The collapse of bonds of countries with transition economies will cause even more damage to the consolidated balance sheet of US banks.

Still, there is no reason to panic yet.

Developing countries are in a comparatively favorable position from an economic point of view, and interest rates in rich countries are likely to remain at low levels for several more years.

Yet the financial system is unstable. And any shock - say, a default in Ireland or Greece - could lead to a sharp flight from the markets in the countries with economies in transition.

Legislators in rich countries cannot do anything to stop these financial flows. The authorities in developing countries should start preparing now for the fact that the money masters may change their minds.

This means they should not let their budgets get out of control.

And they have to watch their own banks very carefully. Perhaps they should also consider setting up a mechanism to control capital inflows.

In the 90s, Chile managed to successfully manage them. Even the International Monetary Fund — a longtime enemy of any impediment to cash flow — admitted this year that such controls are sometimes necessary.