4/1/08 3:00 PM

Wolf: Investors’ Panic Helps Fuel U.S. Financial Crisis

By J.J. Smith

BOSTON—Investors’ fear and panic are helping fuel the U.S. financial crisis, which will impact how companies manage global operations, an international financial expert told an audience at SHRM’s Global Conference and Exposition here March 31, 2008.

In a financial panic, investors reject assets that they normally would embrace such as “triple-A rated” corporate bonds, said Martin Wolf, associate editor and chief economic commentator at the Financial Times, London, during the opening keynote presentation, “What Happens Next? Prospects for the World Economy.”

Investors are rejecting such safe investments as triple-A rated corporate bonds for U.S. bonds to the point that “the spread” between those bonds “is pretty close to an all-time high,” he said.

That is evidence of “the most frightening financial panic.”

To give the current crisis context, Wolf outlined the circumstances that have shaped the global economy since 1981, including the current U.S. financial crisis, which he calls “the Great Revulsion.” In addition, circumstances listed by Wolf that shaped the global economy are “the Great Convergence” and “the Great Moderation,” which lead to what Wolf calls “the Great Imbalance” and “the Great Unwinding.”

The Great Convergence is happening and continuing despite the financial crisis, Wolf said. It is the biggest economic integration, or convergence, that has ever occurred, he said.

What that means is the living standards of relatively poor countries—vast countries with enormous populations—are rising faster than those in the developed world, and are meeting, or converging, with the living standards of the developed world.

The countries with living standards that are rising quickly are China, India and Latin American nations, but “the awakening of China is the most important event of our era,” Wolf said. The rise of China, and India “is the transforming event of our lifetime, and it is indeed shaking the world,” he said.

There are several drivers of the Great Convergence that are supporting the emerging nations to catch up to most of the developed countries, Wolf said. These include the liberalization, or easing, of barriers to trade, the revolution in communications technology and the “explosive” growth of the labor force, he said.

Liberalization of the barriers to trade is important enough that the Chinese and the Indians are still planning to liberalize their markets to keep capital flowing to the rest of the world, he said.

Use of personal computers has increased an estimated 20-fold since 1990, and all those computers have linked to the Internet, he said. In addition, cell phones have become the most radically disseminated technology in the history of the world, he said.

“Three out of every 10 people on the planet have a cell phone, with the fastest growing use of the cell phone in Africa,” he said. There will likely be a time when everyone on the planet will have access to the information on the planet.

The explosive increase in the global labor force is a result of the number of people in countries that have the infrastructure and the policies allowing them to integrate into the world economy. Most of these 3 billion workers, Wolf said, work hard and want the same standard of living as industrial countries, he said.

The Great Moderation

The second driver of the world economy is the Great Moderation, which is an economy that remains stable and strong, Wolf said. Since 1981, the world economy as a whole has not suffered a single significant slowdown, he said.

There was a mild recession in the early 1990s led by an attempt to reduce inflation, and there was another very mild recession in the early 2000s following the first bursting of the stock market bubble, and there was a long period of slow growth in Japan. But on the world economic level, there has been no significant slowdown for 25 years, he said.

There has been an environment of low and stable inflation caused by the rise of China and other suppliers that have helped keep prices low for most of the past 25 years, he said. When slowdowns did occur, they were mild. While there were times when inflation in the advanced countries surpassed 10 percent and when in the developing countries it surpassed 20 percent, by 2006 inflation had all but disappeared, transforming the economic background, he said.

The great convergence and the great moderation were necessary to support the “extraordinary world economy,” he added, so what went wrong?

There is an economic model of what has happened that says that when times are good—periods of moderation creating low inflation—investors will believe there are no financial risks associated with investing, Wolf said. Because times are good, they take on risky investments because the returns are better, but then ultimately they take on too much risk. When assets fall, debt begins to be called in, he said. When debt is called in, assets have to be sold to meet debt liabilities, and when too many assets appear on the market, prices collapse, he said. If asset prices collapse, highly leveraged financial institutions—such as Bear Stearns—collapse.

“The success of the great moderation and convergence bred excess,” and there are economic consequences, Wolf said. The United States is certainly in a recession, but it will not be confirmed for a while, he stated. Nonetheless, some of the consequences that have already appeared are dramatically lower short-term U.S. interest rates, which have been cut by 3 percentage points in the last six months, and a weak U.S. dollar. This is the “weakest dollar there’s ever been,” he said. The devaluation of the U.S. dollar is heralding the end of the U.S. consumer as the buyer of last resort in the global economic system.

The Great Unwinding of the Great Imbalance

The U.S. economy is no longer going to be driven by debt, Wolf said. That the financial sector generated 40 percent of the profits in the United States in 2007 indicates a reasonable balance of the total business efforts of the United States, he said. In addition, because the United States has been supplying 75 percent of the assets of the growing economies of East Asia, there has been an extraordinary rise in indebtedness within the United States, he said. “It has now, quite clearly, come to an end.”

J.J. Smith is manager of SHRM Online’s Global HR Focus Area.

Quick Links:

SHRM Online Global HR Focus Area

Global HR Focus Area Discussions