Sunday, May 18, 2008

A Silver Lining to America's Financial Crisis?

The U.S. financial crisis has been relatively contained, thanks in no small part to the creative and steady leadership of Fed Chairman Ben Bernanke. True, bank losses are running in the hundreds of billions, and trillions more will be lost in “paper” values by the time home prices stop dropping; all the same, the risk of a full-scale global financial meltdown seem to be receding.

There are those, like Paul Krugman, who believe that the diminishing sense of panic may stall the financial reforms needed to prevent a similar (or even worse) meltdown in the future. With Americans fixated on high gas prices and the cost of food, Krugman fears that financial industry lobbyists may be able to resist calls for extending many of the regulations of the normal banking sector to the more obtuse and unregulated world of financial services and derivatives.

While Krugman may be right, I think there is also a potential silver lining in all of this.

Capital usually goes where it can make the quickest buck. In the 1990s it was tech stocks, most recently it was housing. What was disconcerting about both of these speculative frenzies was that money flowed mostly to developed countries, where the returns to capital should be among the lowest (since developed countries are awash in capital); this at a time when billions of people live in capital-starved countries eager for investment.

The reason why money pours into relatively low-return developed markets over the higher returns offered by developing economies is, of course, because of the much greater risk in poorer countries: risks from political instability, corruption, inadequate infrastructure, etc.

But this is starting to change. The emerging markets of Latin America, Asia, Eastern Europe, and Africa have been growing fast these past few years; rising demand in these regions is one of the major factors which up until now has helped the U.S. and the global economy avoid recession.

Now that our latest financial crisis may soon be behind us, there is a new opportunity for investors to take another look at the developing economies (especially since they represent some of the strongest at this point in the global business cycle). When there is so much opportunity for greater returns in the developing world, it is hugely inefficient for investment to be concentrated in the richer countries.

A shift in capital investments would not simply mean profits for investors from wealthy countries, but real material progress for the billions or people still living on a couple dollars or less a day. Investment in the U.S. may mean better computers or video games or other electronic devices; for people in the Global South, it can mean the difference between having a refrigerator or not, having basic transportation, having a cell phone to connect with the rest of the country and the world. The stakes are simply much higher for those at the bottom of the economic ladder.

Hopefully, when the dust finally settles on this latest financial crisis, many more of the world’s investors will realize the amazing opportunities that exist for long-term investment in the least developed parts of the world. For readers who happen to be individual investors, putting your money into emerging markets means that as the world’s poor get richer, so do you. It’s a win-win situation.

Jason Scorse

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