Prosperity Under Siege

Global markets are sinking. The Mideast is boiling. Japanese firms are collapsing. It's scary out there

Hear that roar? That's the sound of global stock market value going down the drain--some $5 trillion of it since the start of the year, estimates Morgan Stanley Dean Witter. What's that snap? An overloaded world bond market splintering. Oh, and that thud was another large Japanese financial institution collapsing.

Led by Wall Street, global markets are down an average 17% since the start of the year, as shown by the Dow Jones World Index. In dollar terms, Europe is off 21%, Japan's Nikkei is down 25%, South Korea is off 51%--and none seems ready to hit bottom. The risk premiums over government debt that investors demand for even good corporate issues are at their widest since the Russian debt default in August, 1998, and in both the U.S. and Europe, the market for new issues of junk bonds is effectively closed. America's ranking bond guru, William H. Gross of Pacific Investment Management Co., warns that he wouldn't touch even a high-quality corporate bond in this climate.

Following the collapse of the Chiyoda Mutual Life Insurance Co. in mid-October--Japan's largest bankruptcy ever--Japanese market watchers have been warning that there may more large financial collapses in the weeks ahead. On Oct. 17, Tokyo authorities were preparing for the liquidation of one of the country's largest leasing companies. There have been warnings that other mid- to large-size financial, construction, and retail enterprises are likely to be liquidated.

What's going on here? Just a month ago, the world economy looked pretty safe. Sure, corporate debt was at high levels, and there had been a dot-com crash starting from last April, but markets kept shrugging off those warnings. Revenues and profits in the U.S. looked healthy, and growth was especially encouraging in both the U.S. and Europe--3.7% for the U.S., 3.5% for Europe.

Japan and the troubled Asian countries were said to be slowly recovering, and investors were beginning to hope that Federal Reserve Chairman Alan Greenspan was done with interest-rate hikes and that the miracle of a soft landing was in sight.

It's true that oil prices were continuing to push up inflation rates across the developed world. But after subtracting energy prices, core inflation was moderate, meaning that oil prices weren't hiking costs across the board. The bitter, violent blowup in the Middle East was and remains a big worry. But short of an oil embargo or a war that shut down the oil fields, that danger too was contained, wasn't it?

Adding it up, the big change that's taking place is that investors everywhere are casting a cold eye on risk. Until recently, U.S. and European investors were spending profligately, throwing the old profit standards out the door and embracing unproven dot-com business models as the next great thing in finance. Now, all of that is over. Risk matters again. Oil, the Middle East, bonds, stocks, Japan, dot-coms--what seemed like discrete concerns have been thrown together in a volatile stew. The idea that the economies of Europe and Asia could accelerate--always a myth--while the U.S. slowed has been demolished. In a world more closely linked than ever, the danger is that once a financial cycle turns for the worse, it will go too far. Global prosperity, a given just a few weeks ago, is now seriously threatened.

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