The Three Marketeers

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The conventional wisdom is that the economic anxiety now gripping much of the world has its roots in the collapse of Thailand's currency, the baht, in July 1997, after investors discovered that Thailand's economic boom was built on a base as solid as a bowl of pad Thai noodles. But the roots actually reach back further, to Black Monday, Oct. 19, 1987, when the Dow Jones industrial average shed 22.6% of its value in a single day. The market, of course, rebounded--and how. But at the time, professional investors thought U.S. stocks were due for a decade of slow-to-sluggish performance. Their eyes--and wallets--quickly alighted on the world's so-called emerging markets. These nations, allegedly "emerging" from centuries of economic backwardness, were posting phenomenal growth rates: Malaysia grew 9.5% in one year, Thailand 13%. Investors--especially young portfolio managers entranced by Malaysian food and Thai night life--rushed to get in.

Between 1987 and 1997, half a trillion dollars flowed in from international investors. Initially the money was a godsend. It gave companies access to world-class technology and know-how. But in cities such as Jakarta or Kuala Lumpur or Bangkok, there aren't a whole lot of world-class companies. And as share prices of those rare firms rose, investors poured money into other, less well-run companies. At the height of the boom, in 1996, office space in Bangkok was commanding First World rents; in Jakarta supermodels Claudia Schiffer and Naomi Campbell inaugurated a Fashion Cafe, and in Kuala Lumpur the world's tallest building opened for business.

Of course it couldn't last. In late 1996 the warp-speed growth in many of these nations began to slow--an inevitable turn in the business cycle. But the stutter was enough to panic a few investors, who headed for the exits. That set off a rapid spiral of defaults that became known as the Asian Contagion. Thailand's problems quickly became Indonesia's, then Korea's, in a dangerous daisy chain that is still looping together--witness last month's shuddering devaluation of the Brazilian real.

The initial downturn didn't surprise the Fed or the Treasury too much. For the better part of two years, Greenspan and Rubin had been quietly fretting about the narrowing "spread"--the difference in interest rates--between U.S. bonds and emerging-market bonds. By 1996 banks were lending money to countries such as Malaysia at interest rates just a few percentage points above what the U.S. Treasuries commanded. The implication: Malaysia was not a much riskier bet than the U.S. This was nonsense, and the committee knew some correction was in order.

But the speed of the collapse, when it came, was breathtaking, and proof that world markets had entered a new and much more volatile phase. Summers has a favorite analogy: "Global capital markets pose the same kinds of problems that jet planes do. They are faster, more comfortable, and they get you where you are going better. But the crashes are much more spectacular."