Is Globalization Collapsing ?

The gigantic experiment in globalization may be about to turn ugly in a classic Jekyl and Hyde type scenario.

In previous blogs I wrote about the fragility of the economy in Iceland. For the past several years, global financial players have been flooding the Icelandic banking system with capital in order to cash in on the higher interest rates being offered. In other words, the classic "carry trade" was at work. The bloated banking system started lending this capital to individuals who predictably went on a spending spree and to corporations who likewise went on an acquisition spree. I can think of 2 major firms right here in Canada that were acquired by firms from Iceland. I can recall thinking at the time – Iceland?, where are these companies getting the money to come to Canada to make acquisitions? But now, this money is seeping out of the system in response to the recent financial turmoil in the global banking sector. In an effort to stave off this outflow, interest rates in Iceland have risen to 15%. The backlash has resulted in the currency shriveling and the trade deficit ballooning.

In one of my blogs I concluded by wondering whether this mess would start to spread to other parts of the globalized economy. Now it seems the answer is yes. Vietnam is making headlines these days with Moody's Rating Agency having just downgraded Vietnamese sovereign debt to a resounding "Negative". For the past number of years, Vietnam was the darling of the Asian group of economies. Foreign capital flowed into the country like a tsumami and factories popped up everywhere to make things from running shoes to T-Shirts. But, an economy cannot be strictly export based. As more and more people started getting these factory jobs and earning wages, the supply of domestic currency surged. With these factories exporting all their output to "shop-a-holic" North American consumers, soon Vietnamese consumers found themselves importing more and more goods that they needed for day to day life. As these consumers directed their earned wages towards making these purchases, inflation began to ratchet up as did the trade deficit. The trade deficit is now looking like it will double over 2007 levels and the rate of inflation has now spiraled to 25%. Labor strikes are the order of the day and policy makers are scrambling to come up with a solution.

But it is not just these 2 tiny countries that are struggling. This week brought news that the Malysian government has now cut fuel subsidies and gasoline prices at the pumps in Malaysia have surged 40%. The same is now set to happen quickly also in the Phillipines, Indonesia and India as well. For many consumers in these nations, the loss of cheap fuel will have a devastating impact on their spending habits which will spill over into the general theme of economic growth. Even in Europe we are seeing unrest. Fishermen are protesting violently in the streets of Brussels these days in response to rising fuel costs.

The world is no longer flat. It is interconnected in more ways than we may care to think about. What started as an isolated incident in Iceland is now spreading. If traders in New York push oil prices higher on speculation, this can trigger foreign policy makers to give up attempts to subsidize fuel. And so it goes. I think we are about to embark on a dark journey into the land of higher interest rates,higher inflation rates and slower growth. The genie is now escaping from the bottle and Central Bankers and policy makers are going to be hard pressed to put her back into the bottle. The experiment in globalization could be about to turn ugly.