Such interest rate
differentials accelerate capital movements in a world of increased
cross-border financial flows. Higher interest rates in the US relative
to Japan, have resulted in capital flows to the former and contributed
to a combination of asset price inflation and exchange rate appreciation.
The resulting high returns on dollar-denominated assets proved self-reinforcing,
till expectations of a decline in asset prices came to dominate investor
behaviour recently. The US became a major target of non-US based investors.
For example, foreign purchases of US Treasury and government agency
bonds are reported to have reached $293.7 billion in 1996, and there
was a further $78 billion of foreign purchases of corporate bonds.
This trend has persisted since then. A large part of these investments
were based on borrowed yen funds, aimed at taking advantage of interest
rate differentials. Global hedge funds indulged in "yen-carry
trades", which involved borrowing in yen, selling the yen for
dollars, and investing the proceeds in relatively high-yielding US
fixed income securities. This proved to be a very lucrative way of
recycling Japanese current account surpluses to finance the US deficit,
inasmuch as the Yen depreciated continuously between May 1995 and
May 1997, which reduced the yen liability relative to the investment
Needless to say, such
speculative foreign capital inflows have been crucial during the years
of the American boom. One consequence of such flows has been steep
asset-price inflation. Stock values, property prices and the values
of other financial assets have risen sharply. This triggers a "wealth-effect"
known to be strong in the US. Rapidly rising asset values which increases
the wealth-holding of households encourages them to go out and spend
triggering a boom. Add to this the effects of the large inflows of
capital on liquidity in the system in the form of easy credit. The
boom in consumer spending and housing starts fuelled by an easy credit
and low interest rates situation strengthens the "wealth effect"
and spurs the American boom based on money from economies which are
ostensibly not doing well.
If past experience
is any guide, an American boom should spur growth elsewhere in the
world as well. Yet, as noted earlier, the phase of globalisation has
been accompanied by remarkable unevenness in development across the
developed countries. Among the many factors contributing to this unevenness
is the American transition away from an era of budgetary deficits
to surpluses. Americas post-War economic hegemony and the associated
fact that the dollar was the worlds leading reserve currency
("as good as gold") had meant that the United States government
faced no national budget constraint on its expenditures. It could
print as much of the dollar as it wanted to and spend it anywhere
in the world, where it was unquestioningly received.
In the past, the US government had used this advantage to finance
large deficits, which helped sustain both US and world economic growth.
By the mid 1990s, however, pressure to reduce the US budget deficit
had begun to work. In the event, precisely during the years when capital
was being sucked from across the globe to finance an American boom,
and partly because of this way in which the boom has been sustained,
a major change has occurred in the fiscal stance of the US State.
The deficit of the United States government has been on the decline
since financial year 1992 and turned into a budget surplus of around
half of a percentage point relative to GDP in financial year 1998
(Chart 6). The surplus rose to 1 per cent in 1999.
Chart 6 >>
The changed fiscal
stance of the US has meant that a major stimulus to global growth
has now been undermined. This explains the fact that through much
of the 1990s there has been a loss of synchrony in the business cycles
encountered by different advanced industrial nations. During the 1970s,
the complacent view that industrial capitalism was finally rid of
the business cycle had to be discarded. During those years and in
the early 1980s, the contractionary responses to two oil shocks resulted
in two major recessions across the industrial world. A noticeable
feature of those recessions was their virtually synchronised occurrence
in all the major industrialised countries. However, matters seem to have changed considerably
in recent times. While it is true that crises still remain an abiding
feature of capitalism, a lack of synchrony in the phase of the business
cycle in different countries appears to the principal feature of the