The era of globalization, marked by the increase in free trade agreements, cross-border capital investment, cross-border speculative trade and the rise of supranational firms, is beginning to unravel.
Foreign direct investment (FDI) and speculative (hot money) flows from the world's wealthy countries into the developing countries are slowing and, in some cases, actually reversing.
The most dramatic evidence of this is the exodus of foreign capital from China that has been accelerating for the past year and has caught the attention of not only the financial sector and investors, but world government leaders.
At the World Economic Forum's annual meeting in Davos, Switzerland, Bank of Japan (BOJ) Governor Haruhiko Kuroda publicly urged China to implement capital controls to prevent the exodus of capital from the country.
The importance of this can't be overstated.
For one country's monetary policy chief to openly advise another country's government leaders to implement capital controls is indicative of panic.
Communications between countries on a topic this sensitive and important to all need to be handled delicately and privately.
This is the nature of leading vs. managing and it applies to the leaders of countries, monetary authorities, companies, the boss-and-subordinate relationship, and even simply between individuals.
I discussed this situation with respect to the U.S. Fed three years ago in the column, "Fed Is a Manager, Not a Leader," in which I noted, "Leading is done publicly, managing is done privately. Leading is a proactive event and managing is a concurrent and reactive event."
When a leader decides to manage publicly, it's because something is terribly wrong, and it is a decision they typically regret later as it usually compounds the situation they are trying to alter.
The best example of this in recent U.S. history was when Treasury Secretary Paul O'Neill announced publicly, "If I could buy stock, I'd be buying a whole lot today," after the stock markets reopened following the Sept. 11, 2001 attacks.
Whether investors are cognitive of the difference between leading and managing, their intuitive Rorschach response to such will be to do the exact opposite of what is being advised, because if stocks were such a great bargain, the Treasury secretary would not be publicly advising doing such.
In this case, the advice to implement capital controls is not about China or because Japan feels the Chinese authorities need the support of Japan to do so. It's because of concerns about the impact of fleeing capital has on Japan.
The process of globalization, the cross-border investments made by wealthy countries and regions, principally the U.S., Western Europe and Japan, into developing countries, which is then levered up to stimulate activity in those countries, is a one-way process if it is to succeed.
If the capital begins to reverse that direction, global economic growth can't continue and the debt taken on by both sovereigns and companies can't be serviced.
In order to encourage the cross-border investment to continue, monetary authorities in wealthy countries lower the cost of debt capital. If that doesn't work, they will move to force the issue by penalizing companies and investors refusing to invest in the capital markets either domestically or globally by moving into negative interest rates.
I addressed this issue in the 2011 column "The Honey Is Gone."
Since then, Europe has adopted a negative interest rate regime, and today Japan announced it too is implementing the same.
In both instances, the monetary authorities are attempting to force the owners of capital to continue to put their capital to work and not to park it.
Specific to the Japanese move, the advice to China not to allow capital to flee is one way of preventing, at least temporarily, the flight of capital back to Japan. The implementation of negative rates in Japan is a means of punishing investors for fleeing from China back to Japan with their capital.
This is akin to a military leader burning his ships upon making landfall in order to prevent his troops from retreating.
If this process continues, and it is highly likely that it will, the rate regimes in Europe and Japan will become increasingly negative, and the U.S. will have to follow with the same prescription for U.S. capital owners.
Former Fed Chairman Ben Bernanke has consistently maintained that the Fed will add negative rates to its policy tools.
Tomorrow in part 2 of this column, I'll address the immediate trajectory and consequences if it does not change.
