If you were searching for a demonstration of how interdependent global financial markets have become, this week's roller-coaster/merry-go-round performance by stock indexes across the world serves nicely. On Monday and Tuesday, Asian markets tanked; in response, the New York Stock Exchange went into free fall. But on Wednesday, revivified by the Federal Reserve's rate cut, Asian markets shot back up. Ben Bernanke wields a mighty power: He waves his magic wand and the ripples propagate instantaneously to everywhere that shares are traded on an exchange.
You might even say the world's stock markets are "tightly coupled," that is, they are bound so closely together that a spike up or down anywhere affects the entire system. But to do so would fly in the face of "decoupling" theory, until recently all the rage in certain circles, which holds that the health of the world's economies are no longer as intimately intertwined as in the immediate recent past.
Popularized in 2006, initially by economists at Goldman Sachs, the decoupling meme was most often summoned in support of the thesis that the U.S. was no longer the single prime locomotive of the global economy, pulling everyone else along with it. China and India were growing so fast and (especially China) becoming so economically powerful that their economic destinies were no longer as one with the U.S. So if the U.S. economy entered a recession, the prospects for the rest of the world might not inevitably be so bleak. The global economy would keep chugging along.
Stock markets are not identical to the so-called real economies in which goods and services are created and consumed, but one of the chief lessons of the subprime debacle is that when you transform real economy activities (like, for example, taking out a loan to buy a house) into tradable securities, you annihilate whatever differences once may have distinguished one from the other. Just the news that trading in the Bank of China was suspended on Tuesday in Shanghai after the bank missed a deadline for declaring its exposure to subprime losses in the U.S. should be enough to prove that point. The Chinese government has now formed a "subprime task force" to figure out the liabilities of Chinese banks to Florida condo speculators. Butterflies flap their wings in front of half-built/abandoned Toll Bros. luxury gated communities, and Shanghai punters get knocked over. The Chinese themselves are being very clear: ""If U.S. consumption really comes down, that's bad news for us," one central banker said earlier this week at a financial forum in Beijing.
What seems remarkable at this juncture is that the decoupling thesis ever gained any traction in the first place. While it is undoubtedly true that Europe, the U.S. and Japan are no longer the sole pillars holding up the global economy, the fact that there has been a wide diffusion of economic vitality does not necessarily imply that the separate pieces now have separate destinies. If anything, the opposite is true.
Globalization is built not just out of the telecommunication and computer network linkages that make financial markets anywhere accessible from your iPhone. The bricks-and-mortar of global production supply chains have turned that iPhone into a product requiring the efforts of multiple nations and multiple companies. An earthquake in Taiwan affects Dell's quarterly earnings. High corn prices in Iowa lead to an expansion of soybean farming in Brazil. Bad investment bets by New York bankers lead to an infusion of funds from Singapore and Abu Dhabi and bankruptcies in small towns in Norway. In every direction one looks the linkages are multiplying.
The decoupling thesis suggested that if the U.S. stumbled, China could keep on running. It would be lovely if this were true. It is not a happy thought to think that the welfare of hundreds of millions of poor people around the world depends on the buying power of American consumers with maxed-out credit cards teetering on the brink of foreclosure. But the jitters visible in global markets this week tell us that when the king stubs his toe, everyone starts limping.