Capital flows in a Globalized World

Countries need foreign currency to pay their import bills.   

They can obtain these from:

- foreign bank loans,

- foreign purchases of stocks or bonds of their countries, or,

- direct foreign investment in local factories.

These flows all are recorded in the capital account of the balance of payments.

Analysts and newspaper headlines tend to focus only on foreign purchases of stocks and bonds.  These are often called "hot money" because foreigners looking for a quick profit can dump stocks and bonds like hot potatoes when crises begin.

Bank loans:  the real hot money 

In recent decades, the most volatile capital flows have actually been bank loans, which are now the real hot money.

China and other emerging markets began opening their doors to foreign capital.  Capital flows rose from 2% of global GDP in 1980 to 16% (a whopping $19 trillion) by early 2007.

Then came the 2008 crisis and optimism about emerging nations vanished. 

By 2014, capital flows had fallen back to $1.2 trillion - once again about 2% of current global GDP.  , Bank lending, the largest portion of capital flows, turned negative during the crisis, indicating that banks were liquidating loans to bring money home.

When capital flows slowed

With capital flows slowing, those countries with persistent current account deficits may run into trouble financing these deficits much sooner.

In the pre-2008 era, the tipping point came when the deficit had been increasing by 5% of GDP for five years in a row.  

In the post-crisis era, the tipping point may come faster and at a lower deficit levels; the 5 percent rule may become a 3% rule.