Monday, November 5, 2012

When I Move You Move

A lot of Krugman's commentary was oddly prophetic; his discussion of the Savings and Loan crisis, of the issues associated with large-scale insurance, and of Japanophobia begged analogy to the financial crisis, AIG bailout, and recent Sinophobia.

But I've already blogged about how well some of these writers predicted future problems. In fact, we all have at least one post to that effect. So I will investigate a Krugman claim I believed no longer holds true.

Krugman questions how global the global market really is. He writes that because "there is so little international 'cross-holding' of stocks, world stock markets do not necessarily move together. This was illustrated spectacularly from 1990 to 1992." (183)

But I interned at an investment firm this past summer and noticed in my first week how global markets frequently moved together. If the S&P was down, you could count on the Nikkei being down before you woke up the next morning like clockwork. But don't just take my word for it. Below is a graph of the S&P 500 index (US), Nikkei Index (Japan), FTSE 100 (Europe), and Hang Seng Index (Hong Kong). Clearly, they move together quite frequently in the modern global economy.

The next question is to evaluate why. Krugman saw no interdependence in the early 1990s because of scant 'cross-holding,' which he defined as "international diversification of portfolios - that is, Americans [as] stockholders of foreign companies, and conversely." (182)

Interestingly, the United States census bureau maintains data on such cross-holding and the trend is as I expected. By the mid 2000s, both the number of international financial transactions and the net purchases of foreign securities in the United States skyrocketed. Unfortunately, the data skips from 1990 to 2000 so it is difficult to isolate the beginning of the trend.

Krugman cites Walter Wriston, former chairman of Citibank, as someone who overreacted to the potential impact of information technology on financial markets. Said Krugman, "much of this is hype." (182) Yet the data does not agree. Reports by economists at HSBC, Cornell, Wells Fargo, and UBS even highlighted correlations in bond and commodity markets across borders since the internet boom of the late 1990s. As the New York Times reported, markets (even more so now in the risk-averse post-2008 era) have "been behaving like synchronized swimmers." (182)

Not quite Krugman's prediction when he published The Age of Diminished Expectations...

US Census Bureau

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