Global capital flows become slow trickle, down 60% since 2007

The global flow of capital (money that moves around for the purpose of investment, trade or production) has fallen to $4.6tn from $11.8tn in 2007, with the UK seeing the steepest decline.

by Rebecca Burn-Callander
Last Updated: 09 Oct 2013

Global capital flows have fallen to worryingly low levels since the downturn began, according to consultancy group McKinsey. The value of loans and investment deals between countries has dropped by some 60%, down in part to global financial uncertainty but - in the main - because of the ongoing eurozone crisis.

Western Europe accounted for around 56% in the growth between 1980 and 2007, but has been responsible for a 72% slump since then. However, while corporations are holding back on European investment, and shelving loans in and out of the region, capital flows into the emerging markets have remained constant across the last five years.

While the UK is not part of the eurozone, our small island has experienced the biggest decline in capital flows since the start of the downturn. The eurozone is our largest trading partner. Cross-border capital flows are down 82% between 2007 and 2011, mostly due to dwindling inflows and outflows of bank loans.

On the bright side, the $4.6tn figure may be a far cry from pre-crisis capital flow levels, but at least we're in not the dire straits experienced in 2009, when the collapse of Lehman Brothers saw global capital flows slump to just $1.7tn - the lowest ebb since 1995. However, the recent decline 'has cast uncertainty over the future evolution of financial globalisations,' says the McKinsey report.

The gist of this report is that banks and businesses are retreating back behind country borders. In the eurozone, for example, domestic lending and the purchase of domestic bonds has actually increased: 'the whole purpose of creating the single currency was to foster market integration - and it's going in the opposite direction,' says Susan Lund, one of the report's authors.

This is exactly the state of affairs that global leaders have been trying to avoid. Note David Cameron's efforts to woo the Indians, and Obama's mooted 'trade pact' with Europe. If national borders become barriers to trade, the world's economies will find it even harder to dig their way out of the global downturn. 'We are not seeing a recovery at all,' is Lund's rather bleak assessment.

Global capitals flows are an interesting phenomenon. Too little, and countries are cut off from new sources of revenue. Too much, and the so-called 'hot money' can cause untold damage to the fiscal policies of a domestic economy, as was the case in Brazil back in 2010. Brazil received $100bn in portfolio flows and foreign direct investment that year, and was forced to put up tax barriers to disincentivise external investors.

Today, captial inflows to the emerging economies have returned to their pre-crisis peaks, hitting $1.8tn last year alone. Money is moving freely between the likes of China and South America, bypassing the West entirely. China now lends more money to Latin America than both the World Bank and Inter-American World Bank combined.

Is this a new world financial order, or just a passing phase? Our money is on the former.

Image: 'Money Wave' at BigStockPhoto

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