The unfolding drama of the Greek economy has roiled markets and awakened fears of global economic calamity that had been dormant for more than a year. The $1 trillion rescue package assembled by the European Union and the International Monetary Fund may be enough to keep the Greek disease from infecting Spain, Portugal, Ireland and other overleveraged European countries. But the events of the past weeks echo the lessons of the near global meltdown of late 2008 and early 2009: the world is indeed a risky place, although not in the places most people think of as risky. The global economy is indeed riddled with problems, but not in the places most people think of as problems.
For most of the past 40 to 50 years, the world has been divided in various ways: communist and capitalist, democratic and authoritarian, West and East, First World and Third World, and developed economies and emerging economies. When it came to business and investing, the First World the Western world and the developed world was seen as secure, stable and capital-rich, while the Third World and the emerging economies were seen as unstable, capital-poor and highly risky. Think of the much heralded and much needed bailout of the Mexican peso in 1994, the contagion of currency devaluations that started in Asia in 1997 or the periodic hyperinflation that has plagued Argentina.
The crises of the past two years, however, stemmed not from the risky parts of the world but from the supposedly safe havens of the U.S. and the euro zone. Risk is no longer over there; it's here. It isn't in exotic parts of the world; it's in the cradle of Western civilization. In the fall of 2008, it wasn't oil shocks in the Middle East that triggered the meltdown; it was subdivisions in Phoenix and financial wizardry on Wall Street. In the 1970s, sovereign-debt defaults in Latin America hit Citibank hard; in the past two years, the near default of Citi rocked Latin America.
Investors haven't adjusted to this new reality, though. Rates on emerging-market bonds a good proxy for how much risk investors perceive there to be from countries like Brazil are more or less on par with the rates charged on Greek and Spanish debt. And the latter two are dead broke. American pension plans, which have every incentive to reduce their risk, allocate on average only 2.1% of their portfolios to emerging-market debt, compared with double digits for U.S. and European debt.
Or take the continued misreading of China's economy. Before 2008, it was commonly assumed that the Chinese banking sector would bring that economy to a halt either in a soft landing, as the loans were written off and the government recapitalized those banks, or in a hard landing, when the banking sector imploded. Turns out Chinese banks weren't the problem; American and European banks were. It wasn't China's nonperforming loans that should have caused anxiety; it was ours.
Today it is the Asian, Brazilian and Indian banks that are well capitalized and run conservatively. Yes, China's banks are chock-full of sketchy loans, but many of those are government-backed, meant to finance an industrial build-out that is key to economic growth. They are less like bad loans and more like government expenditures, and unlike the social handouts of Greece and the E.U., those expenditures are going into infrastructure and investment rather than just consumption. Look around the world and you will see growth and capital discipline born of hard experience in those places still associated with risk; you will see capital profligacy and anemic growth in those parts of the world still seen as safe.
Granted, some of this is human nature. People everywhere suffer from home-country bias the belief that one's own society is safer and more comprehensible than others'. Investors tend to put more money in local stocks and bonds. But for the first time, home-country bias makes sense if you're in Brazil or India or China or dozens of other regions. And it makes much less sense if you're American or European. Although world stock markets are down this year more than U.S. and European ones, that is largely because big institutions in America and Europe have been selling non-U.S. assets to bolster their balance sheets and average investors have remained skittish about a risky world beyond their borders. In short, while the reality of risk has shifted dramatically, the perception of it hasn't.
The Great Recession, so great in the West, is the Great Emergence for the rest, and risk has moved from far away to uncomfortably close. Our compass is broken, and our desire for safety is leading to ever greater risk. We need to understand that new reality, and quickly.
Karabell is the president of River Twice Research and a co-author of the forthcoming book Sustainable Excellence