BORDERLESS FINANCE: FUEL FOR GROWTH

It's Apr. 20, 2010, a fine spring day in Shanghai. You stroll up to a Citibank automated-teller machine along the Bund, insert your plastic card, and log on. A computer in Bombay greets you, and you get down to business.

First, you shift 10,000 German marks into today's special--an Australian-dollar certificate of deposit issued by GE Capital in Rome. Equities are looking good, so you punch in an order for 500 shares of Telefonos de Mexico on the New York Stock Exchange. Then, at the press of a button, an account officer in South Dakota comes onto the screen to answer your questions about a loan for your factory in Argentina.

This is the new world of finance, one where money--and opportunity--know no bounds. It will be a scary new world, one where the sheer might of traders and fund managers will eclipse that of central bankers and politicians. But as trillions upon trillions flow around the globe, the market will also become an even more efficient and potent instrument for economic change than it already is today. Indeed, with its power amplified by incredible leaps in communications and information technology, the evolving financial market may even spawn a golden era of global investment and growth not seen since the days of unfettered international capital flows a century ago.

In this milieu swiftly flowing money and common financial instruments, global interest rates will start to converge (charts, p. 48) as a single standard of finance prevails. Supercurrencies spanning entire regions may emerge, dwarfing Western Europe's recent quest for one unit of exchange. And whole new financial systems will spring up in Asia, Africa, Latin America, and the farthest reaches of the former Soviet empire. With more and more emerging-market consumers and businesses able to tap the savings of the industrial world for the first time, it will be possible to move cash from the mutual fund of a retiree in Great Neck, N.Y., to an industrialist in Guangzhou with no more than one phone call.

The new financial markets of the developing world will also give consumers access to the West's array of investment tools. This will permit them to save as they never have before and creating vast pools of domestic capital to fuel the growth of tens of thousands of new businesses.

THE DARK SIDE. China is building a nationwide foreign-exchange network and bringing in foreigners to sell life insurance and annuities. Thailand is pushing mutual funds. And Russia is considering a nationwide stock market, modeled on America's NASDAQ. Such efforts could generate a stupendous amount of capital to bankroll growth. ``If the five biggest emerging markets--China, India, Indonesia, Brazil, and Pakistan--accumulate just $400 per capita in mutual-fund and pension assets over the next decade,'' notes Morgan Stanley & Co. strategist Barton M. Biggs, ``this will create $1 trillion.''

But this wide-open global money market will also force the world to grapple with a dark side of finance that is only now starting to emerge. As traders pump up their supercomputers and merge physics, math, and money to create ever-more-complex instruments and techniques, capital markets will turn more cruelly efficient and risky than ever. Financial volatility will become ``a fact of life,'' says World Bank Managing Director Ernest Stern, who believes that the once-staid global market for government debt has already turned into a $16 trillion casino that behaves more and more like the rough-and-tumble market for stocks.

In this new battleground for savings, market players will become a new class of stateless legislators. With the power of the purse, they will check governments' ability to tax, spend, borrow, or depreciate their debts through inflation. To be sure, money mavens sitting at computer screens already vote their portfolios on issues as diverse as the value of the Mexican peso, U.S. trade imbalances with Japan, and Sweden's struggle to maintain the archetype of the European welfare state. But that's only the starting point.

As more countries and companies hook themselves up to the global financial network, this shifting and stateless corps of fund managers and traders will not only be passing judgment. To preserve the value of their investments, they will become more and more directly involved in day-to-day affairs of state, meting out guidance, encouragement, and discipline on a daily basis. ``The very sovereignty of nation-states,'' says London-based economist David C. Roche, ``is being defeated.''

And woe to the government that fails to measure up. Canada, for example, currently must pay 9% yields on its 10-year government bonds, despite an inflation rate under 1%. Why? Many global investors are shunning the Canadians because their lavish social spending has swelled the national debt to a staggering 100% of gross domestic product. Faced with an investor revolt, Prime Minister Jean Chretien now has to make deep--and unpopular--spending cuts. ``Who says you have to be elected to influence policy?'' asks Nicholas P. Sargen, managing director of Global Advisors in Newark, N.J. ``The market is saying to policymakers, `We're your watchdog.'''

This enforcement of fiscal rectitude holds profound implications for companies and countries alike. ``Competition between nations'' will be the order of the day on capital markets, predicts Andre Levy-Lang, chairman of the management board of Compagnie Financire de Paribas. So will competition between countries and private corporations. Some even see the market measuring corporations and governments by the same yardsticks. Says David C. Mulford, chairman of CS First Boston Ltd. and a former U.S. Treasury Under Secretary: ``It's remarkable how the system has promoted rising prosperity to those who are prepared to reform their economies and compete for capital. The market responds to that, and very efficiently.''

Of course, some national leaders will try to defy the market. But the cost of facing up to a force collectively worth trillions of dollars is becoming nearly unbearable. Refusing to play ball with the traders could subject an economy to staggering interest rates or a cessation of equity investment in privatizations needed to boost productivity and create jobs. That could lead to increased social tensions that would push an economy even further from the road to fiscal stability. ``You can opt out of the system,'' warns money manager George Soros, ``but if you do, that destroys prosperity.''

INVESTOR POWER. Many countries are already heeding that warning. And that's probably all for the better, because no longer will the bureaucrats of the World Bank and International Monetary Fund be the prime interlocutors between the First and Third Worlds. Instead, investors, many of them supplying equity and demanding decent returns, will take their place. The International Institute of Finance estimates that $200 billion will flow to developing countries this year, 90% of it coming from private investors. With governments around the world planning to sell off some $350 billion in assets by the century's end alone, private investment will remain a driving force for decades.

Such massive movement of cash to the Third World will create divides among the developing countries themselves. Already, nations are splitting into haves and have-nots defined by market criteria. Argentina, Brazil, Mexico, Thailand, China, and several other nations, for example, have seen cash flood in as private stock and bond investors have bet on the spread of democracy. They also are rewarding the development of sound fiscal, monetary, and legal standards; the growth of a managerial middle class; and transparency of corporate accounting. Left behind are such onetime Third World stars as Nigeria and Venezuela, whose political strife and fiscal mismanagement are driving foreign investors to move on to more friendly locations.

Yet the biggest challenge posed by the end of financial geography may be for regulators. Increasingly, the central bankers, finance ministers, and officials of international institutions who have served as custodians of the global financial system are wondering how they can blunt the market's brute force. They are still reeling after a series of routs starting with Europe's currency wars of 1992 right up to the dollar crisis of '94. Indeed, the once-powerful central banks look ever more beleaguered in their efforts to control a foreign-exchange market that now is trading $1 trillion a day. As world trade and GDP continue to expand, this market is likely to get even bigger. And with savers increasingly able to move funds around the world at will, some economists even see central banks being forced to shift their focus from the domestic to the global money supply when considering policy moves.

Making that task easier may be the advent of supercurrencies that will help make trading and political blocs more efficient. Elke Thiel, an economist at Munich's Research Institute for International Affairs believes that despite the turmoil of the past several years in European Union foreign-exchange markets, the EU will have little choice but to move toward a single currency in the next century. Although it will resemble the German mark and will be strongly influenced by the anti-inflation hawks of the Bundesbank, she argues that such a broader-based currency will still be an important symbol of regional political unity.

But elsewhere around the world, the Americanization of global finance may make the greenback the prime monetary standard. With fast-growing economies from Argentina to Hong Kong already pegging their monetary systems to the U.S., and Russians abandoning the ruble for Federal Reserve notes, ``the dollar will conquer all,'' says Nicholas Knight, Nomura Research Institute's London-based strategist. But hopes for an emerging yen bloc in Southeast Asia are ``probably wrong,'' says Knight, in part because the dollar already is the denominator for trade and investment in the region.

The globalization of stocks will become perhaps as powerful a force as the spread of supercurrencies. Baring Securities Ltd. analyst Michael J. Howell estimates that investors worldwide have already poured more than $1.3 trillion into stocks outside their home markets. Much of that has gone into industrial countries. But now, the push is on to make emerging markets the focus of investor attention worldwide.

The flow of equity capital from the developed to the developing world has surged twentyfold since 1988. By 2010, emerging economies may account for 44% of world stock market capitalization, against only 15% today. Howell figures that just as they did in the 19th century, rich industrial nations could continue pumping money into emerging markets for 50 to 100 years.

FEAR OF FLIGHT. The flow of capital from north to south and east is becoming a more pervasive political force. Offshore investors hold some 50% of the Mexican stock market's shares and 25% of the country's government debt, for example. Says Arturo Acevedo, chief economist for the Vectormex brokerage group: ``The bond market plays the role of Congress, checking executive powers.'' In fact, the threat that U.S. and other foreign investors may flee has encouraged the ruling Institutional Revolutionary Party to press ahead with economic restructuring and move to open up its political system to more debate.

For those that win the markets' favor, the rewards can be substantial. The Czech Republic, now entering its second round of post-communist privatizations, recently won praise from Standard & Poor's Corp. for its conservative fiscal policies. Its debt and deficit levels are healthier than those of most EU countries. So foreign investors don't hesitate to snap up Czech bonds. Prague's municipal debt now sells on the Euromarket at yields just 115 basis points higher than U.S. Treasuries.

Many global companies, too, will be forced to play by stricter rules. ``If you have to raise capital, you have to open your books. It's as simple as that,'' says Nicholas V. Didier, who runs Morgan Stanley & Co.'s American depositary receipts business. In the first half of this year, 61 overseas companies raised $8.4 billion from Yankee investors via ADR listings on American stock exchanges. A dozen of them were newly privatized entities from around the world.

One company that recently raised its standards of transparency is Fletcher Challenge Ltd., a New Zealand-based forest-products group. Worried about getting brushed off by American or Asian investors, it spent two years converting all its books from New Zealand to U.S. accounting principles. Indeed, American Express Bank Ltd. Chief Economist Richard R. O'Brien observes that ``any closed cartel or club is generally being broken up'' by market forces.

OPEN-BOOK POLICY. That's clearly the case in Germany. With such a large proportion of domestic savings diverted to the huge costs of unification, Germans will have to open their books as they turn to outsiders for new investment capital. When Daimler Benz broke ranks by opening its books last year to gain a listing on the New York Stock Exchange, other German corporations jumped to criticize the nation's biggest industrial conglomerate. But for a global producer such as Daimler, the move was little more than a bow to the inevitable. ``The days in which [German] banks held all the shares, sat on all the boards, and failed to disclose investor information are essentially over,'' says London economist Roche.

A new sense of openness is also lighting up emerging markets, where once-secretive technocrats and executives now know that disclosure is the price of entry into the global money network. Dozens of Indian manufacturers (page 60) are queuing up to list shares in London and perhaps even New York. So are plenty of companies from China. In August, CS First Boston Group rolled out $333 million worth of ADRs for expansion plans by Shandong Huaneng Power Co. To seal the deal, the Chinese company had to set up a new accounting system from scratch. But to win over Western investors, it also had to cut a U.S.-style rate agreement with regulators to give it a 15% return on capital.

To make the transition, many emerging-economy companies are calling on investment bankers and money managers to help shape business plans from the ground up. Indeed, for the first time, big-bucks equity managers are taking an active role in Third World corporate management. Alliance Capital Management's Mark H. Breedon, who runs the $1.1 billion Global Privatization Fund, found himself helping several Eastern European companies decide how to raise capital and structure takeovers. He has also been thrust into the role of accounting cop--a job normally reserved for securities regulators.

ASIA'S WALL STREET. Alongside such efforts to remake companies comes a parallel drive to remake markets themselves. Not only are emerging economies from Vietnam to Russia opening bourses, they're also building new financial institutions that will yield more control over their economies. In Hong Kong, Peregrine Investments Holdings, a fast-moving securities house with strong mainland Chinese ties, is emerging as Southern Asia's answer to Wall Street. Only eight years old, it already boasts an impressive roster of major deals and $1 billion in assets. Thailand, meanwhile, is building a mutual-fund industry to deepen its domestic savings base and dampen volatility caused by foreign investors. Poland is doing the same.

The need for deep local equity markets is fast becoming apparent to Western Europe, too. Countries across the Continent are preparing to sell off $100 billion in state assets--from Deutsche Bundespost Telekom to Spain's state-owned tobacco company. They would like to keep the crown jewels of their national industrial bases out of foreign hands, but they face a dilemma. Since they don't have funded private pension systems, France, Germany, and Italy all are short on equity capital needed to buy the assets. So they may finally be forced to overhaul their deficit-ridden state systems, which now operate on a pay-as-you-go basis.

As more countries adopt new financial technologies, open new markets, and join the ever-expanding quest for equity capital, one weak spot remains. Amid ever-more sophisticated instruments, regulators have shown little understanding of the new linkages springing up among instruments, markets, and economies. Some $20 trillion worth of swaps, options, caps, collars, and other ``derivative'' products now circulate around the world, giving investors and issuers the ability to do everything from hedging foreign-exchange exposures to speculating on minute spreads among global interest rates. These new financial instruments are becoming so sophisticated that Bankers Trust New York Corp. Chairman Charles S. Sanford Jr. sees markets eventually driven by ``particle finance,'' with money engineers breaking down any given deal into minute components that may be hedged, sold, or kept in portfolios for the long haul.

In coming years, investors will even be trading instruments based on acts of God, predicts financier Richard Sandor, CEO of New York-based Centre Trading Partners and a pioneer in interest-rate and currency futures and options. The Chicago Board of Trade already lists catastrophe reinsurance futures, which permit insurance companies to hedge against future earthquakes, hurricanes, and other disasters by purchasing contracts based on the industry's history of claims and premiums. The proliferation of such high-tech instruments could, over time, even blur the definition of what constitutes money.

But will these new products act like global dominoes in a global financial crisis? This year's bond-market collapse in the U.S. was a prime example of technology getting ahead of the market cops.

The rout started when the Japanese yen and interest rates took off amid a flare-up of trade tensions between Tokyo and Washington. Then the Federal Reserve Board raised U.S. interest rates. Around the world, investors were caught flatfooted. Many had borrowed heavily in yen to buy massive quantities of U.S., European, and Latin American bonds. Squeezed on both sides of the Pacific, investors began ``a panic liquidation of securities around the world,'' says William Sterling, manager of international economics at Merrill Lynch & Co.

Making the selling easier than ever, of course, were some of the same financial innovations that allowed the traders to invest globally with such ease in the first place. Indeed, the borderless capital market ``is a very nice, self-generating development,'' comments Soros, whose own funds lost $600 million in the Japanese markets. But, he adds, this new world market nevertheless ``is in danger of collapsing unless it is properly regulated, supervised, and directed.''

SCARY BUT POTENT. How to regulate markets is another question. It's clear that the sheer multiplicity of financial sources in an era of borderless capital will complicate crisis management. Just as the 19th century boom in global capital flows exposed investors and issuers to scary new risks, so will the technology-driven 21st century money market give birth to problems that are only beginning to become apparent. But consider the upside. An efficient global money market that can as easily channel capital from a saver in Shenzhen to the clothing factory down the street or to a Boeing aircraft plant in Seattle carries with it tremendous potential. It can allow millions of inventive individuals to invest and grow. That can't be a bad thing.