Why investing is safer overseas

Reforms in the developing world

All these reforms just about guarantee that investors won't see a replay of the 1997-1998 crisis in South Korea. For example, the country ran a $3 billion current account surplus in 2006 and is projected to run a $2 billion surplus in 2007. South Korea's foreign reserves stood at $223 billion at the end of April 2007, making them the fifth-largest in the world.

Much of the developing world has taken the 1997-1998 crisis to heart and has taken the following measures:

• Increased fiscal responsibility by running a government budget surplus.
• Increased the stability of the local currency by building up foreign exchange reserves.
• Increased the quality of the banking system to allow foreign banks to enter their markets (which has improved banking operations, added liquidity to markets and increased the openness of the financial system).
• Increased the ability of local companies to raise local capital so they aren't so dependent on overseas hot money for financing.

But not every country in the developing world has adopted these changes with equal energy.

Poland

Poland's government budget is still a mess. The budget deficit for 2007 is projected at 3.7% to 4% of GDP, way above the 3% target set by the European Union. And the country is dangerously hooked on development subsidies from the European Union -- running at about $14 billion U.S. annually at current exchange rates until 2013.

But all improvement is relative. A 3.7% deficit might be regarded with horror in Berlin, but in Warsaw it's a huge improvement from the days when the country needed to export its workers and import foreign capital just to pay current bills.

And the increasing integration of the Polish economy into the European Union provides a high degree of stability by itself. The floating rate senior notes that Central European Distribution sold to raise capital are denominated in euros. The euro inflation rate is set not by Warsaw but by the notoriously conservative European Central Bank in Frankfurt.

Chile

Then there are models of fiscal probity such as Chile. Following the model of Norway, Chile has set up a national savings account funded by taxes and windfall profits from currently high copper prices. The government's budget is set to generate a 1% surplus if copper prices hit a projected average for the year. Any additional revenue from higher-than-projected copper prices goes into a national stabilization fund designed to even out the boom-and-bust cycle of an economy still extremely dependent on the price of a single commodity, copper.

So far, the country has put away about $6 billion. That is a drop in the bucket compared with the $300 billion in Norway's similar fund, financed out of oil revenue, but it's amazing for a country where the per capita GDP is only $12,700 a year, barely a quarter of Norway's $47,800. (U.S. per capita GDP comes to $43,500.) The fund has helped Chile damp inflation and currency appreciation during the copper boom. That, in turn, has kept the good times -- and a more expensive currency -- from killing off the exports of the economy's other growth industries, such as wine.

China

China gets points for its huge foreign exchange reserves, but it loses points for its closed banking system and weak banks. China is likely to pay a huge cost because of its failure to open up its banking system to honest accounting and real competition. The government has had to keep interest rates low -- because raising the rates that banks had to pay on deposits would bankrupt a number of them -- which has fueled massive stock market and real estate speculation.

The Chinese, faced with restrictions on their ability to invest overseas and with interest rates so low that after subtracting inflation they're negative, have poured money into the Shanghai stock market and local real estate. These two huge bubbles will burst with disastrous consequences to the average Chinese saver when the government finally decides to deal with climbing inflation and runaway speculation by raising interest rates.

And back in the United States . . .

But there's another side to this story: the relative slide in the financial stability of the United States. Remember everything on this scale is relative, and I'm not predicting disaster for the United States or saying that our financial markets are as disaster-prone as Thailand's was in 1997. But in contrast to the improvement in big hunks of the developing world, U.S. markets have taken a step backwards.

Score the United States on the scale that the International Monetary Fund demanded from South Korea in 1997-1998. Our current account deficit is larger than it was then and about $800 billion annually in recent years, bigger than it has ever been. We are more reliant now than we were then upon overseas cash flows to finance our dual trade and government deficits. Our banking system is less transparent today than it was then, thanks to the massive use of derivatives held by who-knows-what institutions in who-knows-what amounts -- but intended, Wall Street tells us, to lower market risk.

And as I look ahead, I see few signs that the United States will put its financial ship into better trim and lower the country risk that comes with owning U.S. equities and bonds.

Continued: Look at individual markets

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