, but 40 % by 1997. 12 see imf 1997, p. 244. for example, the index of capital controls calculated by the imf fell significantly in 1992 – 94 ( see imf 1997, p. 242 ). the usual rule is that diversification should match the capitalisation of equity markets. french and poterba ( 1991 ) point out that at the end of the 1980s, us investors held 94 % of their equity wealth in us securities, and for japanese, the figure was 98 %. it was higher still for french, germans and canadians. see imf 1998, p. 187. the details of diversification, see world bank 1997, p. 75 ; bis ( june ) 1998, p. 89 ; imf 1998, p. 185. in addition to these institutional investors, banks have become more internationalised, readier to lend to emerging countries. the high profile of the mutual funds ( and, in particular, the hedge funds ) may distract attention from the central role of the banks. we will see, in a moment, that the bank flows were not just large, but were very volatile. table 3 : international bank and bond finance for five asian countries * ( us $ billion ) 1990 – 9 net interbank lending bank lending to nonbanks net bond issuance total 1995 q 1996 q4 1996 q 1997 q at annual rates 1997 q – 31 – 1 – 31 1998 q at actual rates – 31 – 4 – 2 – 37 * indonesia, korea, malaysia, the philippines and thailand. source : bis ( august ) 1998, bis ( june ) 1998. variability while the general case in favour of capital flows is a powerful one, the practical problem is their variability : the surges and reversals. there has always been variation in capital flows, as relative interest rates changed over the cycle, as profit opportunities opened up and were competed away, and in response to general factors of confidence and exchange rate expectations. however, for the most part, the variability is not enormous. picking an example close to home, even when international financial markets lost confidence in the australian dollar in the mid 1980s ( the “ banana republic ” episode ), the exchange rate reacted significantly, but capital continued to flow to australia – in fact, enough to fund a larger current account deficit as the crisis proceeded. the recent experience in asia has been very different, with strong surges and major reversals of the flows. 13 worth noting is the difference of behaviour between banks

this has occurred. ( yes, house prices can fall, even in china. ) this area – the asset price and credit nexus – is the one to watch, more than the monthly exports or pmis and so on. one of the most remarkable features of the international scene is the exceptionally low volatility of financial prices and the compression of risk premia. yields on sovereign debt of the major countries are very low, the lowest on record in some cases. spreads on investment - grade and financial corporate bonds have reached multi - year lows. nowhere is this phenomenon more striking than in europe. two years ago, some major european countries faced a crisis of sovereign credit. their governments were experiencing borrowing rates that suggested that markets had very serious questions about their budgetary sustainability. now, these same countries are borrowing more cheaply than they did in 2007, prior to the eruption of the crisis – even though they are now carrying considerably more debt than they were back then. 1 there is obviously the potential for multiple equilibria here. if market participants think debt is unsustainable, and borrowing costs correspondingly rise, that itself can be the thing which makes the position unsustainable. bis central bankers ’ speeches corporate borrowing costs are similarly low. investment grade bonds in the us and euro area and australia are yielding only around 100 basis points more than the equivalent government bonds and even “ junk ” bonds from these countries are, on average, yielding around 6 per cent or less. some entities ( graph 1 ) have issued debt with 50 or even 100year maturities. given the uncertainty about the state of the world over that horizon, the returns on offer to investors in financial claims seem strikingly low. 2 graph 1 another pricing puzzle is exchange rates. many in australia have commented at length about the relatively high value of the australian dollar against the us dollar. the bank has made its views on this pretty clear and so i won ’ t reiterate them today. but it ’ s worth noting that many other countries have had a similar puzzle to ours – so the real question is why the us dollar has remained as low as it has. overall then, the global environment remains “ interesting ”, with significant challenges, uncertainties and puzzles. all that said, from australia ’ s point of view, the world economy continues to grow, inflation remains contained, our terms of trade though falling remain high, and financial conditions are remarkably accommodative. on the domestic front,