It is too early to say whether the recent declines in global stock markets signal anything out of the ordinary. Though large, they are hardly unprecedented: 8 percent for the Dow, 19 percent for Japan's Nikkei, 21.7 percent for Brazil's Bovespa (all changes are measured from recent highs, in April or May, until yesterday's closes). But the fact that they've occurred simultaneously suggests herd behavior. Spoiled by years of cheap credit, global investors seem to be reacting to the prospect of higher interest rates by fleeing stock markets almost everywhere. There is danger of a broader financial and economic setback.

The riskiest and most mysterious aspect of the present situation is the increasingly global nature of investment capital. Once, capital was largely compartmentalized by nation. Americans saved and invested in the United States; Germans saved and invested in Germany. This world is disappearing. It is now routine for pension funds, mutual funds and many wealthy investors to move money in and out of American, European, Asian and Latin American stocks and bonds.

The magnitudes are immense. For 2004 tile International Monetary Fund reports that:

Americans invested $ 856 billion abroad, while foreigners invested $1.44 trillion in the United States. Some flows represented "foreign direct investment": buying factories, real estate or entire companies. But most flows involved corporate stocks and bonds, government bonds or international bank loans.

The Japanese invested $414 billion abroad, and foreigners invested $273 billion in Japan.

"Emerging market" countries (China, India, Brazil and many developing nations) received $570 billion in foreign investment and made $935 billion of investments abroad; About $515 billion of the outflow came from governments—dominated by China and other Asian nations—that reinvested their trade surpluses, often in U. S. Treasury bonds.

Thirty years ago, these massive global money movements didn't exist. Most countries had extensive "capital controls" restricting how much (or whether) their citizens could invest abroad and how much (or whether) foreigners could invest in their countries. The United States was a major exception.

A turning point was France's decision in the early 1980s to relax controls, says Rawi Abdelal of the Harvard Business School and author of the forthcoming "Capital Rules: The Construction of Global Finance." The French concluded that controls were so widely evaded by the wealthy that they were impractical, he says. Once France changed, Europe moved to liberalize capital flows. Many other countries gradually joined for fear of losing in the worldwide chase for investment funds.

In theory, liberalization benefits everyone. Capital flows to the most productive investments. Savers earn higher returns. Countries with good investment opportunities expand more rapidly. Huge capital inflows have clearly helped China by financing new factories with modern technology. In many ways, the world economy seems healthy. In 2006, the IMF predicts the fourth consecutive year of growth exceeding 4 percent.

But there's a rub: Global finance has created new risks. At least two stand out.

First, huge trade imbalances. The United States is running massive deficits, counterbalanced by big surpluses in China, Japan and other Asian countries. These imbalances occur in part because countries with trade surpluses can recycle their export earnings—heavily in dollars—rather than buying imports or selling dollars for other currencies, leading to a dollar depreciation. That would lower the American trade deficit by making U. S. imports more expensive and U. S. exports less expensive. Most economists consider today's massive imbalances unsustainable.

Second, worldwide financial crises. Global investors may move in herds, first pouring money into some countries—or investments—and then withdrawi