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lars available for repayment, increasing the risk of default. Holders of assetsdenominated in local currencies feared devaluation or depreciationand tried to sell their assets for dollars before it occurred.As some investors withdrew, others became more jittery, and in thesepanics a chain reaction occurred. Capital fled the countries en masse afterbeing converted from local currencies to dollars. With flexible exchangerates, this leads immediately to depreciation, increasing the quantity ofdebt as measured in local currencies. With fixed or managed exchangerates, capital flight forces governments to buy local currency and sell dollars.This depletes foreign reserves, depriving governments of the resourcesneeded to pay the foreign debt and maintain exchange rates.While the initial decision to flee may have been irrational, flight quicklybecame a rational decision for any remaining investors. Investment in theaffected countries became very risky, and national bonds were rated as“junk.” Desperate to attain capital, governments were forced to offerhigher interest rates to attract the dollars needed to meet short-term obligations,increasing the likelihood that they would be unable to repay thisnew debt. With higher interest rates and no foreign capital available, localbusinesses collapsed, and the domestic economies spiraled downward.Governments and firms lost the tax and sales revenue necessary to meetdebt obligations. Governments were forced to turn to a floating exchangerate, which is almost always accompanied by massive devaluations. Everythingthe speculators feared came to pass, but largely because investorsacted on their fears.In the more recent sub-prime mortgage crisis, default on mortgagesand the securities into which they had been bundled was predictable; realestate bubbles are a regularly recurring phenomenon in market countries.The rate at which the collapse spread to other securities, other countries,and the real economy was an emergent property of the complex ecologicaleconomic system.Many economists treat self-fulfilling panics and widespread collapse offinancial systems as examples of multiple equilibriums. If speculatorswithdraw their capital, the rational thing for others is to withdraw capitalalso, leading to one equilibrium. If speculators leave their capital in placeor invest more, then this also becomes the rational act for others, leadingto a different equilibrium. 20 This analysis has more than a grain of truth.However, there is really no such thing as equilibrium in an evolving andgrowing economy. Eventually, growth in real physical production confrontsbiophysical limits and must stop. Growth in the monetary value ofChapter 20 Financial Globalization • 40320 J. A. Sachs, A. Tornell, and A. Velasco, The Mexican Peso Crisis: Sudden Death or DeathForetold? Journal of International Economics 41:265–283 (1996); P. Krugman, Are Currency CrisesSelf-Fulfilling? NBER Macroeconomics Annual 1996:345–378.