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It's the most likely scenario of all for a financial market bust this year or next, and I missed it.

I want to hit myself over the head with a 2-by-4.

This bust scenario is one that played out recently -- within the last two decades, anyway. And you can even see the beginnings of the bust in cash flows in global financial markets.

All you have to do is follow the money. The global central bank money, that is.

Remember, at the end of my April 8 column I gave a brief list of possible bust scenarios that weren't factored into the rally in U.S. stocks or into stock prices in general. Central banks could produce a spike in interest rates when they begin reducing the size of their balance sheets. The Bank of Japan could produce a yen panic. The eurozone could either break up in chaos or descend into a deep, deep recession. A run of bad loans in China could result in a government bailout of the banking sector.

All those are possible bust scenarios, I concluded, but the odds for any of them happening are relatively low.

But that list didn't include the most likely bust scenario of all -- one that actually seems to be increasing in probability now, although it is by no means guaranteed. It's actually a scenario that we know can happen, because it has happened before. And it's one that, from that experience, we know would be a big deal.

The important question to ask

image: Jim Jubak

Jim Jubak

I'm talking about a replay of the Asian currency crisis of 1997, only this time the crisis wouldn't be limited to Asia but would take in -- and could start in -- any or all of the world's developing markets.

I think I missed adding this scenario to my list of busts because I limited my thinking about central bank cash from the world's developed economies to the effect on those developed economies themselves. But that cash doesn't respect national boundaries. It can flow anywhere.

And the important question to ask is this: Where is all that developed-economy central bank cash going?

It's clearly not all going into developed economies. If it were, the U.S. recovery wouldn't be limping along and the eurozone economy would have grown in the fourth quarter of 2012 instead of shrinking by 0.6%.

Clearly a lot of it is going into developing economies including China, Indonesia, Thailand, Malaysia and the Philippines.

For example, China's reserves are marching upward again. The country's reserves climbed by $198 billion in the first quarter of 2013. That's the biggest jump since the second quarter of 2011. That increase is a sign, economists say, that China is again seeing big inflows of cash from outside its borders.

And the trend isn't limited to China. Indonesia, Thailand, Malaysia and the Philippines -- it's pretty much any place in the developing world that is growing faster and offering higher interest rates than the near 0% rates on offer in the developed world.

The upshot is not only an increase over cash inflows over those in 2012 but also an increase in 2013 of the rate of increase.

Prices head higher

Back in January, the World Bank was reporting that gross capital flows into developing economies had climbed in the fourth quarter of 2012 to $170 billion, close to a record. That was a significant rebound from dips in the second quarter of 2011 and the second quarter of 2012. In January, the World Bank also projected that capital flows to developing economies would increase in 2013 and 2014. Flows in January indeed climbed 0.8% from December levels.

But the World Bank's reporting took on a new urgency in March and April. Gross cash flows in January and February, the bank announced, were up 49% from the January/February period in 2012. For the entire first quarter, gross capital flows into developing economies increased 37% from the first quarter of 2012.

Back in October 2012, Citigroup reported that the timing of this increased cash flow into developing economies tracked closely with the launch of the Federal Reserve's new program of asset buying (Quantitative Easing 3, or something) in September. And that about 90% of the global total in these flows came from North America.

So far, the early numbers show money flowing back into Japan with the start of the Bank of Japan's more aggressive asset-buying program. But I'd be surprised if we don't start to see outflows from that country, too, as the program ages.

The effect of these cash flows has been, as you'd expect, rising asset prices in developing economies.

In February, real estate prices in China climbed in 62 of the 70 cities the government tracks. Prices in Beijing rose 5.9% from a year earlier; in Guangzhou, they were up 8.1%. The effect in smaller economies has been even greater. In Indonesia, for example, real estate prices in Jakarta are rising at a 30% to 40% rate and in second-tier cities at a 50% rate.

All this has led institutions such as the Asian Development Bank to warn that with near-zero interest rates, emerging markets could become swamped by cash inflows. (You can find the bank's January 2013 warning here (.pdf file).

And it has led countries such as China to impose new curbs on the real estate market, such as a new 20% tax on profits in a sale, as well as higher interest rates and down payments for purchases. In addition, China, South Korea and Taiwan have intervened in the currency markets in order to slow or reverse the appreciation of their own currencies.

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