WASHINGTON – 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: 7.3 percent for the Dow, 15.5 percent for Japan’s Nikkei, 20 percent for Brazil’s Bovespa (all changes are measured from recent highs, in April or May, until June 12). But the fact that they’ve occurred simultaneously suggests herd behavior. Spoiled by years of cheap credit, global investors seemed 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, the 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.

* 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. Since then, many countries have relaxed or removed controls.

In theory, liberalization benefits everyone. Capital flows to the most productive investments. 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 imbalances unsustainable.

Second, worldwide financial crises. Global investors may move in herds, first pouring money into some countries – or investments – and then withdrawing abruptly. That’s what happened in the 1997-98 Asian financial crisis. Capital flight plunged countries into deep recessions; investors suffered large losses. There are now fears that “hedge funds” and others may be similarly overexposed in some markets. (Hedge funds are lightly regulated pools of money, mostly from big investors. They are estimated to control more than $1 trillion in financial assets.)

Some economists, most prominently Stephen Roach of Morgan Stanley, consider the recent stock market declines a healthy sign. They signal a retreat from speculative behavior. A prolonged period of cheap credit pushed too much money into risky investments. Some investors put money into emerging market stocks and bonds; others preferred commodities (gold, copper). Housing was the small investor’s favorite. The result: a series of “bubbles” that are best punctured sooner rather than later.

Roach welcomes higher interest rates. Last week, the European Central Bank raised rates; so did government central banks in South Korea, South Africa, Turkey, Thailand and India. The Federal Reserve has been raising short-term rates since June 2004 and may do so again in late June. Sure, says Roach, stock, commodity and housing prices may weaken. Some investors will lose. But the “real economy” of production and jobs won’t suffer much.

This seems plausible. But so is something more menacing. Losses in one market prompt investors to sell in others. As stock markets and housing prices sag, consumer and business confidence ebb. Economies that depend heavily on huge exports to the United States weaken. High oil prices hurt.

We really don’t know much about the interconnectedness of global financial markets. They are too new and changing too fast. We can see the promise and the peril – but don’t know which will prevail.