The next 'emerging markets shock' will not be caused by investors from the advanced economies pulling money out of emerging markets. It will be caused by investors from the South pulling money from the North.
They may do this in response to weakness in their domestic markets, but the knock-on effects on the advanced economies may be sufficient to derail their recovery. In fact, emerging markets now contribute such a large part of global growth – more than 75% compared with 20% to 30% in the mid-1990s – that the prospect of turmoil there bodes badly for the global economy as a whole.
In a recent paper asking ‘how could the emerging markets turmoil affect the advanced economies?’, Citi’s research team identify not a fragile five, but a fragile 10, with Russia and Ukraine (given the political situation), Venezuela, Chile and Argentina added to the original list of Brazil, India, Indonesia, South Africa and Turkey. These 10 countries, point out Citi, have been responsible for 20% of global growth in recent years.
But what has changed since the old days of emerging market shocks is not only their commanding position in terms of global trade and growth but also their new position in terms of global finance.
Their holdings of large parts of the US treasury bond market are well known, although a complete knowledge of the full extent of their external assets and liabilities is held back by a lack of data. International Monetary Fund statistics give an idea of the change, however, stating that in 2012 emerging markets’ external financial assets amounted to 12% of the global total compared with 7% in 1996.
What would happen if they decided to sell off these assets in order to defend their domestic currencies – in the case of central banks – or to prop up faltering businesses and investments in the case of the private sector?
This 'emerging market shock' would be one of falling asset prices and rising yields in the advanced economies which might stop the tapering of quantitative easing in its tracks as central banks go on the offensive in the face of a stumbling recovery. Advanced economy stock markets could also be hit as companies with large amounts of profits coming from the emerging markets see them reduced.
No longer can economic actors in the North set strategy without due consideration of what is happening in the South. We really are in a global economy now, and in new ways that we are only just coming to terms with.
