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Is EU Austerity to Blame for Emerging Market Meltdown?

The popular understanding among the chattering classes is that the Fed’s quantitative easing policies—specifically the looming end of loose monetary policy—are at the root of emerging markets’ recent troubles. Daniel Gros has a great contrarian essay up at Project-Syndicate taking issue with this oversimplified view:

Quantitative easing in the US cannot have been behind these large swings in global current-account balances, because America’s external deficit has not changed significantly in recent years. This is also what one would expect from economic theory: in conditions approaching a liquidity trap, the impact of unconventional monetary policies on financial conditions and demand is likely to be modest. […]

[The US’s] recent economic revival has been accompanied by an expansion of both exports and imports. The impact of the various rounds of quantitative easing on emerging markets (and on the rest of the world) has thus been approximately neutral.

But austerity in Europe has had a profound impact on the eurozone’s current account, which has swung from a deficit of almost $100 billion in 2008 to a surplus of almost $300 billion this year. This was a consequence of the sudden stop of capital flows to the eurozone’s southern members, which forced these countries to turn their current accounts from a combined deficit of $300 billion five years ago to a small surplus today. Because the external-surplus countries of the eurozone’s north, Germany and Netherlands, did not expand their demand, the eurozone overall is now running the world’s largest current-account surplus – exceeding even that of China, which has long been accused of engaging in competitive currency manipulation.

It’s true that the EU’s focus on austerity following the 2008 crisis has hurt emerging markets’ currencies. Moreover, the depressed state of the Eurozone itself has deprived those nations of a normally fecund source of capital: European investors. But Gros should not discount the role that “hot money” plays in capital markets. The expectation of higher interest rates in the US has not only repatriated US capital but also brought foreign investors into US markets.

American markets are now flush. For this reason many will still look to blame the US for this collapse of emerging markets’ currencies, and Gros’s essay is a good corrective to that view. But in reality, investors in those emerging markets live in the same world as those in the US and Eurozone. When changing expectations trigger a run of hot money, they all play the same game. The story is seldom one of “heartless foreign capitalists” pulling their money out of fragile emerging markets. Most of the time it is just a case of money doing what money does: chasing the highest return.

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