They’re the emerging market economies, stupid

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Warren Buffet famously observed that, when the tide goes out, one discovers who has been swimming naked. This adage could not be more apt today for the plight of the major emerging market economies now that the tide of ultra-easy Federal Reserve monetary policy seems to be ebbing. Sadly, the plight of these economies could have a major bearing on the global economic outlook, considering how important an engine of economic growth those economies have been.

Over the past few years, among the more pernicious consequences of the Federal Reserve’s US$3½ trillion balance sheet expansion has been the corresponding increase in dollar-denominated borrowing by emerging market corporations. According to the Bank for International Settlements, borrowing by non-financial corporations in the emerging market economies since 2008 has risen by around US$2.6 trillion. As a result, the leverage of these corporations now considerably exceeds that at the previous peak in 2008, making these corporations very vulnerable to a reversal in capital flows. This would appear to be a very relevant concern for China, Brazil, Russia, Turkey, Indonesia, and Hungary.

If the past is a prologue to the future, the excessive dollar indebtedness of the emerging market corporate sector could subject those countries to the risk of a prolonged economic and financial crisis. This is particularly the case at a time when the rout in international commodity prices has caused emerging market currencies to collectively decline, and to levels not seen since 1999. With the central banks of these countries not able to lower interest rates for fear of precipitating further currency weakness, it seems only a matter of time before high-dollar indebtedness causes real damage to the emerging market corporate sector.

Needless to add, any major slowdown in these economies would constitute a significant headwind to the global economic recovery… especially since the emerging market countries, including China, now account for more than 40% of global GDP and have been the major source of global economic growth.

from AEI » Latest Content http://ift.tt/1KC27Ok