Most exports of emerging markets are commodities. Thus, the performance of their economies depends on the prices of those products. From 2004 to 2012, prices were booming; they stabilized and then began to decline in 2013. Thus, the economic performance of the emerging markets was excellent in the first period and increasingly unsatisfactory in the second.
Many people attributed the good performance of 2004-2012 to good economic policies and, facing low interest rates in the developed countries, decided to invest in those countries. For many years, they made a killing, with just an interruption during the 2008-2009 crisis, as the dollar prices of shares in emerging markets increased at breakneck speeds. The graph below shows the average 12-month changes in the dollar prices of shares in 13 emerging markets, from January 2005 to November 2013. The dive of 2008 and 2009 was rapidly forgotten when the shares went up by even larger rates. Most investors believed that this was because the economic policies of the emerging markets were better than those of the developed countries. In reality, it was because commodity prices, which went down during the crisis, went up again because the US Federal Reserve was creating dollars in large amounts and keeping the interest rates low in the dollar area. As a result, emerging markets saw higher commodity prices and larger capital inflows.
Share prices in dollar terms went up so rapidly because of the large amounts of dollars that were entering these economies through two channels: the higher exports and the larger capital flows. The abundance of dollars flowing toward the stock market created a boom in share prices, which became even larger because the dollar inflows also appreciated the currency. Thus, the large capital gains became even larger when measured in dollars because the local currency was appreciating relative to the dollar.
Lately, however, the changes in the dollar prices of shares had become negative. The virtuous circle became vicious as the lower inflows of dollars led to lower investment in the stock exchange, and this plus the diminishing exports led to currency depreciation, which now subtracted from the capital gains in local currencies.
The next graph shows how the annual change in share prices in dollar terms became negative in many emerging markets as a result of this double hit.
Some observers are surprised that the capital flight that exploded on Friday has not differentiated between “virtuous” countries like Chile and other less virtuous countries. However, it must not be surprising that people are pulling their money out of countries where they are experiencing capital losses. As long as the public believes that the currencies will keep on depreciating, people will keep on pulling out their savings—from virtuous and non-virtuous countries alike. It’s as simple as that.
Many people blame outgoing Fed chairman Ben Bernanke for all these problems—the flood of dollars coming in and the flood of dollars flowing out. The problem, however, does not lie with him. It lies in the very low productivity of economies that depend so much on commodity exports. Productivity is so low in those countries that they lose their equilibrium whenever they receive substantial capital inflows, as they did during the boom years. Ironically, they needed these capital inflows to upgrade their infrastructure to developed country’s standards. Yet, they did not take the measures needed to ensure that the inflowing capital would improve the countries’ productive capacity. If they had done that, these countries would have taken full advantage of Bernanke’s dollar flood. If they had done that, their economies would have been prepared to offer more value at the end of the boom. If they had done that, they would have kept on growing based not on commodity prices but on improved productivity.