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Why outflows are threatening emerging markets

Part 2
Why outflows are threatening emerging markets (Part 2 of 6)

Why China triggered harmful emerging market outflows

China’s commodity consumption

China is so big and its economy grew so much, driven by infrastructure expansion projects, that it became the number-one consumer of several commodities. For example, China accounted for over half the world’s copper demand. The massive demand veered off course and drove prices higher.

Chinese Stock Market 2013-09-13Enlarge Graph

Commodities rally

Several emerging markets, such as Brazil (EWZ) and Russia (RSX), benefited immensely given their rich natural resources. Other emerging markets, perhaps not as lucky in terms of natural resources, were able to afford the commodities since their currencies had strengthened versus the dollar given the increased inflows.

As money poured into the economies, production capacity expanded and exports grew. The so-called “south-south” trade (or trade among developed markets) expanded and bolstered emerging markets, gaining significant importance versus exports to the developed world.

Of course, China accounted for a very large share of the exports of many emerging markets. Brazil, for example, even signed an agreement with China to facilitate the trade of goods through the exchange of Brazilian reals for Chinese renminbi, completely bypassing the U.S. dollar1.

China’s semi-hard landing

Then, suddenly, China started to slow down—and with it, all its imports from other emerging markets. The south-south trade contracted and Europe was still on its knees. The only bright spot was the U.S. market, which had very slowly showed signs of recovery. The problem with recovery in the U.S. market, though, is that it would imply that it would no longer need quantitative easing, effectively shutting down the party for everyone in emerging markets.

Read on to learn how the Fed affected this development.

  1. Usually, the transactions would play out in U.S. dollars and each participant would exchange their local currency for U.S. dollars.

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