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The price of being a truly global economy - Hendren Global G

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Currency risks in emerging markets raise onus on US policies

If currency turbulence in emerging markets escalates into full-scale investor flight, the US Federal Reserve may have a fresh headache in deciding when to slow its dollar printing policy.

Given all the obvious influences on Fed policy — domestic inflation, jobless youths, long-term unemployment, stuttering credit creation or banking stability — gyrations on markets from Turkey to South Africa or South Korea may seem tangential.

But an enmeshing of the US and the economies of the developing world since the turn of the century means the link between US monetary policy and currency runs on the other side of the world could be tighter than many assume.

Another financial shock now in emerging economies that use vast holdings of US Treasury bonds as capital insurance buffers could complicate a Fed exit from quantitative easing.

“As with so many previous emerging crises, although the Fed often triggers the withdrawal, it’s then forced to turn more accommodative by default as a result of the fallout,” said Simon Derrick, strategist at Bank of New York Mellon.

To avert the sort of protracted and devastating investment freeze they suffered in the late 1990s, economies across Asia and around the globe have built up huge hard-cash buffers as protection against future ‘sudden stops’ in foreign financing.

Over the past decade, emerging economies have absorbed trillions of dollars of Western investment seeking higher growth and yields, while China’s historic emergence into the world economy has helped fuel a commodities “supercycle”.

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