Monday, October 6, 2008

Crisis Goes Global

The financial crisis has gone global (see also here). Emerging markets were hit especially hard, the Morgan Stanley Emerging Market Index fell 11 percent, its larges daily fall since 1987. Russia and Brazil experienced large losses in their stock markets, where trading was suspended. This reflects the global demand for safety. Consequently, funds are leaving emerging markets for safe havens. You can see this by looking at what has happened to the dollar price of the euro. The financial crisis has ironically caused a large appreciation in the dollar.

This is perhaps even more apparent when one looks at an emerging economy currency, such as Brazil.

Notice that this dollar rally reflects a flight to safety. It is not a long-term rise in confidence in the US economy. Indeed, one must suspect that in the longer term the dollar must depreciate to offset the current account deficit, and as a reaction to the increase in liquidity injected into the economy.

Given how thin some emerging markets are, especially Russia, the flight to safety causes very large shocks to domestic stock markets. I will return to the Russian case in a later post because this raises the question of what the shock signals about Russia versus the world economy right now.

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