Will emerging markets escape the next big systemic financial crisis?

• Author: Rogoff, Kenneth

For the past four centuries, emerging market debt crises have broken out like clockwork. In the early period, it was the European countries--the emerging markets of that era--that did the defaulting, with France reneging on its external debt eight times and Spain, the all-time record holder, 13 times (see Reinhart, Rogoff, and Savastano 2003). Over the last two centuries, it is today's emerging markets, with countries like Brazil and Mexico having defaulted eight times, and Turkey six times. Venezuela leads them all with nine defaults. Defaults were relatively unknown in Asia until the 1990s, though in large part because most of these countries had been too poor until recently to become major borrowers on the world scene. Another factor, of course, is that they have achieved independence only this century.

Today, the world seems very different, with credit risk premia on emerging market debt near record lows, and most countries in a position to borrow liberally on international capital markets. Indeed, the idea that emerging market countries cannot borrow in their own currency, which Eichenbaum and Hausman (2002) term "original sin," seems like a distant memory, with many governments having issued large pools of internal market-based debt, with foreigners freely entering these markets. Even countries like Brazil, which has experienced two hyperinflations in the past 20 years, have succeeded in issuing domestic currency bonds sold directly to international investors. Now some people are even asking if European countries like Italy may soon face higher spreads than today's emerging markets. Has the world been turned upside down?

In this article, I will consider some rather sharply opposing perspectives on the admittedly complex current situation.

The Optimists

One perspective, advanced by Cooper (2005), among others, is that we are living in a second golden era of globalization, not unlike the halcyon days of the pre-World War I gold standard, where the world enjoyed a long and relatively stable period of growth. According to this perspective, by 2020, Asia will be populated by numerous Korean-success story look-alikes, and the 1990s debt crisis will be seen as a normal growing pain. Latin America, too, will have emerged, with these markets offering real economic growth and financial returns far in excess of anything in the advanced countries. Thus, there is no need for another deep financial crisis, the past is behind us.

A different but also optimistic perspective is that we are in the midst of a global savings glut, potentially implying...