Easy money in the West pumps emerging market inflows We've talked before about how loose monetary policy in deflation-fearing developed nations is a huge problem for their inflation-fearing emerging market neighbors.

Research by the International Monetary Fund confirms that liquidity in developed nations (Advanced Economies, AE) indeed flows into emerging markets (EM), thanks to today's global financial market linkages.

Thus the easy money policy of the West becomes the easy money policy for the world, even when the developing world is trying to tighten its policy.

Why?

Well, if emerging markets tighten monetary policy too much, by raising their interest rates, it will increase the flow of capital into their economies since interest rates will still remain low in developed nations. (Money tends to chase higher returns via interest rates)

Thus as they try to reduce domestic liquidity by tightening monetary policy with higher interest rates, they will be hit by a counter-productive inflow of global liquidity chasing higher interest rates, which sort of kills their attempt to tighten. Higher relative interest rates also lead to currency appreciation, which many emerging markets are loathe to endure since it hurts export competitiveness.

That's how easy money in America and Europe becomes easy money everywhere, and it's already priming potential emerging market asset bubbles:

IMF:

Capital inflows have resumed in EMs that came out relatively unscathed from the crisis. Such flows could be driven by a combination of push and pull factors. Historically, accommodative monetary policies in AEs have been associated with rising capital flows to EMs [See the chart above]. Continued easy policies in the near term in AEs could thus push even more capital to EMs. At the same time, EMs that are recovering briskly from the crisis with better fiscal sustainability indicators than AEs may continue to pull capital by offering promising investment opportunities in a high growth macroeconomic environment. Overall, such inflows are just returning to pre-crisis levels. Although they do not generally pose a problem yet, surges in such flows going forward may complicate policy challenges for EMs recovering quickly from the crisis.

That's why emerging markets could be the next bubble we inflate. There's certainly no shortage of bullishness for emerging markets stocks. Just beware that there are huge concerns all investors should have in regards to how much control foreign investors actually have when they buy so-called 'ownership' via emerging markets shares.

We've embedded the full IMF emerging markets report below, which is more broadly about how EM weathered the recent financial crisis.

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