Currency Crashes

International macroeconomic analysis of emerging country crises has focused on a few analytical approaches: sudden stops (SS) of capital flows, current account reversals (CAR), original sin (OS), debt intolerance (DI) and the balance sheet approach (BSA). The first section considers SS, followed by an analysis of the vulnerabilities of Mexico, with subsequent sections analyzing OS, DI and the BSA. Empirical illustrations and research complement the theory. The lowering of the fed funds rate to 1 percent caused a hunt for higher yields by investors. The Financial Stability Report April 2006 of the IMF shows that the issue of bonds, loans and equities of emerging countries reached $406.4 billion in 2005, an increase by 41.6 percent over the record $286.9 billion in 2004. Gross issue of emerging country bonds reached $182.2 billion in 2005, an increase by 35 percent over the record in 2004. The global EMBI declined in yield spread from 735 basis points in 2000 to 482 in the first quarter of 2004 and to 210 in the beginning of 2006. The theory and evidence show that emerging countries are highly vulnerable to an international event resulting from an exit out of dollar positions accompanied by a rise in interest rates. The wide oscillation of international financial and economic variables—such as exchange and interest rates, output, capital flows and trade—could cause adverse effects on domestic employment and growth in many countries. Crashes of emerging country currencies would magnify their output and job losses. The IMF may not be able to resolve a crisis in several countries because it has only $150 billion of usable resources.