Emerging market (EM) economies¹ witnessed unprecedented growth and provided massive return on investment during the 2000s. Initially sparked by an explosion of foreign investment in the BRIC² economies (Brazil, Russia, India, and China), other developing economies³ saw large amounts of capital inflow⁴ into domestic industries. The MSCI BRIC Index saw returns upwards of 370% from 2000 to 2010, marking a period of economic expansion and exciting investors to invest in a growing bubble.⁵

A prime example of this economic boom in EMs is Brazil. Brazil’s economy transformed practically overnight between the 1990s and 2000s, becoming a commodity and technology powerhouse by 2010 (currently the world’s ninth-largest economy). In 1994, the Brazilian government successfully implemented the “Real Plan”⁶ by creating (and floating)⁷ a new currency, the Real, which tightened monetary policy and curbed the country’s rampant hyperinflation.⁸ The “Real Plan” was a huge success, slashing hyperinflation levels from 50% a month to 1.71% a month after one year.

Noticing a stabilized currency and Brazil’s abundant reserves of natural resources, foreign investors flocked to Brazil’s commodity markets and invested in the development of iron ore, petroleum, and agricultural resources. The prices of these commodities soared from the 1990s until 2011, driven by a voracious Chinese and Indian demand for raw materials to feed their expanding export industries. While the effects of the 2008 financial crisis crippled the US (and developed) markets, the global liquidity entered EM economies like Brazil after failing to materialize in developed markets. Thus, the Brazilian economy continued to flourish with low labor⁹ and production costs¹⁰, steady global demand for raw materials, increased domestic investment in technology, higher productivity¹¹, and high capital inflows from foreign investors.

However, just as Brazil benefited from the influx of capital in the 2000s, it buckled under the effects of capital flight from EMs in 2013. The demand for raw materials in manufacturing countries like China and India began to slump in 2011, causing global commodity prices to fall over 50% from 2011 to 2016¹². Economically dependent on a high global demand for commodities, Brazil took heavy losses and unemployment began to rise. By 2012, GDP in developing economies like China and Brazil began to show worrisome signs of deceleration. These fears of declining growth contributed to increased repatriation of funds to developed economies. In December 2013, these capital flows were exacerbated by the Federal Reserve Board’s announcement that it would begin its QE¹³ tapering¹⁴ program to slow the expansion of its balance sheet. The Fed’s promise proved to “pop the bubble” for EMs, which were propped up by excess capital inflows fueled by low returns in developed economies. As problems in EM economies were exposed, investors continued to withdraw funds and speculation ran rampant. EM economies began suffering catastrophic levels of currency destabilization and plunging stock values as foreign investors pulled funds from these countries. With rising US Treasury yields¹⁵ and higher-performing US markets, foreign investors instead funneled their assets into the US stock and bond markets and stood firm behind the US dollar. As speculators shifted their approach to the US markets, the demand for foreign assets and commodities fell dramatically. This capital flight¹⁶ caused the supply of the Brazilian Real to spike, forcing its exchange rate to fall and inciting its depreciation¹⁷ against the US Dollar.

In 2013, when EMs witnessed their ultimate nightmare of a global capital flight from developing nations, President Rousseff of Brazil (now impeached) allowed inflation¹⁸ and interest rates to spiral out of control as the budget deficit grew out of proportion. The economy entered a contractionary¹⁹ period and a corruption scandal caused widespread political uncertainty, prompting foreign investors to lose all confidence in Brazil. The capital outflows²⁰ caused Brazil’s exchange rate to fall, depreciating the Real against the Dollar. Brazil entered a crippling recession, dubbed the “greatest recession of the century” by Minister of Finance Henrique Meirelles.²¹

Although some economists have blamed the fall of Brazil’s commodity prices on a Chinese economic slowdown, other economists have pointed to the rising accumulation of debt in EMs and an increasingly strong US dollar as the culprit. The Fed’s rate cuts have made borrowing in the US extremely attractive and with such low interest rates, the corporate sector in many EMs are hedging²² their falling prices with borrowing leverage. However, companies in EMs have been forced to sell their commodities at deflated prices to finance their ever-increasing debt.

The capital flight of 2013 continues to impact EMs such as Brazil. As commodity prices are typically inversely correlated with the performance of the Dollar, the continued appreciation of the Dollar will likely result in a continuing decrease in the prices of commodities, creating a worrisome future for the strength of the developing economies that depend upon them. Despite talks of a comeback, the economies of Brazil and other EMs face the strong headwinds of an attractive Dollar and investment opportunities in the United States.

¹Emerging Market (EM) economies are typically low-to-middle income per capita economies that are developing under economic growth and reform. Their economies often focus on the exploitation of raw materials and natural resources, manufacturing industries, and a focus on exporting.

²The BRIC economies are the four main developing countries (Brazil, Russia, India, and China) that drove the mass-investment in emerging markets during the 1990s and 2000s. These countries are considered the “Big Four” because their huge sizes and populations show their potential as catalysts in infrastructure, manufacturing, and technology growth.

³Developing economies are nations that have smaller industrial bases, lower standards of living, lower GDP per capita, and/or less economic maturity than developed countries. Developing economies often display huge growth prospects and excellent investment opportunities.

⁴The movement of capital into a country from overseas, usually through the foreign purchase of domestic assets, financial securities, and bonds.

⁵A bubble is the ballooning of asset prices due to the “frenzied” or speculative behavior of investors, often raising prices above reasonable or typical amounts and ending with a “burst” as the bubble contracts and prices return to normal. (Wall, Emma. “Neptune: Emerging Markets Will Never Repeat 2000's Returns”, Morningstar Finance, June 8th.2016. https://www.morningstar.co.uk/uk/news/150219/neptune-emerging-markets-will-never-repeat-2000s-returns.aspx)

⁶The “Real Plan” was the fiscal and monetary policy of the Brazilian government during the early 1990s to curb hyperinflation and create a stable currency. The Brazilian government first focused on balancing the budget and reducing excess spending. Then, Brazil created URVs (“Units of Real Value”), which functioned as a temporary, fake currency that only operated as a unit of account. This relaxed Brazilian consumers enough to create a stabilized currency market and allowed the government to announce the Real as the new currency.

⁷A floating exchange rate represents an exchange rate where a nation’s currency fluctuates freely based on the market forces of supply and demand. The value of a currency therefore depends upon the private market and established public confidence in that currency, not government intervention.

⁸Hyperinflation is the unruly, extreme rise in price level over a short period of time. This is defined as inflation above 50% per month.

⁹Labor costs represent the costs paid for by a firm/employer for the wages, taxes, benefits, and healthcare of employees in a business. Labor costs can take form as indirect or direct costs.

¹⁰Costs of production (or production costs) are the costs paid for and managed by the producer/business for manufacturing goods or providing services. These can include labor costs, human capital, raw materials, industrial capital, factory costs/rent, and taxes.

¹¹Productivity calculates a firm’s volume of output per one unit of inputs. In other words, productivity measures a firm or nation’s ability to efficiently produce goods or services based on their costs of labor and capital.

¹²Mauldin, John. “Here’s the Real Cause of the Commodities Crash---And It’s Not China” Forbes. https://www.forbes.com/sites/johnmauldin/2016/03/11/heres-the-real-cause-of-the-commodities-crash-and-its-not-china/#61dabd9177d0

¹³QE or Quantitative Easing is a monetary policy used by the central bank of a country to inject liquidity into the economy (increasing the money supply) through the purchase of government bonds or other securities. QE attempts to spur economic growth because a larger money supply drives down interest rates and incentivizes investment. Because of QE measures taken after 2008, the Fed’s balance sheet increased from $900 billion in total assets to $4.5 trillion in 2015 (many of these are toxic assets).

¹⁴QE Tapering is the monetary policy used by the Fed to slow down Quantitative Easing, reducing its monthly purchases of assets to slowly “taper” the rate of QE.

¹⁵The (percentage) interest rate that the US government pays for US Treasury Bonds, also known as the return on investment for US debt obligations.

¹⁶A rapid “Money Exodus”, where financial assets or capital flow out of a country due to political or economic instability and uncertainty, currency devaluation, and exchange rate speculation (among other things).

¹⁷When the value of a currency falls relative to other currencies in the market. High inflation and expansionary monetary policy can often lead to currency depreciation, which can cause a trade surplus and higher net exports.

¹⁸An increase in the general price level of an economy, signifying an enlarged money supply in that country.

¹⁹The period during the business cycle when the economy is in general decline, creating a “slowed down” economy.

²⁰When assets flow out of an economy because investors perceive weaknesses in that economy or anticipate higher returns in other markets.

²¹Amorim, Daniela. “GDP rises 1% this quarter after eight consecutive declines.” June, 2017. http://economia.estadao.com.br/noticias/geral,pib-sobe-1-0-no-1-trimestre-apos-oito-quedas-consecutivas,70001821658

²²Hedging is a term used in finance and economics to describe strategically protecting oneself (or a firm/entity) from the risk of adverse price movements by using market strategies or futures markets. People often use this word in a broader context to mean offsetting the risks of an investment or economic decision with another strategy.