Role Reversal in Global Finance

I document that emerging markets have cast off their “original sin” – their external liabilitiesare no longer dominated by foreign-currency debt and have instead shifted sharply towardsdirect investment and portfolio equity. Their external assets are increasingly concentrated inforeign exchange reserves held in advanced economy government bonds. Given theenormous and rising public debt burdens of reserve currency economies, this means that thelong-term risk on emerging markets’ external balance sheets is shifting to the asset side.However, emerging markets continue to look for more insurance against balance ofpayments crises, even as self-insurance through reserve accumulation itself becomes riskier.I propose a mechanism for global liquidity insurance that would meet emerging markets’demand for insurance with fewer domestic policy distortions while facilitating a quickeradjustment of global imbalances. I also argue that emerging markets have become lessdependent on foreign finance and more resilient to capital flow volatility. The main risk thatincreasing financial openness poses for these economies is that capital flows exacerbatevulnerabilities arising from weak domestic policies and institutions....