Earlier this week, a credit rating agency downgraded Iceland’s government debt, calling the country’s current account deficit unsustainable. Iceland’s national currency, the Krona, instantly plummeted 10% as currency traders rushed en masse for the exits. This, in turn, sent a shock wave throughout global forex markets, causing all emerging market currencies to decline. As the currencies affected by the crisis seemed unrelated, analysts pointed to hedge funds to explain the ripple effect. Apparently, several prominent emerging markets funds were forced to sell their positions in other parts of the world in order to offset their losses in Iceland. The Financial Times reports:

The icy blast spread, prompting the Brazilian real to fall 3 per cent, the South African rand more than2 per cent, the Indonesian rupiah and Polish zloty1.5 per cent and the Mexican peso and Turkish lira 1 per cent.

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