The last time that emerging market debt traded at today's lofty levels of around 350 basis points over US Treasuries was in March 1998. For those eager buyers of emerging market paper who might have forgotten, this was shortly before the infamous Russian debt crisis of August 1998. That crisis shook the global financial system to its very foundations. It also forced the New York Federal Reserve Bank to orchestrate the multi-billion dollar bailout of Long Term Capital Management (LTCM), a large and highly leveraged hedge fund.

As was the case in early 1998, today's emerging market debt rally is being fueled by the ample global liquidity flowing from the world's major central banks. Indeed, interest rates in Europe, Japan, and the United States are all at 45-year lows, as is exemplified by short-term interest rates in the United States and in Europe being as low as 1 percent and 2 percent, respectively. The very low interest rates in the world's financial centers has induced investors to "stretch for yield" in the emerging markets. This has created a situation of progressively narrowing spreads on emerging market paper that has increasingly sucked in investors who were afraid of being left out of the rally.

Rather than ascribe the emerging market debt rally to improved global liquidity conditions, finance ministers in all too many emerging market capitals are complacently claiming that strengthened fundamentals in their individual countries are to explain the extraordinary 300 basis point spread tightening over the past year. This is unfortunate since it is setting up the emerging market economies for a rude shock and leaving them ill-prepared once the global liquidity cycle turns as has happened on all too many previous occasions.

The way in which Argentine paper is presently trading is perhaps the clearest example of the disconnect between emerging market fundamentals and debt prices. From a fundamental point of view, the Argentine government's most recent offer to reschedule its external debt is widely considered to be worth no more than 10 cents on the dollar. Moreover, its commitment under its IMF program to meet a primary budget surplus target of barely 3 percent of GDP in 2004 suggests that the government might be hard pressed to make good on even that paltry offer. Yet this is not stopping Argentine debt from trading at over 25 cents on the dollar, or around 2 1/2 times the government's seemingly firm offer price.

Argentine debt is far from alone in trading at prices that are far out of line with its fundamentals. How does one explain the approximately 800 basis point spread tightening over the past year in Uruguayan debt, when Uruguay's underlying situation still suggests that a further external debt rescheduling is a distinct possibility?  How does one explain that Poland's external debt now trades at barely 80 basis points over US Treasuries at a time that Poland's government budget deficit is blowing out and questions about public debt sustainability are resurfacing?  Or how does one explain how the once hapless South African rand, which traded not so long ago at over 13 rand to the US dollar, now trades at below 6.5 rand to the US dollar, when the South African Reserve Bank's depleted international reserve position still leaves the rand so painfully exposed to a change in market sentiment? Similar questions might be asked of Colombia, Ecuador, Turkey, and countless other emerging market economies.

Brazil too has been a major participant in the past year's strong emerging market debt rally. This is underscored by the highly impressive narrowing in Brazilian external debt spreads from a high of 2350 basis points over US Treasuries in October 2002, shortly before President Lula da Silva took office, to around 500 basis points over US Treasuries at present. It is similarly reflected in the impressive equity rally that has taken the Bovespa to record highs as well as in the marked strengthening of the Brazilian currency from almost 4 reais to the US dollar in October 2002 to below 3 reais to the US dollar at present.

President Lula da Silva's very much better than expected macro-economic policy performance over the past year has undoubtedly been a major factor in the international financial market's vastly improved perception of the Brazilian economy. In particular, his support of a sound central bank monetary policy, his adherence to the terms of an IMF program, his renewal of that IMF program, and his pursuit of social security and tax reforms have all given much comfort to foreign investors about the risks involved in investing in Brazil.

Without wishing to detract from President Lula da Silva's many economic policy accomplishments to date, one needs to ask whether one really can say that Brazil's external debt would be trading with spreads as low as 500 basis points over US Treasuries were it not for today's very ample global liquidity situation. In a less benign global liquidity environment would investors not be very much more concerned by the absence of economic growth in Brazil or by the apparent drying up of foreign direct investment? Might they also not be asking the same hard questions that they did not so long ago about Brazil's still very high level of public debt and about the sustainability of Brazil's public accounts?

The good news for the emerging markets is that the global liquidity cycle is unlikely to turn any time soon. At its last meeting, the Federal Reserve's Open Market Committee could not have been clearer that interest rates in the United States would not be raised for many months to come until the large gaps presently characterizing the US labor and product markets are substantially reduced. Only once unemployment has declined from its present level of around 6 percent towards the "natural rate" of around 5 percent will the Federal Reserve need to concern itself with the risk that inflation will rise from its present level. Indeed, from time to time, Alan Greenspan has characterized the present US inflation rate as being possibly too low.

The chance of any early interest rate increase in Europe would appear to be equally remote. The rapid rise of the euro over the past two months coupled with the recessionary conditions presently characterizing Europe's major economies would point to the greater likelihood of an ECB interest rate cut rather than a hike over the next six months. This would be particularly the case were the euro to continue appreciating as now appears to be increasingly probable in light of the United States' unprecedented large external current account imbalance.

If past experience offers any lessons, it is that now is not the time for emerging market finance ministers to be gloating about the high prices at which their countries' debt trades in the international market. Rather, one would think that now is the time for them to redouble their efforts at strengthening their countries' fundamentals so as to better equip those countries for the rougher international liquidity situation that almost certainly lies ahead. We would appear to be fortunate that the likely maintenance of favorable global liquidity conditions over the next few months affords the emerging markets with a window for the very much needed strengthening of their fundamentals.

Desmond Lachman is a resident fellow at AEI.