The new millennium has witnessed a rapid expansion of external balance sheets and significant changes in the capital, currency and sectoral compositions of foreign assets and liabilities of emerging economies. While foreign lending and investment in these economies have reached unprecedented levels, even deficit emerging economies have acquired sizeable amounts of foreign assets thanks to large inflows of capital. These changes in the size, composition and leverage of external balance sheets have created new channels of transmission of global financial shocks through their effects on international capital flows. They have also amplified the susceptibility of outstanding stocks of foreign assets and liabilities and net external positions of emerging economies to financial conditions in major reserve-currency countries, resulting in large capital gains and losses particularly at times of severe international financial instability. Since a very large proportion of external assets and liabilities of emerging economies are with advanced economies, such capital gains and losses entail transfers of wealth between these economies. Furthermore, emerging economies run deficits on net international investment income not only because their external liabilities exceed assets, but also because the return on their foreign assets is lower than the return on their liabilities. Even some emerging economies with positive net foreign assets positions such as China are in deficit in net international investment income. By contrast, the return differential is positive in all major advanced economies, including those with negative net foreign asset positions such as the US and the UK. This disparity between return differentials of foreign assets and liabilities of emerging and advanced economies, including capital gains and losses, results in a transfer of resources from the former to the latter, averaged at some 2.7 per cent of GDP of emerging economies since the beginning of the new century. To avoid such transfers, they need not only improve their net financial asset positions but also change the nature and composition of their external assets and liabilities. Capital account policies can play an important role in these respects.