Author : John E. Charalambakis
Date : September 2, 2010
Our commentary last Monday August 30th outlined the present circumstances surrounding China. Our September newsletter discussed the facts that may lead to a Chinese collapse. This commentary discusses, the day after the collapse and the still significant role that China and other developing nations will be playing in the aftermath of what is expected to be the third phase of the financial crisis.
Architects of the international economic and political system have come and gone before: the Romans, Ottomans, and British all saw their dream worlds collapse with overexpansion as a common factor in their respective demise. America’s development of its own political system and its own middle class by the mid-1940s created a model of prosperity and power envisaged by the majority of nations which allowed the U.S. to accrue soft power in the regions where it had the best of relations or the strongest control such as Western Europe and the Pacific. Once it developed such an immediate sphere of influence, capitalism could be promoted to other, more remote parts of the globe in a quest for reinstating the economic integration that developed in the late 19th and early 20th centuries. In this way, global stability and American influence were wished to go hand-in-hand without having to maintain the physical control and oversight that previous hegemons had to wrestle with; when the Soviet Union fell in 1991, “the end of history” certainly seemed to favor such a prophesy.
Yet American overexpansion took a different form, one rooted in the divergence between the expansion of finance and the production of the real economy. We tested our limits with the Savings & Loan crisis of the 1980s, the East Asian crisis of 1997, the Long Term Capital Management & Russia in 1998, and the dot-com bubble of 2001, but the Crisis of 2008 pushed us over the edge in terms of intoxication by finance and credit. The use of single currency liquidity as the foundation for global economic relations will end as is evident by countries such as Russia and China being net sellers of U.S. assets. In its place, we believe, will be the elevation of a greater number of actors, the giants of the emerging economies, primarily Brazil, Russia, China, India, and smaller players such as Turkey and few African nations.
The boom period between 2000 and 2008 accelerated the economic, technological, and communication facets of globalization to a point unknown in human history. These developments fostered connections among the emerging world that has gone largely unnoticed in mainstream economic commentary but which was wonderfully encapsulated by a Bloomberg article in early August.
In short, emerging market trade has truly exploded; rising by 18% in those 8 years and now encompasses half of total global trade. Foreign Direct Investment within this economic class has also risen. The trade patterns and commercial relations between countries such as China, Brazil, Saudi Arabia, Nigeria and Uganda, just to name a few, have amounted to what the Bloomberg article identifies as a “New Silk Road”; just as important the integration that has taken place has built the fibers of a global economic buffer to the activity in more advanced economies. This explains why emerging countries have grown in the midst of depressed demand in the West and also why commodity prices have remained relatively stable (although oil did see some serious volatility).
The time period has also seen the development of large corporate institutions as well. Large companies from Brazil, Africa, and China are being granted contracts by both developed and developing economies for various projects such as telecommunications, energy, and infrastructure.
Most importantly, this phenomenal growth of trade within emerging countries gives birth to another common feature with every wave of globalization: an interest in the political stability of trading partners. Since many of these rising nations find themselves in similar circumstances in terms of political institutions and economic development, fostering good relations possesses fewer hurdles. Trust and faith between each partner brings more trade and general cooperation. But in economics, trust and faith on a stage this large will demand one striking feature in the future: liquidity.
If the trend of growing ties among the emerging world expands even more significantly, then there will be much less demand for assets denominated in the U.S. dollar as the United States will not be as large a priority for members of this emerging apparatus. Thus the birth of capital markets, coordination of monetary policy, and bonds denominated in emerging market currency will follow an increase in commercial and diplomatic relations among members of this new Silk Road.
Yet while China may experience a collapse – as contemplated in our September newsletter – it has the capability, the resources, the assets, and the inroads to rise up from a possible collapse and dominate the new Silk Road.
China has a more comprehensive list of ingredients in its kitchen that are needed to elevate the geopolitical ladder compared to the other countries. It has assets and contracts to guarantee needed natural resources such as oil, gas, gold, nickel, and iron, and expansive economic growth. Last February we wrote about its reserves of rare earth elements that are extensively been used in new production methods. It has settled border disputes in the northern and western provinces (although many remain along the border with India) that have facilitated commerce but also allowed the Chinese leadership to focus on naval developments that are always a mark of great powers. Russia’s geological circumstances impede this development while Brazil does not have a navy to the scale of China. While India’s is already extremely large and rising, China is developing a port-presence in India’s backyard while the inverse is not the case. Moreover, if proper deregulation, privatization, and currency policies are followed, it could develop a very powerful middle class that is the engine of consumption, production, and employment levels.
This commentary is not written with the naiveté that sets challenge to the formation of such a system. On the contrary, unsettled conflicts in Central Asia, border disputes between India and China (as well as India and Pakistan), ethnic strife, domestic strife in western China, along with others will all make an influential mark on the policies and structure that will formulate the next international system. Consequently, the fact that such a transformation has occurred over the past 8 years despite conflicts in Iraq and Afghanistan, volatility in agriculture and food markets, and the worst economic climate in 80 years, speaks to the enormous potential available to the emerging market world.
The day after holds a lot of promises to those who start positioning their portfolios in a way that can take advantage of what is shaping to be a very exciting ride.