The world is witnessing a shift in the balance of power, from the West to the East. This shift will take place over decades, and the winners will be:
- Those economies that have financial clout, such as China
- Those economies that have natural resources, whether it be energy, commodities or water, and will include countries, some in the Middle East, some across Africa, Brazil, Australia, Canada and others in temperate climates across, for instance, northern Europe
- And the third set of winners will be countries that have the ability to adapt and change. Even though we are cautious about growth prospects in the U.S. and UK in the coming years, both of these have the ability to adapt and change.

China is at the center of this shift.

The scale and pace of change in China is breathtaking. Against this backdrop of dramatic change, let me look at China’s impact on the global economy, especially in the aftermath of the financial crisis.

It is now clear that the financial crisis was a result of three key factors: an imbalanced global economy; a systematic failure of the financial system in the West; and a failure to heed the many warning signs.

The world needs to move towards a more balanced economy. But that will take years. The imbalanced nature of the world economy led some to point the finger of blame at the savers, such as China. The 1944 Bretton Woods agreement placed no obligation on savers, countries with current account surpluses. The obligation to change was put on those countries with the deficits. This has to change.

Whilst China and other savers may not be the main source of the recent problem, they are part of the solution.

To move to a balanced global economy, the West, or at least countries like the U.S., the UK and Spain, need to spend less, save more. In contrast, regions like the Middle East and Asia need to save less and spend more. It sounds easy. It is not. It requires a fundamental shift in China and in Asia’s growth model.

At the recent Asian Development Bank (ADB) meeting in Bali, the President called for Asia to rebalance its economy by: expanding the social safety net; providing assistance to small and medium-sized enterprises; and deepening bond markets.

Amongst those present, I detected more enthusiasm for the social safety net than for further financial sector innovation. One of the lessons of the 1997-98 Asian economic crises was the need to open up the financial sector at a speed best suited to domestic needs. One speed does not fit at all. Yet, it is important that if Asia is to see a shift in its growth model it needs to see a reduction in savings and this will be achieved sooner by deepening and broadening its capital markets.

This involves many changes, such as increased personal finance and allowing people to borrow against future income. It requires deep and liquid corporate bond markets, shifting the region’s culture away from equities, and giving firms alternative sources to bank lending and, in China particularly, reducing corporate savings, possibly through higher dividends.

China will play an important role in this process. It has already helped regional integration, building on the Chiang Mai Initiative, and it has engaged in a number of bilateral swap arrangements with countries around the world.

Another important global impact is the importance of China in helping world trade, investment and financial flows. Over the last decade the three words seen most regularly were “Made in China”. Over the next decade the three most common words might be “Owned by China”. China’s stock of overseas direct investment is one-thirtieth of that of the USA. The stock of foreign direct investment in China far exceeds the total amount China has invested overseas. Last year, China’s investment overseas was $50 billion. Now this is changing. Chinese firms are taking advantage of a strong renminbi and of strategic backing from Beijing to expand overseas purchases.

The impact of China on global commodities is already evident. China’s rapid growth and its strategic needs saw it accumulating increasing amounts of commodities. For instance, it accounts for about one-third of global demand for aluminum and copper, and as much as 38 per cent for zinc. In the first half of this year there has been stockpiling by China of a range of commodities. This stockpiling could be explained by many factors, including the strength of the Chinese yuan and the weakness of commodity prices. In future years one would expect this to continue. And it will not just be metals. Demand for food and soft commodities will be important. As incomes rise, food tastes will change.

Furthermore, 28 per cent of Europe’s land is arable, while this figure is 19 per cent for the U.S., but for China it is only 10 per cent. As a result, China will not only buy commodities, but it will also invest in countries producing commodities. This will reinforce the new corridors of increasing trade and investment flows between China and Africa, Latin America and the Middle East.

China’s purchase of commodities has a direct link into the inflation outlook globally. In previous years, CPI figures around the world could have been renamed China Price Indices, as China exported deflation. In the next few years, if there is an inflation issue it is likely to be through higher commodity prices, with China’s demand exerting a key influence.

China will have a big bearing on the dollar. There is a slow burning fuse under the dollar. Even if the U.S.’s economic power were to wane, it is important to stress that the U.S. is still the world’s major economy. There are no credible alternatives to the dollar. Long after the UK ceased to be the world’s major economy a century ago, sterling remained the world’s reserve currency for some time. During this crisis it was noteworthy that, despite much negative sentiment towards the dollar, in the time of trouble the depth and liquidity of U.S. financial markets helped support the dollar as a safe haven.

Furthermore, it would not be a surprise if - as a result of this crisis – more countries learned the lesson of Asian economies after their crisis, and decided to accumulate foreign exchange reserves. During this crisis those countries with high FX reserves were afforded an additional degree of protection. Of course, not all reserves need be in dollars. Even now, countries with large reserve holdings do not actively want to sell the dollar. It is not in their interests to do so. Instead of this active diversification – or outright selling of U.S. assets - there is what I call “passive diversification”, whereby a smaller but still sizeable proportion of their net new reserves are allocated to dollars.

For its reserve currency status the dollar needs to retain its status as the medium of exchange and as a store of value. Interestingly, China and Brazil recently agreed to pay each other in their own currencies, not in dollars as is the norm, whilst the pressure China has put on America regarding the dollar’s value highlights the concern some have over its future value.

China still has a huge balance of payments: its surplus reached 9.6 per cent of GDP last year. The authorities have kept the yuan stable versus the dollar, although this has meant it has appreciated on a trade weighted basis. The Chinese are also, it seems, encouraging trade settlement in Chinese yuan. Yet the reality is the Chinese yuan needs to become fully convertible for it to challenge the dollar and that is not going to happen any time soon. In the future I would expect to see more countries manage their exchange rate against the currencies of the countries with which they trade. This, plus the new trade corridors I mentioned earlier, and the likelihood of increased investment flows into emerging economies with higher growth rates, may all suggest downward pressure on the dollar. But this is likely to be a slow process.

On the global stage, China’s rise is also leading to the rise of State Capitalism. A couple of years ago we looked at this in the context of Sovereign Wealth Funds. Add in large foreign exchange reserves, government pension funds and state owned enterprises, and the role of the state has become far more important.

Finally, China’s influence on global policy forum is important. Already this crisis has seen a shift, with the G20 (Group of Twenty) taking a prominent role. The Chinese took a pro-active role ahead of the London Summit, which was welcome, and is perhaps a sign of things to come. One wonders, however, whether it is the G2 of the US and China that might emerge as the real power. Earlier this year President Obama signaled a shift from the Strategic Economic Dialogue, to the Strategic and Economic Dialogue. This extra word “and” signals perhaps a significant change.

Unless global responses are made to the current economic crisis, the biggest threat to international security will be the impoverishment of hundreds of millions of people, leading to radical and violent social movements that will be met with force, resulting in still greater conflict.

Oxford Research Group’s 2008 International Security Report, The Tipping Point?, published on 13 November, points to some improvements in security in Iraq in the past year as well as the potential for major changes in US policy in South West Asia with an incoming Obama administration.  It also finds that the recent deterioration in East West relations after the Russian intervention in Georgia in August can be reversed, but its main conclusion is that it is the global financial crisis that is now the most dangerous threat to international security.

With the G20 meeting due in Washington on 15 November, all the indications are that the response to the crisis of the most powerful states will be to focus narrowly on immediate issues, with calls for improvements in international financial cooperation involving:

•    An effective early warning system.

•    A more effective framework for transnational responses.

•    An independent “college of supervisors” to provide systematic monitoring of the world’s major companies and financial institutions.

These may well be useful responses to the immediate crisis but they have little or no relevance to the wider global predicament.  Instead, the opportunity should be taken to introduce fundamental economic reforms which reverse the wealth-poverty divisions that have got so much worse in the past three decades.

Most of the benefits of these decades of economic growth have been concentrated in the hands of a trans-global elite community of about 1.2 billion people, mainly in the countries of the Atlantic community and the West Pacific, but with elite communities in the tens of millions in countries such as China, India and Brazil.   At the same time, improvements in education, literacy and communications in recent decades have increased the awareness of many marginalised people of this unjust distribution of wealth.

On present trends many hundreds of millions of people among the poorest communities across the world will suffer most.  This is likely to lead to the rise of radical and violent social movements, which will be controlled by force, further increasing the violence.   The intensifying Naxalite rebellion in India and the substantial problems of social unrest in China are early indicators.  Responding to the crisis in a manner which places emphasis on improving emancipation and reversing the widening of the global socio-economic divide is therefore the most important task for the next twelve months.

Trade reform aimed at improving the economies of third world states, coupled with debt cancellation and substantial aid for sustainable development are all required as a matter of urgency if we are to avoid a much more divided global system in which the majority of the world’s population is marginalised, and increasingly resentful and bitter.

We can either respond as a global community or as a narrow group of rich and powerful countries.  The choice we make in the next few months will do much decide whether the world becomes more or less peaceful over the next ten years.

LONDON (Reuters) - Move over America! Make space Europe! The world’s top leadership table is expanding to bring in emerging powers from Asia, Africa and Latin America to help rescue the global economy.

This week’s Washington summit of 20 nations, called to discuss reforming the international financial system and avert a further worsening of the credit crisis that began in the United States, sets a precedent for a new international order.

Emerging economies such as China, India, Brazil, South Africa and Mexico are invited to share responsibility for the economic fate of the planet with the established Group of Eight industrialized nations — the United States, Japan, Germany, Britain, France, Italy, Canada and Russia.

Saudi Arabia is urged to disgorge its petrodollars and China to tap its $1.9 trillion reserves to underwrite rescue packages and buttress a Western-dominated financial system the collapse of which would wreak even worse devastation around the world.

No longer mere appendages invited for lunch at the end of the annual G8 summit, the rising powers are in demand because they have either mountains of cash, vital natural resources, fast-growing economies or regional security responsibilities.

Will they cooperate, and what do they want in exchange?

“A voice is the most important thing,” said a former senior U.S. financial policymaker, who spoke on condition of anonymity.

“As they look out at global economic prospects, they will also want to see that their money is going to be safe. They will want to see a plan that gives them confidence,” he said.

Beyond that, some of the key holders of dollars and oil may seek security guarantees and assurances that the West will not discriminate against investments by their sovereign wealth funds or their exports during the coming recession.

In a joint statement, the so-called BRIC countries — Brazil, Russia, India and China — called last week for “reform of multilateral institutions in order that they reflect the structural changes in the world economy and the increasingly central role that emerging markets now play”. They also sought assurances against protectionism in the financial crisis.

INTERESTS AT STAKE

Here are some of the interests at stake for key players:

CHINA - The world’s most populous nation, a nuclear power and member of the U.N. Security Council, still regards itself as a developing country. Its communist rulers have just announced a huge domestic stimulus package of public investment but they are deeply cautious about opening up further to the world economy.

Chinese investment has not always been welcome in the United States, where many in Congress accuse Beijing of keeping its currency artificially cheap and want to curb imports from China.
Beijing has said nothing about its terms for helping bail out the capitalist West, but it is likely to want a bigger voice in global economic governance and some guarantees against protectionist steps by Washington and Brussels.

It may also want to ease Western pressure on it to curb greenhouse gas emissions in the fight against global warming.

INDIA - The world’s second most populous country has long sought a larger role in global leadership and sees itself as a spokesman for the developing world.

Prime Minister Manmohan Singh has called for reform of the United Nations Security Council and the G8, implicitly to give India a permanent seat in both.

“Our voice on how to manage this crisis in a way that does not jeopardize our development priorities needs to be heard in international councils,” he told a summit with fellow emerging powers Brazil and South Africa last month.

India seeks both assurances against Western protectionism and the right to continue protecting its subsistence farmers. It too wants to deflect Western pressure to curb emissions which it says would deny its right to economic development.

SAUDI ARABIA - The world’s biggest oil exporter is the only Middle Eastern state in the G20, frustrating Egypt, which lacks resources but sees itself as the leader of the Arab world.
Arab specialists say Riyadh seeks above all U.S. protection against Iran’s growing regional power and nuclear ambitions and from the ascendancy of Shi’ite Muslims in Iraq, which it fears will embolden Shi’ite minorities around the Gulf.

It also wants the next U.S. administration to take up an Arab League plan for peace with Israel and pressure the Jewish state to reach accommodations with Syria and the Palestinians and to stop discrimination against Arab investments, such as the blocking of Dubai Ports World’s purchase of six U.S. ports.

The Saudi monarchy also wants an end to what it regards as destabilizing U.S. pressure for democracy in the Middle East.

INCUMBENT POWERS UNEASY

The first-ever G20 leaders summit, for which the European Union has made all the running, comes in the lame-duck period when President George W. Bush is preparing to hand over to President- elect Barack Obama, putting Washington on the defensive.

“It is outrageous that the Europeans would take advantage of the moment of maximum U.S. weakness to call such a meeting,” the former U.S. financial policymaker said.

The G20 was created in 1999 but until now has been limited to broad-brush discussions among finance and monetary officials.

The world’s only superpower prefers bilateral financial diplomacy, in which it has the upper hand, and tried-and-tested smaller formats such as the G7 grouping of finance ministers and central bankers, which does not include Russia.

Washington is trying to deflect a battery of ideas from hyper-active French President Nicolas Sarkozy for supranational regulation or supervision of financial markets, hedge funds, private equity, mortgage lenders and sovereign wealth funds.

The EU has led pressure to expand the G8 to incorporate the emerging nations, whose cooperation the Europeans see as vital not only to help restore financial stability but also on issues such as trade liberalization and fighting climate change.

Despite anomalies in its make-up, such as the inclusion of Argentina, the G20 summit is well placed to become a key forum on financial reform because it already exists, and there are plans to hold a series of such meetings.

This might prove more practical than British Prime Minister Gordon Brown’s proposal for a sweeping review of the post-World War Two financial order, known as Bretton Woods.

But the G20 may be too unwieldy to be effective, and smaller leadership forums seem bound to emerge. One favorite is a G13 or G14 — a forum that would expand the G8 to include China, India, Brazil, Mexico and South Africa. Some see an Arab or Muslim member, either Egypt or Saudi Arabia, as essential.

Spain, Europe’s fifth largest economy and the world’s ninth but not a G20 member, announced at the weekend that it had won a last-minute invitation to the summit.

However many policymakers, both in the United States and in the developing world, see the over-representation of Europe at the world’s top tables as part of the problem.

The Europeans only reluctantly yielded a little of their voting powers to China in the International Monetary Fund this year. The big EU member states remain unwilling to pool their seats into a single EU delegation in global institutions, with the notable exception of the World Trade Organization.

But a further redistribution of European and U.S. votes at the IMF and some consolidation of Europe’s seats at the world’s top tables may be the price to pay for the emerging world’s help in resolving this financial crisis.

(Pictured above: Brazil’s Finance Minister Guido Mantega, South Africa’s Finance Minister Trevor Manuel (R) and British Treasury Financial Secretary Stephen Timms (L) attend a news conference in Sao Paulo November 9, 2008.)