Morningstar Advisor - August/September 2009 - 25

Under globalization, debt is the connectivity, but if power is unequal, the creditor is hostage to the debtor. Andrew Sheng The sad fact is that global resources and the environment cannot support the American dream for the average Chinese and Indian, who together number 37% of world population. The problems of global resources and the environment were not constraints to emerging markets during the Great Depression, but today’s fast-growing countries, such as China and India, must address global warming and environmental sustainability not only for their own health, but for the world as a whole. Environmental issues could easily change the geopolitical landscape in the next decade and throw all current projections out of line. Second, if India and China are both growing at more than 8% per year, while the United States, Europe, and Japan are growing at less than 2% per year, will the relative power between the mature economies and the emerging markets change dramatically? Angus Maddison1 has projected that by 2018 China will have overtaken the U.S. as the largest economy in the world, with India as No. 3. By 2030, he has estimated that Asia (including Japan) will have accounted for 53% of world GDP, whereas the U.S. and Europe will have only accounted for 33%. If this is the case, the global financial architecture will be significantly different in the future than it is today. Already by 2007, Asia accounted for 66.8% of world official reserves, 55% of world population, and 24.5% of world GDP, but only 16% of IMF quotas, equivalent to its voting power in the Bretton Woods institutions. My own crude calculations suggest that Asian financial markets will be the largest in the world within the next 10 years, assuming that financial deepening in Asia continues to improve and Asian currencies appreciate relative to the U.S. dollar and euro. This means that either one Asian currency or Asian currencies as a group will very likely play a role as a global reserve currency by that time. Is Asia ready to play that role? Not by far. In the past, emerging markets were dependent on the advanced economies for markets and financing. Asia’s surplus role has been too recent for that fact to sink in. Asia has had to put its excess savings in the West precisely because its own financial system is not ready to intermediate such savings. Its regulatory structure is still evolving, and Asian bureaucrats are neither internationally minded nor prepared psychologically to act in the international monetary order. In the past 10 years, the number of Asian bureaucrats in the Bretton Woods institutions has declined not just because of better career prospects at home, but also because they see little future for themselves in these institutions. There are very few think tanks in Asia dedicated to researching the international financial order. The third question drawn from the present crisis reflects this parochialism: Is there a future for the international financial architecture? We have global markets but national mind-sets. So far, national responses to the crisis have been faster than regional or global responses. A major defect of the current international financial architecture is that even within Europe, initial reaction to the crisis was at the national level, rather than the global level. Everyone cared for their own banks. There was also insufficient coordination between the United States and Europe on the appropriate response regarding rescue efforts. This implies that we must strengthen domestic crisis management and response policies before we even begin to think about global policies. One World, Three Paths The financial crisis phase is passing, and the world has moved into the crisis management and resolution phase. The United States and Europe are doing whatever it takes to restore order. They have recapitalized banks, used fiscal policy to stimulate the economy, limited the foreclosure of mortgages, engaged in regulatory reforms, and have started to talk about the global architecture. Where do China and Asia fit in? I see three potential paths. Status Quo Although there are signs that there is some willingness to change, there is every chance that the status quo in the international financial order will continue. The reason is very simple. The vested powers in the majority shareholders in the G-7 countries will not want to let go of power, and the emerging markets are psychologically and institutionally not ready to share power. The 1944 Bretton Woods framework was essentially a trade-off between the opening up of global trade in exchange for finance for development under Pax Americana. There is currently little to trade off between the emerging markets and G-7 countries, because the surplus countries do not have anywhere other than the advanced markets to put their excess savings. Under globalization, debt is the connectivity, but if power is unequal, the creditor is hostage to the debtor. In other words, I see relatively little change within the next five years to the present international monetary order. The advanced countries will ask the surplus economies to place more savings with the MorningstarAdvisor.com 25

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Morningstar Advisor - August/September 2009

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