Key Trends in Globalisation

The terrorist attacks in Mumbai

There are concentric rings of horror, and impact, around the events in Mumbai.

At its centre, with all else paling into insignficance, are the lives that have been lost and those injured. Then the impact on relatives and friends. Then on the people in the Jewish community, the companies involved, and others who knew those who died. Then the political impact on India, and between India and Pakistan - with its potential for further loss of life.

The sole aim of this post, trivial in comparison, is to try to convey to non-Indians, who have never been there, something of the importance the places that were attacked held in India. That can help to understand a small part of its impact and therefore judge the unfolding of events to come.

The Oberoi was a key business hotel. The Jewish community held an honoured place in Indian history as a symbol of the country's long tolerance. The Leopold Cafe I don't know.

The Taj Mahal Palace hotel is a landmark in Indian history - its' most famous hotel, and one of the most famous venues in India. It is the centre for events in India's financial capital and its interior discreetly carries in a display case photographs of innumerable presidents and prime ministers, as well as film stars and business leaders, who have stayed there.

The Taj Mahal Palace's historical significance is well summed up in The Creation of Wealth - the official history of the Tata firm which owns it, and which became one of the world's greatest companies:

'There is a colourful story that Jansetji [Tata - the founder of the Tata company] started a grand hotel in Bombay after an incident in when he was refused admission to a second rate Bombay hotel which was reserved "for European only". Sharada Dwivedi, which has researched the history of the Tajo Mahal Hotel, states that she has found no historical evidence for this report, though it is likely that there were hotels at the time that did refuse admission to Indians. Jansetji was too proud a man, she says, to visit such a hotel. It is more likely, she says, that he gave an outstanding hotel to his city because of his deep love for Bombay, a city he was proud of. From the day it opened the Taj Mahal was recognised as one of the best in the world. Jansetji's Taj venture is distinct from his other schemes. Unlike his other enterprises Jansetji did not calculate what it would cost.'

The Taj Mahal Palace symbolised excellence - India created something better than the British who ruled it. It was the same as with the notorious statement by Sir Frederick Upcott, then British Chief Commissioner for the Indian Railways: 'Do you mean to say that Tatas propose to make steel to British specification? Why, I will undertake to eat every pound of steel rail they succeed in making.'

This piece of racist and xenophobic arrogance received its fitting reposte in the Tata's long term development of the Indian steel industry, but then was finally swept away when last year Tata Steel finally took over Corus - the old British steel industry.

No one who is not Indian really can feel it fully but anyone who stayed in that hotel could sense something of what it meant in India's history. And why an attack on it was on one of the very symbols of India - which is why the Tata company announced already it would be rebuilt.

These were attacks involving horrific loss of life and are not only on the financial capital of India, but on one of its cultural nerve centres. To understand that combination explains why their impact will be so great.

India and China's challenge in the current economic crisis

In an earlier post on this blog, 'China and the "third Asian financial crisis"', it was noted that while the present is a global financial crisis nevertheless in Asia it has a further aspect.

Asia has passed through two extremely severe financial crises in the last thirty five years which had long term consequences for the region and therefore for the world economy. The first, starting in 1973, was the financial and economic crisis in Japan which culminated in the creation of the bubble economy of the late 1980s and the collapse in asset prices, deflation and economic stagnation which followed after the bursting of this bubble in 1990. The second was the 1997 currency and devaluation crash in South East Asia - which drastically slowed the former South East Asian 'Tiger' economies of South Korea, Hong Kong, Taiwan etc.

Through this period of the previous Asian financial crises, however, India and China escaped any major long term consequences. Far from slowing, their economies accelerated over the historical period during which these crises took place.

These trends are shown in Figure 1 in comparing the four largest Asian economies - China, Japan, India, and South Korea. The divergence in performance between China and India on one side and Japan and South Korea on the other is evident.

As may be seen, at the beginning of this period, in 1970, Japan and South Korea had annual rates of growth, taking the average for the preceding five years, of over 10 per cent - comparable to China and India's today. However Japan and South Korea's economies then drastically decelerated - Japan's growth rate falling to an average of one per cent a year in the mid-1990s and two per cent a year in the most recent period. South Korea's growth rate fell to around four per cent a year up to the most recent figures available.

In contrast, over the same period, India's growth rate accelerated from four and a half per cent a year to approaching nine per cent a year. China's growth rate accelerated from four and a half per cent a year to over 10 per cent a year.

Figure 1

      

In order to illustrate this more clearly Figure 2 shows the change in the annual average rate of growth for these four economies in comparison to their 1970 growth rates - again the figures are shown as annual averages for the preceding five years in order to eliminate any purely short term fluctuations. Over the period concerned India's growth rate accelerated by four per cent a year and China's by six per cent a year while South Korea's economy decelerated by six per cent a year and Japan's by eight per cent a year.

Figure 2

   

This, therefore, is the challenge which confronts both India and China as they enter the third great Asian financial crisis. The economies of both South Korea and Japan were lastingly decelerated by the previous two financial crises. The reasons, in both cases, was due to a sharp decline in savings and investment rates.

The challenge facing both India and China is to avoid the fate of Japan and South Korea - to maintain their very high savings and investment rates and therefore simultaneously maintain their capacity for very high sustained economic growth. Given the very large size of their economies, in realistic Parity Purchasing Power (PPP) exchange rates India is the fourth largest economy in the world and China the second, the recovery of the world economy out of the current financial crisis will in very large part depend on how well they succeed in maintaining these economic growth rates.

China acquires a hard currency

One of the most important, and permanent, outcomes of the international financial crisis is that China has acquired a hard currency - indeed China's yuan has become one of the hardest currencies in the world. As this process is of considerable importance for both the world and Chinese economies the it is worth outlining in some detail.

The fundamental data is set out in Figure 1 - which shows the change in the exchange rates of four currencies against the dollar since the beginning of 2000. The four are the world's three most important non-dollar currencies (the euro, yen, and yuan) plus the rupee - the latter included not because it has the same weight in the world economy, as yet, as the three others but because India is, after China, the world's largest developing economy. The fundamental trends in currency shifts are clear.

Figure 1

The first feature is the long term policy of the Japanese government to seek to keep down the exchange rate of the yen against the dollar. By 21 November 2008 the yen had risen by only 6.6 per cent against the dollar over almost an eight year period. Furthermore this rise in the yen's exchange rate was entirely due to trends since the beginning of the international financial crisis.

For most of the last eight years the exchange rate of the yen against the dollar has actually been lower than its level at the beginning of 2000 - this period coinciding with relative almost complete stagnation in the Japanese economy. It remains to be seen whether this policy of Japan can be successfully continued during the present international financial crisis - which has seen the emergence of strong and repeated upward pressure on the yen's exchange rate.

In contrast to the yen the euro rose very strongly against the dollar after 2002. By April 2008 the euro was 60 per cent above its exchange rate against the dollar at the beginning of 2000. The exchange rate of the euro against the dollar has fallen significantly since the international financial crisis began but, nevertheless, on 21 November 2008 the euro was still 25 per cent above its dollar exchange rate at the beginning of 2000.

The movement of the yuan's exchange rate against the dollar is clear, simple, and evident. Following the ending of a fixed exchange rate in 2005 the yuan has appreciated against the dollar - rising by 21 per cent by the beginning of September 2008. The yuan's exchange rate since the beginning of the international financial crisis has stabilised and on 21 November it was still 21 per cent above its 2000 level.

This stability of the yuan against the dollar since the financial crisis began, however, disguises the upward movement of the yuan against most other currencies, apart for the yen, as the dollar has itself been rising sharply - therefore taking the exchange rate of the yuan against other currencies up with it. This trend is illustrated in Figure 2 which shows the broad trade weighted index of the dollar's exchange rate. The sharp recovery of the dollar since the beginning of the international financial crisis is evident and as the yuan has been stable against the dollar the yuan's exchange rate has risen against most other currencies. This trend is considered in more detail below.

Figure 2

    

Considering the rupee, its exchange rate against the dollar, after falling in 2000-2002, rose to reach 11 per cent above its beginning of 2000 level by October 2007. After that the exchange rate of the rupee against the dollar began to fall and it has declined sharply during the financial crisis. By 21 November the exchange rate of the rupee against the dollar was 12 per cent below its level at the beginning of 2000.

Taking these trends together the emergence of the yuan as a currency with 'hard' characteristics is evident. The yuan's exchange rate has substantially appreciated against the dollar, the yen and the rupee. For most of the period since 2000 the yuan did not rise in its exchange rate against the dollar by as much as the euro, but the euro has been subject to considerable fluctuations and it has since fallen sharply from its peak. By 21 November the yuan had risen by almost as much as the euro against the dollar and had done so in a stable way. The yuan was, therefore, both a currency with a rising exchange rate and one with a stably rising exchange rate - a virtually perfect definition of a hard currency.

Before going on to examine the implications of these trends Figure 3 shows the above exchange rate movements not in terms of the change in exchange rates against the dollar but in terms of their movement against the yuan.

Figure 3

The trend shown is clear. The only major currency over the last six years against which the yuan has had the advantage of a lower exchange rate has been against the euro - a trend aiding Europe overtaking the US as China's largest export market. That advantage is, however, rapidly disappearing and the yuan has returned during the financial crisis to approximately its beginning of 2000 exchange rate against the euro. Against the dollar, the yen, and the rupee the yuan has been persistently been a currency with a higher exchange rate. By 21 November, compared to the beginning of 2000, the exchange rate of the yuan had risen by 14 per cent against the yen, 21 per cent against the dollar, and 38 per cent against the rupee.

There are,naturally, many implications of the emergence of China as a country with a hard exchange rate. Some of these will be looked at in the future on Key Trends in Globalisation. However for the present two key ones should be drawn attention to.

First, the issue will be posed for China of whether it will allow the yuan to become, to some extent, a reserve currency. The yuan is both stable and any potential for exchange rate movement is likely to be on the upside. A central banker, or private individual, is capable of reading such trends and wishing to hold part of their reserves in the form of yuan.

Second, a consistent and significant upward pressure on the exchange rate will lead to significant internal reorganisation of the Chinese economy. China must learn to compete at a higher exchange rate. As Key Trends in Globalisation noted previously this has major implications for China - not only in general but in terms of the form of economic stimulus package required to deal with the current international financial crisis: 'This [higher exchange rate] requires that... [China's] whole economic mechanism become more efficient, which can only be achieved through investment. China will cease to compete as a pure low wage economy – Vietnam and other economies now occupy the place China did twenty years ago. High levels of investment are therefore vital if China's economy is to compete in this new context.

'Put in other terms, China's traditional strategy has been to keep its currency's exchange rate down to the level of productivity of its economy. In the future China will have to raise the level of productivity of its economy up to its appreciating exchange rate - requiring gigantic further investment in its productive  base.

This makes it vital that China's current economic stimulus package does not aim strategically at reducing the level of saving and investment in the economy in favour of consumption but aims to maintain China's very high savings and investment levels. This does not exclude, of course, than in attempts to maintain short term demand in the economy consumpton cannot be boosted. But the key strategic goal must be the maintain the very high levels of savings and investment that have been the key to China;s economic success and which will be even more vital now that it is acquiring a 'hard' currency.

As Key Trends in Globalisation noted: ''the cyclical requirements of economic management, that is ‘Keynesian’ anti-recessionary measures, coincide with the structural requirements of a high investment level. So far the Chinese government is heading in the right direction in announcing successive waves of infrastructure and other investment – railways, roads, housing. The fact that China has a large state owned economic sector allows it to take far more direct ‘Keynesian’ measure to sustain investment than are available in the US or Europe.'

But China's entire future economic strategy, and that of the rest of the world, must now take into account that China has acquired a hard, and hardening. currency. It is a historic, and in its implications, major shift for both China and the world economy.

Comparison of the current decline in share prices with 1929

In a post in October this blog warned against any underestimation of how severe and how long a fall in share prices could be. The current post provides further comparative information on this, updates relevant data, and justifies the view that a relevant comparison for the current fall in share prices is with 1929 rather than a normal cyclical recession.

Taking first the latest data, Figure 1 shows the daily movement of the Dow Jones Industrial Average following its recent peak on 9 October 2007 with the movement following its peak on 3 September 1929. It updates the data given in the earlier post on Key Trends in Globalisation.

As may be seen the present decline in the Dow continues to be entirely comparable in magnitude, at this stage of the crisis, to its fall in 1929-32.

Figure 1

 

In order to show that such a severe decline in nominal share prices is a specific feature of the 1929 and 2007 crises, and not typical of any recession, Figure 2 shows a similar graph for the four most serious declines in the Dow in the last century - those starting in 1929, 1973, 2000, and 2007.

For the three earlier declines the data covers the period from the peak price preceding the decline to its low point. The data for the decline starting in 2007 are up to the latest available date - the close of trading on 20 November 2008.

Figure 2

 

It may be seen that the falls in nominal prices starting in 1973, associated with the oil price increases and recession of that year, and in 2000, following the bursting of the dot com financial bubble, were far less severe than the drops in either 1929 or in 2007.

The fall in real share prices following 1973 is understated by this graph, as at that time inflation was higher than in 1929, 2000 or 2007, while the decline in real terms following 1929 is somewhat exaggerated as at that time the overall price level in the economy was falling. But the differences of order of magnitude are sufficient to make the pattern clear.

The fall in nominal share prices following both 1929 and 2007 far exceeds that of any other drop in the last century. From the angle of share prices it is entirely justified, and without exaggeration, to speak of the present crisis as comparable only to 1929.

The difference between the fall starting in 2007 and that in 1929 is only, at present, in the duration of the decline. The decline after 1929 continued for 712 trading days before reaching its bottom on 7 July 1932. The decline following the peak of 9 October 2007 has so far continued for 284 trading days - slightly under forty per cent of the period of the decline following 1929.

From this data it should not be implied that is being argued that the current speed of decline of US share prices, which has no parallel since 1929, will continue for as prolonged a period as in 1929. The point is merely being made that the current decline in US share prices is not comparable to a simple cyclical recession - even of a severe type. The only standard of comparison for the current fall in US share prices is with 1929, and the experience of 1929 indicates that a fall in share prices can go significantly further than it has so far.

Taking one measure of fundamentals, the ratio of total equity, including private equity, to GDP this measure has dropped from 1.8 in 2000 at the height of the dot com boom, to 0.8 at present. But during the trough of the decline in share prices in the mid-1970s it was only 0.4. An equivalent drop would imply a further 50 per cent fall of the Dow to around 4000 - meaning that the total fall from peak to trough would be around 72 per cent.

Such decline is not inconceivable in a very serious fall in share prices - the nominal decline of the Dow after 1929 was 89 per cent although, as overall price deflation was occurring, the decline in real prices was somewhat less. The maximum decline of the Nikkei since its peak at the end of 1989 has been 80.2 per cent - although as Japan has been undergoing moderate price deflation the fall in terms of real prices is again slightly less. A fall of the Dow by more than seventy per cent would not, therefore, be historically unprecedented - which is not the same as to say it will occur. At the close of trading on 20 November the decline of the Dow since its peak in 2007 was 46.7 per cent.

Regarding the potential period of a decline of share prices it took 25 years after 1929 for the Dow to regain its pre-crash level even in nominal terms. As Figure 3 shows the performance of the Nikkei after 1989 was even worse than that of the Dow after 1929 - the Nikkei was still registering new lows almost 18 years after the beginning of its decline.

The figures given above are for major stock exchanges, those of the US and Japan, during major stock market crashes. Performance of more minor stock markets, considered historically and for earlier periods, can be worse.

Prices on the French stock market failed even to keep up with inflation for 53 years from 1900-1952. Prices on the German stock market failed to keep up with inflation for 55 years from 1900-1954. Prices on the Japanese stock market, in addition to the recent fall of the Nikkei, failed to keep up with inflation for 51 years from 1900-1950. Prices on the Italian stock market failed to keep up with inflation for 73 years from 1906-1978.

The reasons for making these points and comparisons are not merely theoretical. Private individuals and companies may believe that the decline in share prices will necessarily only be short term and will be followed by a bounce and take investment decisions accordingly. Governments, when undertaking major programmes of purchases of shares in banks and other institutions, may believe that they are buying 'at the bottom of the market' and this will be followed by the taxpayer making profits as share prices rise.

There is no justification for such views. Historical comparisons show that there remains considerable space for downward potential in share prices even in nominal terms. Historical study indicates it may take many years, possible decades, for share prices to recover to previous levels from falls of the present magnitude.

China and the 'third Asian financial crisis'

Having spent the last week attending the Mayor of Shanghai's International Business Leaders Advisory Council, giving a talk to and discussing with Shanghai financial and government officials, and then going on to Beijing to discuss with more business and government figures, it is possible to form a fairly clear view of how the international financial crisis appears in China. It presents a rather different aspect to that as seen in Europe or the US.

Direct financial turmoil is not a key feature in China. China's banks had almost no exposure to now heavily discounted, or worthless, sub-prime mortgage or similar financial products. While in Hong Kong there is some concern over the direct financial fallout, no mainland Chinese bank has suffered significant losses in this field. The immediate issue for China is the effect on its productive economy and on the renminbi’s exchange rate. But underlying these is a still more fundamental issue – maintenance of China’s savings and investment rates.

Indeed. seen from China, the international financial crisis might be posed from a different angle. It may be viewed as the 'third great Asian financial crisis' – the first being that of Japan and the yen in 1973-90, and the second that of the South East Asian debt and currency crisis of 1997. To emerge successfully will require from China an enormous response and a new stage of its economic development.

Key Trends in Globalisation has noted that the fundamental determinant of the much higher rates of growth of a number of Asian economies, compared to the US or Europe, is their far higher investment rates. Therefore for the US and Europe to regain competitiveness with Asia one of two things has to happen. The US and Europe have to raise their investment rates up to Asian levels, or the Asian economies have to lower their investment rates down to US and European ones.

These two courses have very different implications for world economic growth. If the US and Europe raise their investment levels towards Asian ones then Asia will essentially maintain its present economic growth rate and that of the US and Europe will increase – i.e. world economic growth will accelerate. If, however, Asian investment levels are reduced towards US and European levels then the growth rate of the Asian economies will also fall, while economic growth in the US and Europe will not increase – i.e. world economic growth will decline. It is, therefore, far preferable that the US and Europe increase their investment rates rather than that those in Asia fall.

Nevertheless, in successive economic crises of the last thirty years, the outcome was the opposite of the preferable one  – the US and Europe did not increase their investment rates, indeed those in Europe fell, but the investment rates of a number of Asian economies declined.

To illustrate this process in more detail, Figure 1 shows the level of fixed investment as a percentage of  GDP for the US, Germany and France. As may be seen, the US fixed investment level has been essentially constant for the last half century at around 20 per cent of GDP – itself a continuation of a very long term trend in US investment rates. The German and French levels were somewhat higher than that for the US for the period up to the early 1970s, at around 25 per cent of GDP, and then fell to levels comparable to the US. Such investment levels generate rates of growth of 1.5-3.5 per cent a year.

Figure 1

If these US and European trends are compared to the situation in Asia there is a clear contrast. Asian economies have achieved far higher levels of investment, reaching over 40 per cent of GDP, and far higher rates of growth – in some case approaching or achieving double digit rates. However, the effect of both the post-1973 crisis in Japan, and the 1997 crisis in South East Asia, was to reduce these investment rates and with them also rates of growth of growth of GDP.

Considering this trend in a number of Asian countries in greater detail, Figure 2 shows the proportion of GDP accounted for by gross fixed capital formation in Japan. Japan’s fixed investment level peaked at 36.4 per cent of GDP in 1973. At this time, averaging the preceding five years, the annual average rate of growth of Japan’s GDP growth was 9.3 per cent.

Figure 2

The economic events which commenced in 1973, and which were accompanied by the first ‘oil shock', greatly affected Japan. The proportion of GDP devoted to gross domestic fixed capital formation declined to 27.5 per cent by 1986, and Japan’s average annual rate of growth of GDP, over the preceding five years, fell by two thirds to 3.1 per cent. By 1986 the Japanese economy, which had been expanding almost three times as fast as the US in the early 1970s, was growing more slowly than the US – in comparison in 1986 the average annual growth rate of US GDP over the preceding five years was 3.5 per cent.

Japan’s investment rate then temporarily rose under the impact of the hyper lax monetary regime during the  ‘bubble’ economy in the late 1980s – a consequence of Japanese financial policies introduced to aid US economic stability following the 1987 Wall Street stock market crash. Following the bursting of Japan's financial bubble in 1990, the investment rate fell again and by 2002 gross domestic fixed capital formation had declined to 25.8 per cent of GDP while Japan’s five yearly annual growth rate of GDP had declined to 0.2 per cent.

Summarising these processes, under the successive impacts of the oil price increase and the monetary effects in Japan of the measures it chose to take to respond to the 1987 Wall Street crash, the proportion of the Japanese economy devoted to fixed investment fell by 10.6 per cent of GDP, and Japan’s annual growth rate decelerated from 9.3 per cent to 0.2 per cent - a 98 per cent decline.

If Japan post-1973 was the first great Asian economic/financial crisis, the second was the debt and currency crisis of the South East Asian economies in 1997. The similarity of the outcome to the earlier crisis in Japan’s is striking.

Figure 3 therefore shows South Korea’s rate of gross domestic fixed capital formation. This rose progressively to 39.0 per cent of GDP in 1991. By that year the average annual rate of growth of South Korea’s GDP over the preceding five years was 9.4 per cent.

By 1996, the last year before the currency crisis, South Korea was still investing 37.5 per cent of GDP and its five yearly annual average rate of growth of GDP was 7.3 per cent.

Following the 1997 debt and currency crisis, however, the proportion of South Korea’s GDP devoted to fixed investment fell sharply, to only 28.8 per cent of GDP in 2007, and its five yearly annual average growth rate of GDP declined by almost half to 4.4 per cent.

Figure 3

Figure 4 shows the similar process in Thailand. By 1996 the proportion of Thailand’s GDP devoted to fixed investment was 41.1 per cent of GDP – although this level was clearly unsustainable as it far exceeded the domestic savings available to finance it, resulting in a balance of payments deficit of 8.2 per cent of GDP. Thailand’s five yearly average annual rate of GDP growth was 8.1 per cent.

Following the currency crisis, by 2007 the proportion of Thailand’s GDP devoted to gross domestic fixed capital formation had declined to 26.8 per cent and the five yearly average annual rate of GDP growth had fallen to 5.6 per cent.

Figure 4

Figure 5 shows the similar process in Malaysia. By 1996, the last year before the debt/currency crisis, Malaysia’s gross domestic fixed capital formation was 42.5 per cent of GDP - although again this was being unsustainably financed by a balance of payments deficit. Malaysia’s five yearly annual average rate of growth of GDP was 9.6 per cent.

By 2007, ten years after the currency crisis, the proportion of Malaysia’s economy devoted to fixed investment had fallen to 21.7 per cent and the five yearly average annual rate of growth had dropped to 6.0 per cent.

Figure 5

Therefore, although the mechanisms of the crises were different, the outcomes in Japan in 1973-90, and South East Asia in 1997, were essentially the same - the proportion of the economy devoted to investment fell drastically and therefore so did the growth rate.

The impact of these two previous Asian economic crises, therefore, clearly illustrates the challenge facing China. China’s level of investment is significantly higher than Japan’s in 1973 – China's fixed investment rate is over 40 per cent of GDP compared to Japan's 30-35 per cent at that time. China's annual average annual rate of growth for the last five years is over ten per cent compared to Japan's nine per cent in 1973. In a number of South East Asian states, on the eve of the 1997 crisis, their very high investment rates were unsustainable, as they far exceeded domestic savings levels and were financed through extremely high balance of payments deficits. In contrast China’s savings level, running at over 50 per cent of GDP at nominal exchange rates, is even higher than its level of investment – see Figure 6. China, therefore, does not fact the international financial constraints facing South East Asia in 1997. There is, therefore, nothing inherently financially unsustainable in China’s very high investment rates. It has more than adequate domestic savings to finance its current investment levels and, therefore, approximately its present growth rate.

Figure 6

But it is the international context that has changed significantly and poses the economic challenge. With many economies moving into recession, and virtually all slowing, China's export growth will become significantly harder - even more so as simultaneously the renminbi is becoming a ‘hard’ currency.

As illustrated in Figure 7, the renminbi's exchange rate moved up against the dollar prior to the outbreak of the international financial crisis and it has remained constant against the dollar since its onset. As, however, the dollar has moved up against almost all currencies, except the yen, this means that the renminbi has undergone an upward revaluation against almost all other currencies.

Figure 7

 

China’s exporters, therefore, face a double squeeze. First, the markets in the economies into which they are exporting are either contracting or growing far more slowly. Second, the renminbi’s exchange rate is rising. This combination squeezes China’s exporters while simultaneously cheapening imports. China's balance of payments surplus may, therefore, decrease from its current level – the last available data being for 2007 showing a surplus of $372 billion.

However, statistically, the balance of payments is necessarily equal to the difference between domestic savings and investment - China’s balance of payments surplus reflecting that its savings level is even higher than its investment level. If China’s balance of payments surplus declines this can therefore only be achieved by its investment level moving up towards its savings level or its savings level declining  towards its investment level, or a combination of the two.

Which of these two occurs will have a huge influence on both the Chinese and the world economies. As already noted, in the case of both Japan and the South East Asian economies, faced with crisis,  investment levels fell. Their economies consequently drastically decelerated – negatively influencing the rate of growth of the world economy. A major deceleration of China’s economy, particularly under conditions of recession in other major economies, would have very negative consequences for international growth.

The health of the world economy, therefore, requires that if China’s balance of payments surplus is to shrink this should be by moving its domestic investment rate up towards its savings rate, not by its savings level falling towards its investment rate.

Domestic economic requirements China push in the same direction. The exchange rate of the renminbi has not merely moved upwards but will remain higher due to the underlying strength of China’s economy. A clear lesson of the current crisis is  that any primary use of China’s financial resources not for domestic investment but fundamentally to attempt to maintain a low exchange rate of the renminbi will not work as a strategy – even in cases where the renminbi is stabilised against the dollar it moves up against other currencies.

China will, therefore, have to learn to compete at a higher exchange rate. This requires that its whole economic mechanism become more efficient, which can only be achieved through investment. China will cease to compete as a pure low wage economy – Vietnam and other economies now occupy the place China did twenty years ago. High levels of investment are therefore vital if China's economy is to compete in this new context.

Put in other terms, China's traditional strategy has been to keep its currency's exchange rate down to the level of productivity of its economy. In the future China will have to raise the level of productivity of its economy up to its appreciating exchange rate - requiring gigantic further investment in its productive  base.

Consequently the cyclical requirements of economic management, that is ‘Keynesian’ anti-recessionary measures, coincide with the structural requirements of a high investment level. So far the Chinese government is heading in the right direction in announcing successive waves of infrastructure and other investment – railways, roads, housing. The fact that China has a large state owned economic sector allows it to take far more direct ‘Keynesian’ measure to sustain investment than are available in the US or Europe.

Nevertheless the scales of the programme’s which are required are gigantic. If, to take a hypothetical example, China’s balance of payments surplus were to fall by half under the impact of pressure on exporters and cheaper imports due to the higher exchange rate, while its savings level remained the same, this would required $175-$200 billion extra a year investment in China’s domestic economy. While there is no financial constraint on this, due to the high savings rate, the task of physically gearing up the economy for such a scale of extra-investment programmes is gigantic.

Naturally this particular example is arbitrary, and China’s balance of payments surplus may not fall to this degree, but it shows the scale of economic forces and shifts which are involved.

At the same time China faces new economic challenges it has not experienced previously. The fact that China is acquiring a 'harder' currency will undoubtedly lead to central banks of other countries wishing to hold the renminbi as part of their foreign exchange reserves – an issue China has not faced on a significant scale before.

Simultaneously China will come under pressure to use its financial resources for measures other than investment in its domestic economy. The US has announced that it is arranging dollar swaps for four economies that it considers systemically crucial – Brazil, Mexico, Singapore, and South Korea. But there will be a whole series of much weaker economies in deep trouble and it will undoubtedly be proposed that China should finance these, probably via intermediaries such as the IMF, rather than investing its resources in its domestic economy. When China attends the international economic summit in Washington on 15 November the US will also almost certainly propose that China accelerate a programme of buying US Treasury bonds.

So far China is rightly adopting the approach that 'the most important task for us now is to manage our own affairs well', as vice-premier Wang Qishan put it. But pressure put on China to change that stance, and divert resources away from its key goals, will increase. In other words many other people also have their eye on the funds which China could invest in its domestic economy.

With all these pressures, together with domestic programmes of improving social welfare and attempts to improve conditions in rural areas taking place simultaneously, not to mention other issues to manage, Chinese economic policy makers are going to be kept extremely busy in the coming months.

However, as noted, while there are many specific issues to tackle they are all within the framework of  one decisive strategic choice. If China responds in the same way that Japan did in 1973-90, and South East Asia did in 1997, that is by reducing its savings and its investment levels, this will be bad not only for the Chinese economy but for the world economy. If, however, China is able to maintain its savings and investment levels through the present ‘third’ Asian currency crisis, which is a crucial aspect of how the international financial crisis appears from its perspective, not only will that be good for the world economy but it will be one of the greatest pieces of macro-economic management, not to speak of practical management of huge investment programmes, ever seen.

China since 1979 has achieved one of the greatest economic miracles in history. Confronted with the third great Asian financial crisis China again faces a gigantic challenge to its macro-economic management. How successfully it confronts that will have profound consequences not only for its own but for the entire world economy.

On 15 November a new era in world history begins

The theme of Key Trends in Globalisation is that 'It is an error to think globalisation is purely an economic process - it has deep social, cultural and environmental consequences.'

Nothing could illustrate this more than the meeting that will take place on 15 November in Washington to discuss the world financial crisis. The four most powerful people in the room, indeed the four most powerful people in the world, are illustrated above - Barack Obama - ther next President of the United States, Hu Jintao - President of China, Manmohan Singh - Prime Minister of India and Taro Aso - Prime Minister of Japan.

Do you notice anything? Not one of them is white.

It is economically, culturally, socially and ideologically a turning point in the history of the world. The end of the era which symbolically began on 12 October 1492 - the day Christopher Columbus arrived in the Caribbean.

For the next 500 years Europe spread through the world and conquered it. Its greatest offshoot, the United States, extended that European dominance for the 20th century. That Europe created, in racism, a uniquely evil ideology used to justify the greatest crimes in the history of the world - the Atlantic slave trade, the history of colonialism, the Holocaust.

Everyone understands the significance of the fact that for the first time in its history the United States will elect a black president. Everyone who is not a racist bigot in the world will rejoice. For black people it is an event the full significance of which no one who is white can understand. A liberatory moment in history to savour.

But even this president of the United States is not powerful enough to deal with the economic storm that is raging in the world. That is why the leaders of the 20 leading economies are being invited to Washington. It is the admission that the US no longer has the power to control the world. Without the help of others it cannot stablise even its own economy.

And who does the US have to invite? China, Japan, India. These are the three most powerful economic states outside the US - Europe has no comparable voice as long as it remains fragmented and none of the individual European states is an economic power to match the three big Asian economies. Whether Europe succeeds in getting itself together, or slides into further decline, remains to be seen.

On 15 November two great, and interlinked, processes will come together. The first black president of the United States will meet the leaders of the three great Asian states, who represent the future of the world economy. For the first time for 500 years there will not be one white person taking the most important decisions in the world.

It will take decades, even centuries, for all the implications of that to work through and to consolidate. But on 15 November a new epoch in the history of the world will begin.