But a new world order has been in the making, defined by China’s growth surge and a European economic renaissance. At just under $3 trillion, the Chinese economy in nominal terms is still less than a quarter the size of the U.S. economy. But with a pace of expansion now more than four times that of the United States, China is incrementally adding more to global growth than the U.S. is.
The even bigger surprise is the German-led revival of Europe’s economy. Last year the euro zone grew by 2.6 percent, spurred by a 3 percent rise in Germany. An intense focus on increasing productivity has helped Germany’s export sector become highly competitive, and it is now benefiting from booming demand in emerging markets. With projected growth for 2007 in the 2.5 to 3.0 percent corridor, Euroland will likely outperform the U.S. economy for the first time in recent history.
If the U.S. lapses into an outright recession, the impact may still be large enough to unravel the global economic story. But any scenario less drastic than the dreaded recession now looks manageable, with the euro area and China together accounting for a larger share of global GDP than the United States. Almost effortlessly, it seems, the world has escaped its risky dependence on U.S. economic power.
The change in the growth equation is manifesting itself in the rising importance of Chinese equities in determining global financial-market sentiment. Each decade, some asset class or other captures the imagination of investors. In the 1980s it was the Japanese market, due to that country’s rapid ascent. In the 1990s it was the NASDAQ, driven by the tech boom. These days investors are riveted by the movements of the Chinese market, with the daily ebb and flow of the Shanghai exchange often setting the trend for the rest of the region.
Of course, following the near-vertical climb in Chinese share prices of late, the impulsive reaction of many financial commentators is to label that market as another “bubble” waiting to burst. While there are some incipient signs of froth, recent performance is more a result of the changing global economic order. All major stock-market booms are rooted in a powerful growth transformation; the current Chinese share-price appreciation too, in large part, is driven by huge profit growth churned out by a booming economy. Earnings growth for Chinese companies in the first quarter of this year was a phenomenal 80 percent, and according to consensus estimates it could exceed 30 percent for the rest of the year, justifying at least some of the 50 percent gain in the Shanghai composite index this year.
Meanwhile, in the developed universe, investors seem to be consumed by “EU-phoria.” As a recent Merrill Lynch survey shows, investors are extraordinarily bullish about European stocks, with a record number of respondents sharing the view that the euro zone has the most favorable corporate outlook of all major developed-market regions. European stocks are up a strong 10 percent this year, after having tripled in value in dollar terms since the 2003 trough.
It is a sign of the changed times, and also a testament to the dynamism of the U.S. corporate sector, that the U.S. stock market has also reached new highs even as the underlying economy downshifts to a much slower pace. American firms have adapted to the changing economic balance by becoming much more global in nature, with their overseas operations now accounting for nearly 40 percent of sales, up from less than 30 percent in the late 1990s. Empirical Research Partners estimates that half the U.S. equity returns this decade have come from “China plays” such as energy, materials, machinery and construction-spending companies. That is despite the fact that these sectors on average represent only 8 percent of the U.S. market.
A world of multiple growth engines, then, doesn’t mean financial markets are less synchronized. The interlinkages in a globalized world are far too strong for any meaningful decoupling to occur. What the new world order implies is simply this—to get a fix on global growth and financial-market behavior, it is as important to track Chinese and European economic data as the whims of the U.S. housing market.
