With the rise of the emerging market economies, the world is a less homogenous place than it was, with no one dominant ideology (China’s version of capitalism – run by the state for the state – is materially different and leads to a significantly different policy mix), and a less ordered and consensual place, because more countries have the economic might to expect that their concerns over how the global economy is run will be given due consideration. This leads to more variety in policy responses, and less uniformity and adherence to a standard orthodoxy, and results in the more complex world financial system we now have.



One consequence of Asia’s emergence is the large increase in reserves as a percentage of world GDP and world trade. Both of these numbers tell the same story, which is of a world that now operates with more cash per unit of activity. In economic terms, that signifies a reduction in financial efficiency – if money is the fuel that drives economic activity, then the world economy now requires more fuel per unit of output.



This should not be a great surprise, because over the last 20 years the world has moved from a position where global economic activity was dominated by developed (and so presumed efficient) economies, to one where more than 50% of world GDP is now generated by developing (and so presumed less efficient) ones. We know that the Chinese economy is energy-inefficient (literally: it uses much more oil or oil-equivalent to generate a dollar of GDP than the US does), and it is not a great surprise that it is also finance-inefficient.



Given that we don’t expect any of these trends to change – China is not about to become a smaller part of world GDP and it is not going to become a much more efficient economy overnight – the bigger question is what this means for the global economy going forward. I would suggest there are two main consequences: a global financial system with excess liquidity washing around it will be more difficult to control, and a global economy in which increasingly large parts of it are not subject to the automatic stabilisers of market economics (ie, the Chinese authorities can set their face for longer against market-driven corrections of imbalances) will be subject to larger excesses and sharper reversals. Not a very encouraging outlook.

