The current global economic expansion, which began in the U.S. in November 2001, is unusual in one major aspect: for the first time in modern history, China and increasingly India, the world's two most populous countries, are factors in the global economy. Nobody paid any attention to them during economic recoveries in 1975, 1982 and 1991. But today, China, which recently became the world's fourth largest economy, has great significance both as a supplier of manufactured goods and a consumer of natural resources. The demand from China for raw materials has already resulted in higher equilibrium prices for many commodities, from coal to copper to palm oil. And if all goes well in India, which has many economic similarities to China 20 years ago, its economy will clock real GDP growth of more than 7% a year for the next decade, driving further price gains for commodities.
The implications of the rise of China and India go far beyond higher palm-oil prices. There's another, less talked about, shift going on that will profoundly influence investment returns in global markets over the coming years. Since the late 1990s, the U.S. has been on a borrowing and spending binge, aided by low interest rates and very loose monetary policy. As a result, it's running record trade and current-account deficits, particularly with its Asian trading partners, which conversely are running bulging trade and current-account surpluses. Put another way: while the U.S. has been busy consuming (and borrowing heavily to do so), Asia—and China in particular—has been investing in factories and technologies so it can produce even more goods and services to sell abroad.
This scenario has a predictable outcome. Large numbers of Asians are experiencing real per-capita income gains exceeding those in the developed world. Indeed, in the U.S. and Western Europe, median per-capita incomes adjusted for inflation have barely increased in the past 20 years; in China, the median income has doubled every 10 years since the country began opening up its economy in 1978.
A huge shift of wealth and power to Asia is thus taking place, leading to an unprecedented situation in economic history. In the past, it was always the rich countries that financed economic development in emerging economies. European capital built canals and railroads in the 19th century U.S. economy; in the 20th century, European and American money bankrolled development in Latin America, Australia and Asia. But today, it's the poor countries—notably China—that are financing American consumption by purchasing U.S. government bonds. No wonder that with their vast liquidity, stock markets in many developing countries have vastly outperformed the U.S. market. Since lows reached in October 2002, America's S&P 500 index has risen 50%, while indexes in India and Jakarta are up by more than 300%.
This trend is likely to persist, in part because it isn't just wealth that's moving from West to East. Each time manufacturing and services are outsourced to Asia, knowledge, technology and skills are also transferred. Professor Richard Smalley, a Nobel-Prizewinning chemist at Rice University, estimated that by 2010, 90% of all Ph.Ds in physical science and engineering may be living in Asia. With economic prowess comes geopolitical power. For many countries, exports to China have replaced exports to the U.S. as engines of growth—one reason why a longtime U.S. ally like South Korea is cozying up to China. Moreover, China's appetite for raw materials (and India's hunger in the future) is shifting political power from industrialized countries to resource-rich ones, giving leaders like Mahmoud Ahmadinejad, Hugo Chávez and Vladimir Putin extra clout.
Investors must understand that the current changes in economic geography, wealth and geopolitical power, while associated with greater geopolitical risks, also offer huge opportunities in emerging economies. They are the prime beneficiaries of the demise of the communist and socialist ideology, the invention of instant and free communication, and efficient transportation and distribution, as well as easy U.S. monetary policies. Investors would do well to have a significant overweight position in countries as diverse as Thailand, Malaysia, Vietnam, Taiwan and Singapore, which are likely to significantly outperform the U.S. over the next few years.