Topsy-Turvy
Stocks around the world have been tumbling in reaction to the dramatic news on Wall Street. In doing so, financial markets are trashing one of the fashionable economic theories of the past couple of years: that the rest of the world can "decouple" itself from the U.S. and keep on growing strongly. But that may not be the whole story. Just ask Stephen Lussier, an executive director at De Beers, the huge diamond group.
His London office is in the same hulking concrete building as the firm's diamond-sorting operation, so getting in to see him requires navigating through a maze of locked doors and red security zones worthy of Fort Knox. But it's worth the effort if you want to glimpse how globalization is upending a lot of conventional wisdom these days. If history were a guide, Lussier should be a worried man. The U.S. is easily the biggest market for diamond jewelry in the world, accounting for about 50% of the total, and whenever the American economy has hit a rough patch in the past, the diamond industry has quickly felt it. But not this time — or, at least, not yet. U.S. diamond sales have been dropping, but worldwide demand for rough diamonds has been stronger than ever, especially for the largest and most expensive rocks, and that has enabled De Beers to continue raising prices this year. "Normally we would be in a state of battening down the hatches, but so far that's not happening," Lussier says. "This is different from every economic cycle we have seen for the past 25 years."
The state of the diamond market is just one glittering example of a world that, to all appearances, has gone topsy-turvy. It is a world in which the biggest and most sophisticated financial markets, in the U.S. and U.K., are struggling to confront the sort of meltdown more normally associated with underdeveloped economies and feeble banking systems. (The only difference is that, in this case, the International Monetary Fund [IMF] isn't coming to the rescue with loans and tough policy prescriptions.) It is a world in which consumers for years benefited from bargain prices for everything from T shirts to flat-screen televisions thanks to ultra-low-cost producers in Asia — but now suddenly discover that skyrocketing consumption in those same Asian countries is pushing up the prices of staples such as wheat and milk. It is an increasingly interdependent world in which two countries with McDonald's restaurants were never again supposed to go to war — but one in which old-style geopolitics, in the form of Russian muscle-flexing, has suddenly intruded. (Both Georgians and Russians, it turns out, enjoy Big Macs with fries, even as they slug it out on the battlefield).
As he looks around the globe and tries to assess what to make of it all, Jagdish Bhagwati, a senior fellow for international economics at the Council on Foreign Relations in New York City, can't resist quoting the British economist John Maynard Keynes: "The inevitable never happens. It is the unexpected always."
Two Cheers for Free Trade
In such unpredictable times, the big questions are the extent to which the financial and economic woes in the U.S. will continue to spill over into the world economy — and whether this poses a threat to the onward march of globalization itself, as people lose faith in free markets and open trade.
The damage is already considerable: the IMF expects world economic growth to drop to 4.1% this year, its lowest since 2003, after a run of years at around 5%. Much of Europe and Japan seem particularly vulnerable, with Britain and Spain already teetering on the edge of recession. China and India, the huge growth engines of the past few years, also are facing slowdowns. It's still unclear just how far the contagion could spread. Certainly the demise of Wall Street titans Merrill Lynch and Lehman Bros., and the U.S. government bailouts of insurance giant AIG as well as mortgage lenders Fannie Mae and Freddie Mac, sent shock waves around the world.
Sagging growth means even the biggest boosters of free markets and free trade are being a lot quieter these days. While the U.S. government refused to step in to save Lehman Bros., it did intervene to rescue AIG, Fannie Mae and Freddie Mac, in moves that, in ideological terms, amount to a significant retreat from the sort of market liberalism that Washington has long embraced. And skepticism about the benefits of globalization appears to be rising: an international poll earlier this year by GlobeScan shows that, while majorities in most of the 18 countries surveyed continue to support the notion of free markets, there has been a significant erosion of support in Turkey, South Korea, Chile, Britain, Mexico, Russia, Brazil and even China. That's not surprising, says Andrew Watt, an economist at the European Trade Union Institute in Brussels. "It's hard to sustain the idea that markets are perfect and should be left to work against the background of what has happened in the last year." What's less clear is the extent to which this skepticism will feed into national politics and provoke a new bout of international protectionism. Watt and others point out that while globalization has created substantial wealth around the world, its benefits have been distributed disproportionately.
Pockets of Resilience
The good news is that lower growth in emerging markets is relative. Even at an 8-9% annual growth rate, the lower end of economists' predictions for this year and next, China's economy would still be racing ahead, just not at the feverish double-digit rates of recent years. In fact, a cooler international climate could prove beneficial if it helps Chinese authorities to get a grip on inflation and minimize other problems of an overheating economy. There are still only scant signs of a slowdown in other fast-growing countries. Russia's economy is expected to cool this year to about 7% growth, and some highly leveraged businesses there are experiencing the beginning of a liquidity squeeze. But Brazil this month reported that its economy actually accelerated in the second quarter, with growth rising to an annual rate of 6.1%. Meanwhile, the Gulf states and other countries in the Middle East are in the midst of a petrodollar-driven consumption boom that shows little sign of slowing, even though oil prices have fallen below $100 per barrel.
Puzzling Patterns
This resilience helps to explain why De Beers' diamond sales are still thriving: Americans may be less willing to splurge on fancy rings, but from Abu Dhabi to Shanghai, bling is still very much in — and the bigger the better. This is hardly proof that U.S. economic growth and free-spending American shoppers are no longer important to the global economy. Economists at French bank Société Générale have calculated that consumption in the BRIC countries — Brazil, Russia, India and China — would have to rise by almost 25% to fully offset the effects of a U.S. recession, an increase that's beyond even their dynamic capacities. But the linkages of the past no longer seem to be reliable indicators of the direction of individual economies. "Clearly, we're in a period of uncertainty and volatility, and we'll have to get used to it," says Mark Spelman, a globalization-strategy specialist at consulting firm Accenture in London. "The patterns are more confused," says Spelman, who describes the current economic situation as "two steps forward and one step backward."
One trend appears to be intact: companies from China, India, Brazil and other emerging markets continue to make strong inroads on the world scene. Indeed, in FORTUNE's ranking of the top 500 global companies, 61 on this year's list are from emerging countries, up from 55 last year. Bhagwati at the Council on Foreign Relations says there is "very little evidence that people are actually trying to close markets." Indeed, he's optimistic that the current stalemate over a new international trade agreement could be broken after the U.S. presidential election in November, and that the so-called Doha round of World Trade Organization negotiations could reach a conclusion next year, providing more open trade in services and agriculture. At a time when the unexpected is happening, he may or may not be right. But for the moment, at least, the betting is still that globalization, like a diamond, is forever.