Asia and in particular China is emerging as the source of major shock waves that are propagated throughout the world economy. All three centers of the world economy have exhibited signs of vulnerability delivering a somber message: in the new international economic setting no “safe havens” are to be termed as secure or truly safe.

       Amid the renewed turbulence in global financial markets and the steep decline in commodity prices, it looks as if the world economy is grappling with what may be termed as the third wave of the global financial crisis. The latter started off in the US with the mortgage debacle in 2007-2008, it then migrated into Europe, which witnessed several rounds of sovereign debt crisis in countries such as Greece. Now, after staying largely on the sidelines, Asia and in particular China is emerging as the source of major shock waves that are propagated throughout the world economy. All three centers of the world economy have exhibited signs of vulnerability delivering a somber message: in the new international economic setting no “safe havens” are to be termed as secure or truly safe.

       If there is one factor that ties all of the waves of global instability together it is debt/leverage. Leverage showed its destructive force in the US both in the household sector and in various segments of financial markets. In Europe it was the sovereign debt problem that became the key concern for markets, while in China’s case it is the leverage in equity markets as well as rising corporate debt which is stocking financial instability. Furthermore, in China’s case the problem of leverage and debt levels is amplified by uncertainty over the scale of the debt overhang as well as the possible vulnerabilities pertaining not only to corporate debt, but to banks’ and regional government’s debt levels and balance-sheets.

       What makes this a sequel of one crisis going in turn from one region to the other is the lack of a structural response to domestic economic imbalances, with palliative measures such as quantitative easing or new rounds of fiscal stimuli taking precedence. The result is that such loosening in monetary and fiscal policies spills over into other regions, creating bubbles, propitiating debt overdrives and raising volatility in financial markets. The pattern observed in the world economy then is that of competitive currency devaluations, rising protectionism, falling productivity growth and global economic growth rates.

       The root of the “new normal” is not only in the secular factors, but first and foremost in the undermining of economic policy rules and the worsening of the quality of national economic policies and global economic policy coordination. In recent periods the main debate that is waged by international economy experts is whether the world economy is headed into secular stagnation (due to factors such as demographics, ageing of the population, etc) or whether an improvement in the quality of economic policy (including via targeting lower debt levels) can significantly strengthen global growth performance in the coming years. Given the continued progressive worsening in the quality of economic policies across the globe and the lack of a sustained structural reform effort in the key economies of the EM or the DM world, it is the latter view (frequently referred to as the debt super-cycle view of the world) that should hold more sway.

       The key uncertainty and fear associated with the most recent twist of the global financial turbulence is that China until recently was seen as one of the very few anchors of the world economy that exhibited resilience during the crisis tides of the Asian crisis in 1997 as well as during the storm of 2007-2008. Furthermore, China’s difficulties appear to have escalated in the midst of a policy shift characterized by efforts to liberalize forex operations and render the yuan a convertible reserve currency. The world economy, the commodity markets, international investment flows over the past decades have become increasingly dependent on China’s continued strength, with the risks for global growth highly concentrated in several key regions of the world economy. The world economy needs more growth poles, just as it needs more reserve currencies and international financial centers.

       China may yet reverse the crisis tide with new rounds of stimuli – indeed despite all the prognostications of an imminent China economic downfall, the country almost invariably managed to upset the doomsayers. This was possible in part due to the sizeable reserves for growth via higher investment, greater exports and catch-up growth of its regions to the regional leaders in the coastal areas. These reserves may be getting exhausted, particularly as the world economy is not as buoyant and open as it was in the pre-crisis period. The challenge for China is to effect a transition from export-oriented and investment led growth to expansion based on the widening middle class and rising household consumption. For that to work and to be facilitated China needs more open and buoyant global markets – China’s success would redound to greater growth in other Asian economies, while its failure could subject the world economy to a protracted search for new paths towards revitalized development.

       And while the severity of the Asian crisis wave is yet uncertain, there will surely be plenty of risks and shocks to the world economy in the near term. Perhaps the most significant in the coming months may be the Fed decision on rates, which harbors risks of added volatility across emerging markets. In a way the global financial crisis will then come full circle as the first salvos of the global crisis came after the Fed’s belated turn to rate hikes. To safeguard itself from further waves of the global tsunami the world economy needs to strengthen global institutions and improve policy coordination across national borders. Thus far the response to global economic challenges tended to render them chronic and more difficult to address with each new region and each new wave of the crisis.

       Views expressed are of individual Members and Contributors, rather than the Club's, unless explicitly stated otherwise.