Time to reverse global imbalances

THIS has been a pivotal year for global economies. But if 2010 is the pivot then next year will be the fulcrum. 2011 is likely to be the year for developing economies to crowbar the debt-laden west out of its economic woes.

Archimedes of Syracuse once boasted that if he stood in the right place he could move the Earth with a single lever. Moving the entire globe is a strong boast indeed -- moving western economies out of recession is an equally arduous task. To achieve that feat today, Archimedes would need to stand in China if he is to successfully lever the west out of the financial mess it now finds itself in. Eureka!

Let’s not kid ourselves here -- the load is enormous and the task for China is immense. But China knows it has to be done, not only for the health of the west, but for its own health, too.

To get some idea of the enormity of the task, the economies of the US and the European Union are worth a massive $14 trillion (£8.71 trillion) apiece, which together is around three times the size of China in terms of purchasing power. So turning around sickly western economies will not be straightforward. Nor will there be instant gratification.

That said, as any schoolchild will rightly point out, it is possible to achieve huge turning force provided the right amount of effort is applied in the appropriate place. Torque is the key, and 2011 is likely to be a year when we start to see a gradual rebalancing of world trade surpluses from east to west.

China knows it holds the key. The last two decades have unquestionably been a boon for China – it has been growing at a rate of around 9 per cent a year over the last 20 years. The size of its economy has ballooned from around $800bn in 1990 to a whopping $4.9 trillion today. It now accounts for around 8 per cent of the world economy. But with size come more responsibilities.

The size of the economy matters, but it is not the only issue because China has also become the world’s largest exporter. Its trade surplus with the rest of the world has soared to almost $300bn in 2008. However, there are signs that this is starting to moderate. In 2009, China’s trade surplus with the rest of the world fell to $200bn and that could fall again in 2010.

This is the first of many steps that China will try to take to rebalance the economies of the east and west. After all, China knows that an ailing west will stifle growth in its own economy. It’s pointless churning out flip-flops if the west can only afford to buy the flip. To nurse the west back to health, China must start spending some of its $2.7 trillion worth of currency reserves and whittle down its balance of trade surplus.

Reassuringly, China is showing signs of softening its hard-line approach to maintaining an undervalued yuan. Removing this obstacle and allowing the yuan to rise will go a long way to dismantling an artificial trade barrier that has prevented western manufacturers from accessing Chinese markets easily.

Any unleashing of Chinese reserves on the west will be a panacea of sorts, but it could come with unpleasant and unintended side effects. China keeps over a third of its foreign reserves in US Treasuries, and an unwinding of these reserves could push up long-term US interest rates. But the prospect of higher rates may be the price we have to pay if China is to yank the west out of a slump next year.

The upshot is that China will continue to grow, albeit at a slower rate. However, investors may find richer pickings among the bombed-out European and US markets. In the last decade, it has been a case of go east and make your fortune – prior to that it was look west and fill your boots. But the maxim for the next decade will be to look both ways because China is about to truly take on the world stage.

David Kuo is a financial broadcaster. He writes for the Motley Fool and also can be heard daily on BBC London 94.9’s Breakfast Show. He will be speaking at The World MoneyShow on Friday and Saturday 12 - 13 November.