Buckle up as China crashes through

A decade into the 21st century, it is obvious that the global economy is being driven from Asia with the old fogie economies in Europe and North America in long-run decline.

About five years ago, China overtook the euro area to be the second largest economic zone in the world. On current figuring, it will be only three or four years before China will overtake the US to be the largest economy in the world, accounting for around 15 per cent of all output. This is quite remarkable given that as recently as the 1980s, China accounted for less that 5 per cent of global GDP.

The other seismic positive economic trend is the emergence of India which is on track to overtake the euro area and account for 10 per cent of global GDP by 2030. The chart below, reproduced from a recent speech from RBA Governor Glenn Stevens, shows how the composition of the world economy has changed over the last 100 years and is forecast to change over the next 20 years.



These unfolding and unstoppable trends will have a huge impact on the way financial markets and all other economies function.

The nature of China's economy with a huge number of very poor people and a large rural base will mean ongoing demand for commodities as incomes rise. Urbanisation and a move to services based industries will dominate the internal dynamics of China. The urbanisation part will underpin an ongoing requirement for construction and household durable items. The inevitable rise in per capita incomes will also mean strong demand for other consumer goods, protein (food) and so-called luxury goods.

On the supply side, China is likely to remain a low cost source for manufactured goods although the rising living standards will feed into labour costs and slowly erode that advantage.

The changing dynamics in the global economy means that financial markets will continue to alter their focus. Chinese economic policy changes and economic news will increasingly influence global markets, in much the same way as a Wall Street shock or surprise jobs number can send shivers around the world. But it is not just the markets where the change will be seen. Chinese data on industrial production, inflation and GDP will influence financial markets as much as the equivalent numbers in the US and elsewhere.

Policy changes in China and even India will move global markets in much the same way as a shock move from the US Federal Reserve or the European Central Bank.

Market watchers will be as familiar with the People's Bank of China as it is with the US Fed. Speeches from PBOC Governor Zhou Xiaochuan will be more important to the stock, bond and currency markets of the world than utterances from US Fed Chairman Ben Bernanke, the ECB President Mario Draghi and whomever it is that replaces them. The Reserve Bank of India and its Governor Duvvuri Subbarao are also gaining profile and influence in the new world order.

For Australia, the emergence of China and India has already been good news through the obvious lift in commodity prices and commodity export volumes. Investment flows have boomed as the mining sector is taking advantage of these changing global dynamics. Over the last decade, there has also been a clear shift in tourism, education and other services exports to China and India and this trend will inevitably continue for years to come.

For the financial services industry, the benefits are only just unfolding. As the stock, bond and currency markets for securities in China and India evolve over the next decade or two, Australian banks can and almost certainly will be involved. Australian banks are financial sound, savvy and hungry for expansion. The obvious area will, in time, be making prices on the rupee and yuan, on Indian and Chinese bonds and stocks and all the bells and whistles that go with it.

It is exciting to see these changes in Asia unfold. Australia is benefitting from its geographic and economic proximity to the dynamic countries and if we play our cards right, we can be full participants in this massive structural change in the world order.

By the way, here are the links to the RBI webpage and the English version of the PBOC webpage. These will increasingly be vital sources of information for all of us trying to work out where the economy and markets are going.

Stephen Koukoulas is an economist and financial market strategist who between October 2010 and July 2011, was economic policy advisor to Prime Minister Julia Gillard.

Follow @TheKouk on Twitter.