Crisis will hasten China's rise; will India gain or mess up?

This time it’s really different.

The last three years have turned the world upside down. This is why no one can predict what exactly will happen to the world economy or the markets. Consider the huge changes that the world has only now begun to acknowledge, and that, too, in hushed whispers.

First, countries and continents are collapsing this time, not just companies and banks.

As investment maven Madhu Kela told CNBC TV-18 on Friday, 2011 is different even from 2008. In 2008, Uncle Sam stepped in to save big banks and financial institutions. It pumped in money like water (QE1, QE2, and now a “Twister”) - and all it has achieved is a debt figure that exceeds its GDP and an S&P downgrade.

Who will rescue the US if it goes down?

We all know Greece is insolvent, and the rest of Europe is scrambling to see if it can, or should, be bailed out. Portugal, Ireland, Spain and Italy are next in line for huge bailouts. In short, not just one country, but an entire continent is trying to save itself. In the process, it will ask its banks to take huge losses (the so-called “hair-cuts”), which means all available capital surpluses will have to be soaked up and the hat passed around for more from Japan and China.

In the meanwhile, one can’t see money flowing to the emerging markets.

Second, the anointed rescuers cannot really rescue anybody unless they make their own sacrifices.

Who, in the current situation, has the surplus cash to invest in all the bonds that Europe or America may want to issue? China is the only one. But China is factory to the world - it exports far more than it imports. The only way to pass on its wealth to the US and Europe is to buy more from them - not export as much. This means its own export machine will face a crimp on its lifeline.

The key to global redemption lies in a China-financed Marshall Plan (the American plan that rescued Europe with money after World War II). This needs China to become less mercantilist, and focus on what benefits the world rather than itself. Most of China’s $3-trillion-plus foreign exchange reserves are in US dollar or related assets. This debt cannot be paid unless China buys more from the US. Else, the US will be happy to debase the dollar by printing more of it and pay back less in devalued dollars.

There are two other possible sources of surpluses - the oil-rich Arab world and Russia. The Arab world is busy trying to democratise itself with a socio-cultural revolution, while Russia is battling its own demons and coming to terms with a down-sizing of its global status. So they will not be of anything more than marginal help in funding the capital crisis in the US and Europe. Arab and Russian money will flow to strategic partners, not the world in general.

In short, one can’t see too much money flowing from the oil-rich countries, too.

Third, the remedies will be extremely painful for all three major economies - US, Europe and Japan.

The current global crisis is the result of (1) US overconsumption, (2) the European creation of a monetary eurozone without fiscal union or labour and welfare reforms, (3) Japanese stagnation resulting from internal demographic changes and an unwillingness to open up its own markets, and (4) China’s bid to grow by exporting and helping finance them by lending money to its importers.

The world cannot move on without all these four errors being corrected. Correction means the US and Europe have to reduce consumption and state benefits (i.e. become poorer) and reduce national debts by selling off their assets (and become more solvent). China has to spend more than its saves (and import more than it exports) and Japan has to be forced to open itself up both to immigration and imports.

It’s a tall order.

Given the mutual suspicions that all big powers have towards one another - it’s China versus the rest - there is little chance that all these problems are going to be solved simultaneously and through global cooperation.

The rise of China as an imperial power will be the inevitable result as it globalises itself and is forced to rescue the world. But it is not an outcome the rest of the world is willing to accept too soon.

Fourth, we have to prepare for India’s own nirvana.

The current global situation, given our demographic advantage till 2045 (a growing working age population) is the biggest opportunity India has ever had. We can become a geopolitical counter-weight to China and the second growth tiger of the world. India can reap whatever it sows now in spades.

To grasp the opportunities we have to reform with a vengeance - open up industries to foreign capital, including China, open up infrastructure, open up almost everything except strategic areas like defence.

If we do that - India will be growing like gangbusters. The markets will boom like never before.

But for now that looks like a pipedream. The UPA seems incapable of imaginative thinking. It’s political paralysis is acute. Even as economic opportunities loom, the UPA government, as one colleague wrote, is behaving like Bahadur Shah Zafar’s declining Mughal empire.

Our market will gain, all right, as we blunder along from mistake to correction. But there’s a difference between gaining big and gaining small advantages in homeopathic doses.

The world’s problems will be solved in bits and pieces over several years. We are thus entering a period of great global uncertainty.

We will continue to live in interesting times.