More Than One Engine

Sometimes the most telling event is the one that did not happen. The lack of any global contagion from the U.S. economy's weak growth path over the past year has confounded analysts conditioned to consider the United States as the sole engine of the world economy. That continued single-minded obsession with the U.S. economic trajectory has led many investors to prematurely bail on the bull run—the sharp but short-lived sell-off triggered by convulsions in the U.S. housing market earlier this year being a case in point. For them, it was unimaginable that global growth could power ahead when the United States has been expanding at an annual rate of just 2 percent, as has been the case for the past five quarters.

But a new world order has been in the making, defined by China's growth surge and a European economic renaissance. At just under $3 trillion, the Chinese economy in nominal terms is still less than a quarter the size of the U.S. economy. But with a pace of expansion now more than four times that of the United States, China is incrementally adding more to global growth than the U.S. is.

The even bigger surprise is the German-led revival of Europe's economy. Last year the euro zone grew by 2.6 percent, spurred by a 3 percent rise in Germany. An intense focus on increasing productivity has helped Germany's export sector become highly competitive, and it is now benefiting from booming demand in emerging markets. With projected growth for 2007 in the 2.5 to 3.0 percent corridor, Euroland will likely outperform the U.S. economy for the first time in recent history.

If the U.S. lapses into an outright recession, the impact may still be large enough to unravel the global economic story. But any scenario less drastic than the dreaded recession now looks manageable, with the euro area and China together accounting for a larger share of global GDP than the United States. Almost effortlessly, it seems, the world has escaped its risky dependence on U.S. economic power.

The change in the growth equation is manifesting itself in the rising importance of Chinese equities in determining global financial-market sentiment. Each decade, some asset class or other captures the imagination of investors. In the 1980s it was the Japanese market, due to that country's rapid ascent. In the 1990s it was the NASDAQ, driven by the tech boom. These days investors are riveted by the movements of the Chinese market, with the daily ebb and flow of the Shanghai exchange often setting the trend for the rest of the region.

Of course, following the near-vertical climb in Chinese share prices of late, the impulsive reaction of many financial commentators is to label that market as another "bubble" waiting to burst. While there are some incipient signs of froth, recent performance is more a result of the changing global economic order. All major stock-market booms are rooted in a powerful growth transformation; the current Chinese share-price appreciation too, in large part, is driven by huge profit growth churned out by a booming economy. Earnings growth for Chinese companies in the first quarter of this year was a phenomenal 80 percent, and according to consensus estimates it could exceed 30 percent for the rest of the year, justifying at least some of the 50 percent gain in the Shanghai composite index this year.