Crisis has seen East emerge from West's shadow

In early August 2007, as the world was waking up to "sub-prime", I wrote a newspaper column arguing that the credit crunch was a "pivotal moment in the history of global capitalism".

Readers were asked to contrast the major Western economies - "squandering their role as the bedrock of global finance" - with "the relative stability of the emerging giants of the East".

The indebted Western world, I suggested 20 months ago, "is now far more vulnerable to financial meltdown than many of the nations we used to deride". The likes of Brazil, Russia, India and China, I argued - with their huge reserves - were "better placed to deal with a global crisis than their Western counterparts". That's why, I concluded, "when sentiments improve and investors' risk-appetites return, there could well be a flight to quality - but away from the West and towards the economic powerhouses of tomorrow".

During late 2007, my prediction seemed to be coming true - much quicker than I expected. Shares on many exotic exchanges surged as swathes of global capital, spooked by the toxic waste on Western banks' balance sheets, sought refuge elsewhere. Last year that trend reversed, as the collapse of Bear Stearns and Lehman Brothers sparked blind panic - with Western investors dumping anything remotely "risky" and taking "ultra-safe" domestic positions, often in sovereign debt. As a result, EM shares suffered.

In recent months, though, the game has changed again. Facing a prolonged Western recession, and alarmed by share movements and standards of economic management in the "advanced" countries, global capital flows are shifting East once more. So far this year, the world's top ten performing stock markets are all EMs. China's main share index has gained 39 per cent since the start of 2009. Russian stocks are up 28 per cent and Brazilian shares 27 per cent. Meanwhile, the FTSE 100 has lost 10 per cent and America's Dow Jones is down 11 per cent.

These are exceptional times. Future historians will ponder the 2007/09 sub-prime debacle many decades hence. When they look back, this could be seen as the moment when the large EMs truly entered the financial mainstream, seeing much greater portfolio inflows from the rest of the world.

The "West-to-East" shift has been a discernable investment trend for some years. But the loss of confidence in Western markets and policy making due to "sub-prime" is now accelerating that trend. One reason is that EM economies will grow faster for the foreseeable future, and from a lower base, than their "credit-crunched" Western rivals.

The developed world will contract 2 per cent this year, says the IMF, while the EMs grow 3.3 per cent. The relative gap is vast next year too - with the West set to manage only 1.1 per cent growth (some hope) and the Eastern upstarts expanding 5 per cent. Over the last decade, Western consumers have binged on cheap EM-produced goods, often funding such purchases with finance also ultimately provided by the exporting nations. This has led to large Western deficits and huge Eastern surpluses. China ran a current account surplus last year equal to 10.2 per cent of GDP - and is a massive creditor to the West.

Despite its "basket case" media portrayal, Russia has also run a big external surplus for the last decade - and is a major holder of Western sovereign debt. Western governments, in contrast, already weakened by huge deficits and tiny reserves, have reacted to sub-prime by taking on even more debt. That leaves them ever more vulnerable to future shocks, another reason EMs are gaining favour.