IMAGINE SOMEONE HAD TOLD YOU in early 2008 that the U.S. stood on the verge of a financial market meltdown of historic proportion and the longest and deepest recession since the 1930s. Would you have believed it? What if you were told that the euro zones very survival would soon become a subject of front-page debate? Or that a wave of unrest would soon sweep the Middle East, toppling autocrats across the region, forcing Egyptian president Hosni Mubarak into prison and plunging Syria into civil war?
Would you have believed that all of those things would happen within five years?
Recent news appears more encouraging. The U.S. economy looks to be slowly regaining its footing, and equity markets have climbed to new heights. Europe, despite continued queasiness, appears headed toward calmer waters. The upheaval in the Arab world has so far generated limited global market impact. Yet the convulsions of the past five years arose from structural faults financial, economic and political that have not been fully resolved. And there are new worries. Economic growth among leading emerging markets has slowed considerably as much-needed reforms have been postponed. In particular, China on track to become the worlds largest economy while still a poor country has lately behaved in erratic ways on the international stage. Talk of a peaceful rise rings increasingly hollow for many of Chinas neighbors as its military picks fights with Japan in the East China Sea; with Vietnam, the Philippines and others in the South China Sea; and with India along the Line of Actual Control that has divided the two states since 1962. A wave of cyberattacks on U.S. companies and government agencies traced to the Chinese military creates more friction. But the biggest longer-term worry is that Chinas new leadership faces the most ambitious economic reform process in history as its unstable, unbalanced and ultimately unsustainable development model must be rebuilt to shift wealth from politically connected elites and state-run companies toward an increasingly plugged-in and demanding middle class.
Adding to the volatility, were living in a G-Zero world, in which no single power or working alliance of powers has both the muscle and the appetite to provide global leadership. Thats important, because the world needs leaders that are willing and able to accept the costs and risks of establishing and maintaining a coherent global order putting out fires, writing the checks others cant afford and imposing compromise to prevent conflict.
In a G-Zero world it takes a crisis to force cooperation among, and sometimes within, governments. In the U.S. only an obvious emergency could have persuaded so many lawmakers of both parties to support big-ticket bailouts and massive stimulus spending in 200809. Only a potentially catastrophic market meltdown could have induced China and other emerging-markets heavyweights, Europe and the U.S. to agree on concrete actions to help pull financial markets back from the brink. It took the threat of systemic calamity to European banks and fears for the future of the broader European project to create public support for the sharp spending cuts that have inflicted pain across entire societies and elite support for a redesign of the euro zone. Only revolution could have toppled seemingly well-entrenched autocracies and brought the beginnings of long-overdue political change to the Middle East.
Unfortunately, the sense of crisis has lifted on all these fronts, encouraging some to see in the changed landscape a sustainable new normal, a period of painfully slow but predictable economic progress, as forecast by Pacific Investment Management Co. CEO and co-CIO Mohamed El-Erian, or the more sanguine view of many investors willing to bet that a surge in liquidity in the U.S., Europe and Japan makes for a more robust way forward for all these countries and for everyone else. Some believe U.S. lawmakers can now afford to postpone tough choices, the Europeans will muddle through, China can smoothly rebalance its economy, and fires in the Middle East can be left to simply burn themselves out.
These are dangerous illusions. The deeper questions that created the recent convulsions have not been answered, and the easing of so much useful fear will make them much more difficult to address. Thats why the uncertainty and volatility of the past half decade is far from finished and is almost sure to trigger new crises. Be sure your seat belt is securely fastened, because nothing has really come to rest. We have entered the New Abnormal, a period in which every market assumption must be questioned and the wise investor is prepared to be surprised.