A major source of volatility in the global financial markets over the past year relates to the emergence of a huge secular change in the global monetary order, the first since the early 1970s: China’s integration into the global financial system. Highlighting this change was the inclusion of China’s currency last November in the International Monetary Fund’s (IMF) foreign reserve asset known as the SDR (Special Drawing Rights), whose value is determined by a basket of international currencies, including the U.S. dollar, the euro, the yen and the British pound.
This integration is momentous, marking another major advance by China onto the world stage. China’s imprint on the global financial markets is now unmistakable; its actions influence foreign exchange rates, interest rates, capital flows, equity markets and, by extension, the decisions made by global central banks.
Adjustments to China’s integration contributed to the two swoons in global equity markets last August and this past January, with two dips of about 10% in major markets. The severity of these market moves demonstrates that investors need to gain a greater understanding of this “new order” to avoid the potential pitfalls and take advantage of the potential opportunities.
The sunny side of the disruption
China’s integration into the global economic system began literally decades ago, starting in 1978 with a series of market reforms in China. It accelerated after China became a member of the World Trade Organization in December 2001. Today, China is a dominant force in global trade and the world’s biggest exporter.
China’s rapid pace of economic growth, averaging around 10% for over 30 years, has been integral to its success on the world stage and is the fastest sustained expansion by a major economy in history.1 This growth has also led to remarkable domestic achievements, in particular a spectacular reduction in poverty2 (see Figure 1).