China Will Be a Winner in the New Economy

Its cash will help fuel our recovery.

ZACHARY KARABELL

The incoming Obama administration will face formidable challenges, but global economic collapse is no longer imminent. That may be small short-term comfort to the markets and Main Street. But having stared down the abyss, governments around the world appear determined to address root issues. The G-20 gathering of the world's major powers in Washington on Nov. 15 was only the beginning of a long and constructive process of revising the global system.

In the new system the United States will still be the largest economy but no longer the sole determinant of global economic health. The new winners will be cash and China.

Those without cash are in a precarious position. Tens of millions of homeowners and property owners in the U.S., Europe, the Gulf region and Asia have seen the value of their assets decrease sharply. They either have negative equity or insufficient income to make payments. Pension plans and 401(k) accounts have been devastated by a 50% plunge in global equities. Millions of workers have lost or are about to lose their jobs. The U.S. government balance sheet will become even more debt-laden.

But every crisis creates opportunities -- or at least so goes the old Chinese saying. This time is no exception, and China will emerge victorious. As its recently announced $600 billion stimulus package makes clear, those who have cash can spend their way through this global crisis, and China has lots.

The global economy for the past five years has been driven by credit, with cash as currency pushed to the sidelines. With cheap credit, deals got pricier and valuations higher, to the point where some transactions were about as carefully assessed as a Monopoly trade. Now credit is cheap but not readily available. New government regulations and internal risk-mandates will mean that credit won't flow as promiscuously.

There is more cash sloshing around the world than most people think. The problem for the U.S. and to some extent Europe is that this cash is now in unfamiliar places, some of which -- as John McCain reminded us on the campaign trail -- can be found in countries that "don't like us very much."

The McKinsey Global Institute assessment of global financial assets (which includes bank deposits, stocks, bonds and private equity) released earlier this year showed about $167 trillion world-wide at the end of 2006. That figure is now considerably less but still probably three times global GDP, and represents a massive supply of fuel for economic activity.

Tens of trillions in noninvested money (not in stocks or bonds) sit largely unused. Those who have it are hoarding it, unclear about the short term. As the dust settles, however, that cash will be king.

Some cash will be used for purely private gain, for example by vulture real-estate investors in southern Florida, buying up those unused, unwanted and unsold condos at fire-sale prices. Such cash will do little to enhance the public good. But other uses of cash will.

Corporations in the U.S. alone may have up to $1 trillion reserved, and they will begin to pick at deals amid the market wreckage. They are also likely to weigh future cash flow more cautiously. That doesn't mean that all deals will turn out well, but the reliance on cash will temper excessive greed and speculation.

Sovereign wealth funds have cash. After being burned in some of their deals at the end of last year, they have become more stringent. But they still have trillions, and they have every intention of investing that money with an eye on future returns, as demonstrated by Abu Dhabi's recent investment in Barclays, and Saudi Prince Alaweed's raising his percentage to 5% of deeply depressed Citigroup shares.

Private equity and hedge funds also have pools of cash. We hear about the blowups, but not as much about the ones weathering the storm.

In the next few years, these custodians of private capital are likely to assume the role of venture capitalists, merchant bankers and deal makers all in one. They will take on less leverage (by choice or necessity) and put more of their own skin in the game, which is always a good reason for thinking twice and checking your assumptions.

Then there is China. Yes, the balance of power at the G-20 summit shifted toward Russia, Brazil and its hundreds of billions in reserves, Saudi Arabia, and a rich though still economically stagnant Japan. But China remains in a league of its own.

With $2 trillion in central-bank reserves alone, China is cash-rich and almost debt-free. That is true not just for the government but for many individuals. Because there is no mature bond market and the currency remains unconvertible, individuals in China have a savings rate approaching 50%.

To be sure, there have been real-estate bubbles in many Chinese cities, and these have been popping. But China's overall cash position is extremely high, and its dependency on exports is less than most suppose.

The immense stimulus package just announced by China should erase fears of a major Chinese slowdown. Yes, some factories will close because labor is cheaper inland than in the more expensive coastal regions. But the shortfall created by sagging exports will be made up by state spending. Beijing has the money, and the willingness to spend it.

China's actions could also have direct -- and positive -- effects on the U.S. economy. An investment arm of the Chinese government is now deep in talks to buy up parts of AIG. China is already the primary source of growth for many U.S. companies, including ones like Caterpillar that make things in the U.S. and export them to China. As the developed world sags, China is becoming even more important to the global system.

China also needs a vibrant U.S. (and Europe). Beijing will likely take action to prevent a collapse by continuing to purchase U.S. Treasuries. We may not like the fact that China is our creditor, but having no creditor would be a good deal worse.

The U.S. government can spend for a time, provided the dollar remains the currency of last resort and buyers like China keep lending. But as the New Deal showed, and as Barack Obama understands, government alone cannot fuel the economy. Government must jump-start the system when it stalls, but after that, cash and China will drive the recovery.

Mr. Karabell is the president of River Twice Research. His book on China and the United States will be published by Simon & Schuster next year.