All of a sudden, financial markets look sickly. From a Western perspective, it's not difficult to see why.
President Obama no longer appears invincible and while the administration lashes out at the banks, some Democrats on Capitol Hill are beginning to wonder whether Ben Bernanke, the chairman of the Federal Reserve, is really up to the job.
Western governments are struggling to offer credible solutions to widening fiscal imbalances.
There is more, however, to the darkening of the financial mood. At the beginning of the year, many investors seemed to think we were living in the best of all possible worlds. Growth was picking up, deflationary fears were fading, asset prices had risen rapidly and, for the most part, central banks seemed intent on keeping short-term interest rates low for an extended period of time. This looked like economic nirvana.
Yet the recovery in activity in the Western world has really not been that strong. Most of the good news on global economic growth has come from China. As 2008 ended, many economists believed its economy was facing an export-led economic collapse. As it turned out, exports fell dramatically but the overall economy proved to be robust, largely as a result of increases in infrastructure spending and extra credit.
A China-led global recovery brings with it some obvious costs and benefits. For the Western world, strong Chinese growth boosts exports of capital goods but drives up commodity prices. China, a poor country in per capita terms, has a voracious appetite for raw materials to satisfy the need for investment in infrastructure, the kind of capital spending that took place in the West many decades ago. With fuel prices still relatively high, it's clear China is exerting its own gravitational pull on the global economy.
For many emerging nations, meanwhile, China's strength has provided an important counterweight to US and European weakness. Higher commodity prices have boosted the export earnings of Brazil, Chile, the Middle East and Russia, leaving their economies in a much better position compared with previous global economic downswings. The balance of payments crises of old have, as yet, been kept at bay.
China's influence needs to be taken seriously. One of the reasons financial markets have been jittery is the recognition that China has to tighten monetary policy to slow domestic demand growth. China's exports are staging a rebound because China's exports are super-competitive. When world trade collapses, as it did last year, even China cannot cope. But if world trade stabilises, as it has recently, China's exports tend to bounce back. In effect, China's share of world trade is continuously rising.
I prefer to think about China's export success from a supply-side perspective: a mixture of 21st-century capital and remarkably cheap workers prepared to offer their services for very low wages has made China highly competitive. With exports now rebounding, China is in danger of growing too quickly. Indeed, figures released earlier in the week show the Chinese economy expanded at a 10.7% rate in the final quarter of 2009, providing an average growth rate for the year of 8.7%. Earlier credit expansion has, if anything, proved to be too effective, leaving growth very strong and inflation on a rising trend.
In the old days, financial markets would take fright at the thought of monetary tightening from the Federal Reserve. Alan Greenspan was treated like a colossus as he seemed to set interest rates for the whole world. Bernanke doesn't have the same status because the Fed is simply not as important as it used to be. The world is changing. Investors have to think about what happens in Washington and in Beijing. If China cools its economy, financial markets are potentially vulnerable. For the US, China's growing influence is deeply uncomfortable.
If, at the end of the year, China is still growing quickly while the US is struggling with high unemployment, it doesn't take a genius to realise that a serious trade dispute could easily emerge.
How it ends is anybody's guess, but it's not difficult to imagine a world in which a US President, desperate to shore up domestic support, adopts a populist China-bashing manifesto. We could then end up heading into trade wars, heightened protectionism and ultimately, collapsing economic activity. No wonder investors are suddenly feeling nervous.