Is China Too Big For The World?(Global Investor)

Byline: Mohamed A. El-Erian; El-Erian is co-CEO and co-CIO of PIMCO.

China may be the rare case of a modern, fast-growth economy that has turned the terms of the trade against itself.

Every year, PIMCO employees lock themselves (mentally, that is) in a room for three days to discuss what the world will look like in three to five years. In the process we draw on the expertise of outsiders and the fresh ideas of our new recruits.

This exercise attracts a lot of attention, focused mainly on the baseline scenarios for global growth, inflation and capital flows. Also of interest is the identification of what investor Nassim Taleb would call "Black Swans"--the events and scenarios no one is considering, because markets currently treat them as "unthinkable."

Black Swans should be taken seriously, not necessarily because they are likely to happen, but because they would have a sizable impact that cannot be easily handled by existing market and policy infrastructures. We see four main risk hypotheses in this category: first, China may now be too big for the global economy; second, the United States may matter less for global growth than commonly thought; third, markets may soon realize that the notion of core inflation (which excludes food and oil prices as misleadingly volatile) is no longer a meaningful concept for the design of policies and market pricing, and fourth, a deep institutional realignment of the U.S. financial system may follow the recent crisis actions taken by the Federal Reserve to manage Bear Stearns' demise.

The Black Swan scenarios for China and the United States undermine the conventional depictions of the global economic system. Many of us have grown up with the notion of a resilient world, led by the United States, and able to handle breakout growth spurts in individual emerging economies.

Yet in China, we may be witnessing the first modern-day case of a rapidly growing economy that has turned the terms of trade against itself. China has added upward pressure on global commodities like oil and steel that it imports heavily, while helping to contain global prices for the manufactured goods that are its key exports. Without policies that help shift the emphasis of the Chinese economy toward domestic consumption, and that give China a proper voice and representation in multilateral discussions on policy coordination, these dynamics can become unsustainable and subject to disorderly correction.