"When this is over we will wake up and realize that the issue is that the transformation of wealth and information and industrial activity is taking place at a pace none of us has ever experienced." Michael S. Klein, Chairman and Co-Chief Executive Officer, Markets and Banking, Citi, USA

It might be tempting to lay the blame for the unfolding financial crisis at the feet of bankers like JérÔme Kerviel, the young trader whose misadventures have allegedly cost Société Générale US$ 7.3 billion, to castigate the supposed greed of investment banks or to demonize the derivatives at the heart of the turmoil. But what became clear during discussions at this year's Annual Meeting was that the sub-prime crisis roiling global financial markets is but a dramatic and costly chapter in a much larger, more profound story - the rebalancing of global wealth away from the developed economies of the West towards the emerging economies of Asia and the Middle East.

"When this is over we will wake up and realize that the issue is that the transformation of wealth and information and industrial activity is taking place at a pace none of us has ever experienced," said Michael S. Klein, Chairman and Co-Chief Executive Officer of Markets and Banking at Citi. Or as Kishore Mahbubani, Dean of the Lee Kuan Yew School of Public Policy, put it: "We are entering a completely new era of world history - the end of Western domination. In the Industrial Revolution there was a rapid increase in living standards of 50% in one lifetime. In Asia today in one lifetime you will see an increase of 10,000%".

It may not seem like it to those watching their portfolios plummet, but this trend is not all bad news. The rising prosperity of the East is lifting millions out of poverty and is even spreading to the poorest corners of Africa. The challenge to policymakers and businesspeople as the crisis subsides will be how to alleviate the more dangerous side effects of global economic growth - rising inequities within nations and a worsening global environment. Climate change has underscored the limits of development: without dramatic advances in resource efficiency and reductions in emissions, universal prosperity is environmental suicide. "If everyone tries to consume the way America has consumed, the world is not viable," said Nobel Prize-winning economist Joseph E. Stiglitz.

One of the most remarkable features of the current crisis is how widely it was predicted. "A year ago we said there was an underpricing of risk," recalled European Central Bank President Jean-Claude Trichet. Indeed, participants at last year's meeting warned of a bubble in the US housing market and of a worrying proliferation of complex credit derivatives.

Underlying the flood of money into mortgagebacked securities was a tsunami of global capital, fuelled by growing Asian export earnings that has helped finance America's swelling debt and kept global interest rates and inflation low.

This so-called liquidity bubble was good for emerging economies, providing them with cheap capital to pay off their debts and finance development and trade. The boom in global growth and investment has surpassed the resource industry's ability to supply it, sending prices for commodities soaring. Record prices for oil, metals and food have been a boon to nations that export them.

Booming markets and easy money also put pressure on financial managers to take greater risks, and borrow more money, in search of higher returns. "If you are in a risk business, one of the easiest ways to grow is to leverage up," observed James Dimon, Chairman and Chief Executive Officer of JPMorgan Chase & Co. The industry responded with innovative collateralized debt obligations, or CDOs, that allowed lenders to sell their risks on to investors searching for yields, the quest for which fuelled a boom in lending to home buyers with poor, or sub-prime, credit.

CDOs were repeatedly repackaged and resold to investors paying with borrowed funds, creating a mountain of leverage that is now collapsing. What was a liquidity bubble has instead become a liquidity crunch as holders of CDOs search in vain for anyone willing to buy or lend. "It's not mistrust that other institutions will go bankrupt," said Walter B. Kielholz, Chairman of the Board of Directors at Credit Suisse, "It's mistrust that if I lend to them they may not lend to me, so I'll keep my money. And that was something that I in my career had never seen before".

Predictably, the sub-prime debacle has sparked calls for regulatory reform, in particular the harmonization of regulations internationally to prevent banks from "regulatory arbitrage". "Regulation is fragmented," said Malcolm Knight, General Manager and Chief Executive Officer at the Bank for International Settlements. "There has to be more conformity in the way these regulations are implemented across jurisdictions".

The US Federal Reserve and other central banks are also under scrutiny. Some argue that their efforts to pump liquidity into money markets and lower rates to stave off recession are critical to keep the global financial system working. Others say such moves only reward investors for their excesses and encourage continued American profligacy. "The Fed's attitude is that they are here to clean up after bubbles burst, not prevent them from happening in the first place," said Stephen S. Roach, Chairman for Asia at Morgan Stanley. "This is a dangerous and irresponsible and reckless way to run the world's largest economy".

Now there are concerns that the sub-prime mortgage crisis will spread to other credit markets - areas dependent on cash-strapped US consumers such as auto loans, as well as markets for other exotic credit derivatives.

The billions in losses suffered by banks and other investors could go so far as to reduce credit available to corporations to invest. The real question, however, is what impact falling housing prices will have on US consumers and the global economy. While policy-makers extolled the resilience of the US economy, many economists predict a US recession, which could lead to a sharp slowdown in demand for raw materials and manufactured exports and with it slower global growth. If that happens, countries and regions with stronger fiscal positions, like China, East Asia and Latin America are likely to be able to cushion themselves better than those with heavy overseas debt, like Eastern Europe.

But a sharp debate took place between those who say the world still depends on US demand and those who believe that the emerging markets' boom has produced enough momentum that, combined with Europe and Japan, the world is less reliant on the US. "When the US catches a cold, maybe the rest of the world catches a sniffle, but certainly not pneumonia," noted C. Fred Bergsten, Director of the Peterson Institute for International Economics. On the contrary, Bergsten argued that the world may experience its first episode of "reverse coupling" in which reasonably rapid growth in China and other economies softens and shortens the US downturn.

Perhaps the best indication of the changing balance of economic power, though, is the list of who has been bailing out the big banks wounded by the sub-prime fiasco. Swollen with revenues from oil, electronics and public savings, sovereign wealth funds have become the latest global financial force, sparking concern that they may have more than profits in mind as they buy up strategic assets in developed countries.

Bankers point out that sovereign wealth funds have been ideal investors, taking only small stakes and serving as silent, long-term investors. Moreover, their investments help ensure that some of the money spent on oil and electronics finds its way back to the US. Nonetheless, scepticism has emerged about whether the funds' owners - particularly those that are non-democratic governments - would refrain from interfering if their national interests were at stake.

Ultimately, however, the wealth of exporters alone will not solve the enduring problems confronting the global economy. Charting a more equitable and sustainable course will require long-term investments in human capital, education, health and environmental protection. Conventional models of corporate investment and development are not adequate. "The world is getting better, but it's not getting better fast enough, and it's not getting better for everyone. We have to find a way to make the aspects of capitalism that serve wealthier people serve poorer people as well," said William H. Gates III, Chairman of Microsoft Corporation. "If we're going to find a sustainable way to help those who can't pay, we have to use self-interest and caring - capitalism and philanthropy - to direct attention to people who have been left behind".

Sovereign Wealth Funds: A New Development

The rising importance of Sovereign Wealth Funds (SWFs) received much attention at the World Economic Forum Annual Meeting 2008, fuelling concern about their potential political influence. Many agreed that the growing financial clout of SWFs - governmentcontrolled funds estimated at US$ 2.5 trillion in assets - should be welcomed, not opposed, by global policymakers because: •  SWFs represent a valuable pool of stable, long-term capital, and have reduced, rather than increased, capital market volatility. •  SWFs not only contribute to domestic economic stability but to the stability of the global economy as well. •  There is virtually no difference between going to a SWF for investment capital and going to a state pension fund in the US. •  If high oil prices continue to channel surplus funds into the coffers of the major exporting countries, sovereign investments could reach US$ 15 trillion within the next five years. This growth will inevitably make SWFs major players in the global capital markets.

"If everyone tries to consume the way America has consumed, the world is not viable."
Joseph E. Stiglitz, University Professor, Columbia University, USA

"We are entering a completely new era of world history - the end of Western domination. In the Industrial Revolution there was a rapid increase in living standards of 50% in one lifetime. In Asia today in one lifetime you will see an increase of 10,000%."
Kishore Mahbubani, Dean, Lee Kuan Yew School of Public Policy, Singapore

"So far as we can see, these investments have been made on commercial, not political grounds. We welcome that type of investment, whether it is from an SWF or anyone else."
Robert M. Kimmitt, US Deputy Secretary of the Treasury.