The new titans: India & China

This survey will argue that all of these puzzles can be explained by the growing impact of emerging economies. For instance, low bond yields and the dollar's refusal to plunge are partly due to the way these countries have been piling up foreign reserves. Likewise, higher oil prices have mostly been caused by strong demand from developing countries rather than by an interruption of supply, so they have done less harm to global growth than in the past. And their impact on inflation has been offset by falling prices of goods exported by emerging economies. This has also made it easier for central banks to achieve their inflation goals with much lower interest rates than in the past.
All this will require some radical new thinking about economic policy. Governments may need to harness the tax and benefit system to compensate some workers who lose from globalisation.
Monetary policy also needs to be revamped. Central bankers like to take the credit for the defeat of inflation, but emerging economies have given them a big helping hand, both by pushing down the prices of many goods and by restraining wages in developed countries. This has allowed central banks to hold interest rates at historically low levels. But they have misunderstood the monetary-policy implications of a positive supply shock. By keeping interest rates too low, they have allowed a build-up of excess liquidity which has flowed into the prices of assets such as homes, rather than into traditional inflation. They have encouraged too much borrowing and too little saving. In America the overall result has been to widen the current-account deficit.
The central banks' mistake has been compounded by the emerging economies' refusal to allow their exchange rates to rise, piling up foreign-exchange reserves instead. Bizarrely, by financing America's deficit, poor countries are subsidising the world's richest consumers. The opening up of emerging economies has thus not only provided a supply of cheap labour to the world, it has also offered an increased supply of cheap capital. But this survey will argue that the developing countries will not be prepared to go on financing America's massive current-account deficit for much longer.
At some point, therefore, America's cost of capital could rise sharply. There is a risk that the American economy will face a sharp financial shock and a recession, or an extended period of sluggish growth. This will slow growth in the rest of the world economy. But America is less important as a locomotive for global growth than it used to be, thanks to the greater vigour of emerging economies. America's total imports from the rest of the world last year amounted to only 4% of world GDP. The greater risk to the world economy is that a recession and falling house prices would add to Americans' existing concerns about stagnant real wages, creating more support for protectionism. That would be bad both for the old rich countries and the new emerging stars.
But regardless of how the developed world responds to the emerging giants, their economic power will go on growing. The rich world has yet to feel the full heat from this new revolution.

The new titans Economist.com