Still tracking US moodswings?

However, with the crisis of confidence in the US credit market over the past few weeks, assumptions underlying the big trends of this decade are being questioned. Emerging markets have been the asset class of choice this decade, rising by nearly 300 per cent from the October 2002 lows, due to rapidly improving economic fundamentals. But in the past month, as foreigners have pulled more money from emerging stock markets than in any other decline, old fears have resurfaced about how markets are doomed to rise and fall with American mood swings.

The important questions for investors are: does the credit crisis have the potential to become a full-fledged systemic shock that breaks the back of the US economy, and, if that happens, what are the implications for growth in the emerging markets? Given the role the US housing market has played in the current economic cycle, it seems unlikely that it will have no macroeconomic follow-through.

The best-case scenario for the US economy is subpar economic growth. However, it should be able to avoid a recession due to the strength of corporate balance sheets. After all, corporations in the US are flush with cash, have little leverage and 8212; most importantly 8212; overseas sales account for an increasing share of their earnings. But the fate of the global economic expansion will more likely be determined by whether the world8217;s most powerful growth engine 8212; China 8212; continues to barrel ahead.

This year, for the first time in modern history, China is set to contribute more to global growth than the United States. The contribution of the US in the global economy has dropped to below 30 per cent.

One positive unintended consequence of any Fed easing might be that while economic growth in the US and the rest of the world has increasingly decoupled, monetary policies remain synchronised. Despite an improving economic profile that warrants stronger currencies in developing countries, China and many of its peers are not keen to let their exchange rates appreciate too rapidly against the US dollar. These countries will be forced to run even more accommodative monetary policies if the Fed cuts rates, as they don8217;t want their currencies to rise against the dollar. The relatively low interest rates will boost domestic demand and offset some of the negative impact from weak US growth.

The current scene is starting to look a lot like 1997 and 1998, but in reverse. Back then, emerging markets were in crisis, but it did not stop the underlying US bull market, which continued on the back of a tech-driven productivity boom and inflows of foreign capital. Now the US is in financial trouble, but the uptrend in emerging markets seems likely to persist, as strength in domestic investment spending and rising productivity keeps growth humming in China, as was the case with the US in the late 1990s.

The upshot of major financial dislocation is that the world may become excessively dependent on the spending of one economic superpower to keep growing. Today, it is China. If the parallel to the late 1990s does indeed play out in the reverse, then the volatility of the past few weeks was just another twist to the otherwise unchanged tale that this decade belongs to emerging markets.

The writer is head of emerging markets at Morgan Stanley Investment Management