U.S. dollar guides world economies

According to Sam Kahan of the Federal Reserve Bank, the United States economy continues to be the touchstone for the rest of the world.

Jan 1st, 2006

According to Sam Kahan of the Federal Reserve Bank, the United States economy continues to be the touchstone for the rest of the world. The strength of the U.S. dollar, combined with U.S. gross domestic product of 6.5%, means that Europe, China, and most of the rest of the world want to maintain trade relations with the United States-regardless of political, environmental, or other factors that may be at play. And Kahan doesn’t see this scenario changing any time soon.

“If you look at the world situation right now, the United States is still the major game in town, and it is growing fairly rapidly and providing an impetus for the rest of the world,” he said. “Because of this, there is an increase in raw material prices worldwide, and that is helping developing countries and emerging market economies by providing them with more growth. So it looks as if world economic growth is healthy and accelerating over the next year or so.”

At the same time, however, Kahan says the continued healthy growth in world economies means the potential for upward price pressures is beginning to develop-which further increases the chance of a build-up of inflation. He also points to several critical imbalances that the U.S. and world economy are facing that pose challenges to policymakers and corporations alike:

Trade deficits. “There is a fear that if everyone decides they don’t like the dollar, there would be massive depreciation. But that hasn’t occurred because in essence people want to trade with the US because they want to keep their people employed, so they are willing to let their currency be lower. In addition, countries like Malaysia, China, and Japan know that if there is some major problem in the world they want the stability of a major buying power. The United States accounts for about 50% of world trade, and when you look at the value of reserves, other countries hold 70% to 75% of their assets in U.S. dollar accounts.”

Budget deficits. “The U.S. budget deficit is relatively benign right now at about $300 billion or so. But with the hurricanes, the war in Iraq, the way Congress is spending, and additional potential budget cuts, the deficit will likely increase. And the consequence of a widening budget deficit raises the specter of inflation and the sense that the government is taking away funds that will no longer be available to the private sector.”

Consumer balance sheet. “People look at consumers in terms of debt and of overspending their income. The savings rate is considered to be virtually zero in the United States, but there are problems in terms of our measurement. Say you earn $1000/month, and you take $500 for rent, $200 for food, $200 for other items; you would have $100 left over, which is a savings rate of 10%. But if you put that $100 into a CD or other investment, it is considered zero savings. So when you look at savings rates or income/debt ratios, they are not always an accurate reflection of savings. Which means this is not as threatening an issue as might appear on the surface.”

Consumer spending. “We may have more toys and goods at our disposal today, but more spending is now being focused on services, not goods. So within the goods area, you are going to go where the money is. So I would anticipate that more of the optoelectronics and laser technologies will be focused on the higher end of the population (in terms of wealth and age), whether for consumer electronics, automobiles, health, even toys. Your grandfather probably had one suit and one car, but today, a person your grandfather’s age has many suits and more than one car, and this is purely a function of wealth.”

- Kathy Kincade

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