For decades, a major component of the global economy was the theory that when the U.S. economy sneezed, the global economy caught a cold. It was believed that the strength and size of the U.S. economy influenced business and trade in every corner of the world, such that when economic troubles were experienced in the United States, the rest of the world was affected as well.
However, over the last few years a new theory has emerged, called "decoupling," which reverses this idea. In the wake of globalization, the economic emergence of the developing world, as well as the rise of the Euro as a powerful currency, it is now thought that the global economy has "decoupled" from the United States - stable growth could be achieved regardless of what was happening in America. But recent economic events have turned the decoupling theory on its head. It now appears that, even with all the changes the world economy has seen in recent years, one fact still remains: global economic health still begins in the United States.
The idea behind the decoupling theory was that the rise of developing countries' economies would offset slowdowns in the developed world. The emergence of new economic powers like Brazil, Russia, India and China, and their growing manufacturing sectors and consumption-hungry middle-class consumers, would provide strong domestic demand, allowing them to be, in part, self-supporting. In addition, trade between these emerging countries and established economies like Europe and Japan was strong and growing, and American economic activity had little involvement. The United States was still important, but it was no longer the driving force it once was.
Believers in the decoupling theory point to the fact that the U.S. economy has been on a slower growth path over the last few years - growing well below its historical 3.3 percent annual average since 2005. Yet developing economies continued on with strong, stable growth rates. This year, the U.S. economy has stalled and may be in recession. But growth has continued in Europe, Japan and the emerging markets. However, new quarterly data suggests that the troubles in the American economy have finally spilled over, and the global economy is starting to suffer.
The European economy, which had been enjoying a number of years of stable growth, low inflation and strong employment, appears to be slowing down. In 2Q 2008, economic growth in the 15-nation Eurozone contracted. China, which has experienced strong, increasing growth for a decade, is likely to see a reduction in 2008, the first fall in its growth rate in seven years. Japan's economy also contracted in 2Q 2008, and real exports fell by 3.3 percent. Japan has strong economic ties to China, and it was thought that strong Chinese growth would support Japan's exports. However, China's exports are closely tied to the West, and as Europe begins to follow the direction of the American economy, Chinese, and thus Japanese, export sectors are being hit hard.
The troublesome U.S. economy is impacting the rest of the world via the usual cause - slowing demand for imported goods. The dollar, which has been falling in value over the last six years, has created a resurgence in U.S. exports, particularly in manufacturing, since American-made goods are now relatively cheaper. However, the low dollar also has made imports relatively more expensive, and this is slowing demand for foreign-made goods. In addition, the U.S. economy on the whole is slowing, and this also reduces demand for goods from foreign sources. Since the United States is a huge consumer of imported goods, falling demand has significant implications for big exporting countries.
In addition to slowing U.S. demand, the U.S. housing market slump also is impacting the global economy. The crisis in the American housing sector and the rise in home foreclosures have hit the U.S. economy hard and are now spilling over to other economies around the globe. U.S. mortgage-backed securities, which are financial assets created by the packaging of thousands of home loans together, have fallen in value and are leading to solvency issues for institutions that purchased them. The collapse of large American firms like Bear Stearns, Lehman Brothers, Freddie Mac and Fannie Mae all can be tied to losses from mortgage-backed securities. But it's not just a "local" problem - firms all over the world purchased these assets. Lending among global financial institutions is slowing dramatically as concerns about solvency spread. As a result, global market interest rates are increasing and lending standards are tightening, resulting in a reduction of available credit. This has strong, negative implications for any economy.
Although the global economy continues to transform, it appears that the role of the United States remains fairly constant. The size of the American economy and the stability of its financial institutions are still important to the global economy. And because of this, it may be that the current slowdown in the U.S. economy will be exported to the rest of the world.
Charles Chesbrough may be reached at charleschesbrough@csmauto.com.
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