US is key to global economy---size, US dollar dominance and dependence.

America’s sheer size and the dominance of the US dollar as a reserve currency makes it a bellwether of the global economy, explains independent economist Dr Rebecca Harding

Ever since the 1929 Wall Street Crash, it has been common for economists to quip, “When America Sneezes, the rest of the world catches a cold.”1 The Chinese economy is apparently suffering from long Covid and despite the intention to release it from the grip of lockdown in the wake of protests,2 fears that China’s sluggish growth will impact the global economy’s performance in 2023 still prevail.3 Yet it is the Federal Reserve, and its view of the US economy that still has the major impact on global markets and the confidence of investors. So, does this mean that the mantra still holds?

The short answer to this question is ‘yes’. Despite the supply chain disruptions caused by Covid, and the energy crisis in Europe as a result of the Russia-Ukraine conflict, the US economy and how it performs in 2023 could arguably determine the nature, depth and length of any recession in the rest of the world.

“The US economy and how it performs in 2023 could….determine the nature…of any recession in the rest of the world”

Dr Rebecca Harding, Independent trade economist

The mighty US dollar

There are three reasons why this is the case.

First, and quite simply, size matters. The US economy accounts for the largest proportion of global economic activity at nearly 24% of global GDP.4 While China’s economy had grown more quickly than the US up to the Covid pandemic, it still only accounts for 18.5%, while Japan accounts for 5% and Germany 4.4%. Although the US has lost its place as the world’s largest exporter (its exports were US$1.6trn in 2021 compared to China’s US$2.8trn) the US is the world’s largest importer at about US$2.9trn compared to China’s US$2.5trn in 2021; At US$1.4trn, Germany imports under half the amount that the US does.

Second, the sheer size of the economy is arguably less important than the dominance of the US dollar in financial markets, energy markets, foreign exchange reserves and of course international trade. The dollar is the leading reserve currency accounting for 60% of international foreign exchange reserves and the bulk of these are held in US Treasuries, in other words, US government debt. Although foreign ownership of US debt has declined – which makes the US economy less vulnerable to, say, China disposing of its holdings – there is still approximately 33% held by foreign investors.5 Only in Europe is the dollar not the main currency for international trade.6

More than this, the Bank for International Settlements estimates that at the end of the second quarter of 2022, some US$13,257bn was outstanding in US dollar denominated debt, around 40% of which was in emerging economies.7 According to the Financial Stability Board, around 80% of emerging market debt is dollar denominated.8

Third, this global dependency on the dollar is why the US economy will determine the economic narrative in the coming year. Because the dollar is central to emerging market debt, energy markets and global trade the dollar is also the mechanism through which the US effectively could fuel inflation around the world. For example, if a country prices its trade in US dollars, and the dollar strengthens, this will help exporters, but puts up the prices of imports. Oil and gas prices are increasing anyway as a result of the Russia/Ukraine crisis. If there is then a dollar conversation to be made, this pushes up prices disproportionately.