America’s economic decline becomes clear

On Monday Fund Strategy published a comment by me on the idea that America is “decoupling” from the rest of the world economy. I argued instead that America’s relative economic decline is becoming increasingly apparent.

The increasingly popular idea that the world is “decoupling” from America is misleading. It is not that the integration of the world economy is lessening in any way. The real trend is for a decline in the relative importance of America in the global economy.

Proponents of the decoupling thesis argue that the world is becoming less dependent on America. Two weeks ago the International Monetary Fund argued that Asia could weather an American soft landing. Last week Merrill Lynch went even further and argued that Asia could ride an American recession without any significant problems.

Their evidence is essentially that Asia in particular, and the rest of the world in general, is already weathering an American slowdown. In addition, both Asia and Europe are becoming more integrated regions in trade terms. China is becoming central to the new Asian economy while Europe is becoming increasingly integrated between its East and West.

This misses the fact that the world is still closely linked to America in other ways. Most notably there are huge capital flows between America and the rest of the world.

More importantly, America’s relative decline should have already been apparent before its recent slowdown. As Fund Strategy has previously argued the idea that America was the locomotive of global growth earlier this decade was always misleading. It was primarily Asian production that was subsidising American consumption. Asia has long been the engine driving the world economy (see Fund Strategy book review, February 6, 2006).

What has happened recently is that the declining relative importance of America has simply become more obvious. Although America is still the world’s largest economy it no longer has the overwhelming weight it once enjoyed. The balance is shifting towards Asia while the developing world is growing in relative importance compared with the advanced nations.

As a result of these shifts a new world economy is emerging. China is taking a far larger role than in the past. Asia and Europe are both becoming more internally integrated regions. The developing countries have more weight in global economic affairs. And America, increasingly in hock to the rest of the world, is moving towards losing its pre-eminent position.