America is living beyond its means- Larry Elliot,The Guardian.

I read a excellent article about the fate of US econmy.Posting it below. Read it repeatedly!

America is living beyond its means

China and India will be calling the shots when the US is no longer top dollar

Larry Elliott, economics editor,The Guardian

It's 2056. After a coup in Saudi Arabia, the new government announces it is cutting off supplies of its dwindling stock of oil to the United States. The White House responds by sending in the troops, but is forced to withdraw after Beijing says it will only continue shoring up the dollar if the military action is called off.

Marking the 100th anniversary of Suez, the Americans have no choice but to comply. Fanciful? Ludicrous? Certainly, that would have been the reaction of the traders on Wall Street who last week sent the Dow Jones industrial average to within a whisker of its all-time high. But even if the US can avoid a hard landing in the short term, as equity dealers believe it can, the medium and long-term risks to the economy remain.

Optimism seems to be inspired by falling oil prices and the expectation that the next move in interest rates from the Federal Reserve will be down. It is an optimism not shared by the bond market, which is sending out clear warnings of impending recession. It is possible those who have pushed the Dow back well over 11,000 points have got it right. Many economists believe, however, that the equity market has got it wrong. They can hear the sound of fluttering wings as the chickens come home to roost.

Stephen King, chief economist at HSBC, has downgraded his forecast of US growth next year to 1.9%, and believes that by the end of 2007 the economy will be expanding at only just over 1% a year. That, by US standards, is very slow growth and would certainly lead to a sharp jump in unemployment. The Fed would be cutting rates by this time next year in an attempt to get the economy going again. It may not be that simple. For one thing, the downturn in the housing market looks like it has a lot further to run. Activity and prices may continue falling for another year, and with US consumers already drowning in a sea of debt it's not obvious that they will be prepared to load up on any extra borrowing, whatever the level of interest rates. And the wisdom of curing the hangover from one bubble by another binge has to be questioned.
Consumers have been using their homes like ATMs - borrowing against rising prices - but this cannot go on forever. The US economy needs quite a prolonged period in which consumer spending grows more slowly than the economy: that is the only way that the trade deficit is going to be reduced. There are those who say that the trade deficit is not a problem for the US. They argue that it is perfectly sustainable to run sizeable deficits in perpetuity because the dollar's status as a reserve currency means that there will always be demand for US assets. But there are two points here. First, running a permanent trade deficit affects the structure of your economy. It means fewer manufacturing jobs where productivity tends to be higher and more jobs in the service sector, where productivity tends to be lower.

The US has struck a Faustian bargain with its trading partners, particularly China, responsible for about one third of the $700bn-plus trade total last year. As the American economist Tom Palley puts it: "US consumers get lots of cheap goods in return for which they give over paper IOUs that cost less to print. Meanwhile, China creates millions of jobs and builds modern factories that are transforming it into an industrial superpower, and it also accumulates billions of dollars in financial claims against the US. From this perspective, trade deficits don't matter because there are no limits to either government or private borrowing, and because manufacturing doesn't matter either." The logic of this, Palley notes drily, is that the US would benefit even further if China devalued its exchange rate and ran a larger trade surplus. The second point is potentially much more explosive: it is the one sketched out in the crystal ball gazing at the top of this piece. What would happen if, as a result of global developments over the coming decades, the dollar ceased to be the reserve currency of choice. This was a point raised by Avinash Persaud, one of the financial sector's more original thinkers, in a recent lecture in New York. Persaud's argument is as follows.

Throughout history, there has always tended to be one dominant reserve currency along with a host of lesser rivals. In the 19th century Britain was the pre-eminent economy and sterling was the main reserve currency. Yet currencies don't retain their dominance forever; part of Britain's problem at the time of Suez was that it was struggling to adjust to a world in which it was no longer the top-dog currency but the creditors came knocking at the door asking for their cheques to be cashed. The US is living beyond its means, hoping that nobody cashes the cheques it has been merrily writing as the current account has gone deeper into the red. That's the advantage of being a reserve currency, even though, as Persaud notes, there is no rule which says that you have to run current account deficits simply because you are a reserve currency.
Britain didn't a century ago. In the decade or so up to the first world war it had a trade surplus of 5% of GDP. "That is a mirror image of the US today. The UK was in surplus by as much as the US is in deficit." That deficit has enabled the Chinese to build up their industrial strength at a rapid rate, so much so that it is probable that China - and perhaps India - will have overtaken the US as the world's largest economy (on a purchasing power parity basis, at least) by 2050. Persaud thinks that the upshot of this will be that in the next few decades the dollar will start to lose its reserve status just as sterling did in the last century. "In the case of sterling's loss of reserve status, world war one and two accelerated a process that had begun more slowly before and ended abruptly with debt and inflation."

Today the process is also being accelerated - by wars where the end is as elusive as the enemy and by a consumerism built on a property bubble. Perhaps we will not have to wait until 2050. In my lifetime, the dollar will start to lose its reserve currency status, not to the euro but to the renminbi or the rupee. This would clearly have massive economic and geopolitical consequences. As Persaud rightly says: "If it was economically and politically painful for the UK, even though its international financial position did not begin from a position of heavy deficit, what will it be like for the US which has become the world's largest debtor. There will be an avalanche of cheques coming home to be paid when the dollar begins to lose its status."

And this "avalanche of cheques" is likely to make for the most horrendous geo-political tension. The idea that the US will give up global financial hegemony without a fight seems fanciful in the extreme.