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Guess who's spending again?

Michael Collins  |  17 Feb 2016Text size  Decrease  Increase  |  

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Michael Collins is an investment commentator at Fidelity Worldwide Investment. This is a financial news article to be used for non-commercial purposes and is not intended to provide financial advice of any kind.

 

Nine years after the last increase, seven years after zero was reached and two years since quantitative easing was abandoned, recent history's most awaited rate rise occurred.

The Federal Reserve raised the US cash rate to all of 0.25 per cent in December, and such is the importance of this central bank that the anticipated consequences of this decision were noticeable long beforehand.

A looming Fed rate increase sucked in capital from the rest of the world, (thereby boosting the US dollar, the world's reserve currency) and boosted shorter-dated US bond yields, which are the benchmark for global credit markets.

It was even behind the "taper tantrum" of 2013. So why does the Fed (and the US dollar) loom over the world to such a great extent?

Part of the answer is that the US is the world's biggest economy. The US' output of US$17.4 trillion (A$24 trillion) in 2014 was about four times the size of Japan's by way of comparison. But add the 28 EU members together and the EU economy is larger, at US$18.5 trillion in 2014.

Yet the European Central Bank, which covers the 19 euro-using countries plus other EU members indirectly as they have currencies tied to the euro, is well behind the Fed on influence.

China's economy is bigger than the US' in purchasing-power-parity terms, which is the fairest way to compare countries. It's US$18.01 trillion for China versus US$17.4 trillion for the US in 2014, yet there are far fewer People's Bank of China watchers.

The complete answer to the question of why the Fed dominates over other central banks (and the US dollar over other currencies) is that the US citizen is the world's "consumer of last resort".

This term, which sounds silly taken literally, acknowledges the importance of the US consumer to the global economy ever since the US became the world's largest economy in 1916. US GDP is about 68 per cent consumption, which is a bigger number than for other large economies.

Chinese consumers, for instance, only power 37 per cent of China's economy, while EU consumers only drive 57 per cent of EU output and the ratio is 60 per cent for Japan.

Given the size of the US economy to the world economy, the US consumer is responsible for about one-fifth of global output. Thus, US consumer spending is a key determinant of global growth.

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