Why the US Economy Still Matters

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Brendan McDermid / Reuters

Traders work on the floor of the New York Stock Exchange, January 22, 2008.

There used to be a popular idea, up until a few days ago, that the world's economies had "decoupled." The United States, though worth 29% of the planet's GDP, no longer controlled the economic fate of everyone else, the thinking went, thanks to the rise of the global consumer, Europe selling to Asia, Asia selling to Asia. And so the increasing number of signs that the U.S. was headed toward recession — falling retail sales, weak jobs numbers, a cratering real estate market — were not really so worrisome. Even if growth in the U.S. lagged, everyone else would be just fine.

Except the markets aren't taking it that way. On Monday, stock exchanges around the world swooned, from east to west, as investors, spooked by more fallout from the subprime crisis and credit crunch, failed to be reassured that a $145 billion stimulus package rolled out by the Bush Administration would do much to keep the U.S. economy afloat. The main index in Hong Kong dropped 5.5%, its biggest percentage loss since Sept. 11, 2001. India's benchmark shed 7.4%. In Europe, Britain fell 5.5%, France 6.8%, and Germany 7.2%. Brazilian stocks dropped 6.6% and Canada's main index lost 4.8%. In the U.S., markets were closed for the Martin Luther King Jr. holiday, but when they reopened on Jan. 22, the Dow industrials promptly shed 300 points, joining the sell-off that continued overseas, forcing trading to be suspended in India and South Korea.

Even before U.S. markets reopened, the Federal Reserve Board cut the federal funds rate 75 basis points, to 3.50%, "in view of a weakening of the economic outlook and increasing downside risks to growth," the Board said in a statement. It was the first time since the markets reopened after Sept. 11, 2001, that the Fed had changed the federal funds rate between scheduled meetings. The move buoyed stocks in Europe, and added to speculation that the European Central Bank and the Bank of England would also cut rates in an attempt to stave off a slowdown. In morning trading in Europe, though, stocks fell. Britain's FTSE 100 dropped 1.25%, Germany's DAX index slid 2.16%, and France's CAC-40 fell 2.10%. Markets in Asia rebounded however, with Hong Kong's Hang Seng Index rising 10.7% — its biggest gain in 10 years — and indexes in Korea, Singapore and Japan gaining more than 3 percent.

But bad news may not be over on Wall Street. On Tuesday, Bank of America announced that its fourth-quarter profit tumbled 95%, largely due to a $5.44 billion trading loss driven by write-downs of collateralized debt obligations, the often mortgage-related securities creating havoc on banks' balance sheets worldwide. Rumors circulated that the Bank of China would be the next to report big losses.

More than one commentator used the word "panic" to characterize the sell-off. Panic — as if the sudden fear might be a bit of an overreaction, a tad on the hysterical side. Should it be?

It is true that in many ways the United States does not have the global economic heft it once did. The U.S. stock market today accounts for 35% of world market cap, compared to 50% just 10 years ago. In recent times, as the American economy has slowed, other countries, such as China and Germany, which once could have been relied upon to follow, have actually continued to see growth.

But in other ways, the world's economies are more linked than ever before. Today, 45% of the revenue for S&P 500 companies comes from overseas, compared with just 30% a decade ago. Securities backed by mortgages on homes in Miami and Detroit are held by banks from Switzerland to China. So, how much does the U.S. really matter? "If the world economy were a train, we'd now have a greater number of engines pulling that train," says Sam Stovall, chief investment strategist at Standard & Poor's Equity Research. "However, the biggest engine is still the U.S., and as a result, the speed of that train depends on it."