Will the Giant Fall?

The US economy is the world’s largest national economy, with a recorded GDP of $14.2 trillion or 22.99% of the world economy, according to World Bank. Thus, there was a common belief amongst US leadership that America, as the world’s largest economy, is too big to fail despite facing huge fiscal deficit of $14.3 trillion. Is that real? Or just an illusion?  Are the Americans aware of the vicious threats?

The US inflation rate rose to 3.6% in May, the highest since July 2009. However, there is some good news. Gasoline prices have slipped by almost 10% since reaching a three year high at the start of May which should give US consumers a small boost.

The rise in inflation has been more painful because the majority of Americans have not enjoyed pay rises since the crisis of 2008.

Hopes that 2011 would see the US recovery strengthen have so far been dashed as high gasoline and food prices erode the spending power of millions of Americans.

A plunge of one third off the price of the average American home from the peak reached in 2006 has impacted US consumers as house prices are the yardstick most Americans use as a measurement of their financial well-being. Housing accounts for a substantial part of the US gross domestic product, and a three-year slump in prices wiped out trillions of dollars in homeowner equity. A new tax incentive for home purchasing was introduced by US government in 2009 to spur the market, but the volume of sales has retreated since it expired.

However, house prices were helped by the start of spring selling season increasing by 0.7%, according to the Standard & Poor’s/Case-Shiller index of 20 metropolitan areas. Nonetheless, economists warned prices are likely to crawl along at low levels as a large number of homes come up for sale at bargain prices. Moreover, consumers were still pessimistic about the current house market outlook because of worries about labour market and income prospects.

Unemployment is a major problem to the US economy. It rose in May from 9% to 9.1%.  Based on the Fed’s forecast, the unemployment rate will stay above 8% throughout 2012. It is disappointing that the US economy only created 54,000 new jobs in May leaving 13.6m people unemployed.

The more pressing question is whether the disappointment is just the start of a worrying trend. The release of this month’s unemployment figure will begin to offer an answer.

The USA has reached its debt ceiling of $14.3trillion and Congress is required to raise the borrowing limit before 2nd August to avoid a damaging default. A combination of costly, state-funded retirement programmes, high defence spending and the financial crisis have sent America's share of debt ballooning to GDP 62% last year from 40% before the recession.

Without a budget cut agreement or an increase of taxes, the ratio will worsen.However, negotiation is going nowhere on Capitol Hill. Until Republicans and Democrats come to an arrangement on the debt ceiling we are likely to see the yields increase on US treasuries and the value of the dollar continue to decline relative to its peers.

Unlike Greece and other nations who are struggling, the US has the ability to fix its own problems. It simply lacks the political will to do so. The IMF said the US government should increase their debt ceiling to avoid a default, while cutting their spending and increasing taxes.  The IMF projects U.S. GDP growth of 2.5% in 2011 and 2.75% in 2012, with a slow decline in unemployment.  According to U.S. Treasury SecretaryTimothy F. Geithner, with long-term U.S economic growth of about 2.5%, the unemployment rate will gradually come down.