IMF BOMBSHELL: AGE OF AMERICA NEARS END

This is pretty amazing. Most people aren’t prepared for this. They aren’t even aware it’s that close.

By Brett Arends, MarketWatch

April 25, 2011, 6:31 p.m. EDT

The International Monetary Fund has just dropped a bombshell, and nobody noticed.

For the first time, the international organization has set a date for the moment when the “Age of America” will end and the U.S. economy will be overtaken by that of China.

According to the latest IMF official forecasts, China’s economy will surpass that of America in real terms in 2016 — just five years from now. And it’s a lot closer than you may think.

Put that in your calendar.

It provides a painful context for the budget wrangling taking place in Washington right now. It raises enormous questions about what the international security system is going to look like in just a handful of years. And it casts a deepening cloud over both the U.S. dollar and the giant Treasury market, which have been propped up for decades by their privileged status as the liabilities of the world’s hegemonic power.

According to the IMF forecast, whomever is elected U.S. president next year — Obama? Mitt Romney? Donald Trump? — will be the last to preside over the world’s largest economy.

Most people aren’t prepared for this. They aren’t even aware it’s that close.

Listen to experts of various stripes, and they will tell you this moment is decades away.

The most bearish will put the figure in the mid-2020s.

China’s economy will be the world’s largest within five years or so.

But they’re miscounting. They’re only comparing the gross domestic products of the two countries using current exchange rates.

That’s a largely meaningless comparison in real terms. Exchange rates change quickly. And China’s exchange rates are phony. China artificially undervalues its currency, the renminbi, through massive intervention in the markets.

The comparison that really matters

The IMF in its analysis looks beyond exchange rates to the true, real terms picture of the economies using “purchasing power parities.” That compares what people earn and spend in real terms in their domestic economies.

Under PPP, the Chinese economy will expand from $11.2 trillion this year to $19 trillion in 2016. Meanwhile the size of the U.S. economy will rise from $15.2 trillion to $18.8 trillion. That would take America’s share of the world output down to 17.7%, the lowest in modern times. China’s would reach 18%, and rising.

Just 10 years ago, the U.S. economy was three times the size of China’s.

Naturally, all forecasts are fallible. Time and chance happen to them all. The actual date when China surpasses the U.S. might come even earlier than the IMF predicts, or somewhat later. If the great Chinese juggernaut blows a tire, as a growing number fear it might, it could even delay things by several years. But the outcome is scarcely in doubt.

We have lived in a world dominated by the U.S. for so long that there is no longer anyone alive who remembers anything else. America overtook Great Britain as the world’s leading economic power in the 1890s and never looked back.This is more than a statistical story. It is the end of the Age of America. As a bond strategist in Europe told me two weeks ago, “We are witnessing the end of America’s economic hegemony.”

And both those countries live under very similar rules of constitutional government, respect for civil liberties and the rights of property. China has none of those. The Age of China will feel very different.

WILL THE AGE OF AMERICA END IN 2016?

From Peter Shadbolt for CNN

April 26, 2011 2:41 a.m.

Is the Age of America drawing to a close? According to the International Monetary Fund (IMF), its demise as the leading economic power is five years away and the next president of the United States will preside over an economy that plays second fiddle to China's.

The lender posted data on its World Economic Outlook that puts 2016 as Year Zero for China as the world's dominant economic power -- the year when China's growth trajectory intersects the decline of the U.S.'s share of world gross domestic product in terms of purchasing price parity.

According to the figures, the Chinese economy would grow from $11.2 trillion in 2011 to $19 trillion in 2016. Over the same period, the U.S. economy will rise from a dominant $15.2 trillion to a trailing $18.8 trillion.

But, as the saying goes, statistics are often used like a drunken man uses a lamp-post -- for support rather than illumination. An analyst at the IMF said in a statement much hinges on whether economic size is measured by purchasing power parity -- what your money can actually buy on the ground in any given economy, the basis of the famous "Big Mac" index -- or GDP at market rates -- which is measured by converting the national currency into a common currency (normally the U.S. dollar) and measuring how much is flowing through the economy.

The IMF projects U.S. GDP in dollars will be $15.2 trillion this year while China's will be $6.5 trillion, rising to $18.8 trillion and $11.2 trillion respectively by 2016. Under this measure, the US looks likely to stay the world's No. 1 economy if current growth rates are maintained.

"The IMF considers that GDP in purchase-power-parity (PPP) terms is not the most appropriate measure for comparing the relative size of countries to the global economy, because PPP price levels are influenced by non-traded services, which are more relevant domestically than globally," the IMF said.

"The Fund believes that GDP at market rates is a more relevant comparison. Under this metric, the U.S. is currently 130% bigger than China, and will still be 70% larger by 2016."

Nevertheless, the PPP index still has its fans, with some contending that China could be even stronger than it appears on paper thanks to the current artificially suppressed level of its currency.

"China actively suppresses the renminbi on the currency markets through massive dollar purchases. As a result the renminbi is deeply undervalued on the foreign-exchange markets. Just comparing the economies on their exchange rates misses that altogether," said MarketWatch columnist Brett Arends.

"Purchasing power parity is not a perfect measure. None exists. But it measures the output of economies in terms of real goods and services, not just paper money. That's why it's widely used to compare economies. The IMF publishes PPP data. So does the Organisation for Economic Co-operation and Development (OECD). Many economists rely on them," he said.

While the slope of the graph is declining for the U.S. and rising for China, reports of the death of the U.S. economy look certain to be greatly exaggerated and could still be many decades away.

Other measures such as per capita income as a proportion of GDP still sees the United States many years ahead of China and other readings that measure social and structural problems could still see the Chinese juggernaut blow a tire yet.

WHY THE DOLLAR'S REIGN IS NEAR AND END

For decades the dollar has served as the world's main reserve currency, but, argues Barry Eichengreen, it will soon have to share that role. Here's why—and what it will mean for international markets and companies.

Wall Street Journal's David Wessel sits down with three senior experts in international finance - Edwin M. Truman, Joseph E. Gagnon and Eswar Prasad - for a discussion on the major issues facing currencies and the global economy.

The single most astonishing fact about foreign exchange is not the high volume of transactions, as incredible as that growth has been. Nor is it the volatility of currency rates, as wild as the markets are these days. Instead, it's the extent to which the market remains dollar-centric.

The greenback, in other words, is not just America's currency. It's the world's. But as astonishing as that is, what may be even more astonishing is this: The dollar's reign is coming to an end. I believe that over the next 10 years, we're going to see a profound shift toward a world in which several currencies compete for dominance.

The impact of such a shift will be equally profound, with implications for, among other things, the stability of exchange rates, the stability of financial markets, the ease with which the U.S. will be able to finance budget and current-account deficits, and whether the Fed can follow a policy of benign neglect toward the dollar.

The Three Pillars

How could this be? How could the dollar's longtime most-favored-currency status be in jeopardy?

First, its allure reflects the singular depth of markets in dollar-denominated debt securities. The sheer scale of those markets allows dealers to offer low bid-ask spreads. This makes the dollar the most convenient currency in which to do business for corporations, central banks and governments alike.

Second, there is the fact that the dollar is the world's safe haven. In crises, investors instinctively flock to it, as they did following the 2008 failure of Lehman Brothers. This tendency reflects the exceptional liquidity of markets in dollar instruments, liquidity being the most precious of all commodities in a crisis. It is a product of the fact that U.S. Treasury securities, the single most important asset bought and sold by international investors, have long had a reputation for stability.

Finally, the dollar benefits from a dearth of alternatives. Other countries that have long enjoyed a reputation for stability, such as Switzerland, or that have recently acquired one, like Australia, are too small for their currencies to account for more than a tiny fraction of international financial transactions.

What's Changing

First, changes in technology are undermining the dollar's monopoly. Not so long ago, there may have been room in the world for only one true international currency. Given the difficulty of comparing prices in different currencies, it made sense for exporters, importers and bond issuers all to quote their prices and invoice their transactions in dollars, if only to avoid confusing their customers. Now, however, nearly everyone carries hand-held devices that can be used to compare prices in different currencies in real time.

Second, the dollar is about to have real rivals in the international sphere for the first time in 50 years. There will soon be two viable alternatives, in the form of the euro and China's yuan.

Americans especially tend to discount the staying power of the euro, but it isn't going anywhere. Contrary to some predictions, European governments have not abandoned it. Nor will they. They will proceed with long-term deficit reduction, something about which they have shown more resolve than the U.S. And they will issue "e-bonds"—bonds backed by the full faith and credit of euro-area governments as a group—as a step in solving their crisis. This will lay the groundwork for the kind of integrated European bond market needed to create an alternative to U.S. Treasurys as a form in which to hold central-bank reserves.

China, meanwhile, is moving rapidly to internationalize the yuan, also known as the renminbi. The last year has seen a quadrupling of the share of bank deposits in Hong Kong denominated in yuan. Seventy thousand Chinese companies are now doing their cross-border settlements in yuan. Dozens of foreign companies have issued yuan-denominated "dim sum" bonds in Hong Kong. In January the Bank of China began offering yuan-deposit accounts in New York insured by the Federal Deposit Insurance Corp.

Admittedly, China has a long way to go in building liquid markets and making its financial instruments attractive to international investors. We Westerners have underestimated China before. We should not make the same mistake again.

Finally, there is the danger that the dollar's safe-haven status will be lost. Foreign investors—private and official alike—hold dollars not simply because they are liquid but because they are secure. The U.S. government has a history of honoring its obligations, and it has always had the fiscal capacity to do so.

But now, mainly as a result of the financial crisis, federal debt is approaching 75% of U.S. gross domestic product. Trillion-dollar deficits stretch as far as the eye can see. And as the burden of debt service grows heavier, questions will be asked about whether the U.S. intends to maintain the value of its debts or might resort to inflating them away.

U.S. Impact

In this new monetary world, moreover, the U.S. government will not be able to finance its budget deficits so cheaply, since there will no longer be as big an appetite for U.S. Treasury securities on the part of foreign central banks.

Nor will the U.S. be able to run such large trade and current-account deficits, since financing them will become more expensive. On the other hand, the next time the U.S. has a real-estate bubble, we won't have the Chinese helping us blow it.

Dr. Eichengreen is the George C. Pardee and Helen N. Pardee professor of economics and political science at the University of California, Berkeley. His new book is "Exorbitant Privilege: The Rise and Fall of the Dollar and the Future of the International Monetary System." He can be reached at reports@wsj.com.