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As the US slows, and consumers in the world's biggest economy feel the buying power of the dollar in their pocket declining, global growth will be hit hard, economists say. The greenback took yet another turn for the worse on Friday, after a survey of the US manufacturing sector showed output declining for the first time in more than three years.

Some analysts have argued that a more balanced global economy, with strong growth in Asia and Europe, means the impact of a US slowdown will be limited; but Stephen Roach, chief economist at Morgan Stanley, believes China - and in turn the rest of Asia - will follow.

'America is China's largest export market, accounting for 21 per cent of its total exports over the past five years,' he said, adding that economies such as Japan, Korea and Taiwan, which export directly to the US but also sell components to China that are assembled before being sent on to the US, will be hit.

Eurozone finance ministers have expressed alarm at the strength of the euro against the dollar, fearing that their exporters will suffer; but the European Central Bank is expected to push up interest rates by another quarter-point on Thursday, as it frets about inflation.

Despite increasing signs of weakening demand in the world's biggest economy, ECB chairman Jean-Claude Trichet has insisted the 12-member single currency zone can shrug off a US slowdown.

'The ECB's in a complete state of denial,' said Paul Mortimer-Lee, global head of market economics at BNP Paribas. 'Quite a lot depends on how Trichet plays it at the ECB press conference next week. They're hankering after raising rates again next year.'

Wall Street will also be watching Bernanke for signals of a change. The Fed has left rates on hold at 5.25 per cent since the summer, after increasing them 17 times over the previous two years as the US economy recovered from the post-dotcom downturn. Bernanke sought to reassure the currency markets last week by stressing that the Fed is still concerned about inflation, but his words failed to stem the sell-off. 'It's as though the markets are saying, "you central bankers are worrying about inflation, we're worrying about the reality of life",' said Bloom.

Mortimer-Lee said the Fed would wait for definitive evidence before making a move. 'At the end of the tightening cycle, you know you've got an inflation problem, and it's only when the evidence is overwhelming that you move.' However, he believes that evidence will come soon: with investment in construction already falling as the housing boom turns to bust, BNP Paribas is predicting that a million jobs will be lost in the building industry alone over the coming 18 months.

Equity markets are already wobbling as investors weigh the cost of a US slowdown. Graham Turner of GFC Economics said a shake-out would raise questions about this year's merger frenzy.

'We have had an absolute monster year in terms of leveraged transactions,' he said. 'A lot of them looked quite dubious in terms of their economic value. Once the market starts to retreat, all the suspect things that went on come out of the woodwork.'

Heather Stewart

Published on 3rd December 2006, by The Observer 

Henry "Hank" Paulson, the US treasury secretary, reiterated on a visit to London that the Bush administration remained wedded to a "strong dollar" but this failed to stem the tide as dealers bet that the long-expected slump in the greenback's value had finally arrived.

In reality, though, the dollar has been falling steadily for four years. On a trade-weighted basis against a basket of other currencies, it has lost nearly 31% of its value as fears over its giant current account deficit drag on the currency.

A big deficit, caused by Americans consuming more goods from abroad than they export, theoretically pushes a currency down until imports become more expensive and exports cheaper, at which point the deficit is reduced. But the dollar has held up because big exporters to the US, such as China, have used their current account surpluses to reinvest in American assets, thus keeping demand for dollars high.

Indeed, the dollar surprised everyone in 2005 by regaining some of the losses of the previous three years and so is still not back to the lows it visited at the end of 2004, in spite of the recent falls.

A weaker dollar means a shopping bonanza for Britons. Airlines and travel firms have seen a surge in bookings as people rush to take advantage of cheap US goods that just got cheaper. The flipside, though, is for British companies such as Jaguar to get hit hard in the American market if prices in dollars rise.

About 10% of British trade is with the United States, so exporters will suffer from the stronger dollar but importers of US goods will see costs fall. Petrol prices at the pump could fall as the world's oil and oil products are priced in dollars.

Mr Paulson, former head of the US investment bank Goldman Sachs, repeated the usual mantra of US treasury secretaries that he favoured a strong dollar. "A strong dollar is clearly in our nation's interest and I feel very good today about the strength of the US economy," he said after addressing the CBI conference in London.

He was upbeat about the US economy in spite of the slowdown in growth and, in particular, the housing market. "We have a healthy economy that is making a successful transition from a rate of growth that earlier in the year was not sustainable to one that is sustainable."

Mr Paulson said again that the US sought greater flexibility from China. The US has long wanted Beijing to let its currency rise against the dollar to remove the artificial advantage that the pegged yuan gives Chinese exporters.

But data out shortly after he spoke showed that the weakness in the dollar might be more home-grown. Orders for durable goods fell unexpectedly sharply, by 8.3% in October from September, driven by big falls in civilian aircraft, computer and electronics orders.

James Knightley, of ING Financial Markets, said: "This perhaps suggests that the US economic slowdown is spreading to the corporate sector." He said the Federal Reserve, which raised rates from 1% in 2004 to 5.25% this year, may cut them again as soon as March.

But Ben Bernanke, Federal Reserve chairman, said in a speech last night that there were still inflationary forces in the US economy and hinted that the Fed may need to raise rates. That dampened hopes for an early rate cut, although Mr Bernanke noted that the weak housing market posed a downside risk to growth.

Data released yesterday showed sales of existing homes rose in October for the first time since February, to an annual rate of 6.24m homes. But the figures also showed that house prices dropped 3.5% on a year earlier - the third straight month of decline and the worst year-on-year fall since records began in 1968.

To compound American woes, the Paris-based Organisation for Economic Cooperation and Development said in its latest outlook that the US economy was slowing and would only grow by 2.4% next year after a downwardly revised prediction of 3.3% for this year.

Ashley Seager

Published 9th November 2006, by The Guardian