America’s Economy Is No. 1. That Means Trouble.

If you want a single number to capture America’s economic stature, here it is: This year, the U.S. will account for 26.3% of the global gross domestic product, the highest in almost two decades.

That’s based on the latest projections from the International Monetary Fund. According to the IMF, Europe’s share of world GDP has dropped 1.4 percentage points since 2018, and Japan’s by 2.1 points. The U.S. share, by contrast, is up 2.3 points.

China’s share is up since 2018, too. But instead of overtaking the U.S. as the world’s largest economy, the Chinese economy has slipped in size to 64% of the U.S.’s from 67% in 2018.

In other words, despite trade wars, the pandemic, inflation and societal division, the U.S. is gaining on its economic peers based on this admittedly simple metric.

A caveat: These figures are based on current prices and exchange rates. Using purchasing power parity, which adjusts for different price levels across countries, the U.S. share of world GDP would be lower and that of big emerging markets—such as China and India—much higher.

But you don’t pay for oil, iPhones or artillery shells at purchasing-power parity. Current prices and exchange rates better capture a country’s relative economic power. Moreover, currencies are barometers of economic strength, and the U.S. has outperformed its peers even after adjusting for inflation and exchange rates.

Real U.S. economic growth has been much faster than Japan’s or Europe’s in the last two years. China has grown faster, but there are reasons to suspect that its data overstates reality.

U.S. wages (adjusted for inflation) are roughly level with just before the pandemic, whereas they are lower in other advanced economies, the IMF found.

This isn’t to suggest Americans should somehow be content with stagnant real wages or high inflation just because people elsewhere are even more miserable.

Still, it’s worth studying the reasons the U.S. is outperforming. In a nutshell, there’s an encouraging reason and a worrisome one.

The encouraging reason is that structurally, the U.S. continues to innovate and reap the rewards, judging by big-tech stocks and artificial intelligence adoption. The U.S. has done better at boosting productivity (output per worker).

It has also benefited from what economists call its terms of trade: The price of what it exports, notably natural gas, has risen more than the price of what it imports. In Europe, the opposite has happened.

The second, more worrisome, reason for stronger U.S. growth is government borrowing—including former President Donald Trump’s 2018 tax cut, bipartisan Covid-19 relief in 2020 and President Biden’s 2021 stimulus.

In fact, Washington continues to inject stimulus, albeit not with that label: hundreds of billions of dollars for veterans’ benefits, infrastructure, semiconductor manufacturing and renewable energy.

U.S. deficits have run roughly 2% of GDP higher than the IMF expected back in late 2022. They will be the highest, by far, among major advanced economies for the foreseeable future.

In the long run, deficits inflate future interest bills and crowd out private investment. But they might be leading to dangerous imbalances right now.

Deficits were justified when unemployment was high, private demand moribund and inflation and interest rates low. None of that is true now.

Instead, Biden and Congress continue to stoke demand in an economy that already has plenty. Through February, Biden had canceled $138 billion in student debt—and he has just unveiled plans to erase billions more—which directly boosts debtors’ purchasing power. Of the $95 billion in aid to Ukraine, Taiwan and Israel just approved by Congress, $57 billion will flow back to U.S. producers in the form of more weapons purchases.

It’s one reason inflation, though down from a year ago, has stalled above the Federal Reserve’s 2% target. The IMF thinks core inflation (which excludes food and energy) is a half percentage point higher than otherwise would be because of fiscal policy.

This, in turn, is keeping the Fed from cutting short-term interest rates. That, along with the flood of Treasury debt to finance the deficit, is pushing up long-term bond yields.

Textbooks predict that a combination of tight monetary and loose fiscal policy will suck in capital from overseas and drive up the dollar. That has often precipitated financial crises in emerging markets as exchange rates are devalued, governments default and banks fail.

The dollar has, indeed, risen this year. It hasn’t undermined emerging markets, which are generally in better shape than in previous crisis eras, though the risk bears watching. It might, however, destabilize the international economy another way: through protectionism.

In 1971, high U.S. inflation and government deficits led to an overvalued dollar and trade deficits. After the Nixon administration imposed a 10% surcharge on imports, West Germany and Japan agreed to revalue their currencies against the dollar.

In 1985, the script repeated: Higher U.S. interest rates and budget deficits had driven up the dollar and trade deficit. At New York’s Plaza Hotel that September, the Reagan administration persuaded Japanese and European officials to boost their currencies against the dollar. It followed with trade actions against Japan, in particular on autos and semiconductors.

The dollar hasn’t risen nearly as much now as it did in 1985, yet similar frictions are emerging. The Biden administration badly wants to boost American manufacturing, in particular of electric vehicles, and is watching with dismay as China, aided by a weaker yuan, floods the world with cheap exports. The U.S. trade deficit, after shrinking through most of last year, is growing again.

The macroeconomic solution would be for the U.S. to stimulate its economy less and China to stimulate its economy more. Neither seems likely. And unlike in 1971 and 1985, when West Germany and Japan felt compelled to raise their currencies to mollify the U.S.—their ally and protector—China feels no such obligation.

The result will almost certainly be more protectionist pressure. Biden is already planning higher tariffs on China. If Trump returns to the White House, expect no action on the deficit and, if his first term is a harbinger, more tariffs and a push to weaken the dollar.

The U.S. economy might still be king, but the reign will not be harmonious.

Write to Greg Ip at [email protected]