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Dollar and markets dive on greenspan warning { November 20 2004 } Original Source Link: (May no longer be active)
http://www.sfgate.com/cgi-bin/article.cgi?file=/c/a/2004/11/20/MNGG49UVFB1.DTLhttp://www.sfgate.com/cgi-bin/article.cgi?file=/c/a/2004/11/20/MNGG49UVFB1.DTL
Dollar, markets dive on Greenspan warning
Trade gap and deficit hurting U.S., he says
- Tom Abate, Chronicle Staff Writer
Saturday, November 20, 2004
Federal Reserve Chairman Alan Greenspan delivered a blunt warning Friday that foreign investors might get sick of subsidizing the nation's widening trade and budget deficits, remarks that caused U.S. financial markets to tremble.
Greenspan's comments, delivered before an audience of central bankers in Frankfurt, Germany, sent the dollar near its record low against the euro, Europe's common currency. The three leading U.S. stock indexes each dived more than 1 percent, and long-term bond yields rose, making borrowing more expensive.
What rattled markets was Greenspan's warnings about the U.S. current account deficit, a broad measure of dollars Americans send abroad and foreigners send back to the United States. Most of the gap is made up of the trade deficit, the imbalance between the goods and services Americans import and what the nation sells abroad.
According to current account calculations, the United States went into hock by a record of more than $540 billion in 2003 and is on track to pass $600 billion in 2004 -- a deficit that, so far, largely has been underwritten by foreigners who send investment dollars back into this country. Much of those returning dollars have gone to buy U.S. government debt, helping finance the other gaping deficit in the U.S. economy -- the federal budget shortfall.
Greenspan Friday raised the question of how long that would go on. The Fed chief said foreign investors might grow wary of holding U.S. stocks, bonds and other investments, suggesting that could drive down demand for dollars.
"Given the size of the U.S. current account deficit, a diminished appetite for adding to dollar balances must occur at some point,'' the Fed chief told his audience.
If foreigners become less willing to lend to the United States, interest rates will have to rise to attract new money to finance the national debt, said Nariman Behravesh, an economist with the forecasting firm Global Insight in Massachusetts.
"That could affect borrowing costs in general, which is why people should care,'' he said.
In a sense, Greenspan said nothing new Friday. Richard Meese (pronounced Macy), a managing director at San Francisco's Barclays Global Investors, one of the world's largest money managers, said Greenspan and other Fed officials had been warning for months now that the nation -- as well as consumers -- was borrowing too much and saving too little.
"What he's saying is that the nation's balance sheet is out of whack, and the family balance sheet is out of whack,'' Meese said.
In his remarks Friday, Greenspan repeated the two-pronged prescription for fiscal health that Fed officials have long been preaching: reduce the federal deficit -- thus the need for borrowing -- and boost personal savings, so the United States would depend less on foreign investors for whatever borrowing must occur.
"Reducing the federal budget deficit (or preferably moving it to surplus) appears to be the most effective action that could be taken,'' Greenspan said, adding, "Significantly increasing private saving ... from its current, extraordinarily low level, of course would also be helpful.''
Greenspan spoke two days after Treasury Secretary John Snow told a London audience that the United States would not help European banks intervene to halt the dollar's slide against the euro.
The falling dollar has helped make U.S. exports to Europe cheaper but has hurt European exporters, especially because leading Asian nations, notably China, have so far not let their currencies rise against the dollar. Foreign central banks, particularly in Asia, have been major buyers of the dollar, helping to prop up the greenback in order to keep Americans buying their exports.
Meese said it was unusual for Fed officials to make remarks that might affect the value of the dollar, which is traditionally the Treasury secretary's bailiwick. Greenspan must have understood that his remarks would focus attention on the reasons for the dollar's weakness, he noted, speculating that the Fed chief used the European forum to emphasize the urgency of curbing the federal deficit.
"There's just no plan on the table,'' Meese said.
Economist Irwin Stelzer with the conservative Hudson Institute in Washington, D.C., described himself as a Bush supporter who is nevertheless critical of the administration's belief that the economy will grow speedily and strongly enough to curb the budget deficit by increasing the flow of revenues into federal coffers, a central tenet of what is called supply-side economics.
"The neoconservative faction of the Republican Party does not believe the federal deficit is a problem,'' Stelzer said. "They have imbibed this supply- side notion to the point of inebriation.''
In an interview with Bloomberg News, Sen. Richard Shelby, the Alabama Republican and chairman of the Senate Banking Committee, said cutting the deficit "would be the right signal."
"What we need to do in the Congress is put some spending caps and walls and separate some things that are essential and nonessential," Shelby said.
Jim Paulsen, chief investment strategist with Wells Capital Management, offered a theory that Greenspan, who knows his utterances have worldwide ripple effects, might have wanted to nudge the bond market. Recent inflation reports have shown a price spike. Paulsen speculated that the Fed chief might have wanted to make long-term debt a bit more expensive to cool demand, thus helping the Fed fight inflation.
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What Greenspan said
A summary of statements Friday by Federal Reserve Chairman Alan Greenspan:
-- Every year, the United States imports some $600 billion more in goods and services than the nation sells abroad. That deficit is financed as foreigners put dollars into U.S. stocks, bonds and other investments.
-- At some point, Greenspan said, foreigners will become less willing to put money into U.S. financial markets. As foreigners retreat, a series of adjustments will have to take place.
-- The value of the dollar must fall as the supply of U.S. currency in the hands of foreigners rises and the demand for dollars to fund investments in the United States drops.
-- Interest rates on government bonds and other forms of debt will climb as foreign appetite for U.S. investments falls.
-- As foreign goods and services become more expensive, Americans will consume relatively fewer imported products.
-- For adjustment to take place without a major recession, Americans will have to increase their savings to pick up the slack left as foreigners exit. The best way to build savings is to slash the federal budget deficit, thereby increasing the pool of money available for all other investments.
Source: Chronicle staff
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