Greenspan Sees Threat in Free-Trade Curbs

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By Nell Henderson
Washington Post Staff Writer
Tuesday, June 7, 2005

Federal Reserve Chairman Alan Greenspan said yesterday that recent efforts to restrict international trade and hinder free markets represent a "truly worrisome" threat to global prosperity.

He also warned that many hedge funds -- highly leveraged private investment firms -- are pursuing high-risk and complex trading strategies that could result in significant losses. He added that he did not believe those losses would be significant enough to pose a threat to broader financial stability.

Speaking via satellite to a bankers' conference in Beijing, Greenspan did not mention specifics. But his remarks come at a time of increasing tension between the United States and China over textile trade and China's unwillingness to let its currency's value fluctuate.

Greenspan warned that he and other economic policymakers cannot always foresee and prevent financial crises. The best insurance against such events is to promote financial "flexibility and resilience," he said.

Financial "flexibility" is Greenspan's shorthand for policies that allow free markets to drive the movement of prices, interest rates, currency values, labor and investment. Such policies have made the U.S. economy highly resilient, as was clear by the way it was able to absorb the shocks of the Sept. 11, 2001, terrorist attacks, he said.

Greenspan did not comment otherwise on the health of the U.S. economy or the likely path of the Fed's interest rate policy in coming months.

But he did express concern that the U.S. and global economies could be hurt by the movement away from financial flexibility. "The recent emergence of protectionism and continued structural rigidities in many parts of the world are truly worrisome," he said.

The Bush administration and the European Union, responding to a surge in Chinese textile exports, recently imposed new limits. Beijing responded by lifting textile export tariffs that it had earlier imposed on United States- and Europe-bound goods as a goodwill gesture.

Meanwhile, the U.S. and some European governments are taking an ongoing dispute over aircraft manufacturer subsidies to the World Trade Organization. And President Bush faces an uphill battle to win congressional ratification of his proposed free-trade agreement with Central America.

Greenspan didn't spell out what he meant by "structural rigidities," but many economists would point to China's currency peg as one obvious candidate. China maintains the value of its currency, the yuan, at 8.28 per dollar, a rate many U.S. manufacturers complain is too low, unfairly boosting Chinese exports in global markets.

The Bush administration has urged China to relax its peg, stepping up the pressure recently by threatening to brand Beijing a currency "manipulator" in the future if it does not do so.

Greenspan, responding to a question after his prepared remarks, said it would be "to the advantage of the Chinese to allow a little more flexibility in its exchange rate" and added, "I'm sure it's something they will take on reasonably soon."

He also indicated he hasn't found a convincing explanation for why long-term interest rates are so low globally. The Fed has raised short-term U.S. rates steadily for nearly a year, and long-term rates typically follow. This time they have fallen, a situation he said "is clearly without recent precedent."

"Yields for both investment-grade and less-than-investment-grade corporate bonds have declined even more than Treasurys over the same period," he added.

Greenspan said this phenomenon has caused increasing numbers of investors -- often operating through hedge funds -- to take greater risks in their "search for yield," or efforts to make a bigger profit, he suggested.

"But continuing efforts to seek above-average returns could create risks for which compensation is inadequate," he said. Put more bluntly, "the hedge fund industry could temporarily shrink, and many wealthy fund managers and investors could become less wealthy."

But, he added, if banks and the others who lend money to hedge funds are managing their credit risks effectively, "this necessary adjustment should not pose a threat to financial stability."


© 2005 The Washington Post Company

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