Federal Reserve Chairman Alan Greenspan yesterday urged the federal government to reduce its budget deficit and to encourage greater personal saving, warning that foreign investors will not finance endless growth in America's huge trade gap.
Greenspan, speaking at a banking conference in Germany, repeated that he believes market forces probably will rein in the trade gap without provoking a financial crisis. But he expressed more concern about the issue than in previous remarks, saying, "We cannot become complacent."
Greenspan also made his most explicit public comments about the likelihood that interest rates are headed higher. "Rising interest rates have been advertised for so long and in so many places that anyone who hasn't appropriately hedged his position by now obviously is desirous of losing money," he said in answer to a question posed during a panel discussion at the conference, according to a transcript published by Bloomberg News.
Stocks, bond prices and the dollar all fell after Greenspan's comments, which he delivered before attending a weekend meeting of finance ministers and central bankers from a group of 20 wealthy and developing countries. The dollar initially tumbled to its lowest level against the Japanese yen in four years and dropped sharply against the euro, but it regained some ground later.
U.S. Treasury Secretary John W. Snow, on his way to the same meeting, told reporters yesterday that the dollar's recent decline will not be on the G-20's agenda. Snow has said repeatedly in recent days that financial markets should determine currency values -- comments which traders have interpreted as ruling out any kind of government intervention to halt the dollar's slide.
Greenspan's comments appeared to reinforce that impression. They "can hardly be described as an effort to prop the dollar up," according to an analysis by economists at J.P. Morgan Economic Research.
European officials, however, have expressed concern that the dollar's fall, by pushing up the euro, will stymie growth in the nations that share the common currency.
The broadest measure of the U.S. trade gap, the current account deficit, reached a record $550 billion last year and appears headed to around $650 billion this year, which would be equal to 5.7 percent of the nation's gross domestic product. That is up from less than 4 percent before 2000.
The deficit measures the shortfall in trade and investment between the United States and the rest of the world. It generally reflects how much Americans borrow from abroad to finance their spending and investment.
International investors finance the gap by using the dollars they earn through trade to buy U.S. assets, including the Treasury securities sold by the federal government to cover its budget deficit, which swelled to a record $413 billion in the fiscal year that ended Sept. 30.
Many economists have worried about what would happen to the U.S. and global economies if foreigners decided suddenly to buy fewer U.S. assets or sell off those they have. Under the worst-case scenarios, the dollar would plummet, stock prices would plunge and U.S. interest rates would soar, hurting U.S. and global economic growth.
The International Monetary Fund said earlier this year that the mounting U.S. budget and current account deficits "pose significant risks for the rest of the world."
Greenspan has appeared to downplay such concerns for many months, through speeches and remarks on Capitol Hill, by stressing that market forces should gradually resolve such trade imbalances because of increased global financial flexibility -- the ability of interest rates, stock prices, product prices and most currency exchange rates to move freely.
In his remarks yesterday, however, he sounded less sanguine, warning more forcefully that foreigners eventually will slow and possibly stop their accumulation of U.S. assets because they won't want to concentrate their risk. Alternatively, he warned, they might demand a higher return -- such as higher interest rates -- to compensate for the risk.
"Given the size of the U.S. current account deficit, a diminished appetite for adding to dollar balances must occur at some point," he said, adding that it is impossible to predict when and how this will happen. The trade deficit "cannot continue to increase forever" at the recent pace, he said.
For U.S. policymakers to help make the inevitable adjustment less painful, he said, "domestic saving must rise."
Greenspan again recommended that U.S. policymakers try to cut the record federal budget deficit, which would reduce the government's borrowing needs and effectively increase national saving.
Additionally, he said, "finding policies that would elevate the personal saving rate from its current extraordinarily low level . . . would also be helpful," he said.
Greenspan said both the United States and Europe must work to increase financial flexibility. In particular, he said, Europe should take more steps to remove restrictions on the movement of workers and cash flows across national borders, and to "enhance competition in product, labor and financial markets."