Greenspan Has a Faulty View of the Landing

That royalty would run forever unless we export more and consume less. And given the way global trade policies work, Buffett concludes, massively expanding U.S. exports isn't likely. Hence, paying off this royalty would require a huge decline in U.S. consumption, Buffett says, with all sorts of nasty consequences for the global economy and the lives of U.S. workers and retirees. Don't pay it off and the already-projected squeeze on such frills as health care and education spending just gets worse.

Greenspan: The Landing Is Soft

Don't worry, Greenspan says. We're headed for a soft landing. Foreigners will continue to send us their savings without demanding a huge increase in U.S. interest rates. Market forces -- a fall in the price of the dollar and a consequent rise in U.S. exports and a drop in imports -- will gradually defuse the potential bomb represented by the huge increase in the U.S. trade deficit.

What's his logic?

Because the federal budget deficit, the run-up in consumer debt, projections of huge future retirement liabilities and the buildup in the trade deficit haven't resulted in the expected crisis to date -- and, in fact, haven't even produced the big projected hike in U.S. interest rates or a crash in the dollar -- something must be different this time. "Has something fundamental happened to the U.S. economy that enables us to disregard all the time-test criteria for assessing when economic imbalances become worrisome?" Greenspan asks.

Answering his own question, it's the increasing globalization of capital markets that has made all the difference. What Greenspan calls the "home bias" that kept investors' money in their national financial markets has eased so that investors seeking higher returns or diversification have sent more of their savings overseas. And the U.S. has been the prime beneficiary of that trend. (As you'd expect from Greenspan, he has data to support his belief in a decline in home bias: One measure of the propensity to invest at home for the developed countries representing four-fifths of world GDP has declined to 0.8 in 2003 from 0.97 in 1990.)

The Problems With Greenspan's Theories

I have two problems with Greenspan's formulation. First, as Greenspan admits, a change in home bias doesn't solve the U.S. current account deficit; it just delays the reckoning. But because economists don't really know -- and can't reliably project -- the lag between trade deficits and deficit corrections, we don't really have any idea whether we are currently just in the lag period for a business-as-usual correction of the trade deficit, or whether we've entered some unspecified lag period created by Greenspan's increasingly global financial markets.

It's an interesting theory. But as a guide to investing strategies, it leaves me completely without a road map or time line.