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Just about everyone is worrying about the tanking dollar and theenormous U.S. trade deficit. So it's high time for Alan Greenspan, thenation's central banker, to step in and tell us how we might deal with the wilting greenback.
Instead, the Fed chairman has made a speech that will go down as the one of most flagrant pieces of self-serving tripe in financial history.
The markets slumped after taking in the speech, because investors thought they detected real alarm and concern about America's deficits in Greenspan's comments. But a close reading of the text betrays something far more serious that will steadily eat away at investors' confidence in this country and its currency. The problem starts with easy credit and Greenspan's refusal to acknowledge its many side effects.
The speech, given last Friday at the European Banking Congress in Frankfurt, clearly shows that Greenspan is refusing to deal with the root cause of the dollar's slide because his policies are the main reason for its decline. Now it very much appears that Greenspan will pull up short of doing what's necessary to fix the current account deficit, because it would mean admitting that he's created the mess that led to the blowout trade deficit.
Since Greenspan almost never admits he's wrong, the Fed -- under himor one of his acolytes (he's
likely to retire in early 2006) -- almost certainly isn't going to change course. This makes it increasingly likely that America will be laid low bythe mother of all currency crises before long. It's incredible tothink that in a governmental system known for its checks and balances,the pride of one man could cause the fall of the world's largesteconomy. But that's what we're looking at here, going by the centralbanker's Friday speech.
Greenspan couldn't wait much longer to give this speech, with thedollar having fallen to all-time lows against the euro -- the Europeancurrency climbed to $1.31 Tuesday -- and with the currentaccount deficit at a record 5.7% of GDP in the second quarter (themost recent number available).
Clearly, the Fed chairman had to give the appearance of concern inthis speech, or else the market would have reacted twice as badly asit did. And Greenspan's worry was what captured the headlines.
Quoted just about everywhere were these words of his: "Current accountimbalances, per se, need not be a problem, but cumulative deficits,which result in a marked decline of a country's net internationalinvestment position -- as is occurring in the United States -- raise morecomplex issues." At first glance, that comes across as opaque central-bank speak, but it's Greenspan's way of saying that it is clearly aproblem if America has to keep on borrowing larger and larger sumsfrom foreigners to pay for the consumption and investment the U.S.hasn't got the savings to finance.
But the rest of the speech was artful dissembling. To see why, wemust recognize what has led us to the mess we're in. The current accountdeficit has grown to a grotesque size and become such a worry to theworld because Americans are consuming beyond their means. They'redoing that on easy credit. And the reason that credit has been so easyis that Greenspan has kept interest rates at artificially lowrates.
Haste Makes Waste
Current account deficits are not so much to be feared when foreignersare pouring investment dollars into the U.S. After all, that helps makeAmerican companies more productive, which means in the future they'llhave the means to pay back the foreign financing.
That just isn't happening now. American companies have a small surplusof savings. But for the first time in decades, it is households thatare in deficit, points out Paul Kasriel, chief economist at NorthernTrust. (By deficit he means personal income minus expenditures onconsumption and residential investment.) In addition, the governmentalso has a deficit that has been mainly created by sharply higherdefense, education and health care spending under Bush.
As a result, America is borrowing from abroad to financespending by individuals and the government. Spending by these two addsalmost nothing to the productivity of the economy, and that means Americais less likely to generate the extra returns needed to repay foreignfinancing. The large inflows of foreign capital should not be seen asa vote of confidence in the U.S. economy by foreign entrepreneurs. Norshould they be seen as evidence that foreigners are happy to financethe deficit.
That's because foreign central banks have been doing a large portionof the buying, and they are only parking the dollars that have floodedinto their reserves as America sucks in goods and services fromabroad.
In the 12 months ending Sept. 30, foreign nonprivate net purchases ofU.S. Treasuries totaled $214 billion, compared with $78 billion in thesame period ending Sept. 30, 2003. By contrast, private foreignpurchases of Treasuries inched up to $167 billion from $162billion over the same period.
In his speech, Greenspan says this: "Even considering heavypurchases by central banks of U.S. Treasury and agency issues, we seeonly limited indications that the large U.S. current account ismeeting financing resistance." But notice that Greenspan gives nonumbers to make his case there. And it is absolutely the case that,without those central-bank purchases, the dollar would be a lot lowertoday.
Christmas in July
Greenspan did sort of acknowledge the two main causes of this problem: the fiscal and household deficits. He's been a fiscal conservativefor a long time, so he's being consistent in his speech when he callsfor a budget surplus. But when it comes to the unprecedented anddeeply harmful household deficit, Greenspan merely tosses in thisline: "Significantly increasing private saving in the United States ... ofcourse would also be helpful." Absolutely no mention of the Fed's rolein giving people an incentive to borrow like never before and run down thesavings rate to current low levels.
Greenspan then says that he has faith in the markets to restore asustainable U.S. balance of payments without crisis, citing a Fedpaper that supposedly shows this happening in many Western countriessince 1980. Problem is, many of the Western countries included in thatpaper did go through wrenching economic slowdowns in order to cuttheir trade deficits. What's more, very few of them had the sort ofdebt levels America now has, and likely none of them had interestrates as low as they are now in the U.S.
In other words, rates in the U.S. are going to have to go up in any adjustment -- and the impact on the debt mountain could be horrible. Indeed, during the last big current account adjustment in the U.S.rates rose sharply, prompting the 1987 stock market crash.
Greenspan also argues that because the U.S. economy hasn't skidded badly since 2001 in face of many shocks, it is strong enough to withstand a current account adjustment. But the main reason the Americaneconomy muddled through is that Greenspan slashed rates and shoredthings up with cheap credit. But it is that cheap credit that hascaused the current account deficit to balloon. Take it away, and thecurrent account deficit will decline -- but the economy will also stopin its tracks and debt defaults will be rampant.
In his speech, Greenspan asserts that "inducing recession to suppressconsumption" is not a long-term solution. But it looks like the onlyone left -- because of him.
In keeping with TSC's editorial policy, Peter Eavis doesn't own or short individual stocks. He also doesn't invest in hedge funds or other private investment partnerships. He welcomes your feedback and invites you to send any to