Like Treasury Secretary John Snow,
Chairman Alan Greenspan tacitly approved a fall in the U.S. dollar Friday, saying the current account deficit is unsustainable at more than 5% of gross domestic product.
In a speech delivered at the European Banking Congress in Frankfurt, Germany, Greenspan said foreign investors eventually will tire of financing the burgeoning trade deficit and that the U.S. cannot afford to be complacent about the issue.
"It seems persuasive that, 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.
"Although we have evidence that, among developed countries, current account deficits, even large ones, have been defused without significant consequences, we cannot become complacent. History is not an infallible guide to the future."
With personal savings so low and budget deficits soaring, the U.S. has become increasingly reliant on overseas investors for funding. But foreigners won't continue to lend money to the U.S. at the rate they have in the past if debt continues to pile up, Greenspan said.
The dollar declined against the yen to its lowest level in more than four years and dropped against the euro in the wake of the speech. A falling dollar tends to reduce imports and increase exports, thus narrowing the deficit. Stocks lost ground, with the
down 105 points at 10,466 and the
off by 12 points at 1171.
So far, Greenspan said foreign demand for U.S. stocks and bonds has not fallen sharply and "we see only limited indications that the large U.S. current account deficit is meeting financing resistance."
"Yet, net claims against residents of the United States cannot continue to increase forever in international portfolios at their recent pace," he said.
Greenspan said net debt-service costs are modest right now but could "eventually become burdensome."
"A continued financing even of today's current account deficits as a percentage of GDP doubtless will, at some future point, increase shares of dollar claims in investor portfolios to levels that imply an unacceptable amount of concentration risk."
If and when demand for U.S. assets wanes, Greenspan said interest rates would have to increase or the country would be forced to import less.
"The world's financial authorities can either remain in denial and get blindsided by a dollar crash or move ahead of the markets and manage the downside," said Stephen Roach, chief economist at Morgan Stanley. "A sustained but managed weakening of the dollar is good news for the global economy and world financial markets."
Earlier this week, Treasury Secretary Snow suggested that the Bush administration wouldn't take steps to halt the dollar's slide. "The history of efforts to impose nonmarket valuations on currencies is at best unrewarding and checkered," he said.
While a slide in the dollar is considered crucial to reducing the trade deficit, Greenspan said cutting the budget deficit must be a priority.
"Reducing the federal budget deficit (or preferably moving it to surplus) appears to be the most effective action that could be taken to augment domestic saving," he said.
"Corporate saving in the United States has risen to its highest rate in decades and is unlikely to increase materially. Alternative approaches to reducing our current account imbalance by reducing domestic investment or inducing recession to suppress consumption obviously are not constructive long-term solutions."
Ashraf Laidi, chief currency analyst at M.G. Financial, said this comment is "crucial especially when the U.S. Congress last night rejected restrictions on tax cuts and spending, and raised the federal debt limit by $800 billion to $8.18 trillion."
The budget deficit hit $413 billion in fiscal 2004, according to the Congressional Budget Office. In September, it predicted that the deficit would hit $348 billion in 2005, if current laws and policies do not change.