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Updated from 3:34 p.m. EST

"Seems like that guy singing this song has been doing it for a long time -- is there anything he knows that he ain't said?"


Falling from Above,

Neil Young

During his 17-year tenure,

Federal Reserve

Chairman Alan Greenspan has gotten credit for rescuing the economy many times, including after the 1987 stock market crash, the Russian debt default, the popping of the Internet bubble and the terrorist attacks on 9/11. This week saw a lengthy two-part profile highlighting some of those achievements in

The Wall Street Journal


On Friday, Greenspan was back on the lecture circuit, trying to shoot down the latest possible threat to U.S. economic stability: a dollar crash.

Speaking at the European Banking Congress in Frankfurt, Greenspan acknowledged that the U.S. couldn't count on the world's munificence forever. Thank to the U.S. consumer's appetite to buy exports with borrowed funds and the government's inability to balance its budget, the country is running up a record current account deficit. Foreign investors are plugging the gap to the tune of $2.6 billion a day.

That situation can't continue indefinitely, Greenspan said. "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. A diminished appetite

could in theory

result in a falling dollar, which would stoke inflation and require much higher interest rates.

The markets didn't take too kindly to Greenspan's speech, ending a three-week winning streak. For the week, the

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Dow Jones Industrial Average

was down 0.8% to 10,456.91, the

S&P 500

lost 1.2% to 1170.34, and the

Nasdaq Composite

dropped 0.7% to 2070.60.

Greenspan's remarks overshadowed a busy week of corporate news, highlighted by the





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Vioxx recall;

Fannie Mae's


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Bears on Board

Not wanting to spark a panic, the Fed chairman peppered his remarks with vague statements about the unknown timing of any correction. Six times he added caveats to his prediction of a dollar decline such as "at some future point," "eventually" and "at some point."

On the risk posed to the global economy, however, Greenspan was quite clear: no risk. "Market forces should over time restore, without crises, a sustainable U.S. balance of payments," he said.

Somewhat surprisingly, frequently bearish Morgan Stanley economist Stephen Roach is in agreement with the maestro on this one.

Roach wrote Friday that the world economy was "dangerously out of balance" because the U.S. is consuming 80% of all surplus savings to finance consumer and government consumption. While noting that the situation could turn into a full-blown crisis if foreign central banks stopped buying Treasury bonds, Roach favors a scenario of gradual dollar erosion leading to more modest economic consequences in the U.S. Demand for housing, durable goods like cars and business capital spending might suffer, but there wouldn't be a free fall in stocks.

"With the dollar now back in play and depreciation proceeding at a gradual pace, there is more reason for hope than despair," he wrote. "Provided the currency shift doesn't get out of hand, a sustained but managed weakening of the dollar is good news for the global economy and world financial markets."

Of course, what's good for the world economy isn't what the Treasury market seeks. Prior to Friday, bond prices mostly rallied this week despite the weakening dollar and higher-than-expected inflation reports amid anticipation of currency intervention by Japan to prop up the yen. When the Bank of Japan makes such a move, it sells yen to buy dollars and invests the proceeds in Treasury securities.

Roach warned that government intervention opposing dollar depreciation could actually bring on the crisis scenario that otherwise could be avoided. And numerous analysts have said Japan may be content to let the yen rise at least a while longer.

Perhaps recognizing that reality, the yield on the 10-year Treasury note, which moves in opposition to its price, rose to 4.20% Friday, up 2 basis points for the week and after trading as low as 4.11% on Thursday.

Academia Unconvinced

The rosy dollar scenario has fewer adherents in academia. In a revised paper released this week, Nouriel Roubini of New York University and Brad Setser of Oxford argued that if the status quo persists, the amount of debt that the U.S. owes to outsiders could reach 28% of the size of the economy's GDP by the end of 2004 and 50% by 2008.

Although the U.S. is unlikely to default on its debt as emerging-market borrowers have in the past, drastic changes will be needed as the country runs out of credit abroad.

"The adjustment -- likely both a recession and/or a sharp fall in the dollar and/or a sharp increase in real interest rates -- needed to stabilize the U.S.' external debt-to-GDP ratio would feel like a crisis," Roubini and Setser wrote.

Some argue that the dollar will never crash because so many investors around the world are attracted to U.S. companies which are in many cases more efficient and profitable than competitors elsewhere. It's a red herring, as foreign investment in U.S. equity is but a sliver of overall foreign investment in dollars.

In 2003, for example, foreign investors liquidated a net $63 billion of equities while buying $242 billion of debt securities. And that's in large measure because the financing load has been carried more and more by foreign central banks eager to weaken their own currencies relative to the dollar to spur exports. Central banks held $934 billion of the $3.4 trillion of Treasuries outstanding at the end of 2003 and are projected to own $1.2 trillion of $4.3 trillion at the end of this year.

It's a trend that can't continue to keep up with U.S. borrowing needs even if the foreign central banks wanted to continue their currency manipulations. China and Japan would have to add $350 billion a year for the next four years to keep the U.S. afloat, Roubini and Setser wrote.

Greenspan didn't offer much policy advice in his speech Friday except a throwaway line that the government ought to reduce its budget deficit.

Before he steps down in 2006, maybe he'll reveal if there's any more he knows that he ain't said.

Then again, the current dollar crisis can in many ways be tracked back to Greenspan's constant decision to add liquidity after economic shocks, as

Street Insight

contributor Allen Gillespie noted on Friday. All those interest rate cuts helped fuel the Internet bubble and the long-running rallies that continue in bonds and housing.

In keeping with TSC's editorial policy, Pressman doesn't own or short individual stocks. He also doesn't invest in hedge funds or other private investment partnerships. He invites you to send

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