Saturday, November 20, 2004

Deficits may repel foreign investors

The Atlanta Journal-Constitution

MICHAEL E. KANELL, Staff

Federal Reserve Chairman Alan Greenspan roiled financial markets Friday, saying a widening U.S. trade deficit could scare off foreign investors and dampen the U.S. economy.

Greenspan's remarks from Europe echoed across the Atlantic: The Dow Jones industrial average fell more than 100 points, the price of bonds dropped and the dollar fell to a near-record low against the euro.

U.S. exports now are lagging imports at a record annual pace of more than $600 billion. Economists have been sounding alarms about the gap for more than a decade, but Greenspan's words were taken as fair warning by America's monetary policy chief.

"That's why the markets reacted the way they did," said Mark Weisbrot, co-director of the Center for Economic and Policy Research. "Stocks, bonds and currency all went down. He hit the trifecta."

Greenspan's comments were an implied embrace of a weaker dollar, despite official government support for a strong dollar. A weak dollar effectively eases any trade deficit by boosting U.S. exports and making imports more expensive.

The effect of Greenspan's speech was amplified by his forum: a conference of European bankers in Germany. The Europeans already have complained about the dollar's value falling to levels that make their products too expensive in the United States.

The dollar Friday fell to its lowest level in four years against the Japanese yen. Against the Euro, the dollar slipped, too, approaching a new low.

While noting that the trade deficit has been widening for some time, Greenspan warned against "complacency."

Foreign investors have made up much of the trade gap by buying bonds and U.S. Treasuries, in effect making a loan to American companies and taxpayers. That money helps pay for consumption and investments.

Foreign investment also bridges the gap between federal spending and tax revenues, in effect allowing the U.S. government to run a budget deficit.

But the arrangement depends on foreign banks and investors continuing to put their money here, and there are limits to that willingness, Greenspan said.

To keep their money, the United States may have to offer higher interest rates.

"Current account imbalances, per se, need not be a problem, but cumulative deficits, which result in a marked decline of a country's net international investment position --- as is occurring in the United States --- raise more complex issues," Greenspan said.

America should cover more of its own investments, Greenspan said, by borrowing less and saving more.

And the way to do that is to deal with the other threatening deficit --- the red ink of the federal budget.

Yet Greenspan was hardly counseling panic, said Dorsey Farr, senior economist for Wilmington Trust in Atlanta. "There are a lot of alarmists out there. I don't want to say the deficit cannot be a problem, but I think it's unlikely." Popping the bubble

The trade deficit is largely a matter of how markets work, said Farr. "It's a result of me and you buying Hondas and Sonys instead of Fords and RCA."

A growing number of economists have come to see the trade gap as unsustainable, although they disagree on the urgency of the problem.

But the economy is vulnerable, Weisbrot said. "When the dollar falls, there will be an increase in long-term interest rates, and that could pop the housing bubble."

Copyright 2004 The Atlanta Journal-Constitution

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