Thursday, March 10, 2005

Greenspan: Budget Deficit More Worrisome Than Trade Gap

By Campion Walsh
Dow Jones Newswires

WASHINGTON -- Future effects from the growing U.S. international-trade deficit and the sharp appreciation in home prices in recent years aren't "overly worrisome," but the growing U.S. fiscal deficit could do long-term damage, said Federal Reserve Chairman Alan Greenspan.

"The resolution of the current-account deficit and household-debt burdens does not strike me as overly worrisome, but that is certainly not the case for our fiscal deficit, which, according to the Congressional Budget Office, will rise significantly as the baby boomers start to retire in 2008," he said in remarks prepared for delivery at an annual conference of the Council on Foreign Relations in New York.

In his prepared remarks, the Fed chairman didn't directly discuss monetary policy, saying, "Our fiscal prospects are, in my judgment, a significant obstacle to long-term stability because the budget deficit is not readily subject to correction by market forces that stabilize other imbalances."

Greenspan reiterated concerns raised most recently in his congressional testimony about the effect on the country's fiscal health, as 30 million baby boomers reach retirement age over the next 25 years.

Demographics and the current fiscal outlook "are going to place enormous pressures on the ability of our economy to supply the real benefits promised to retirees under current law," he said, suggesting U.S. success in attracting foreign investment may be masking the full impact of "deficient domestic saving."

The Fed chairman said international investors will at some point rebalance their portfolios as they find increasing concentrations of dollar assets, likely leading to smaller U.S. current account deficits.

"To date, the proportional shift out of dollars from the total of official and private-sector foreign currency accounts has been modest when adjusted for exchange-rate changes," Greenspan said, citing recent data from the Bank for International Settlements. He added, "The market has absorbed this change in an orderly manner."

Greenspan went on to say the more-rapid aging of European and Japanese populations compared with the U.S. should slow the amount of foreign savings available for investment in the U.S, but so far little evidence of that has emerged.

He also cautioned foreign support for U.S. budget and trade deficits might turn out to be a "transitional paradigm" in globalization that could come to an end later this decade.

The U.S. has benefited from what seems "to be a one-time shift in the degree of globalization and innovation that has temporarily altered" historical parameters for when economic imbalances, such as trade gaps and fiscal deficits, become dangerous, said Greenspan.

He added, "While the outlook for the next year or two seems reasonably bright, the outlook for the latter part of the decade remains opaque because it is uncertain whether this transitional paradigm, if that is what it is, is already far advanced and about to slow, or whether it remains in an early, still-vibrant stage of evolution."

The U.S. appears to have benefitted from international capital flows resulting in part from a sharp decline in foreign investors' "home bias" since the early 1990s, said Greenspan. "As a result of these capital inflows, the ratio of foreign net claims against U.S. residents to our annual [gross domestic product] has risen to approximately one-fourth," he added.

Although the U.S. is pressing against the limits of its capacity for both trade and budget deficits, the Fed chairman said future trade-gap adjustments are less threatening than potential adjustments to the budget deficit. If globalization continues without major protectionist outbursts, Greenspan said history suggests the U.S. current-account deficit, which is rising to nearly 6% of GDP, can readjust with little risks of broader economic disruption.

He also played down the risk of a national collapse in housing prices following the recent period of low interest rates and booming real-estate valuations. Greenspan said a faster rise in home-resale prices than rents suggests "at least the possibility of price misalignment in some housing markets," but a destabilizing drop in prices nationally isn't the most likely outcome. "Even should more-than-average price weakness occur, the increase in home prices should buffer the vast majority of homeowners."

In a speech that generally welcomed the effects of globalization on the international economy, Greenspan ended with a note of caution about the suffering of "a significant minority, trapped on the adverse side of the market's process of creative destruction." He said, "This is an issue that needs to be more fully addressed if globalization is to sustain the public support it requires to make further progress."


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