Thursday, March 10, 2005

Greenspan reviews threats to growth


Fed chairman says budget deficit is biggest threat

WASHINGTON (MarketWatch) -- Federal Reserve Chairman Alan Greenspan addressed all of the possible looming difficulties facing the U.S. economy, and said the federal budget deficit is the biggest threat.

In a wide-ranging address prepared for delivery to the Council of Foreign Relations in New York, Greenspan talked about the imbalances that have economists concerned about the long-term sustainability of the current economy, from the potential of a housing bubble and the expanding current account budget deficit to the rising level of household debt.

While not dismissing the potential problems from each of these factors, the Fed chairman said the budget deficit was the biggest problem because it is immune from market forces.

"The resolution of our 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," he added.

"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."

Current account deficit

The U.S. current account deficit is moving into the neighborhood of 6 percent of gross domestic product. At the same time, the dollar has fallen, but has not approached its previous low in 1995.

A current account deficit of 6 percent of GDP would probably not have been fundable "even a couple of decades ago," he said.

"Has something fundamental happened to the U.S. economy that enables us to disregard all the time-tested criteria for assessing when economic imbalances become worrisome?" he asked. "Regrettably the answer is no."

But there may have been a "one-time shift in the degree of globalization and innovation that has temporarily altered the specific calibrations of those criteria," he added.

Greenspan indicated that he was unsure if positive impact from globalization and innovation was about to slow or still in its early stages.

"While the outlook for the next year or two seems reasonably bright, the outlook for the latter part of the decade remains opaque," he said.

But there is no sign that these forces are diminishing yet.

Greenspan reiterated that foreign firms might have to raise their prices if the dollar declines further and that this would lead to fewer imports, leading to some adjustment in the trade deficit.

At some point, foreign governments and international investors will seek to shift out of dollars, he said. And the aging population of Europe and Japan will slow the amount of savings available to the United States, he added.

Greenspan pointed out that the one force that could upset the apple cart is protectionism. "Protectionism ... could erode global flexibility and hence undermine the global adjustment process."

Housing bubble

He also noted that some analysts believe the extended period of low interest rates has spawned a bubble in housing prices that could implode.

While acknowledging that the data do show "at least the possibility of price misalignment in some housing markets," Greenspan said he did not fear a sharp drop in prices.

"A destabilizing contraction in nationwide housing prices does not seem the most probable outcome."

In the end, Greenspan declared that he could not rule out trouble for the economy. "The penchant of humans for quirky, often irrational behavior gets in the way of this conclusion.

"A discontinuity in valuation judgments, often the cause or consequence of the building and bursting of a bubble, can occasionally destabilize even the most liquid and flexible of markets," he said.

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