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Greenspan concerned with weak dollar
Federal Reserve chairman says U.S. must address trade, budget deficits or face future woes.
November 19, 2004: 11:30 AM EST

NEW YORK (CNN/Money) - Federal Reserve Chairman Alan Greenspan warned the U.S. must deal with the causes of the weak dollar -- the U.S. trade deficit and the federal budget deficit -- or the country could run into economic problems down the line.

Greenspan said that while history has shown that developed countries are not necessarily hurt by a weak currency, "we cannot become complacent. History is not an infallible guide to the future," he said in a speech delivered in Europe.

The text was released in Washington.

"More will need to be done in Europe as well as in the United States to ensure that our economies are sufficiently resilient to respond effectively to all the shocks and adjustments that the future will surely bring," he concluded.

Greenspan focused on the nation's current account deficit, the measure of both trade and investments across the national board, which he said has risen to more than 5 percent of gross domestic product, the broad measure of the nation's economy.

"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.

Greenspan said it is therefore important that the U.S. budget deficit be cut, a move that would reduce the current account deficit.

"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."

Remarks send dollar lower

The value of the U.S. dollar, which has been hitting a series of four-year lows versus the yen and record lows against the euro during the last couple of weeks, fell following Greenspan's remarks.

The Fed chairman, "left little imagination to currency traders other than to sell the US currency," said Ashraf Laidi, chief currency analyst at MG Financial Group. He said Greenspan's comments warnings about future declines in the dollar unless the federal budget deficit is reduced were particularly telling to the markets.

"This last 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," Laidi said.

Economist Robert Brusca of FAO Economics suggested that he doesn't agree that the speech is a warning from Greenspan about a weak dollar.

"If anything Greenspan is afraid that the dollar will not get weak enough, and as a result the U.S. current account deficit could stay too large for too long," he said.

Brusca concedes that his interpretation is reading between the lines and is not the way some others are interpreting the remarks. But he argues that while Greenspan voiced support for closing the budget deficit, it's really the current account deficit that worries him more. And one way to close the current account deficit is see the dollar drop even farther compared to the other major currencies.

A call to shrink the US current account deficit, as long as we conclude that is it not a call for a recession in the U.S., is also a call for stronger growth abroad and for a weaker dollar," said Brusca.

Not a crisis

Greenspan said that so far the evidence is that there is still strong demand for U.S. assets by overseas investors and central banks. Those investments help limit the current account deficit and keep the dollar from sinking further.

"We see only limited indications that the large U.S. current account deficit is meeting financing resistance," he said. He added, however, "Net claims against residents of the United States cannot continue to increase forever in international portfolios at their recent pace.

"This situation suggests that international investors will eventually adjust their accumulation of dollar assets or, alternatively, seek higher dollar returns to offset concentration risk, elevating the cost of financing of the U.S. current account deficit and rendering it increasingly less tenable," said Greenspan.

Alan Greenspan
Government Debt
International Trade

Greenspan said he did not foresee a crisis in markets if the United States does not close its so-called twin deficits. While he didn't identify what potential crisis he was referring to, some economists have suggested that a sudden collapse in the value of the dollar was possible without taking steps to close the deficits. Greenspan's comments seemed to dismiss that worst case scenario.

Greenspan began his comments saying he was speaking as an individual, not for the Federal Reserve.  Top of page

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