Greenspan Issues Warning on Dollar


Richard Moore


  Greenspan Issues Warning on Dollar
 By David Streitfeld and Jeffrey Fleishman
 The Los Angeles Times

 Saturday 20 November 2004

The Federal Reserve chairman is concerned that foreign
investors may unload the U.S. currency because of the growing
trade deficit.

Berlin - Foreigners will eventually sour on U.S. bonds and
the dollar because of America's bulging trade and budget
deficits, posing significant risks to the nation's economy,
Federal Reserve Chairman Alan Greenspan said Friday in remarks
that rattled financial markets.

Greenspan told a banking conference in Frankfurt, Germany,
that international investors were likely to either unload
their dollar-denominated investments or demand higher interest
rates. Either scenario would present problems for an economy
that is heavily dependent on foreign capital to fuel its
free-spending ways.

Some countries have "defused" their trade deficits without
significant consequences, Greenspan noted. But, he warned, "we
cannot become complacent. History is not an infallible guide
to the future."

The Fed chief's concern about the deficits is not new, but
his remarks were interpreted by some traders as a warning that
a day of reckoning was drawing closer. And they came against
the backdrop of the dollar's continued weakness in
international currency markets.

After Greenspan spoke, the dollar dropped to its lowest
level against the Japanese yen in more than four years. The
dollar also fell against the euro, which hit the highest point
in its five-year history this week. The stock market fell
sharply. The Dow Jones industrial average dropped 115.64
points, or 1.1%, to 10,456.91.

"Greenspan frightened the markets by raising the specter of
a dollar panic," said Peter Morici, former director of the
Office of Economics at the U.S. International Trade

The Fed chief also seemed to be practically guaranteeing
higher interest rates, saying that investors who weren't
hedged against a rise were "desirous of losing money."

Earlier this month, the Fed raised its benchmark short-term
rate for the fourth time since June, to 2%. After the market
digested Greenspan's latest comments on rates, which weren't
part of his prepared remarks, yields on Treasury securities
jumped. Another rate increase is expected at the Fed's next
meeting Dec. 14.

But it was Greenspan's remarks on the dollar that sparked
the most reaction.

The federal government spent $413 billion more than it
raised through taxes in the fiscal year that ended Sept. 30.
The current account deficit, the broadest measure of the
nation's trade balance with the rest of the world, was a
record $166 billion in the second quarter. The current account
deficit is now approaching 6% of U.S. gross domestic product,
another record.

Increasingly, the U.S. buys products from other nations,
particularly China, but sells them relatively little in
return. Foreign countries instead take their dollars and buy
U.S. Treasury securities. These investments allow Americans to
enjoy tax cuts, cheap imports and low interest rates in a time
of war.

Even if the current account deficit stops increasing,
Greenspan said in his speech, foreign investors are likely to
realize they have put too many of their eggs in the dollar

As a result, he said, they will "eventually adjust their
accumulation of dollar assets or, alternatively, seek higher
dollar returns to offset concentration risk."

As interpreted by Lehman Bros. chief economist Ethan
Harris, Greenspan was saying what many economists and currency
strategists have been saying recently: "The current account
deficit is too big, and asking foreigners to lend us $600
billion a year to cover it is creating great risk for the

Harris, attuned to Greenspan's often-Delphic
pronouncements, said he heard "a subtle language change" from
the chairman's previous remarks on the subject.

"Before it was, 'There will be a day of reckoning but I
don't know when,' " the economist said. "Now it's, 'There's
going to be a day of reckoning and we're worried about it.'
He's saying the market should worry now."

The Bush administration has been quietly supportive of the
dollar's recent drop, which could shrink the trade deficit by
making U.S. exports less expensive abroad and raising the
price of imports. That's one reason almost everyone on Wall
Street expects the decline to continue.

The question that divides them is whether the descent will
be slow and orderly, or quick and panicky.

Joel Prakken, an economist with Macroeconomic Advisers, is
in the first camp. "If you look around at the world's
economies, there's really none better than ours," he said.
"It's not like in the 1980s, when people thought the Japanese
or the Germans were going to rule the world, and people wanted
to invest in them."

Harry Chernoff, an economist with Pathfinder Capital
Advisors, expects the situation to get more unpleasant.

"No nation in the history of the world has ever escaped
this level of indebtedness - annual and cumulative - without a
severe and totally involuntary adjustment," he said. "The only
question is whether we manage our crisis into a catastrophe or
whether the international financial community clamps down on
us before we have the opportunity to make things even worse."

Morici, the former trade official, believes the fate of the
dollar will be determined not in Washington, but in Beijing,
because of the huge dollar sums China has accumulated.

"The Chinese have created a Frankenstein's monster. If they
go cold turkey and stop financing the deficit, the dollar will
collapse and they'll lose their export market, which will mean
riots in the streets," said Morici, now a professor at the
University of Maryland.

Alternatively, China can engineer an orderly revaluation of
its own currency, which is tied to the dollar. One effect
would be to moderately raise prices of Chinese exports.
There's little evidence, however, that China is willing to do
this anytime soon.

The European economic community, whose currency has risen
9% against the dollar during the last year, is getting
impatient for action.

The dollar's fall is not on the official agenda for this
weekend's summit in Berlin of leading economic ministers from
the Group of 20, but it is definitely the hot topic. German
Finance Minister Hans Eichel described the dollar's plunge
against the euro as a "brutal development" that threatens the
global economy.

The Group of 20 is composed of the seven top industrial
nations and other strong and developing economies, including
Mexico, South Korea, Russia and Argentina. Economic ministers
heard Greenspan's speech as they began arriving.

The dollar's spiral "will have to be talked about," Eichel
said in a radio interview, adding that the U.S., Japan and
Europe should find a "common position" to bolster the dollar.

The likelihood of such an agreement is slim. Speaking in
Poland earlier this week, U.S. Treasury Secretary John W. Snow
blamed Europe for its slow economic growth and said
intervention in the currency market was "non-rewarding at

Germany faces grim financial news. Economic growth is
sluggish, consumer spending is down, and unemployment is above
10%. Economists fear that if the dollar continues to drop,
making German goods more expensive abroad, exports from the
troubled German car market will decline and the effect will
ripple through the middle class.

Heinrich von Pierer, chief executive of Siemens, said that
in recent months the German engineering giant had to raise
prices by 30%. A German panel of economic experts recently
estimated that a further 10% drop in the dollar would mean the
German economy would shrink by nearly half of a percent.

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Richard Moore (rkm)
Wexford, Ireland

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