- The Washington Times - Saturday, February 5, 2005

Federal Reserve Chairman Alan Greenspan told world economic leaders yesterday that the gigantic U.S. trade and budget deficits most likely are peaking.

Worries about the sprawling twin deficits have driven the dollar down to levels not seen in 10 years, and spurred calls for action by the Bush administration and Congress at a meeting of the Group of Seven finance ministers in London that started yesterday.

“The voice of fiscal restraint, barely audible a year ago, has at least partially regained volume” in Washington, Mr. Greenspan assured his European and Asian counterparts. He was alluding to President Bush’s proposal to halve the record $427 billion budget deficit by freezing spending outside defense, homeland security and entitlements.

“If actions are taken to reduce federal government dissaving, pressures to borrow from abroad will presumably diminish,” the Fed chairman said, easing pressure on the dollar and averting the financial crisis that many finance ministers believe could be developing.

Mr. Greenspan’s upbeat outlook on the deficits, combined with news of a drop in the U.S. unemployment rate to 5.2 percent amid growing jobs, helped spur a surge in U.S. stocks and the dollar yesterday.

The Dow Jones Industrial Average ended up 123 points at 10,716, and the dollar advanced to a three-month high against the euro, cheered on by a 146,000 job increase in January that ensures growth will continue in U.S. incomes and spending.

The job gain served to erase a 2.5-million job deficit that emerged during President Bush’s first term. The economy generated a net gain of 119,000 jobs from January to January 2005, meaning Mr. Bush escaped being the first president since Herbert Hoover to record a net job loss.

While Congress and the president appear ready to tackle the budget deficit this year, the Fed chairman said the $660 billion trade deficit also appears “poised to stabilize and over the longer run possibly to decrease” as a result of market forces precipitated by the dollar’s fall.

Mr. Greenspan’s remarks are aimed at explaining what recently emerged as the world’s biggest economic puzzle: The U.S. current account deficit has been accelerating despite a nearly 40 percent drop in the dollar’s value against the euro and pound sterling since 2001, and sizable but smaller declines against other currencies.

A principal reason the dollar’s fall hasn’t precipitated a drop in U.S. imports, Mr. Greenspan said, is because exporters in Europe and Asia have sought to maintain their share of the vital U.S. market by absorbing the dollar losses and narrowing their profit margins.

The result has been only mild increases in the price of imported goods other than oil, where the dollar’s fall has led to a 40 percent increase in import costs in the past year.

But the ability of European and other exporters to keep absorbing losses through dollar-hedging strategies and lower profits appears to be coming to an end, as seen in a steady upward creep in European import prices in the past year, he said.

Another reason the trade deficit has failed to decline or level out, he said, is that the dollar’s relentless climb against most currencies during the 1990s caused imports to exceed exports by 50 percent.

Now, to reverse that, exports would have to grow 50 percent faster than imports, he said, something that has not happened despite a revival of exports in the past year.

Imports also have burgeoned because U.S. consumers have not cut back on oil purchases, despite surging prices. Also, U.S. incomes and economic growth have exceeded those of trading partners in Japan and Europe, adding to the trade imbalance.

While these factors have prevented an improvement in the trade deficit, Mr. Greenspan suggested that situation could soon change because U.S. consumers are likely to start saving more and consuming less as a result of the Fed’s campaign to raise interest rates.

In particular, a massive accumulation of mortgage debt that has helped cause a drop in the personal savings rate to a paltry 1 percent last year from 6 percent in 1993 likely has reached a culmination, he suggested.

The mortgage debt, which has been largely financed with loans from abroad, was accumulated during the housing boom of the past five years as many consumers bought and financed homes with sharply rising prices, while others tapped into their rising values using home equity loans and cash-out refinancings.

Mr. Greenspan said he senses a connection between the unprecedented growth in mortgage debt and the fast-growing trade deficit, although the two are not directly related.

“Interestingly, the change in U.S. home mortgage debt over the past half-century correlates significantly with our current account deficit,” he said.

Without a doubt, he said, consumers have used their increasing wealth from home appreciation to finance increased spending on imports of everything from European cars to Japanese plasma TVs. And he suggested that the wealth effect from rising home values may need to be curbed to help bring down the trade deficit.

Peter Morici, University of Maryland business professor, said he also sees a connection between the trade deficit and lackluster job growth in the United States.

“The primary culprit is the growing trade deficit, which is now more than 5 percent” of economic output, he said, blaming import penetration for the loss of 47,000 manufacturing jobs since September. The factory job losses have been offset by growth in health care, education and other services jobs.

Taking a view held widely among the G-7 ministers, Mr. Morici said the problem is the dollar hasn’t fallen enough against Asian currencies, particularly the Chinese yuan, which is fixed against the dollar.

China was invited to participate at the summit, but few delegates expect quick action by the Chinese to break the link between the dollar and the yuan.

Associated Press

Federal Reserve Chairman Alan Greenspan assured G-7 finance ministers that the United States is getting control of its twin deficits.

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