Greenspan says US deficit cannot grow forever
November 15, 2005
Washington - Federal Reserve chief Alan Greenspan said on Monday the huge US current account deficit cannot expand forever as foreigners will one day tire of financing it.
But in a speech to the Bank of Mexico, he said the US economy should be able to weather the adjustment provided it stays flexible.
Greenspan noted that thus far, the United States has experienced little difficulty in obtaining the foreign investment needed to finance a deficit running at more than six percent of gross domestic product.
But the deficit "cannot persist indefinitely", he said, as investors are likely to grow alarmed about the country's ability to pay its external debts as the trade and capital account shortfall expands further.
"At some point investors will baulk at further financing," Greenspan said, according to the text of his speech delivered by video conference to the Bank of Mexico's 80th anniversary conference.
"Such a development would be particularly likely should risk-adjusted rates of return on assets outside the United States rise relative to investment opportunities in the United States," he said.
But there is little US policymakers can or should do to stem this natural evolution of market forces, Greenspan added.
Rising interest rates may help US households save, reducing the need for foreign investment. But foreign capital would be attracted by higher US rates and that would boost the dollar's value.
Americans' insatiable desire for imported goods, coupled with slower growth among major industrial partners, have sent the US current account deficit skywards.
The deficit last year widened to $665.9 billion from $530.7 billion in 2003. In the second quarter it was running at $195.7 billion, or 6.3 percent of gross domestic product.
Some analysts fear that exploding deficits will send the United States eventually into an economic tailspin as borrowing costs rise and the dollar declines.
But Greenspan, although a strong advocate of fiscal discipline, threw cold water on suggestions that a cut in the US federal budget deficit would help reduce the current account gap.
A reduction in the federal deficit would only work "to an uncertain and possibly small extent" in narrowing the current account shortfall, Greenspan said.
The Fed chief noted that private international investors are using the euro more in their transactions this year.
But central banks have not so far followed suit, he said, playing down the prospect of the dollar losing its status as a reserve currency because of any deficit adjustment.
Unlike Britain after World War II, when the pound lost its own status as the world's favoured reserved currency as the British empire unravelled, the United States today is a highly deregulated economy.
"Any diminution of the reserve status of the dollar, should it occur, is likely to be readily absorbed by a far more flexible US economy than existed in Britain immediately following World War II," Greenspan said.
"This, of course, presupposes that we in the United States in the years ahead maintain and, I trust, enhance our economy's degree of flexibility and our involvement in the highly successful globalisation of recent decades."
The dollar traded close to two-year highs against the euro and reached new 27-month highs against the Japanese yen after Greenspan's remarks.
Bank of New York currency analyst Neil Mellor said they amounted to "typically balanced Greenspan comments" and were not enough to upset the current bullish mood towards the dollar.
The euro dropped to $1.1661 in late European trading, from $1.1732 late on Friday in New York. The greenback stood at ¥118.88 from ¥118.04 on Friday. - AFP
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