Bloomberg: Greenspan Says Current Account Gap May Begin to Fall

Greenspan Says Current Account Gap May Begin to Fall (Update7)

Feb. 4 (Bloomberg) -- Record U.S. trade and budget gaps may soon shrink, Federal Reserve Chairman Alan Greenspan said in London, addressing a major complaint of finance ministers and central bankers from industrialized nations who are meeting there this weekend.

The ministers from the Group of Seven nations have warned that the swelling twin U.S. deficits are a threat to global economic stability. Adjustment has been slow, even with a two-year decline in the dollar, because companies exporting to the U.S. have been willing to put up with smaller profits, Greenspan said. That's now changing.

``We may be approaching a point, if we are not already there, at which exporters to the United States, should the dollar decline further, would no longer choose to absorb a further reduction in profit margins,'' Greenspan told the Advancing Enterprise 2005 conference. At the same time, ``U.S. exporters' profit margins appear to be increasing, which bodes well for future U.S. exports and the adjustment process.''

The dollar rose as Greenspan's comments suggested its 16 percent drop since February 2002 against a basket of currencies from its 30 largest trading partners is beginning to have an effect on the U.S. current account, the widest measure of trade in goods, services, and financial transfers.

Market pressures ``appear poised to stabilize and over the longer run possibly to decrease the U.S. current account deficit and its attendant financing requirements,'' Greenspan said. The current account deficit widened by $17.5 billion, to a record $164.7 billion in the third quarter of last year, from $147.16 billion in the first quarter.

Market Reaction

The dollar rose after Greenspan's speech, gaining to $1.2869 per euro at 1:40 p.m. in New York, from as low as $1.3045 earlier.

The speech was important because it ``runs against conventional wisdom regarding the Fed's thinking on several grounds'' about the fiscal and current account deficits, said Stephen Stanley, chief economist at RBS Greenwich Capital in Greenwich, Connecticut. ``He laid out today the case that the foundation for relief on these fronts is already in place. Thus, we should downgrade our fears, or at least our perception of the Fed's fears, about these two issues.''

Greenspan said that from ``early 2002 to early 2004, the dollar's exchange rate against the euro and sterling, on average, declined about 30 percent, yet dollar prices of imported manufactured goods from the European Union rose only 9 percent, slightly more than dollar prices of U.S. manufactured goods during the same two years,'' Greenspan, 78, said.

Exports

That willingness of exporters to the U.S. to accept lower margins to preserve market share, along with strong American consumer spending financed in part by mortgage debt and faster growth in the U.S. than its trading partners ``offset'' the effects of the dollar's decline.

The squeeze on profit margins ``absorbed'' about three- quarters of the dollar's decline relative to the euro and the British pound, he said.

At the same time, Americans financed greater spending on imports in part by refinancing mortgages or selling homes to spend the equity. ``Interestingly, the change in U.S. home mortgage debt over the past half-century correlates significantly with our current account deficit,'' he said. Consumers in the countries of U.S. trading partners don't have readily available access to mortgage financing ``to finance consumption expenditures,'' he added.

Budget Deficit

Those forces leading the U.S. current account deficit to expand are changing, he suggested. While foreign companies may have hedged their exposure to the falling dollar, many of those contracts likely will expire, he said. And now, although slowly, ``the lower dollar has undoubtedly boosted the competitiveness of U.S. exports and the profitability of U.S. exporters,'' Greenspan said.

In addition, ``some forces in the domestic U.S. economy seem about to head in the same direction,'' he said, as demands to cut the U.S. federal budget deficit mount. That would lower pressure to borrow from abroad, he said. ``The voice of fiscal restraint, barely audible a year ago, has at least partially regained volume.''

Last year, Greenspan also called on reduction in federal spending as a way of slowing demand and growth in the trade deficit. He hasn't called for increases in taxes, which would also lower demand.

Asian Central Banks

Asian governments have been buying dollars ``in support of their currencies,'' Greenspan said. ``Such intervention may be supporting the dollar and U.S. Treasury bond prices somewhat, but the effect is difficult to pin down.''

At the same conference today, Bank of England Governor Mervyn King suggested the mounting U.S. current account deficit and hoarding of dollar assets by Asian central banks might threaten the stability of the world economy.

King urged members of the Group of Seven industrial nations to agree ``on the nature of the risk'' and collaborate with China and India to rebalance currency reserves. He called on the International Monetary Fund to propose a series of changes. Greenspan is in London for a meeting of G-7 finance ministers and central bankers.

``There is likely to be a limit to the amount of debt that one country can issue as a result of persistent deficits before investors start to worry about its ability or willingness to repay,'' King said in his speech. Asia's accumulation of dollar reserves ``contributes to the potential instability of the international monetary system.''

Rubin's Concerns

China, Taiwan, and Korea had the largest stocks of international reserves in the world at the end of 2004. China's foreign reserves rose 51.3 percent to $609 billion, while Japan's reserves rose 26.3 percent for the year to $824 billion. All four countries ranked among the top eight nations in trade of goods with the U.S., according to the most recent government data through November.

Former U.S. Treasury Secretary Robert Rubin also told the conference America's record trade and federal budget deficits might lead to further declines in the dollar.

``The U.S. imbalances can have bond market effects and raise complex questions about our currency,'' Rubin, now chairman of Citigroup Inc.'s executive board, said. ``There is a fairly good chance the dollar could decline.''

Rubin called on President George W. Bush to rein in the budget deficit, which the White House anticipates will reach $427 billion this year. Bush pledges to halve the gap by 2009. ``It ``will not be fixed by tinkering around the edges,'' Rubin said. ``The U.S. is at a critical juncture.''

Some of the world's wealthiest investors expect the dollar to continue to fall, which would help narrow the current account deficit. George Soros, chairman of New York-based Soros Fund Management LLC, and Warren Buffett, chairman of Berkshire Hathaway Inc., have said they expect additional declines. And Bill Gates, the world's richest man and chairman of Microsoft Corp., said at the World Economic Forum in Davos, Switzerland Jan. 28 that he's short the dollar, expecting it to fall.