Greenspan silent on near-term outlook

Joseph Rebello, Dow Jones, Washington

Federal Reserve Chairman Alan Greenspan on Thursday played down financial-market worries about the record U.S. current-account deficit, suggesting the gap is likely to narrow without triggering a destabilizing drop in the U.S. dollar.

In a speech at an economic conference, Greenspan said there is "little evidence" that the U.S. is having trouble raising funds abroad to finance the deficit, which hit a record 5 percent of gross domestic product this year.

He attributed that to the growing sophistication of U.S. and global financial markets, which he said has allowed developed countries to run up large current-account gaps without imperiling their economies.

"Spreading globalization has fostered a degree of international flexibility that has raised the probability of a benign resolution to the U.S. current-account imbalance," Greenspan said in prepared remarks at a conference sponsored by the Cato Institute and The Economist magazine.

"Such a resolution has been the general experience of developed countries over the past two decades."

Greenspan didn't discuss the near-term outlook for U.S. monetary policy.

Worries about the U.S. current-account deficit - the gap between the amount of money flowing into the country and the amount flowing out - have grown as federal deficits have replaced the surpluses of just a few years ago.

Many economists have fretted that foreign investors who finance the deficit will eventually pull their money out if the gap grows much larger. That, they say, could trigger a dangerous fall in the value of the U.S. dollar.

But Greenspan suggested that danger has been overblown. Although the U.S. dollar has declined 20 percent against other major currencies since 2002, he said, it has yet to exhibit the standard signs of weakness.

"Inflation, the typical symptom of a weak currency, appears quiescent," Greenspan said. "Indeed inflation premiums embedded in long-term interest rates apparently have fluctuated in a relatively narrow range since early 2002."

Greenspan also played down long-standing worries that the growing use of the European common currency in world financial markets could enlarge the risk of a destabilizing outflow of capital from the U.S. At the end of 2002, U.S. dollars accounted for 65 percent of the foreign-exchange reserves of central banks, he said, while the euro accounted for 15 percent.

"Should globalization be allowed to proceed and thereby create an ever more flexible international financial system, history suggests that current imbalances will be defused with little disruption," Greenspan said.

"And if other currencies, such as the euro, emerge to share the dollar's role as a global reserve currency, that process, too, is likely to be benign."

Still, Greenspan said the outlook for globalization has become murky. "Some clouds of emerging protectionism have become increasingly visible on today's horizon," Greenspan said.

A new round of World Trade Organization negotiations on liberalizing global trade failed recently, and the U.S. government has faced increasing pressure from Congress to restrict imports from China.

The U.S., moreover, faces the prospect of trade sanctions from the European Union and other countries over tariffs the Bush administration imposed on imported steel two years ago.

"Over the years, protected interests have often endeavored to stop in its tracks the process of unsettling economic change," Greenspan said.

"Pitted against the powerful forces of market competition, virtually all such efforts have failed. The costs of any new such protectionist initiatives, in the context of wide current-account imbalances, could significantly erode the flexibility of the global economy. Consequently, it is imperative that creeping protectionism be thwarted and reversed."