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February 4, 2005
Carrying the dollar on his shoulders
Greenspan singlehandedly moves the currency market. From Reuters:
NEW YORK (Reuters) - The dollar rallied against most currencies on Friday after Federal Reserve Chairman Alan Greenspan said market forces and tighter U.S. fiscal policy should stabilize and may cut the U.S. current account gap.
The euro fell to its lowest level in almost three months below $1.2900, although its heavy losses against the yen also dragged the dollar lower against the Japanese currency.
"I think the Chairman's taking a much more sanguine view on the current account deficit than he's taken for some time," said Robert Sinche, head of currency strategy at Bank of America in New York.
"He's taking a longer-term view, laying out a set of conditions under which the current account deficit can improve this year and next," Sinche said.
News reports like this are so bland. Want to know what he said? Read here. A few key passages follow.
Arguably, however, it has been economic characteristics special to the United States that have permitted our current account deficit to be driven ever higher, in an environment of greater international capital mobility. In particular, the dramatic increase in underlying growth of U.S. productivity over the past decade lifted real rates of return on dollar investments. These higher rates, in turn, appeared to be the principal cause of the notable rise in the exchange rate of the U.S. dollar in the late 1990s. As the dollar rose, gross operating profit margins of exporters to the United States increased even as trade and current account deficits in the United States widened markedly. But these deficits have continued to grow over the past three years despite a decline in the dollar, whose broadly weighted real index is now much of the way back to its previous low in 1995.
I seem to remember someone talking about 1995 a while back. Oh, yeah! Back to Greenspan:
To understand why the nominal trade deficit--the nominal dollar value of imports minus exports--has widened considerably since 2002, even as the dollar has declined, we must consider several additional factors. First, partly as a legacy of the dollar's previous strength, the level of imports exceeds that of exports by about 50 percent. Thus exports must grow half again as quickly as imports just to keep the trade deficit from widening--a benchmark that has yet to be met. Second, as is well-documented, the responsiveness of U.S. imports to U.S. income exceeds the responsiveness of U.S. exports to foreign income; this difference leads to a tendency--even if the United States and foreign economies are growing at about the same rate--for the growth of U.S. imports to exceed that of our exports. Third, as of late, the growth of the U.S. economy has exceeded that of our trading partners, further reinforcing the factors leading imports to outstrip exports. Finally, our import bill has expanded significantly as oil prices have risen in recent years.
To be sure, the lower dollar has undoubtedly boosted the competitiveness of U.S. exports and the profitability of U.S. exporters. These factors help explain the considerable increase in exports over the past couple of years. Yet the positive effect of the dollar's decline on exports and on the trade balance has been offset by the other aforementioned factors.
Besides market pressures, which appear poised to stabilize and over the longer run possibly to decrease the U.S. current account deficit and its attendant financing requirements, some forces in the domestic U.S. economy seem about to head in the same direction.
The voice of fiscal restraint, barely audible a year ago, has at least partially regained volume. If actions are taken to reduce federal government dissaving, pressures to borrow from abroad will presumably diminish.
That is all he said about fiscal policy. Some might say even that is too much. As for actions taken to reduce government dissaving--that's a big "if." The Reuters story elevates it to the lead paragraph. It will certainly be interesting to see if this takes hold anywhere else in the media or the public debate. Remember, you heard it here first.
Greenspan concludes:
The interaction of a wide range of economic forces, which adjust at national borders to create what we call the current account balance, has proved difficult to predict with any precision, primarily because of the difficulty of forecasting exchange rates. These same forces have lessened our ability to anticipate the consequences of a buildup of either a surplus or a deficit.
In addition, numerous issues that have arisen with respect to the adjustment of the U.S. current account remain unresolved. One is the effect of Asian official purchases of dollars in support of their currencies. Such intervention may be supporting the dollar and U.S. Treasury bond prices somewhat, but the effect is difficult to pin down. Another issue is the influence of still-growing globalization, arguably one of the key factors that has facilitated the financing of the U.S. current account deficit. There is little evidence that the growth of globalization has yet slowed.
The dramatic advances over the past decade in virtually all measures of globalization have resulted in an international economic environment with little relevant historical precedent. I have argued elsewhere that the U.S. current account deficit cannot widen forever but that, fortunately, the increased flexibility of the American economy will likely facilitate any adjustment without significant consequences to aggregate economic activity. That argument will be tested, I suspect, by possibly new twists and turns that will emerge in a seemingly ever-more complex international economic and financial structure.
References to footnotes have been taken out. Read the whole thing, it's worth your time. The conclusion pretty much agrees with things I have been thinking and writing on this blog in the last few months, at least about our flexibility and response to market forces. It's an optimistic outlook, to be sure. I just hope it's right.
Posted by William Polley at February 4, 2005 4:27 PM
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