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November 21, 2004
Greenspan on global economy
News reports are saying that US Federal Reserve Chairman Alan Greenspan has warned that the U.S. must deal with the causes of the weak dollar -- the U.S. trade deficit and the federal budget deficit -- or the country could run into economic problems down the line. Greenspan is saying that the twin deficits need to be reduced by cutting the U.S. budget deficit.
It would appear that the US is talking the dollar down, despite the spin about defending a strong dollar.
Does that also mean big cuts to federal government spending, given the recent Republican tax cuts?
In the light of the above news this account by Stephen Roach over at Morgan Stanley's global forum is well worth reading. Roach says:
"A $40 trillion world economy is dangerously out of balance and seriously in need of a fix. A decline in the dollar is not a cure-all for all that ails the world, but it should go a long way in sparking a sorely needed rebalancing. That adjustment may now be under way."
It's a very downbeat diagnosis.
Roach goes onto say that instead of America’s consumption binge being supported by internally-generated income growth, US consumers have borrowed against the future by squeezing saving to rock-bottom levels. Moreover, large federal budget deficits have taken the government’s saving rate sharply into negative territory.
Stephen then says that:
"The day will come when foreign investors simply say “no” to this arrangement — refusing to fund America’s consumption binge without getting a meaningful concession on the terms of financing. That’s when the dollar collapses, US interest rates soar, and the stock market plunges. Under such a crisis scenario, a US recession would be all but inevitable. And a US-centric global economy would undoubtedly be quick to follow. Unfortunately, with America’s current-account deficit now in the danger zone, that day of reckoning could well come sooner rather than later."
Stephen the says that the only way to avoid this endgame is for the world’s major central banks to move preemptively on the dollar, carefully managing a gradual but significant depreciation over the next several years.
For comments on Greenspan, see the remarks on Brad de-Long's webjournal. For an analysis of Stephen Roach's diagnosis see General Gluts Globblog. He says more than a depreciation of the $US is required: "the US is going to have to start saving a hell of a lot more to get out from under this weight."
For comments on the relationship between productivity growth, deficits and servicing debt, see John Quiggin.
Posted by Gary Sauer-Thompson at November 21, 2004 11:25 AM
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