re: what's worrying greenspan? and others
Are they subtlely preparing us? Is this a deliberate softening up for a 'deliberate' act?
Lets play spot the rug-puller
U.S. Fed Worries About Global Risks: John M. Berry (Correct) By John M. Berry
June 2 (Bloomberg) -- Federal Reserve officials can't be happy with what they see as they look around the world.
Economic and political developments in both Europe and Asia are moving in directions that are likely to make the U.S. current account deficit worse, not better, and perhaps making the eventual adjustment in the trade balance more painful for everyone. Meanwhile, trade frictions are increasing between the U.S. and both Europe and China, raising new threats of protectionism that could hurt all the countries involved.
To Fed officials, these developments carry a heightened risk of a possible global financial crisis down the road. Unfortunately, there is little they can do about the worsening external deficit, since it isn't really a monetary policy problem. So they will continue to concentrate on promoting non- inflationary growth in the U.S. while urging others in government to take steps to reduce the federal budget deficit, which would hardly cure the problem but might help a bit.
The diverging trends in growth between the U.S. and some of its major trading partners ``are likely to widen the U.S. current account in coming quarters,'' Lewis Alexander, Citigroup's new chief global economist, told his clients on May 27.
Increasing Deficit
That deficit, which rose to 5.7 percent of GDP last year, will increase to 7.5 percent of GDP in 2006, even with a 5 percent appreciation of the Chinese currency, the yuan, and resumed depreciation of the dollar against the euro and the Japanese yen, he predicted.
``We continue to believe that the most likely long-run outcome is that global payment imbalances will be contained without major economic or financial disruptions, largely through additional exchange rate changes,'' Alexander said. ``But further widening of those imbalances in the near term, which we expect, carries with it two major sets of potential risks.
``First, a significant additional increase in the U.S. current account deficit only raises the chances of a sharp sell off of the dollar at some point in the future,'' he said. ``Second, protectionist pressures, which have already surfaced, could intensify.''
The Fed's Concern Those are precisely the risks that concern the Fed. A sharp sell off of the dollar, of course, could easily trigger a sudden sharp increase in longer-term U.S. interest rates as well because the dollar sell off would be the result of foreigners becoming much less willing to invest in dollar-denominated assets.
With U.S. economic growth this year likely to be more than double that in the euro zone, there is little prospect that the market for U.S. exports will improve in that part of the world. The recent rapid rise of the dollar against the euro -- spurred by the rejection of the new European Union constitution in France and the Netherlands -- only makes matters worse.
All three of the euro zone's major countries -- Germany, France and Italy -- are in economic trouble.
In Italy, the debate is over whether the country is in a recession and whether it might be forced to stop using the euro. In Germany, where unemployment is already 11.8 percent, the economy is barely growing.
EU Policy In France, exit polls showed that the ``Non'' vote on ratifying the EU constitution was based on unhappiness with current economic conditions and the fear that market-oriented EU rules would erode some of the protections French workers and companies now enjoy.
``That mandates a change from the current thrust of EU policy, which has tried to promote fairly orthodox monetary and fiscal policies and structural reform,'' International Strategy & Investment told its clients yesterday.
Of course, the European Central Bank has given no hint it is about to cut its 2 percent interest rate target, arguing that lower rates would do little to spur growth. And with the euro now worth close to $1.22, there is less pressure on the ECB to act than when it was at more than $1.35.
At the same time, attempts by German Chancellor Gerhard Schroeder to enact structural reforms to make his economy less rigid and more competitive have already undermined his political support.
``Trade issues are likely to get more contentious as well,'' the ISI analysis said. ``It's hard to imagine the EU offering up any meaningful agricultural reforms now, which is what the U.S. and developing countries are expecting from the EU in the Doha Round of World Trade Organization talks.''
China's Currency
Even though both the U.S. and Europe have filed suits over each other's subsidies of commercial aircraft production and sales, the most serious protectionist threat is between the U.S. and China over the latter's refusal to let its currency appreciate against the dollar.
Fed Chairman Alan Greenspan has said that China will eventually be forced to let the yuan's value rise in order to keep inflation under wrap, because the currency peg makes it very difficult for China to keep growth of its money supply under control. Nevertheless, China has managed to do so while its economy has had spectacularly rapid growth.
Fed officials are concerned that if protectionist efforts in Congress to impose special tariffs on Chinese imports were to succeed, it could set off a serious, economically disruptive trade war.
Revaluation's Impact
The irony is that, as a number of economists have said in congressional hearings, a revaluation of the yuan might have only a small impact on the huge and growing U.S. trade deficit.
In some instances, exports from other Asian countries might replace any decline in exports from China. And it could well turn out that Chinese exporters would simply absorb the impact of an increase in the yuan's value by accepting lower profit margins. To a large extent that is what happened when the euro's value shot up beginning three years ago.
In fact, changes in relative exchange rates seem to have a much smaller effect on prices of exports than was true in the past, and Fed economists who have studied the matter aren't entirely sure why.
Japan and Trade
The U.S. also continues to have a large trade deficit with Japan, and growth prospects there are somewhat worse than they are in Europe. The economy is growing, though weakly, and the overall level of consumer prices continues to fall -- that is, Japan is still suffering from a mild deflation.
Once again, with the U.S. growing so much more rapidly than a trading partner, there is little likelihood that the deficit with Japan will shrink.
Like Citigroup's Alexander, Fed officials still believe the eventual reduction in the U.S. current account deficit can occur without causing a financial crisis. The larger the deficit relative to the size of the U.S. economy, the greater is the risk that they will be wrong. [email protected]. http://quote.bloomberg.com/apps/new...id=azYiU9yR.5P0
