Chairman Greenspan's Testimony & Semi-annual Monetary Policy Report to the Congress

"The Federal Reserve will pursue its statutory objectives of price stability and maximum sustainable employment--the latter of which we have learned can best be achieved in the long run by maintaining price stability. This is the surest contribution that the Federal Reserve can make in fostering the economic prosperity and well-being of our nation and its people."

http://www.federalreserve.gov/boarddocs/hh/2005/february/testimony.htm

Economic Projections for 2005 and 2006

Federal Reserve policymakers expect the economy to expand moderately and inflation to remain low in 2005 and 2006. Real GDP growth is expected be be 3.75 to 4 percent for 2005 and about 3.5 percent in 2006. The unemployment rate is expected to average about 5.25 percent in the fourth quarter of 2005 and they expect the unemployment rate to edge down to between 5 percent and 5.25 percent for 2006. The price index for core personal consumption expenditures is expected to be about the same as the 1.6 percent increase posted over 2004.

http://www.federalreserve.gov/boarddocs/hh/2005/february/fullreport.htm

Tom notes that real estate still looks like a good investment.

Tossing A Coin

During the next two days, Chairman Greenspan will be testifying before congress. The global economy will be intent on his remarks. In the meantime, I report here on his Frankfurt panel discussion from November 19, 2004, which he mentioned in his recent London remarks.

Perhaps the most sensible observation he makes is not one I would like to hear. "Nonetheless, despite extensive efforts on the part of analysts, to my knowledge, no model projecting directional movements in exchange rates is significantly superior to tossing a coin. I am aware that, of the thousands who try, some are quite successful. So are winners of coin tossing contests."

This is confirmed by my own experience trading currencies over the years, and yet. . . the game goes on.

In the November speech, Greenspan takes what seems to me an unusual step and emphasizes that "I speak for myself and not necessarily for the Federal Reserve." He also refers to a paper by Caroline L. Freund. The type of document is an International Finance Discussion Paper, "circulated to stimulate discussion and critical comment." Caroline Freund is an economist in the International Finance Division of the Federal Reserve Board. She emphasizes that the views presented are solely her responsibility and should not be interpreted as reflecting the views of the Board of Governors of the Federal Reserve System or any other person associated with the Federal Reserve System.

The International Finance Discussion Paper, Number 692, is dated December 2000, and is called Current Account Adjustment In Industrialized Countries. In it she presents 25 examples of large current account adjustments which have occurred since 1980. (Including the United States in 1987). The typical current account reversal begins when the current account deficit as about 5 percent of GDP, that it is associated with slowing income growth and a significant real depreciation over a period of about three years. The short-term interest rate displays a hump-shaped pattern, it is elevated by about 2 percent in the year the current account bottomed out.

The conditions facing the U.S. are similar to those seen before. The current account deficit is now more than 5 percent of GDP. Short term interest rates are expected to ramp up by around 2 percent this year. The dollar may weaken over the next three years to bring the deficit under control. Conceivably the economy could be headed toward slower growth in the next three years.

What is not mentioned specifically is the trade imbalance with China. The current arrangement between the U.S. and China is a fixed exchange rate. This does not allow the current account to adjust in the normal way. China must revalue its currency. They will drag their feet as long as they can. But change must come.

Treasury International Capital Data for December

Because I prefer to look at the data for myself, rather than depend on the spinmeisters and headline makers, and because I still enjoy the instant publication of the source data over the internet, I visited the U.S. Treasury web site this morning to get the report on the net capital flows for December. http://www.treas.gov/press/releases/reports/js2251tic_data.pdf

I like to download and print out the .pdf file from the Treasury and print it out because it is only two pages, and I like the picture of the treasury building that is part of the 'letterhead.' It just looks like money. The report follows a consistent format and with a little practice, your eye can look on page two and pick out the number that is so widely reported. Under the heading Net Long-Term Securities Flows it appears. It appears again at the bottom right hand corner of the table of numbers published at the end of the report.

The numbers in the table give a context to The Number in terms of a series of similar numbers. Thus we see that December's $61.3 billion inflow of net long-term securities can be compared with the monthly figures for the previous three months, and with the figures for the whole years of 2004, 2003 and 2002.

A useful number for comparison is our balance of trade in goods and services for the latest month. You need to look to the Census Department for that one.
http://www.census.gov/foreign-trade/statistics/highlights/monthly.html

So we see that the December 2004 trade balance was minus $56.4 billion. This was a 4.9% improvement from the previous month. So basically the Treasury International Capital data released today shows that the trade imbalance was financed by net capital inflows from foreign investors.

A third useful number for comparison to the TIC data is the expected number. In other words, the market will anticipate what the Treasury will release. If the number is better than expected, this would be positive for the dollar. If the number is not as good as expected, this can have an impact negatively. Today's number was a bit better than expected.

This number caused an added volatility in the market for about an hour, but now the market is trading about where it was before the report was released. A good place to find what the expected number is, previous to its release is the U.S. Economic Calendar published by Refco Global Research among many others. See link at https://research.refco.com/ms/reports/

For a more in-depth article on the TIC system, see Federal Reserve Bulletin for October 2001, pages 633-650

Australian Dollar Rising

If you visit the link today, you may see the current Australian Dollar chart.

http://www.mizuho-cb.co.uk/TresInternet/PDF%27S/start.pdf

A good link for Australia financial information is the webpage of Reserve Bank of Australia--their central bank. Tom says check it out.

www.rba.gov.au/PublicationsAndResearch/

The Reserve Bank of Australia (RBA) finalized a Statement on Monetary Policy on February 3. One of the highlights of the report is that world prices of Australia's base metals exports are now around 40 percent higher than they were two years ago. Supply bottlenecks in the mining sector have held back export growth recently, but capacity expansions are being worked on. BHP Billiton is a Melbourne-based company with global interests in resources such as iron and coal, copper, etc.

http://www.bhpbilliton.com/bb/aboutUs/home.jsp

Their shares trade on the New York Stock Exchange as American Depository Receipts (ADR) with the symbol BBL. Might be interesting to follow that company and see if it benefits from the continued demand for base metals and coal due to the global expansion and especially Chinese expansion.

If you get a chance, read the RBA statement on monetary policy. It is a fast road to familiarity with that sector of the world economy.

Stock photo 

Still Pondering Greenspan's February 4 Remarks in London

Chairman Greenspan's remarks last Friday, February 4, in London regarding the U.S. current account were weighty, complex, and revealing. A close reading of his speech allows the student of the world economy to glimpse shapes beyond the swirling mists of data and the distorting media haze. To begin, the scene is set with reference to the 1980 Economic Journal article by Martin Feldstein and Charles Horoika, vol. 90, pp. 314-329. The article is a kind of stepping stone which allows those uninitated into the fraternity of economic globalization to grasp the chairman's opening remarks. Without that stepping stone, the water gets deep quickly. So I spent several hours poring over Domestic Savings and International Capital Flows and finally crawled up onto that first stepping stone.

The article examines 15 years of data for 21 developed countries to answer the question 'How internationally mobile is the world's supply of capital?' Does capital flow among industrial countries to equalize the yield to investors? Or, does the saving that originates in a country remain to be invested there? If the ratio of savings to investment is close to 1, then the reality is that domestic savings stay at home. If the ratio approaches zero, then domestic savings can escape overseas to seek the best return to the investor.

The 1980 article shows that domestic savings stay at home, despite the level of foreign trade imbalances.

Chairman Greenspan remarks that "in the past decade, expanding trade has been associated with the emergence of ever-larger U.S. current account deficits. . . matched by a corresponding widening of external surpluses in a majority of trading nations."

"The increasing dispersion of these external imbalances is mirrored in a decline in the tight association between national saving rates and domestic investment rates. The correlation between the two, for countries representing four-fifths of world GDP, declined from a coefficient of around 0.96 in 1992, where it had hovered for half a century, to an estimated low of 0.8 last year."

So the proposition that domestic savings stay at home to be invested at home is becoming less true, though it is still 80 percent true. Greenspan concludes: "The decline in home bias, as economists call the parochial tendency to invest domestic savings at home, has clearly enlarged the capacity of the United States to fund deficits."

Later in his remarks, he refers to the speech he gave in Frankfurt on November 19, 2004.

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.

More on that speech later. We note that at the time of the speech the Euro was about $1.30, and that it continued to appreciate for more than a month to $1.3666 on December 29, before returning to $1.2872 the day before these February 4 remarks.

Greenspan at the Adam Smith Memorial Lecture, February 6, Kirkaldy, Scotland

Alan Greenspan followed his dollar-supporting London speech on February 4 with an important, though lower key lecture on Superbowl Sunday. (http://www.federalreserve.gov/board/Docs/speeches/2005/20050206/default.htm)

The following wry remarks show Greenspan's respect and affinity for Gordon Brown, Chancellor of the Exchequer:

Kirkaldy--the birthplace, in 1723, of Adam Smith and, by extension, of modern economics--is also, of course, where your Chancellor of the Exchequer was reared. I am led to ponder to what extent the Chancellor's renowned economic and financial skills are the result of exposure to the subliminal intellect-enhancing emanations of this area. . .

Starting in the 1970s, American Presidents, supported by bipartisan majorities it the Congress, deregulated large segments of America's transportation, communications, energy, and financial services industries. Similar initiatives were advanced in Britain and elsewhere. The stated purpose was to enhance competition, which following Adam Smith was increasingly seen as a significant spur to the growth of productivity and standards of living. The slow, but persistent, lowering of barriers to cross-border trade and finance assisted in the dismantling of economic rigidities.

By the 1980s, the success of that strategy in the United States confirmed the earlier views that a loosening of regulatory restraint on business would improve the flexibility of our economies. Flexibility implies a faster response to shocks, a correspondingly greater ability to absorb the downside consequences, and a quicker recovery in their aftermath. Enhanced flexibility has the advantage of enabling market economies to adjust automatically and not having to rest on policymakers' initiatives, which often come too late or are misguided. Such views, which echo Jean Baptiste Say in some ways, clearly have been paramount in a renewed twenty-first century appreciation of Adam Smith's contributions.

My Analysis

The first remark is praise. Simple enough.

The second is less obvious, but the word "flexibility" is nuanced. Chancellor Brown is encouraging the UK to join the European Union, an "irreversible" decision, provided the economics are right. Since 1997, the government has set 5 tests that must be met to show the economic case for joining is clear and unambiguous. One of these tests (the second) is "flexibility."

Greenspan points out that "flexibility" has been brought about in America by deregulation and by "slow, but persistent, lowering of barriers to cross-border trade and finance." He also mentions that such views echo Jean Baptiste Say--a Frenchman. I don't know if I'm reading too much into it, but it seems to me that he hints that too much government regulation in the UK has been the problem and that a French economist from the early 19th century who in effect disagreed with Lord Keynes got it right after all. A gentle and humorous chiding, perhaps?

For more on the 5 tests, see the following link:

http://www.hm-treasury.gov.uk/documents/the_euro/assessment/report/euro_assess03_repindex.cfm

What Did He Say Exactly?

Alan Greenspan's London address in toto (with footnotes) can be read at this link
http://www.federalreserve.gov/boardDocs/speeches/2005/20050204/default.htm

So far the results are bullish for the dollar.

Greenspan's first footnote refers to a June 1980 article from The Economic Journal (p. 314-329) called Domestic Saving and International Capital Flows. That sent me scurrying to my reference library--thank goodness for the internet!

Footnote 6 refers to the correlation between the current account deficit and mortgage refinancing. Pretty interesting stuff. R squared equals 0.7. How bout them apples?

Non-Farm Payroll Report

On the other hand, the calm may be due to traders squaring up their positions before the twin events tomorrow morning of the Non-Farm Payroll Report, notoriously unpredictable but expected to come in around 190,000 jobs created, and Chairman Greenspan's words on the balance of payments. Either or both of these events may shake the markets out of their range bound condition. I'm betting on a continuation of the range, due to the parity in interest rates. But of course, I'm willing to be wrong and jump the other way if the market changes direction.

Interest Rate Parity

One of the models for making sense out of the levels of the currency exchange markets is the Interest Rate Parity Theorem. Supposedly the exchange rate will hold steady at some interest rate. Other things being equal, of course. Lately the Fed has been raising our interest rates at a measured pace of a quarter percent per meeting of the Federal Open Market Committee (FOMC). Last week (January 25) the Bank of Canada did not change their overnight interest rate at their meeting, but left it at 2.5%. This week the Federal Reserve raised ours to 2.5%. Thus, we have interest rate parity between the two currencies. The USD/CAD rate has been holding pretty steady at around 1.24 for the past week. Today the European Central Bank (ECB) left its rate unchanged at 2%. The perception is that the Fed will continue to raise interest rates here and the ECB will hold steady at 2% for the next few months. If there were no other factors involved, this would tend to strengthen the dollar vs. the euro. Since the euro has appreciated quite a bit vs. the dollar in the past quarter, these interest rate moves may restore stability in this important exchange rate. The relative calm in the currency markets over the past few days may be a result of an temporory equilibrium due to interest rate parity.

Bush's State of the Union Message

President George W. Bush's State of the Union speech last night passed without incident in the currency markets. This is no small feat of statesmanship. With the jaundiced eyes of the world looking on for an hour, not to make waves takes a bit of skill.

Chairman Greenspan's speech on the trade balance deficit in the morning may require the nuance of a virtuoso--and he will no doubt deliver.

Opining with elbows. 

Fed Raises Rates As Expected

Without signaling any change in policy, the Fed increased interest rates today by a quarter point. We look forward to Chairman Greenspan's comments on the trade balance at the upcoming G-7 meeting.

The announcement did not disturb the equilibrium of the markets that has been in effect for the past few days.