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<nettime> An American in Berlin
Soenke Zehle on Wed, 14 Jan 2004 03:03:03 +0100 (CET)

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<nettime> An American in Berlin

Following an invitation by Ernst Welteke of the German Bundesbank (which is
currently looking for new tasks now that the European Central Bank leaves
them with little to do - so hey, why not start a must-attend lecture series
like any newcomer to the academic proletariat),
Alan-what-did-he-just-say-Greenspan (77) gave one of his rare 'overseas'
speeches (no more than 5 in ten years, I think). Here it is, a fascinating,
rich, inspiring piece of economic prose that will leave you cheering for
comparative advantage, sz

Remarks by
Alan Greenspan
Board of Governors of the Federal Reserve System
before the
Bundesbank Lecture 2004
BERLIN, Germany
January 13, 2004

Globalization has altered the economic frameworks of both developed and
developing nations in ways that are difficult to fully comprehend.
Nonetheless, the largely unregulated global markets do clear and, with rare
exceptions, appear to move effortlessly from one state of equilibrium to
another. It is as though an international version of Adam Smith's "invisible
hand" is at work.

One key aspect of the recent globalization process is the apparent
persistent rise in the dispersion of current account balances. Although for
the world as a whole the sum of surpluses must always match the sum of
deficits, the combined size of both, relative to global gross domestic
product (GDP), has grown markedly since the end of World War II. This trend
is inherently sustainable unless some countries build up deficits that are
no longer capable of being financed. Many argue that this has become the
case for America's large current account deficit.

There is no simple measure by which to judge the sustainability of either a
string of current account deficits or their consequence, a significant
buildup in external claims that need to be serviced. In the end, the
restraint on the size of tolerable U.S. imbalances in the global arena will
likely be the reluctance of foreign country residents to accumulate
additional debt and equity claims against U.S. residents. By the end of
2003, net external claims on U.S. residents had risen to approximately 25
percent of a year's GDP, still far less than net claims on many of our
trading partners but rising at the equivalent of 5 percentage points of GDP
annually. However, without some notion of America's capacity for raising
cross-border debt, the sustainability of the current account deficit is
difficult to estimate. That capacity is evidently, in part, a function of
globalization since the apparent increase in our debt-raising capacity
appears to be related to the reduced cost and increasing reach of
international financial intermediation.

The significant reduction in global trade barriers over the past half
century has contributed to a marked rise in the ratio of world trade to GDP
and, accordingly, a rise in the ratio of imports to domestic demand. But
also evident is that the funding of trade has required, or at least has been
associated with, an even faster rise in external finance. Between 1980 and
2002, for example, the nominal dollar value of world imports rose 5-1/2
percent annually, while gross external liabilities, largely financial claims
also expressed in dollars, apparently rose nearly twice as fast.

This observation does not reflect solely the sharp rise in the external
liabilities of the United States that has occurred since 1995. Excluding the
United States, world imports rose about 2-3/4 percent annually from 1995 to
2002; external liabilities increased approximately 8 percent.
Less-comprehensive data suggest that the ratio of global debt and equity
claims to trade has been rising since at least the beginning of the
post-World War II period, though apparently at a more modest pace than in
recent years.

>From an accounting perspective, part of the increase in the ratio of world
gross claims to trade in recent years reflects the continued marked rise in
tradable foreign currencies held by private firms as well as a very
significant buildup of international currency reserves of monetary
authorities. Rising global wealth apparently has led to increased demand for
diversification of portfolios by including greater shares of assets
denominated in foreign currencies.

More generally, technological advance and the spread of global financial
deregulation has fostered a broadening array of specialized financial
products and institutions. The associated increased layers of intermediation
in our financial systems make it easier to diversify and manage risk,
thereby facilitating an ever-rising ratio of both domestic liabilities and
assets to GDP and gross external liabilities to trade. These trends seem
unlikely to reverse, or even to slow materially, short of an improbable end
to the expansion of financial intermediation that is being driven by
cost-reducing technology.

Uptrends in the ratios of external liabilities or assets to trade, and
therefore to GDP, can be shown to have been associated with the widening
dispersion in countries' ratios of trade and current account balances to GDP
to which I alluded earlier.
Theoretically, if external assets and liabilities were always equal,
implying a current account in balance, the ratio of liabilities to GDP could
grow without limit. But in the complexities of the real world, if external
assets fall short of liabilities for some countries, net external
liabilities will grow until they can no longer be effectively serviced. Well
short of that point, market prices, interest rates, and exchange rates will
slow, and then end, the funding of liability growth. A measure of that
dispersion, the sum of the absolute values of the current account balances
estimated from each country's gross domestic saving less gross domestic
investment (the current account's algebraic equivalent), has been rising as
a ratio to aggregate GDP at an average annual rate of about 2 percent since
1970 for the OECD countries, which constitute four-fifths of world GDP.

The long-term increase in intermediation, by facilitating the financing of
ever-wider current account deficits and surpluses, has created an
ever-larger class of investors who might be willing to hold cross-border
claims. To create liabilities, of course, implies a willingness of some
private investors and governments to hold the equivalent increase in claims
at market-determined asset prices. Indeed, were it otherwise, the funding of
liabilities would not be possible.

With the seeming willingness of foreigners to hold progressively greater
amounts of cross-border claims against U.S. residents, at what point do net
claims (that is, gross claims less gross liabilities) against the United
States become unsustainable and deficits decline? Presumably, a U.S. current
account deficit of 5 percent or more of GDP would not have been readily
fundable a half-century ago or perhaps even a couple of decades ago. The
ability to move that much of world saving to the United States in response
to relative rates of return would have been hindered by a far lower degree
of international financial intermediation. Endeavoring to transfer the
equivalent of 5 percent of U.S. GDP from foreign financial institutions and
persons to the United States would presumably have induced changes in the
prices of assets that would have proved inhibiting.

There is, for the moment, little evidence of stress in funding U.S. current
account deficits. To be sure, the real exchange rate for the dollar has, on
balance, declined about 15 percent broadly and roughly 25 percent against
the major foreign currencies since early 2002. Yet inflation, the typical
symptom of a weak currency, appears quiescent. Indeed, inflation premiums
embedded in long-term interest rates apparently have fluctuated in a
relatively narrow range since early 2002. More generally, the vast savings
transfer has occurred without measurable disruption to the balance of
international finance. Certainly, euro area exporters have been under
considerable pressure, but in recent months credit risk spreads have fallen,
and equity prices have risen, throughout much of the global economy.

To date, the widening to record levels of the U.S. ratio of current account
deficit to GDP has been, with the exception of the dollar's exchange rate,
seemingly uneventful. But I have little doubt that, should the rise in the
deficit continue, at some point in the future further adjustments will be
set in motion that will eventually slow and presumably reverse the rate of
accumulation of net claims on U.S. residents. How much further can
international financial intermediation stretch the capacity of world finance
to move national savings across borders?

A major inhibitor appears to be what economists call "home bias." Virtually
all our trading partners share our inclination to invest a disproportionate
percentage of domestic savings in domestic capital assets, irrespective of
the differential rates of return. People seem to prefer to invest in
familiar local businesses even where currency and country risks do not
exist. For the United States, studies have shown that individual investors
and even professional money managers have a slight preference for
investments in their own communities and states. Trust, so crucial an aspect
of investing, is most likely to be fostered by the familiarity of local
communities. As a consequence, home bias will likely continue to constrain
the movement of world savings into its optimum use as capital investment,
thus limiting the internationalization of financial intermediation and hence
the growth of external assets and liabilities.

Nonetheless, during the past decade, home bias has apparently declined
significantly. For most of the earlier postwar era, the correlation between
domestic saving rates and domestic investment rates across the world's major
trading partners, a conventional measure of home bias, was exceptionally
high. For OECD countries, the GDP-weighted correlation coefficient was 0.97
in 1970. However, it fell from the still elevated 0.96 in 1992 to less than
0.8 in 2002. For OECD countries excluding the United States, the recent
decline is even more pronounced. These declines, not surprisingly, mirror
the rise in the differences between saving and investment or, equivalently,
of the dispersion of current account balances over the same years.

The decline in home bias doubtless reflects, in part, vast improvements in
information and communication technologies that have broadened investors'
scope to the point that foreign investment appears less exotic and risky.
Moreover, there has been an increased international tendency for financial
systems to be more transparent, open, and supportive of strong investor
protection. Accordingly, the trend of declining home bias and expanding
international financial intermediation will likely continue as globalization

It is unclear at what point the rising weight of U.S. assets in global
portfolios will impose restraint on world current account dispersion. When
that point arrives, what do we know about whether the process of reining in
our current account deficit will be benign to the economies of the United
States and the world?

According to a Federal Reserve staff study, current account deficits that
emerged among developed countries since 1980 have risen as high as
double-digit percentages of GDP before markets enforced a reversal. The
median high has been about 5 percent of GDP.

Complicating the evaluation of the timing of a turnaround is that deficit
countries, both developed and emerging, borrow in international markets
largely in dollars rather than in their domestic currency. The United States
has been rare in its ability to finance its external deficit in a reserve
currency. This ability has presumably enlarged the capability of the United
States relative to most of our trading partners to incur foreign debt.

Besides experiences with the current account deficits of other countries,
there are few useful guideposts of how high America's net foreign
liabilities can mount. The foreign accumulation of U.S. assets would likely
slow if dollar assets, irrespective of their competitive return, came to
occupy too large a share of the world's portfolio of store of value assets.
In these circumstances, investors would seek greater diversification into
nondollar assets. At the end of 2002, U.S. dollars accounted for about 65
percent of central bank foreign exchange reserves, with the euro second at
19 percent. Approximately half of the much larger private cross-border
holdings were denominated in dollars, with one-third in euros.

More important than the way that the adjustment of the U.S. current account
deficit will be initiated is the effect of the adjustment on both the U.S.
economy and the economies of our trading partners. The history of such
adjustments has been mixed. According to the aforementioned Federal Reserve
study of current account corrections in developed countries, although the
large majority of episodes were characterized by some significant slowing of
economic growth, most economies managed the adjustment without crisis. The
institutional strengths of many of these developed economies--rule of law,
transparency, and investor and property protection--likely helped to
minimize disruptions associated with current account adjustments. The United
Kingdom, however, had significant adjustment difficulties in its early
postwar years, as did, more recently, Mexico, Thailand, Korea, Russia,
Brazil, and Argentina, to name just a few.

Can market forces incrementally defuse a worrisome buildup in a nation's
current account deficit and net external debt before a crisis more abruptly
does so? The answer seems to lie with the degree of flexibility in both
domestic and international markets. By flexibility I mean the ability of an
economy to absorb shocks, stabilize, and recover. In domestic economies that
approach full flexibility, imbalances are likely to be adjusted well before
they become potentially destabilizing. In a similarly flexible world
economy, as debt projections rise, product and equity prices, interest
rates, and exchange rates could change, presumably to reestablish global

The experience over the past two centuries of trade and finance among the
individual states that make up the United States comes close to that
paradigm of flexibility, especially given the fact that exchange rates among
the states have been fixed and, hence, could not be part of an adjustment
process. Although we have scant data on cross-border transactions among the
separate states, anecdotal evidence suggests that over the decades
significant apparent imbalances have been resolved without precipitating
interstate balance-of-payments crises. The dispersion of unemployment rates
among the states, one measure of imbalances, spikes during periods of
economic stress but rapidly returns to modest levels, reflecting a high
degree of adjustment flexibility. That flexibility is even more apparent in
regional money markets, where interest rates that presumably reflect
differential imbalances in states' current accounts and hence cross-border
borrowing requirements have, in recent years, exhibited very little
interstate dispersion. This observation suggests either negligible
cross-state-border imbalances, an unlikely occurrence given the pattern of
state unemployment dispersion, or more likely very rapid financial

We may not be able to usefully determine at what point foreign accumulation
of net claims on the United States will slow or even reverse, but it is
evident that the greater the degree of international flexibility, the less
the risk of a crisis. The experience of the United States over the past
three years is illustrative. The apparent ability of our economy to
withstand a number of severe shocks since mid-2000, with only a small,
temporary decline in real GDP, attests to the marked increase in our economy
's flexibility over the past quarter century.

In evaluating the nature of the adjustment process, we need to ask whether
there is something special in the dollar's being the world's primary reserve
currency. With so few historical examples of dominant world reserve
currencies, we are understandably inclined to look to the experiences of the
dollar's immediate predecessor. At the height of sterling's role as the
world's currency more than a century ago, Great Britain had net external
assets amounting to some 150 percent of its annual GDP, most of which were
lost in World Wars I and II. Early post-World War II Britain was hobbled
with periodic sterling crises, as much of the remnants of Empire endeavored
to disengage themselves from heavy reliance on holding sterling assets as
central bank reserves and private stores of value. The experience of Britain
's then extensively regulated economy, harboring many wartime controls well
beyond the end of hostilities, testifies to the costs of structural rigidity
in times of crisis.

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. 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.

I say this with one major caveat. Some clouds of emerging protectionism have
become increasingly visible on today's horizon. Over the years, protected
interests have often endeavored to stop in its tracks the process of
unsettling economic change. Pitted against the powerful forces of market
competition, virtually all such efforts have failed. The costs of any new
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

The question of whether globalization will be allowed to proceed rests
largely on the judgment of whether greater economic freedom, and the often
frenetic competition it encourages, is deemed by leaders in societies to
enhance the interests, one hopes the long-term interests, of their
populations. Such broad judgments in the end determine how societies are

The reasons that some economies prosper and others sink into long-term
stagnation consequently has been the object of intense interest in recent
decades. Agreement is growing among economic analysts and policymakers that
those economies that have been open to cross-border trade have, in general,
prospered. Those economies that chose to eschew such trade have done poorly.
Most economists have long stipulated that, for a society based on a division
of labor to prosper, the exchange of goods and services must be subject to a
rule of law--specifically, to laws protecting the rights of minorities and
property. Presumably to be effective such arrangements must be perceived as
just by an overwhelming majority of a society. Thus, a rule of law arguably
requires democracy.

Clearly, ideas shape societies and economies. Indeed, I have maintained over
the years that the most profoundly important debate between conflicting
theories of optimum economic organization during the twentieth century was
settled, presumably definitively, here more than a decade ago in the
aftermath of the dismantling of the Berlin Wall. Aside from the Soviet Union
itself, the economies of the Soviet bloc had been, in the prewar period,
similar in many relevant respects to the market-based economies of the west.
Over the first four decades of postwar Europe, both types of economies
developed side by side with limited interaction. It was as close to a
controlled experiment in the viability of economic systems as could ever be

The results, evident with the dismantling of the Wall, were unequivocally in
favor of market economies. The consequences were far-reaching. The
long-standing debate between the virtues of economies organized around free
markets and those governed by centrally planned socialism, one must assume,
is essentially at an end. To be sure, a few still support an old fashioned
socialism. But for the vast majority of previous adherents it is now a
highly diluted socialism, an amalgam of social equity and market efficiency,
often called market socialism. The verdict on rigid central planning has
been rendered, and it is generally appreciated to have been unqualifiedly
negative. There was no eulogy for central planning; it just ceased to be
mentioned, and a large majority of developing nations quietly shifted from
socialism to more market-oriented economies.

Europe has accepted market capitalism in large part as the most effective
means for creating material affluence. It does so, however, with residual

The differences between the United States and continental Europe were
captured most clearly for me in a soliloquy attributed to a prominent
European leader several years ago. He asked, "What is the market? It is the
law of the jungle, the law of nature. And what is civilization? It is the
struggle against nature." While acknowledging the ability of competition to
promote growth, many such observers, nonetheless, remain concerned that
economic actors, to achieve that growth, are required to behave in a manner
governed by the law of the jungle and are hence driven to an excess of

In contrast to these skeptics, others, especially in the United States,
believe the gains in material wealth resulting from market-driven outcomes
facilitate the pursuit of broader values. They support a system based on
voluntary choice in a free marketplace. The crux of the largely
laissez-faire argument is that, because unencumbered competitive markets
reflect the value preferences of consumers, the resulting price signals
direct a nation's savings into those capital assets that maximize the
production of goods and services most valued by consumers. Incomes earned
from that production are determined, for the most part, by how successfully
the participants in an economy contribute to the welfare of consumers, the
presumed purpose of a society's economy.

Clearly, not all activities undertaken in markets are civil. Many, though
legal, are decidedly unsavory. Violation of law and breaches of trust do
undermine the efficiency of markets. But the legal foundations and the
discipline of the marketplace are sufficiently rooted in a rule of law to
limit these aberrations. It is instructive that despite the egregious
breaches of trust in recent years by a number of America's business and
financial leaders, productivity, an important metric of corporate
efficiency, has accelerated.

On net, most economists would agree that vigorous economic competition over
the years has produced a significant rise in the quality of life for the
vast majority of the population in market-oriented economies, including
those at the bottom of the income distribution. The highly competitive free
market paradigm, however, is viewed by many at the other end of the
philosophical spectrum, especially among some here in Europe, as obsessively
materialistic and largely lacking in meaningful cultural values. Those that
still harbor a visceral distaste for highly competitive market capitalism
doubtless gained adherents with the recent uncovering of much scandalous
business behavior during the boom years of the 1990s.

But is there a simple tradeoff between civil conduct, as defined by those
who find raw competitive behavior demeaning, and the quality of material
life they, nonetheless, seek? It is not obvious from a longer-term
perspective that such a tradeoff exists in any meaningful sense.

During the past century, for example, economic growth created resources far
in excess of those required to maintain subsistence. That surplus, even in
the most aggressively competitive economies, has been in large measure
employed to improve the quality of life along many dimensions. To cite a
short list: (1) greater longevity, owing first to the widespread development
of clean, potable water and later to rapid advances in medical technology;
(2) a universal system of education that enabled greatly increased social
mobility; (3) vastly improved conditions of work; and (4) the ability to
enhance our environment by setting aside natural resources rather than
having to employ them to sustain a minimum level of subsistence. At a
fundamental level, Americans, for example, have used the substantial
increases in wealth generated by our market-driven economy to purchase what
many would view as greater civility.

The collapse of the Soviet empire, and with it central planning, has left
market capitalism as the principal, but not universally revered, model of
economic organization. Nevertheless, the vigorous debate on how economies
should be organized in our increasingly globalized society and what rules
should govern individuals' trading appears destined to continue.


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