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Strategies & Market Trends : Mish's Global Economic Trend Analysis -- Ignore unavailable to you. Want to Upgrade?

To: RealMuLan who wrote (22310)	1/27/2005 7:55:28 PM
From: RealMuLan	Respond to of 116555

DAVOS-World economy seen threatened by U.S. deficits Wed Jan 26, 2005 10:38 AM ET By Stella Dawson DAVOS, Switzerland, Jan 26 (Reuters) - Massive U.S. deficits pose a major risk to the world economy, which is enjoying its best peformance in decades, and correcting them will prove tricky, top economists and business leaders said on Wednesday. As the World Economic Forum kicked off in the Swiss mountain resort of Davos, there was a sense of wary optimism about a global economy that has absorbed higher oil prices and a weaker U.S. dollar without major hiccups in growth or inflation. The United States and emerging Asia are growing strongly, driving steady recoveries in Japan and Europe, putting the world on track for another year of 4 percent or better global growth. Last year the world saw its best growth in three decades. But the savings deficit in the United States means it must suck in billions of dollars in foreign capital, particularly from Asia, to finance its current account deficit, which is above 5.6 percent of GDP and growing. This clouds the economic picture, participants in the 34th annual gathering of corporate leaders and politicians said. "Very little is being done about it," said Jacob Frenkel, former central banker to Israel and now vice chairman of the U.S. insurance company American International Group inc. (AIG.N: Quote, Profile, Research) , said of the U.S. savings, trade and budget deficits. Relying on a weak U.S. dollar or currency appreciation in Asia to correct the U.S. deficits problem is not enough. Higher U.S. rates will be part of the answer but are risky, participants said. Laura Tyson, dean of London Business School and former top economist to the Clinton administration, said the U.S. administration has developed no credible programme to stimulate domestic savings and bring down its deficits. Stephen Roach, chief economist at Morgan Stanley USA, said: "It would take an unacceptably huge degree of dollar depreciation to achieve (a correction)". And that, he added, could cause the U.S. and even global economies to crash. "It's very risky," said Mexican Economy Minister Fernando Canales of a U.S. dollar crash. "It's not a scenario we would like to have." MENU OF ACTIONS Group of Seven policymakers have laid out a list of reforms for world economies -- Europe must boost its productivity, loosen government regulations and revive consumer and business demand; markets must be opened to free trade; and the U.S. raise its savings rate to pay for its deficits. All are difficult, but the last may prove the trickiest and most treacherous act to pull off. The Federal Reserve must proceed with credit tightening to raise U.S. rates that are "unconscionably low" because they have inflated real estate prices and encouraged U.S. consumers to borrow huge amounts against homes, Morgan Stanley's Roach said. "They have turned their homes into massive ATM machines, sucking out dollars to buy DVD players made in China." The Fed has pushed up the official interest rate by 1.25 percentage points to 2.25 percent in the past seven months and says rate hikes may well accelerate. But the hikes have really just brought real U.S. rates, adjusted for inflation, to zero. "I am increasingly concerned that the overly leveraged, savings-short, asset-dependent American consumer is the weak link in the chain as the Fed raises rates," said Roach. Moreover, higher U.S. rates could disrupt bond markets where yield spreads between safe government issues and riskier emerging nation and corporate debt are historically tight, Frenkel and Roach both said. Analysts agreed Fed tightening was a key part of solving the U.S. addiction to foreign borrowing, especially if over-reliance on too sharp and too-fast currency moves are to be avoided. "Currency restructuring will be needed in a year or two to rebalance the global economy," said Takatoshi Ito, formerly Japan's vice minister of international finance and now a university professor. Already the dollar has dropped nearly 20 percent on a trade weighted basis (.DXY) in the past two years while Europe and the U.S. are pressuring China to float its currency -- a call that is heightening ahead of the Group of Seven meetings next week. But Ito said not to expect China to float its currency this year. Not until the pressure of currency speculation comes off China's central banks will they consider revaluing, said Victor Chu, chairm of First Eastern Investment Corp. in Hong Kong. (additional reporting by Thomas Atkins and Knut Engelmann) © Reuters 2005. All Rights Reserved. reuters.com