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    Greenspan to Admonish Congress, Not Consumers, on Need to Save

    Feb. 15 (Bloomberg) -- Federal Reserve Chairman Alan Greenspan will face questions from Congress this week on the record budget and trade deficits, and Social Security. Chances are there will be less talk about the common issue behind each of those problems: the need to boost U.S. savings.

    Greenspan, who testifies before the Senate's banking committee tomorrow and the House's on Feb. 17, has repeatedly called for lawmakers to reduce the federal deficit, the biggest drain on total domestic savings. The U.S. government racked up a record $412 billion deficit in fiscal 2004, and the Bush administration projects that will rise to $427 billion in the current fiscal year, which ends Sept. 30.

    At the same time, the Fed's recession-fighting low-interest- rate policies helped drive down household savings in 2004 to the lowest level since the Great Depression, analysts say.

    ``It is absolutely an inconsistent message,'' said Tom Schlesinger, executive director at the Financial Markets Center, a Philomont, Virginia, research group that studies the Federal Reserve. The Fed is ``egging households on, and has been at least since the great easing began in January 2001,'' he said, referring to the central bank's previous, steep interest-rate cuts.

    High rates of domestic savings make a country less reliant on foreign capital to finance growth. Consumers saved 1 percent of disposable income last year, the lowest since 1934. Many households are spending or borrowing against their assets to finance consumption.

    When to Worry

    ``As long as people's wealth relative to income stays high, Americans are in good shape, and it can be sustained,'' said Edward Prescott, co-winner of the 2004 Nobel Prize in economics. ``If America's wealth starts going down, then I start worrying.''

    In a Nov. 19 speech, Greenspan argued that ``reducing the federal budget deficit, or preferably moving it to surplus, appears to be the most effective action that could be taken to augment domestic saving.'' Critics, though, say some of the Fed's own policies and statements may have contributed to the problem.

    In March 2001, after the U.S. reported a budget surplus of $236.9 billion for fiscal 2000, Greenspan told Congress that ``it is far better'' that ``surpluses be lowered by tax reductions than by spending increases.'' That, analysts say, gave political momentum to the 2001 Bush tax cuts, which were signed into law in June that year. Congress, however, chose not only tax cuts, but more spending as well.

    Powerful Inducement

    And even after the central bank lifted its benchmark lending rate six times in as many meetings, to 2.5 percent from a 46-year low of 1 percent last June, yields on many short-term savings accounts still hover around zero after inflation. That provides consumers with a powerful inducement to spend rather than save: Personal spending rose 6.1 percent in the 12 months through November, compared with a 4.9 percent rise in incomes.

    One reason for that: household net worth is rising, thanks to appreciating homes and stock and bond portfolios, and consumers are spending those assets.

    Household net worth rose $546 billion from the second to the third quarter last year. Seeing those gains, consumers saved $20.6 billion less out of income in 2004 than they did the previous year.

    Government measures capture money spent from a cash-out mortgage refinancing as an expenditure, though this asset-based spending is not recorded as income. Because saving is derived through subtraction of expenditures from income, a smaller number results, which is one reason why U.S. savings rates are lower.

    Still, consumers are culling less cash out of income to supplement gains in their portfolios, meaning they are optimistic that a sustained increase of property, stocks, and other assets will finance their retirement, medical needs, and the educational expenses of their children.

    `Pixie Dust'

    ``Equity extraction has been the pixie dust of America's post-bubble recovery,'' Stephen Roach, chief economist at Morgan Stanley in New York, wrote in a Feb. 7 note to clients. ``By warmly embracing asset appreciation and the debt binge it fostered, the central bank has encouraged consumers to all but abandon traditional income-based saving strategies.''

    Some Fed officials are beginning to signal concern. ``I don't believe house prices are going to continue to rise at the same pace over the next five years,'' Janet Yellen, president of the San Francisco Fed bank, said in an interview Feb. 11. ``To keep wealth rising over time, if that's what households want, people are going to have to do more of the hard work of spending less, saving more.''

    New York Fed President Timothy Geithner said in a Feb. 9 talk in Washington that the U.S. reliance on foreign savings to finance consumption makes financial markets ``vulnerable.''

    The Dollar's Fall

    The dollar has fallen 15 percent over the past two years against a basket of currencies from the U.S.'s largest trading partners, and the current account deficit, which measures investment as well as trade in goods and services, reached a record $164.7 billion in the third quarter of last year, 5.6 percent of gross domestic product. Lower federal spending and higher household savings would help reduce the trade imbalance, which Geithner described as ``unsustainable.''

    In the third quarter, household liabilities rose by $244.4 billion, according to Federal Reserve data, while the net accumulation of new financial assets rose by just $72 billion. Analysts suggest that higher rates might cool household appetite for debt.

    ``The biggest imbalance at the moment is the lack of saving in the U.S. economy,'' said Nigel Gault, director of research at Global Insight Inc. in Lexington, Massachusetts. ``Raising interest rates will persuade people to spend less.''

    Social Security

    So far, neither Congress nor the Bush administration has proposed a way to increase national savings at the federal or personal level, although advocates of personal investment accounts to supplement or replace Social Security say they would free up savings for private investment. Because the ratio of workers to retirees will fall, the U.S. needs high rates of capital investment to sustain faster, more productive growth to help boost tax revenue.

    Fed watchers will be looking this week to see whether the Fed chairman provides any guidance.

    ``Greenspan is trying to walk a tightrope,'' said Kathleen Bostjancic, senior economist at Merrill Lynch & Co. in New York. ``He doesn't want to declare that consumption needs to slow down, because that puts the economy at risk,'' she said; at the same time, ``the low savings rate may be the most critical variable that needs to be corrected.''


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