Fed chairman writes that cutting the budget gap would reduce risk that foreign capital will flee.
March 1, 2004: 5:56 PM EST
WASHINGTON (Reuters) - Federal Reserve Chairman Alan Greenspan said reducing the U.S. budget gap would lessen the potential risk foreign capital might flee the United States, hurting the economy.
"Taking steps to increase our national saving through fiscal action to lower federal budget deficits would help diminish the risks that a reduction in the rate of purchase of dollar assets by foreign investors could severely crimp the business investment that is crucial for our long-term growth," Greenspan told the Senate Banking Committee in a written response to a question posed at a hearing on Feb. 12.
The committee released Greenspan's response Monday.
The Fed chief said it was hard to gauge how long global investors would continue to place their funds disproportionately in U.S. assets, but so far overseas investors did not appear to be pulling out despite the decline in the dollar over the past year.
"The decline generally has been gradual, and no material adverse side effects have been visible in U.S. capital markets," he said.
Greenspan said the dollar drop had helped to narrow the shortfall in the U.S. current account when the gap was measured against the size of the economy last year and said the drop in the greenback "of late" should eventually help contain it.
The current account is the broadest measure of U.S. trade with the rest of the world.
He noted that U.S. import prices had begun to rise but said, "the turnaround to date has been mild."
Responding to a question on how the U.S. economy could be hurt if China ends its policy of holding the value of its currency, the yuan, fixed to the dollar, Greenspan cited concerns that such a move could spark a crisis in China's banking system.
"Many in China fear that removal of capital controls that restrict the ability of domestic investors to invest abroad and to sell or to purchase foreign currency -- which is a necessary step to allow a currency to float freely -- could cause an outflow of deposits from Chinese banks, destabilizing the system," he said.
"U.S. residents do not have substantial claims on Chinese banks, but financial instability in a major emerging market economy such as China would present a risk to the global economic outlook," he said, adding that Beijing needed to take a number of steps to strengthen its banking system.
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