Economic Report of the President 2006

Report Plays Down Economic Woes

Bush Advisers Stay Upbeat
Amid Record Trade Deficit,
Low Personal-Saving Rate
By GREG IP
February 14, 2006; Page A2

WASHINGTON -- The U.S.'s rock-bottom personal-saving rate and record trade deficit aren't major worries, the White House said in its latest economic review.

Striking a more optimistic tone than many economists, the Economic Report of the President said the decline in the personal-saving rate last year to post-Depression lows "may not be cause for alarm." It blamed much of the trade deficit on other countries that save too much, rather than the U.S. saving too little.

The report, released yesterday, is prepared annually by the Council of Economic Advisers. Much of this year's report was prepared while new Federal Reserve Chairman Ben Bernanke was still the council's chairman, but he recused himself from preparing the forecast, which was first released last fall. It sees economic growth of 3.4% this year, unemployment at 5% and inflation at 2.4%.

As is customary, the report provided the administration's interpretation of current economic issues and the role of its proposed policies, rather than suggesting new policies.

ECONOMISTS' VIEW



See and download forecasts for GDP, inflation, productivity, employment and interest rates in the latest WSJ.com forecasting survey.Last year, household spending exceeded after-tax income, producing a negative saving rate for the first time since the Great Depression. The rate of household saving in 1980 was 10%. The White House report said the decline is "potentially misleading" because it doesn't reflect how the rising values of houses and stocks make households feel more financially secure and willing to spend.

The report said baby boomers and their children are wealthier than boomers' parents were at the same age. But it cautioned that future generations might live longer and face bigger health-care bills.

Other economists warned about taking comfort in higher household wealth. "It's too sanguine to equate capital gains with cash-flow saving -- they're not the same," said Alan Auerbach, economist at the University of California at Berkeley.

To live off capital gains, a retiree would have to sell the underlying asset. But for many, selling their home is impractical. While high housing prices might enrich the elderly, moreover, they can hurt younger families who have yet to buy a home.


Former Fed Chairman Alan Greenspan has noted that "capital gains do not finance capital investment," because they exist only on paper. Americans don't save enough to both buy those assets from future retirees and finance new investment, forcing the U.S. to directly or indirectly sell assets to foreigners or borrow from them. The assets might remain in the U.S., but a growing share of the income they generate would go to foreigners, Mr. Auerbach said.

The report identified two risks to Americans' retirement security: the weak state of defined-benefit pensions, and Social Security's large unfunded liabilities.

The report also played down concerns over the nation's current-account deficit, the broadest measure of trade in goods, services and investment income between the U.S. and the rest of the world. That deficit was an annualized $751 billion through the first nine months of last year, or a record 6% of gross domestic product. It is financed by borrowing from, or selling assets to, countries that are running current-account surpluses.

The report pinned those surpluses largely on flaws in foreign economies. It said slow population growth and an overhang of excess capital in Japan have depressed investment and thus the demand for savings. In Germany, it said, "structural rigidities" have reduced "opportunities for profitable investment." And in China, the absence of a "strong safety net" and "well-developed financial markets" has kept saving high. The report suggested that high saving can lead to lax bank lending and problem loans.

The report said the U.S. draws in so much foreign capital to finance its current-account deficit because of strong economic growth, a sound business climate, and large, efficient capital markets. It acknowledged the federal budget deficit has contributed to U.S. demand for foreign savings, but cited Fed research that plays down the magnitude.

William Cline, senior fellow at the Institute for International Economics, a Washington think tank, criticized the report for suggesting the deficit is due largely to "factors outside the U.S. and in time this will all take care of itself." He said it lacks "recognition that we have to take corrective action because most of the problem is from our own sources," such as the large budget deficit and the high level of the dollar. The report does state that the U.S. should keep trying to "reduce its fiscal deficit," and the currency systems of China and other countries should be "liberalized."

The report's sanguine view of current accounts appears to reflect the thinking of Mr. Bernanke, who previously has attributed the current-account deficit to a "global savings glut."

Japan Policy Shift May Set New Tone

Japan Policy Shift May Set New Tone

Expected Tightening Stance
Could Affect World Markets;
Change Likely to Be Gradual
By LAURENCE NORMAN
February 25, 2006; Page B5

NEW YORK -- Wind up your watches and start the countdown. The Bank of Japan is about to start a process that could ripple through global capital markets for years to come.

After more than a decade of near-zero interest rates and five years of "quantitative easing -- the injection of trillions of excess yen into the banking system to defeat deflation -- BOJ officials have sent strong signals recently that they are ready to start tugging at the reins of monetary policy.

Yet patience will be required. With the pace of the policy shift likely to be glacial and the timing of watershed changes uncertain, analysts warn it could be years before the full impact is revealed.

The gradual removal of ultraloose policy from the world's second-largest economy "is one of the great stories over the course of the next three or four years" for financial markets, said Jack Malvey, chief global fixed-income strategist at Lehman Brothers in New York.

"The capital flow implications, the effect on U.S. interest rates, on Japanese domestic markets are all to be sorted out."


If Japanese rates rise, this money could start to return home. Meanwhile, foreign investors, who have already been drawn to the fast-rising Nikkei equity index, could begin investing more broadly in Japanese assets.

Mr. Malvey said this could send U.S. interest rates higher and the dollar lower, as Japanese private investors shift away from U.S. assets. It could also result in higher consumer spending in Japan and a lower Japanese current account surplus, boosting global growth.

The yen could appreciate across the board, as negative bets -- against the euro, the New Zealand dollar and other high-yielding emerging-market currencies -- are unwound.

However, David Abramson, global strategist at Bank Credit Analyst Research in Montreal, said there are a number of uncertainties that cloud the impact of what he calls "the mother of all [policy] normalizations."

In the short term, he said no one quite knows the extent to which investors have taken advantage of Japan's ultraloose policy to borrow in yen and buy other assets.

"There's a lot of liquidity around the world and some of it is because Japanese rates...are still very low. We just don't know the size" of these investments.

In the longer term, it is still unclear how long the BOJ will take to completely remove quantitative easing, when the bank will lift interest rates or whether an eventual rate-tightening cycle would be brief or protracted.

Mr. Abramson is confident about one prediction. A cautious BOJ -- blamed by politicians for raising rates too quickly in the past -- will likely move very slowly, giving the market ample time to adjust.

"What's most likely to happen is that it will be a relatively smooth process," he said.


Jin Saito, Japanese analyst at Washington-based financial advisory The G7 Group, said a gradual adjustment is all the more probable because Japan is just one source behind the currently high global liquidity levels which have kept U.S. long-term rates low and demand for high-yield and emerging-market assets strong.

Moreover, Mr. Saito said that with the government having a massive debt to service, there could be "intense" opposition from the powerful Ministry of Finance to a tightening cycle that pushed short-term rates above 1% -- lifting longer-term rates and raising borrowing costs.

Treasury Trading

Treasury prices settled near unchanged levels Friday, reversing earlier gains briefly accrued after a surprise fall in durable goods orders. In market activity Friday, the benchmark 10-year Treasury note declined 4/32 point, or $1.25 per $1,000 face value, to 99 13/32 points, while its yield rose to 4.577% from 4.561% Thursday.

Corporate Bonds

Dana Corp. bonds fell sharply again after a Wall Street Journal article said the auto-parts supplier has hired restructuring advisers.

The losses extend a selloff that began in earnest Thursday, as market participants questioned whether the company would be able to successfully renegotiate its crucial lines of bank financing -- essential to Dana's long-term viability. The company's troubles intensified when two major ratings companies cut Dana's credit rating multiple notches Friday afternoon -- to nearly the bottom of the ratings scale. Dana's 6.5% notes due 2008 sank more than nine points to 64 cents on the dollar, according to MarketAxess. Its 6.5% notes due 2009 fell more than four points to 63 cents on the dollar.