Federal Reserve Chairman Alan Greenspan said Monday he does not have a good explanation for why long-term interest rates have been falling at a time when he and his Fed colleagues have been raising short-term rates.
Greenspan called the pronounced decline in long-term interest rates over the past year at the same time the Fed was boosting short-term rates “clearly without recent precedent.”
Speaking by satellite to a monetary conference in China, Greenspan rejected the suggestion that U.S. rates have been held down by a massive flow of foreign investment from such countries as China. He said a recent Fed study found that foreign purchases of U.S. Treasury notes have had only a “modest” impact on U.S. interest rates.
Greenspan participated on a panel with key central bank officials from China, Japan and Europe.
He repeated comments he has made in the past that it would be good for China to stop pegging its currency, the yuan, tightly to the U.S. dollar, a practice critics say has undervalued the Chinese currency and given the country a tremendous trade advantage over U.S. companies.
Greenspan, however, said he doubted the change would have much impact on America’s record $162 billion trade deficit with China. But he said the change would boost the Chinese economy by making it more flexible.
Need for flexibility
“In enhancing global growth, it is important that the structure of the Chinese economy be as flexible and integrated into the world economy as much as possible,” Greenspan said.
Zhou Xiachuan, head of China’s central bank, told the conference that China needed to do careful analysis of the impact such a change would have on China’s economy and make sure its financial system is prepared.
Officials in the Bush administration have been increasing the pressure on China to make a move soon to a more flexible currency, saying they have already taken all the preparations necessary.
Greenspan’s comments on the conflicting movement of interest rates were his most extensive remarks on the subject since he called the persistence of low long-term rates in the face of Fed credit tightening a “conundrum” in February.
The Fed has boosted a key short-term rate, the federal funds rate, a total of eight times since last June 30, moving it up in quarter-point increments from a 46-year low of 1 percent to its current level of 3 percent.
But over that same time period, Greenspan noted, the yield on Treasury’s benchmark 10-year note has fallen from around 4.8 percent a year ago to around 4 percent currently. The yield on the 10-year Treasury note dipped again Monday to 3.95 percent.
Greenspan said the continued decline in long-term interest rates has not been a development just in the United States but in many other countries around the world.
“Long-term rates have moved lower virtually everywhere,” Greenspan said, noting that in many major economies the declines have been more pronounced than in the United States.
He said access to credit has even improved for many developing nations, noting bond sale success stories in Mexico and Colombia.
Greenspan said a number of explanations have been advanced for what he called “this remarkable worldwide environment of low long-term interest rates.” But in examining the various explanations, Greenspan said, none of them seemed satisfactory.
He noted that some economists had advanced the idea that the large accumulation of holdings of U.S. Treasuries by foreign governments such as China had “doubtless” helped to lower rates on long-term U.S. Treasury securities. But he said a Fed study estimated that this impact was still “modest” given the overall size of the U.S. Treasury market.
Another explanation — that the decline in long-term rates is signaling economic weakness ahead — could not explain why rates continued falling in areas of the world even when other indicators were signaling strength, the Fed chief said.
Greenspan said the need of pension funds for increased investments as baby boomers near retirement or the fact that global financial markets have become more closely linked were not adequate explanations either.
“The economic and financial world is changing in ways that we still do not fully comprehend,” Greenspan concluded.
In his comments, Greenspan also included a warning to operators of large hedge funds, investment vehicles for wealthy individuals, saying that most of the “low hanging fruit of readily available profits has already been picked.”
He said hedge fund managers who feel driven to continue pursuing above-average returns may encounter risks to their investments that will result in setbacks for the hedge fund industry.
“Consequently, after its recent very rapid advance, the hedge fund industry could temporarily shrink and many wealthy fund managers and investors could become less wealthy,” Greenspan warned.
But he said that as long as banks and other lenders to hedge funds manage their own credit risks effectively, “this necessary adjustment should not pose a threat to financial stability.”