Mainers respond to Greenspan report

Markets didn’t tumble and headlines didn’t scream after Federal Reserve Board Chairman Alan Greenspan stood before the House Financial Services Committee last week. But, as usual, the chief’s remarks drove economists and investment pros worldwide to read deeply between the lines.

In Maine, the chairman’s report suggested a mixed bag of encouragement and caution through the rest of the year.

Christopher Nelson, a certified financial analyst and chief investment officer at Bangor Savings Bank, said Greenspan described an economy clearly on the mend: more jobs, lower inflation and plenty of excess production capacity ready to be brought on-line. Combined with the chairman’s remark that “the Federal Reserve can be patient” in holding to its “accommodative” policy, Nelson anticipates no near-term change in interest rates.

“We just can’t see anything that would spark a jump [in interest rates] here, even a preemptive move, before the end of the year,” he said.

That is good news for some, not so much for others. If Nelson’s view holds and the federal fund’s rate remains unchanged at 1 percent through the end of the year, it would keep the fire lit under Maine’s healthy home sales markets for realtors and mortgage brokers. The segment logged record numbers of home sales through several years of a difficult economy. Observers agree the refinance boom is largely over, but low rates would help keep up demand for loans from homeowners looking to remodel or expand.

Also on the plus side, low rates would continue to push automobile and building supply sales. Those two categories generate about a third of Maine’s sales tax and have helped shore up the state budget against losses from slumping income tax.

“It hasn’t completely made up for the loss of capital gains,” said state economist Laurie LaChance, “but it has certainly kept us from going into a free fall in tax collection.”

But not everyone in Maine gets a boost from a low-interest economy. Another year of low rates means one more year of depleted interest income for the state’s growing population of fixed income earners.

“Those people who are currently living off retirement income with CDs in all of our banks are getting clobbered with those same low interest rates,” said Bar Harbor Banking & Trust Co. chief executive Dean Read.

The state itself is on the losing side of the low interest equation, seeing a reduced income from investments, earned primarily on overnight investment of state reserves. LaChance said the budget crunch drew down reserves, accounting for part of the drop in investment income from $20 million in 2000 to an estimated $1.4 million for the coming year. But low interest rates account for a large portion of the loss.

The most worrying threat outlined in Greenspan’s testimony: deficits. Recent and pending budget deficits are at record highs in terms of actual numbers, although well within historical limits as a percentage of gross domestic product.

But Greenspan focused on the current account deficit, a broad import/export measure that adds international financial transfers to goods and services measured by the standard U.S. trade deficit. The account deficit, which reached $550 billion last year, or 5 percent of GDP, underscored an increasing ownership of U.S. debt by foreign investors.

The U.S. Treasury Department estimates foreign ownership of U.S. debt increased from 20 percent a decade ago to a current 43 percent. The key players in that trend are central banks in Japan and China, the Bank of Japan buying about a third of $340 billion in Treasury bonds issued since January 2003.

Why the spree? A weak U.S. economy and high debt tend to weaken the dollar. A weak dollar buys fewer goods imported from Asian manufacturers. Banks in Japan and China, flush with surplus capital from high levels of personal savings in those countries, buy U.S. bonds to buoy U.S. currency and boost their own export trades.

That trend isn’t a problem as long as it continues. The threat, according to Adrienne Kearney, economics professor at the University of Maine, comes when those banks perceive too much risk in U.S. spending, deficits and relentlessly increasing debt.

“All of this is about, what if foreign investors pull out of domestic stocks and bonds because they think we can no longer pay back the debt?” Kearney said.

With the level of foreign ownership nearing 50 percent, even a perceived change in buying trends could have significant effects on securities markets. What would the potential impact be to a healing national economy hoping to add 2 or more million jobs in the coming year?

“It’s a tremendous risk,” said Alan Day, chief economist, Banknorth Investment Management Group. “If they would elect to stop buying [U.S. bonds] … it would force interest rates up. If interest rates go up on treasury debts, that means interest rates go up on home mortgages, which cools down the housing market.”

A rate increase would also drive up the costs for companies and municipalities to issue bonds, slowing economic growth and depreciating the value of the dollar. In Maine, however, the effects might not be all bad.

Increased bond rates would mean more income for thousands of retirees. And a weaker dollar would ease the fierce foreign price competition for anchor industries including forest products, textiles and manufacturing.

“When the dollar is strong, we get nailed in our traditional industries,” LaChance said. “If the dollar comes down, that takes a little pressure off those industries.”

Another boost would likely arrive from across the border, as Canadian tourists loaded up their cars to take advantage of a favorable exchange rate.

But, like Nelson, Day anticipated no change in interest rates or in the direction of the economy through 2004. What about 2005? For that, even the pros must wait for Greenspan’s next deftly worded report to lawmakers in July.

“[Greenspan] knows the financial markets listen to them and they know the bond market is first to react, so their words are measured,” Day said. “And that spawns a whole industry trying to figure out just what they mean.”