By Steven K. Beckner

“Households have suffered unusually large shocks to both income and
wealth and many remain highly leveraged,” he explained. “Although the
household debt to net worth ratio has declined considerably from its
peak, it is still around 26%, well above the already elevated average of
the past decade.”

“Moreover, even if consumers wanted to borrow, credit availability
is still constrained and underwriting standards remain relatively
tight….,” he continued. “Given that the personal saving rate is still
relatively low, it will be hard for consumer spending to grow more
quickly without large increases in real labor income.”

“But big increases in real labor income won’t be possible without a
much stronger recovery in output,” he said. “And a much stronger
recovery in output is unlikely without stronger consumption.”

Although residential investment did increase over the second half of
2009,” Dudley said “recent data on the housing sector indicates that the
recovery has stalled.”

Dudley said “only business fixed investment is in a position to be
a true locomotive of growth.”

“However, even here, the growth impulse is likely to be weak,” he
said. “Prospective startup businesses are going to find it difficult to
obtain funding. And larger businesses will unlikely increase investment
spending sharply at a time when capacity utilization rates remain
unusually depressed.”

Dudley said “relatively sluggish growth implies that the output gap
will be closed very gradually. This suggests that inflation pressures
will stay subdued.”

And he added that “longer term inflation expectations remain well
anchored. These expectations have not declined and are broadly
consistent with my views on the appropriate inflation goal.”

“This is actually a welcome development right now because it will
likely help to keep the trend inflation rate from falling too much,” he
said.

Fed officials usually avoid talking about the dollar, but Dudley
ventured into that sensitive area as he spoke about the current account
deficit and the financing of that deficit.

“The last three decades have been marked by a shortage of U.S.
domestic saving relative to investment,” he noted. “The United States
has almost continuously run a current account deficit since the early
1980s. In 2005 and 2006 that current account deficit averaged around 6%
of GDP.”

“Yet, the real exchange value of the dollar today is not terribly
different from what it was in the early 1990s,” he continued. “A massive
flow of saving into the United States from around the world offset
forces that otherwise would have driven the exchange value of the dollar
lower.”

Dudley observed that “foreign savers have been willing to lend to
the United States in the U.S. currency. This means that foreign savers
are exposed to the exchange rate risk that the dollar’s value might
change relative to their own currencies.”

“Finally, one might expect that over time, as their holdings of
dollar-denominated assets increased, foreign savers would demand higher
interest rates, but, in fact, U.S. interest rates in both nominal and
real termshave been generally declining over the past three decades.”

Dudley said that “despite the large flow of foreign saving into the
United States, our international financial position does not appear
precarious at the present time. The United States still has substantial
investments in foreign countries, and income from U.S. investments
abroad still exceeds the income generated by U.S. assets owned by
foreigners.”

“Part of the reason is that U.S. firms operating abroad earn higher
rates of profit than foreign firms operating here,” he said. “In
addition, low interest rates minimize the cost to the United States of
our substantial negative net debt position.”

“In addition, the fact that our foreign indebtedness is for the
most part denominated in our own currency is a huge advantage in the
event the dollar were to come under significant downward pressure,” he
went on. “That is because a decline in the dollar would raise the value
of the income earned on our foreign direct investment and
foreign-currency denominated assets, relative to the income that
foreigners earned on their dollar-denominated investments in the United
States.”

“All else being equal, this would boost our net investment income
balance.”

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** Market News International **

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