Greenspan: Low Rates Not a Sign of Weakness

Federal Reserve (search) Chairman Alan Greenspan (search) said it was hard to say why long-term interest rates were so low, but that even if they moved below short rates it need not signal a weakening economy.

Speaking to a bankers' conference in Beijing via satellite from Washington, Greenspan said "new forces" in international markets were likely behind the unusually low level of long-term rates around the globe.

"Their nature and their behavior is not something we are going to fully understand, if ever; certainly except in retrospect," he said.

Although the Fed has raised overnight borrowing costs by 2 percentage points since June 2004, taking the benchmark federal funds rate (search) to 3 percent, long-term rates have fallen — confounding policymakers.

As in February, when he termed the low level of long-term interest rates "a conundrum," the Fed chief wrestled with a number of explanations that have been offered for the atypical environment — but again found them all inadequate.

"One prominent hypothesis is that the markets are signaling economic weakness," he said. "This is certainly a credible notion. But periodic signs of buoyancy in some areas of the global economy have not arrested the fall in rates."

A narrowing spread between short- and long-term rates has often signaled economic softness, and some analysts have said this is what it likely portends in the United States.

Greenspan, however, downplayed such an interpretation when asked what signal would be sent if short rates moved above long rates, which in the past has foreshadowed recession.

"I'm not sure what such a configuration, should it occur, would mean," he responded. "I'm reasonably certain we would not automatically assume that it would mean what it meant in the past."

Greenspan told the conference low long-term rates had led hedge funds, the largely unregulated investment pools that cater to the wealthy, to take on greater risks in a scramble for returns.

And he warned that, with the "low-hanging fruit" of easy profits already picked, hedge funds may be set for a fall.

"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 said.

"Significant numbers of trading strategies are already destined to prove disappointing."

He said, however, that the financial system should escape widespread damage from hedge fund woes as long as banks lending to them managed risks effectively.

Although warning of hedge-fund troubles ahead, Greenspan, who spoke on a panel with European Central Bank President Jean-Claude Trichet, Bank of Japan Deputy Governor Toshiro Muto and People's Bank of China Governor Zhou Xiaochuan, reiterated his view that they had improved the economy's resilience.

Asked about China's currency peg, Greenspan repeated that it was in China's interest to move toward greater flexibility.

But he also said, as he has before, a more flexible yuan might not help narrow the record U.S. current account deficit.

He said the United States would turn to other low-cost countries to satisfy its big appetite for foreign goods if the value of the yuan rose.

U.S. manufacturers and a growing chorus of U.S. lawmakers say Beijing's policy of pegging the yuan at about 8.28 to the dollar has given Chinese producers an unfair leg up in international markets.