Current Account gap poses risk to growth-Fed's Geithner http://today.reuters.com/investing/...3_RTRIDST_0_ECONOMY-USA-GEITHNER-UPDATE-3.XML LONDON, Jan 23 (Reuters) - The massive and growing U.S. current account deficit poses a threat to the world economy and an eventual adjustment will not necessarily be gradual, New York Federal Reserve Bank President Timothy Geithner said on Monday. He said most analysts agree the external deficit is unsustainably large and will need to come down over time, but there is little consensus on how the adjustment process will unfold or the implications for the economy and financial markets. "The plausible outcomes range from the gradual and benign to the more precipitous and damaging," Geithner said at a conference in London on global financial imbalances. "The size and duration of these imbalances, perhaps the most visible of which is the U.S. current account deficit, present challenges -- and risks -- for the world economy." Geithner pointed out that the U.S. current account gap is nearing 7 percent of gross domestic product, a level without precedent for a major economy. He warned that the longer the deficit continues to grow, the more painful the eventual reckoning will be. "Time does not necessarily help. The longer these gaps continue to build, the greater the ultimate adjustment required, and the greater the risks that accompany that process," Geithner said in a speech that revisited many of the concerns the central banker has raised in the past. While Geithner highlighted the current account deficit, International Monetary Fund chief economist Raghuram Rajan spoke of the need for the United States to cut its fiscal deficit in order to help right global imbalances. The deficit is projected to rise above $400 billion in fiscal 2006 from $319 billion, which was less than three percent of GDP, for the fiscal year ended Sept. 30, 2005. But the Bush administration says this is a temporary rise because of the cost of providing Hurricane Katrina relief. Treasury Secretary John Snow maintains that tax revenues are growing at a record rate and that the country is on target to reduce the shortfall to below 2 percent of GDP by 2009 when President George W. Bush leaves office. "The U.S. should reduce its fiscal deficit," Rajan told the conference, adding that global imbalances were a threat to the health of the world economy. "Some revenue-raising measures had to be considered after Hurricane Katrina ... but we believe some of those measures are optimistic," Rajan added. MONETARY POLICY Rajan also said that a tightening of Japanese monetary policy, following rates rises in the United States and from the European Central Bank, would help to curb global asset prices, "Asset prices due seem relatively inflated. When all three central banks are in tightening mode we will see more of the effects of monetary policy on asset prices," he added. Geithner, a voting member of the Fed's policy committee, said at a question and answer session that monetary policy is limited as a tool to fix economic imbalances. "I don't think you can use monetary policy or think of monetary policy as being a particularly effective tool to, in a pre-emptive way, defuse ... the future evolution of imbalances," Geithner said. But he did note in his speech that past and future capital flows matter for monetary policy through their impact on the outlook for growth and inflation. The low level of long-term U.S. interest rates complicated the task of judging the appropriate level for U.S. monetary policy, Geithner said. Dismissing an argument that the current low level of U.S. bond yields signalled pessimism over the economy, Geithner attributed the low rates to the rise in global savings and a substantial reduction in long-term inflation expectations. Geithner noted that for now, risk premiums suggested there was little concern in financial markets about the size of the deficit. But the size of the deficit and the "inevitability" of an eventual adjustment mean the world will be living for a considerable time with the risk of greater volatility in asset prices and periods of slower economic growth in the United States and the rest of the world. Geithner said although other industrial countries have gone through a rebalancing of large deficits without damaging moves in interest rates or foreign exchange rates, the U.S. case seems "sufficiently different" that history may not be a good guide. "And even in these past cases, the adjustment process did entail a slowdown in GDP growth, increasing unemployment, and a sharp fall in investment," he said. While there are several arguments that may improve the odds of a gradual, benign adjustment process, "they do not really alter the general conclusion that these imbalances are unsustainable and that they will need to unwind at some point."