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Sunday January 7, 3:11 AM Markets misread US strong dollar policy -Feldstein CHICAGO, Jan 6 (Reuters) - A misunderstanding by financial markets of the so-called "strong dollar" mantra preached by U.S. officials is helping keep the U.S. currency overpriced and contributing to bloated external deficits, Harvard University economist Martin Feldstein said on Saturday. Speaking on a panel on the U.S. current account deficit at the Allied Social Sciences Conventions, Feldstein outlined several factors that are holding the dollar at an overly high, and unsustainable, level. Repeated statements by U.S. officials in support of a strong dollar "are a nice slogan, but that's all it is," said Feldstein, who is also head of the private National Bureau of Economic Research. Feldstein said a correct interpretation is that "we would like to have a strong U.S. dollar at home (helped by low inflation rates) and a competitive dollar in the world." Financial markets are "mislead" if they think there would be government intervention or a shift in the Federal Reserve's monetary policy to protect the dollar's value, he said. "The Treasury should not advocate a decline in the dollar, but it should not mislead the markets to think there is some hidden support there for the currency," he said. Feldstein said the sense that foreign investment will keep flowing to the United States because it is still the healthiest economy is another "error of understanding." Most of the money now coming into the country is for debt purchases by foreign governments, not from equity investors attracted by fundamental strength in the U.S. economy, as was more the case in the 1990s, he said. Speaking on the same panel, Michael Mussa, senior fellow at the Peterson Institute of International Economics, a leading think-tank, said the dollar will need to depreciate substantially, in real effective terms, probably by at least another 20 percent over the next decade to help cut the U.S. current account deficit in half. The dollar has fallen in the past five years by about 15 percent on a trade-weighted basis against an index of major trading partners. Nonetheless, Feldstein and others say it is still overvalued. ALFRED E. NEWMAN VS CHICKEN LITTLE The current account is the net flow of transactions, including goods, services and interest payments, between countries. The U.S. deficit most recently was running at about $900 billion a year, almost 7 percent of U.S. gross domestic product or roughly double the peak deficit of a share of GDP reached in the 1980s. Many economists regard that level as unsustainable, but the timing, trajectory and impact of any adjustment process remains subject to vigorous debate. Mussa said opinions on issue are typically split between the Alfred E. Newman "What Me Worry?" school, and the Chicken Little "The Sky is Falling" contingent. Slashing the deficit with a weaker currency "will not be completely smooth" but the risk of a disruptive dollar crash is not particularly great, Mussa said. At the same time, China's currency, the yuan, needs to adjust more rapidly than the nominal changes made over the past 18 months, he said. "The need for substantial appreciation of the yuan against the dollar over the medium term is unmistakable," he said. China, in contrast to the United States, runs a huge current account surplus. In addition, it runs a large trade surplus with the United States. In October, Washington reported a record $24.4 billion trade deficit with China, 40 percent of the total U.S. trade deficit. Feldstein said both an increase in U.S. domestic savings, now running at a negative rate, and a dollar decline were necessary to wrestle the current account deficit to the mat. "An increase in the savings rate is necessary but not sufficient to bring about an adjustment," he said.