Fed chairman worried about impact of trade deficits

Friday, November 19th 2004, 8:19 am

By: News On 6

WASHINGTON (AP) _The persistence of bloated U.S. trade deficits over time can pose a risk to the U.S. economy, which thus far has proven resilient, Federal Reserve Chairman Alan Greenspan warned Friday. Policy-makers must not get lulled into a sense of complacency, he said.

The broadest measure of trade, called the current account deficit, swelled to an all-time high of $166.2 billion in the second quarter of this year, the most recent period for which this information is available.

``Current account imbalances, per se, need not be a problem, but cumulative deficits ... raise more complex issues,'' Greenspan said in speech in Frankfurt, Germany. A copy of his remarks was distributed in Washington.

So far, foreigners are willing to lend the United States money to finance the current account imbalances, Greenspan pointed out. The worry, however, is that at some point foreigners might suddenly lose interest in holding dollar-denominated investments. That could cause foreigners to unload investments in U.S. stocks and bonds, sending their prices plunging and interest rates soaring.

The sliding value of the U.S. dollar has made some private economists more concerned about this potential risk.

``It seems persuasive that, given the size of the U.S. current account deficit, a diminished appetite for adding to dollar balances must occur at some point,'' Greenspan said. ``But when, through what channels and from what level of the dollar? Regrettably, no answer to those questions is convincing,'' he said.

The U.S. dollar has been persistently weak against the euro _ the currency used by 12 European countries. The dollar had dropped to a new record low against the euro on Thursday before bouncing back.

The dollar's slide has been good for U.S. manufacturers because it makes their goods less expensive in foreign markets. But the corresponding rise of the euro makes European goods more expensive in foreign markets.

Greenspan, in his speech, did not specifically discuss the value of the dollar. Although he said that forecasting exchange rates ``has a success rate no better than that of forecasting the outcome of a coin toss.''

In his speech, Greenspan also didn't discuss the future course of interest rate policy in the United States.

Wanting to keep inflation from becoming a danger to the economy, Fed policy-makers last week boosted short-term interest rates for a fourth time this year. The action left a key rate, called the federal funds rate, at 2 percent. The funds rate is the Fed primary tool for influencing economic activity.

With recent signs that inflation is heating up again after a long cool spell, economists believe the chances are increasing that the Fed will raise rates again at its last meeting of the year on Dec. 14.

President Bush says the best ways to handle the yawning trade deficits is to get other countries to remove trading barriers and open their markets to U.S. companies. Democrats, including John Kerry, Bush's former rival for the presidency, have blamed Bush's free-trade policies for the loss of U.S. jobs.

Greenspan said that although there's been evidence that ``among developed countries, current account deficits, even large ones, have been diffused without significant consequences, we cannot become complacent.''

Reducing the U.S. federal budget deficit, Greenspan said, would be an important action to boost U.S. savings. Continued flexibility in the U.S. economy also has been important in the economy's ability to absorb and rebound from economic shocks, he said.