Federal Reserve Chairman Alan Greenspan today urged the federal government to reduce its budget deficit and encourage greater personal saving, warning that foreign investors will not finance endless growth in America's huge trade gap.
Greenspan, speaking to a banking conference in Germany, repeated that he believes market forces probably will rein in the trade gap's expansion without provoking a financial crisis. But he expressed more concern about the issue than in previous remarks by adding, "we cannot become complacent."
The trade deficit "cannot continue to increase forever" at the recent pace, he said.
The dollar fell in response to Greenspan's comments, which he delivered before a weekend meeting of officials from 20 wealthy and developing countries.
The nation's broadest measure of its trade gap, the current account deficit, reached a record $550 billion last year and appears headed toward around $650 billion this year, which would be equal to 5.7 percent of the nation's gross domestic product. That is up from less than 4 percent before 2000.
The deficit measures the shortfall in trade and investment flows between the United States and the rest of the world. It generally reflects how much Americans live beyond their means, borrowing from abroad to finance their spending and investment.
International investors finance the gap by using the dollars they earn through trade to buy U.S. assets, including stocks, corporate bonds and the Treasury securities sold by the federal government to cover its budget deficit. Many economists have worried about what would happen to the U.S. and global economies if foreigners decided suddenly to sell or buy fewer U.S. assets. Under the worst-case scenarios, the dollar would plummet, stock prices would plunge and U.S. interest rates would soar, hurting U.S. and global economic growth.
The International Monetary Fund said earlier this year that the mounting U.S. budget and current account deficits "pose significant risks for the rest of the world."
Greenspan has appeared to downplay such concerns for many months, through speeches and remarks on Capitol Hill, by stressing that market forces should gradually resolve such trade imbalances because of increased global financial flexibility, or the ability of interest rates, stock prices, product prices and most currency exchange rates to move freely.
In his remarks today, however, he sounded less sanguine, warning that foreigners "at some point" will slow and possibly stop their accumulation of U.S. assets because they won't want to hold too much, concentrating their risk. Alternatively, he warned, they might demand a higher return -- such as higher interest rates -- to compensate for the risk.
