Federal Reserve Chairman Paul A. Volcker said yesterday that pursuing free-trade principles will be of little use unless something is done about volatile exchange rates.

In a speech in Seattle, Volcker said that "the kind of extreme volatility we have seen -- particularly when measured over periods of months or years -- is hardly acceptable."

He said that the governments of the world will have to strive for more stability "lest fluctuations in exchange rates undermine the very goals of the liberal trading order we want to support."

The large shifts in the value of the dollar compared with the Japanese yen and European currencies "have been the mechanism inducing, in large part, the shifts in trade," Volcker asserted. A text of his speech was released in Washington by the Fed.

Volcker said that a continuation of huge trade deficits would have "ominous" implications, undermining the growth of American manufacturing and mining industries, and requiring massive borrowing from abroad to pay the bills.

"We are a big and strong country, and we can carry those debts if we have to. But the trend is ominous. At some point, the pressures on our industries could undermine our own economic growth, and the confidence that underlies the ease with which we can now borrow abroad," he said.

The main theme of Volcker's speech was that the economic theorist's ideal of the benefits of free trade has been undermined by "a feeling of grievance" over the $125 billion annual trade deficit, generating protectionist sentiment.

He warned against the use of protectionist threats as a negotiating tactic, because it could "become tomorrow's reality." The more constructive approach, he argued, is first to make sure that the rules for trade are applied fairly, and then to expand those rules to new products and services through a global round of trade negotiations.

"I doubt that protectionst pressures can successfully be turned back toward freer trade by a succession of small bargains," Volcker said.

"More general multilateral negotiations, to which there can be political commitments by all participating countries and a wider area for mutual concessions, stand a better chance of galvanizing the necessary support and energies. Or, to put the point more simply, a good offense may be the best defense."

Volcker acknowledged that freer trade alone won't end the huge American deficits or the equally impressive Japanese surpluses, or assure economic growth and prosperity without dealing with a fundamental issue -- the huge American budget deficit.

In addition, he repeated a suggestion he has made publicly before -- that Japan and Western Europe should contribute to global economic health by emphasizing "home grown" expansionary policies.

On the question of exchange rates -- an issue he has increasingly emphasized in recent months -- Volcker did not make concrete suggestions on how to achieve greater stability. But he said there is wide agreement that strong intervention "standing alone, could hardly be successful in achieving greater stability if more fundamental policy imbalances are not corrected."