Greenspan Sees Trade Deficit Stabilizing

Federal Reserve (search) Chairman Alan Greenspan (search) said Friday that a variety of factors from a weaker dollar to tougher budget discipline in Congress may finally start to restrain the explosive growth in the U.S. trade deficit.

Greenspan, however, cautioned that the global economy is essentially in uncharted waters given the unprecedented level of economic interaction between countries and thus any forecast of where the U.S. trade deficit (search) is headed could prove to be wrong.

"The dramatic advances over the past decade in virtually all measures of globalization have resulted in an international economic environment with little relevant historical precedent," Greenspan said in remarks prepared for a business conference in London. A text of his speech was released in Washington.

In November, Greenspan sent the dollar and U.S. stocks plunging when in a Berlin speech he expressed concern about the increasing amount of money that America is borrowing from abroad to finance its record trade deficits.

However, in Friday's speech he did not repeat that particular worry, saying instead that he believed that any adjustment in the trade deficit will be accomplished "without any significant consequences to aggregate economic activity."

Through November, the U.S. trade deficit in goods and services was running at a record annual rate of $612 billion, far above the previous record deficit of $497 billion set in 2003.

To finance that trade deficit, the United States is dependent on the willingness of foreigners to continue loaning that amount of money by taking on new investments in dollar-denominated investments such as stocks and bonds.

Some have worried that this soaring level of U.S. assets in foreign hands, in the context of a dollar that has been falling in value for three years, will at some point raise concerns among foreign investors and they will begin dumping their U.S. assets, causing stock prices to plunge and U.S. interest rates to soar.

Greenspan heightened those fears in his November speech when he said that at some point "diversification considerations will slow and possibly limit the desire of investors to add dollar claims to their portfolios."

In his Friday speech Greenspan instead focused on a number of developments that he said should help to restrain the growth in the trade deficit.

A weaker dollar, by making foreign goods more expensive to American consumers and U.S. exports cheaper for foreigners, should narrow the deficit.

Greenspan said one of the reasons that has not happened yet is that foreign companies have been willing to take a hit on their profit margins rather than raise prices in the U.S. market. But Greenspan said there were indications that foreign companies have reached a point where they are no longer willing to absorb the impact of the weaker dollar and will start boosting the price of their goods in the U.S. market.

Greenspan said there were also encouraging signs that Congress and the administration were getting serious about tackling the soaring federal budget deficit, which last year hit a record $412 billion. A rising budget deficit tends to boost the U.S. trade deficit by increasing the demand for goods, which increases imports, and lowering the national savings rate.

"The voice of fiscal restraint, barely audible a year ago, has at least partially regained volume. If actions are taken to reduce federal dissaving, pressures to borrow from abroad will presumably diminish," Greenspan said.