WASHINGTON – Foreign investors will likely tire of bankrolling the bloated U.S. trade deficit but the economy's flexibility should help temper any fallout, Federal Reserve Chairman Alan Greenspan said Monday.
Greenspan's remarks delivered via video link to a conference in Mexico referred to the broadest measure of U.S. trade called the current account deficit, which swelled to a record $668 billion last year. The shortfall is financed mostly by foreign investors.
The huge current account deficits the U.S. has been running up each year "cannot persist indefinitely," Greenspan warned in prepared remarks. "At some point, investors will balk at further financing," he said. The Fed chief didn't say when this might occur.
This current account deficit is considered the best measure of a country's international economic standing because it tracks not only goods and services but investment flows between countries.
So far, foreigners have been willing to lend the United States money to finance its current account imbalances. But the worry is that at some point foreigners will lose their appetite in holding dollar-denominated investments. That could cause them to unload investments in U.S. stocks and bonds, which would send prices plunging and interest rates soaring.
On Wall Street, stocks had little reaction to Greenspan's latest remarks.
The current account deficit accounts for more than 6 percent of the total U.S. economic output as measured by gross domestic product.
Greenspan suggested that constraints on financing of the U.S. trade deficit are likely to come from "foreign investors' fears" of holding too large a share of their investment portfolios in U.S. stocks and bonds.
He suggested that this change could already be under way. He noted that of the more than $30 trillion in foreign investment tracked by the Bank for International Settlements in the first three months of 2005, 42.5 percent were in dollars and 39.3 percent were in euros.
The dollar's share was down by 4 percentage points from around three years earlier, while the euro's share was up by 5 percentage points, Greenspan said.
Greenspan said the United States has benefited from being considered the world's reserve currency, the currency foreigners turn to first when they want to hold investments outside of their country.
This foreign investment has helped to lower U.S. interest rates.
"Although I doubt that the U.S. dollar will lose its status as the world's reserve currency any time soon, there are in my judgment lessons to be learned from the experience of (Britain's currency) as it faded as the world's dominant currency," Greenspan said.
Britain made the mistake of trying to impose extensive regulations to try and support its currency's position on the world's stage, which made Britain's economy too rigid in times of financial crisis, he said.
For the United States, the lesson to be learned from Britain is for America to maintain financial flexibility, Greenspan said. The country's flexibility thus far has allowed it to weather a host of shocks including the Sept. 11, 2001 terror attacks and a steep rise in energy prices over the last two years, he said.
Any pullback from foreign financiers of the U.S. current account deficit "is likely to be readily absorbed by a far more flexible U.S. economy than existed in Britain immediately following World War II," Greenspan said.
The chairman's comments come amid rising tensions over globalization and the world's trade climate.
U.S. Trade Representative Rob Portman last week expressed disappointment that hurdles couldn't be cleared in crucial talks leading up to a major World Trade Organization meeting next month.