Swollen trade deficits eventually could threaten the economy by souring foreign appetites to invest in the US, Federal Reserve Chairman Alan Greenspan warned. The US dollar, already sliding, took another nosedive after his remarks.
Greenspan's remarks, to a banking conference in Frankfurt, Germany, referred to the broadest measure of US trade, the current account deficit. That swelled to a record US$166.2 billion in the second quarter of this year, the most recent figure available.
This 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 as well. For all of last year, the current account deficit mushroomed to an all-time high of more than US$500 billion.
So far, foreigners are willing to lend the US money to finance its current account imbalances, Greenspan said. The worry is that at some point foreigners might suddenly lose interest in holding dollar-denominated investments.
That could cause them to unload investments in US stocks and bonds, which would send prices of the stocks and bonds plunging and interest rates soaring. Japan, followed by China and then Britain are the biggest holders of US Treasury securities.
The sinking value of the US dollar, which reflects in part investors' fears about the big US trade and budget deficits, has some private economists more worried about this potential risk.
"It seems persuasive that, given the size of the US current account deficit, a diminished appetite for adding to dollar balances must occur at some point," Greenspan said. That, in turn, could elevate the cost of financing the deficit, he said.
On Wall Street, Greenspan's warning sent stocks down. The Dow Jones industrials lost 115.64 points to close at 10,456.91. It was the biggest single-session point drop for the Dow since Sept. 22.
The US dollar has been sagging against the euro, the currency used by France, Germany and 10 other European countries.
After Greenspan's remarks, which spurred traders to dump more dollars, the dollar fell again, flirting with a record low against the euro. The value of the greenback dropped to a 4-and-a-half-year low against Japan's yen.
The dollar's slide has been good for US manufacturers because it makes their products less expensive in foreign markets. That can help US exports and narrow the trade gap.
Although the Bush administration publicly espouses a "strong dollar" policy, officials have done nothing meant specially to stem the dollar's decline. Private economists believe that's because the administration is OK with what so far has been a relatively orderly decline of the dollar.
The dollar dropped early this week as Treasury Secretary John Snow reaffirmed the administration's dollar policy and signaled the US had no intention of intervening in currency markets to stop the greenback's decline.
Greenspan, in his speech, did not specifically discuss the value of the dollar.
He said that forecasting exchange rates "has a success rate no better than that of forecasting the outcome of a coin toss."
The Fed chief also didn't talk about the future course of interest rates in the US.
With recent signs that inflation is heating again after a long cool spell, economists believe the chances are increasing that the Fed will raise short-term interest rates for a fifth time this year on Dec. 14.