BERLIN — Foreigners will eventually sour on U.S. bonds and the dollar because of America's bulging trade and budget deficits, posing significant risks to the nation's economy, Federal Reserve Chairman Alan Greenspan said Friday in remarks that rattled financial markets.
Greenspan told a banking conference in Frankfurt, Germany, that international investors were likely to either unload their dollar-denominated investments or demand higher interest rates. Either scenario would present problems for an economy that is heavily dependent on foreign capital to fuel its free-spending ways.
Some countries have "defused" their trade deficits without significant consequences, Greenspan noted. But, he warned, "we cannot become complacent. History is not an infallible guide to the future."
The Fed chief's concern about the deficits is not new, but his remarks were interpreted by some traders as a warning that a day of reckoning was drawing closer. And they came against the backdrop of the dollar's continued weakness in international currency markets.
After Greenspan spoke, the dollar dropped to its lowest level against the Japanese yen in more than four years. The dollar also fell against the euro, which hit the highest point in its five-year history this week. The stock market fell sharply. The Dow Jones industrial average dropped 115.64 points, or 1.1%, to 10,456.91.
"Greenspan frightened the markets by raising the specter of a dollar panic," said Peter Morici, former director of the Office of Economics at the U.S. International Trade Commission.
The Fed chief also seemed to be practically guaranteeing higher interest rates, saying that investors who weren't hedged against a rise were "desirous of losing money."
Earlier this month, the Fed raised its benchmark short-term rate for the fourth time since June, to 2%. After the market digested Greenspan's latest comments on rates, which weren't part of his prepared remarks, yields on Treasury securities jumped. Another rate increase is expected at the Fed's next meeting Dec. 14.
But it was Greenspan's remarks on the dollar that sparked the most reaction.
The federal government spent $413 billion more than it raised through taxes in the fiscal year that ended Sept. 30. The current account deficit, the broadest measure of the nation's trade balance with the rest of the world, was a record $166 billion in the second quarter. The current account deficit is now approaching 6% of U.S. gross domestic product, another record.
