Federal Reserve Chairman Alan Greenspan said ballooning trade deficits have not hurt the U.S. economy so far, but he warned that “creeping protectionism” could jeopardize the nation’s ability to narrow the deficits without adverse consequences.

Major Market Indices

Greenspan, who has often warned about the potential threat soaring trade deficits pose, took a more positive view in a speech Thursday. He said that rising globalization had made the United States and other economies more flexible and thus more able to correct economic imbalances such as trade deficits when they occur.

“Spreading globalization has fostered a degree of international flexibility that has raised the possibility of a benign resolution to the U.S. current account imbalance,” Greenspan said in remarks to a monetary conference sponsored by the Cato Institute.

But Greenspan said this needed flexibility could be jeopardized by pressure to erect trade barriers to protect U.S. industries from foreign competition.

“Some clouds of emerging protectionism have become increasingly evident on today’s horizon,” Greenspan said.

Greenspan did not single out the protectionist moves that concerned him. But the Bush administration has been criticized by open trade supporters for imposing high tariffs on foreign steel to protect the U.S. industry and by this week imposing quotas on certain types of Chinese textiles and clothing in response to pleas from the U.S. textile industry.

Greenspan said that throughout history domestic industries have sought government help to fight off foreign competition, only to find that these efforts were eventually overwhelmed by free market forces.

“The costs of any new such protectionist initiatives, in the context of wide current account imbalances, could significantly erode the flexibility of the global economy,” Greenspan said.

“Consequently, it is imperative that creeping protectionism be thwarted and reversed,” he said.

Greenspan said nothing in his remarks about the current state of the economy. The Fed has pushed interest rates to a 45-year low and most analysts believe the central bank will leave rates at low levels perhaps into next fall, in an effort to assure a sustained economic rebound.

Greenspan said that the current account deficit, the country’s broadest measure of trade, is running at a level equivalent to 5 percent of total U.S. economic output. That is far above the previous record level of 3.5 percent set in 1986. In dollar terms, the current account trade deficit hit a record of $480 billion last year and is on track to be well above that mark this year.

Despite this increase, Greenspan said there was “little evidence of stress in funding” the deficit by borrowing from foreigners.

He said while the value of the dollar has fallen by about 20 percent against a market-basket of major currencies since early 2002, that decline has not triggered any problems with rising inflation.

“Inflation, the typical symptom of a weak currency, appears quiescent,” Greenspan said. “To date, the widening to record levels of the U.S. ratio of current account deficit to GDP has been seemingly uneventful.”

Greenspan said there would come a point when economic forces would be triggered that would require a narrowing of that deficit, but that it was hard to forecast when that would occur.

He said as long as the U.S. economy remained flexible, it reduced the risk that a reversal of foreigners’ interest in loaning the United States money to finance its current account deficit would trigger an economic crisis.

“In domestic economies that approach full flexibility, (trade) imbalances are likely to be adjusted well before they become potentially destabilizing,” Greenspan said.

FED policy can stay accomodative 
Chicago Federal Reserve President Michael Moskow said on Thursday that even with strong economic growth next year, inflation is unlikely to pick up significantly, suggesting Fed policy can remain accommodative.

“Even though growth last quarter was exceptionally strong, we are still likely quite a ways from seeing the kinds of pressure on labor and capital resources that often signal an increase in inflation,” Moskow told the Chicagoland Chamber of Commerce.

Moskow, a voting member of the Fed’s policy committee this year, said labor markets are still “a key area of weakness” with payrolls more than 2 million below their peak in 2001.

He told reporters after the speech that even with recent increases in monthly payrolls figures, “I still think it’s early to say ... the job market is in a full recovery mode.”

The Fed official said there are still “appreciable amounts” of excess capacity in some industries and the economy needs to grow more quickly than its potential for a time to use up that excess slack and “neutralize” downward pressure on inflation.

“Despite recent strengthening in activity, the level of actual output is still well below the level of potential output, so there is still an output gap.

“Today, part of the Fed’s policy challenge is to help stimulate economic activity in order to close this output gap,” Moskow said.

He forecast economic growth will be above potential growth of 3 percent to 3.5 percent through the end of 2004. But even this outlook did not suggest inflation worries on the horizon.

That echoes comments from other Fed officials in the past few weeks that they are in no rush to raise official interest rates, even with strong economic growth, because inflation is still so low.

The central bank has kept the benchmark federal funds rate at a 45-year low of 1.0 percent since June, and financial markets expect no increase until the spring at the earliest.

“Even though the outlook calls for strong GDP growth, so long as the output gap persists and there are diminished pressures on resources, inflation rates are unlikely to increase significantly,” Moskow said.

He said the Fed’s ability to keep monetary policy accommodative, or supportive of growth, should help keep borrowing costs for consumers and businesses at low levels.

Moskow was optimistic that growth will remain solid, and said the “general tone” of anecdotal reports from businesses is noticeably better than it was a couple of months ago.

But he did sound one note of caution — that pockets of inflationary pressure could emerge in certain sectors if unused resources did not move efficiently to areas where demand was strong.

While that risk bears watching, he reiterated the central bank’s expectation that inflation is more likely to fall than increase.

Asked about recent U.S. tariffs placed on Chinese textiles, Moskow, whose manufacturing-heavy district has been hard hit in the recent downturn, said he strongly supports open markets and expanded trade.

He noted that tariffs result in higher prices for U.S. consumers, which can affect their spending.

Although industry has recently blamed much of its woes on cheap Chinese imports, a recent study by the Chicago Fed took issue with the standard criticism among manufacturers and said China was not to blame for the weak U.S. factory sector.

Moskow said in response to a question that although recent tax cuts helped lift the economy in the short term, the United States faces “very serious” long-term fiscal problems “and we can’t underestimate them” as projected deficits mount.

© 2012 The Associated Press. All rights reserved. This material may not be published, broadcast, rewritten or redistributed.

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