Greenspan reassures on burgeoning deficit

Alan Greenspan, the chairman of the Federal Reserve, delivered a veiled warning yesterday that a further decline in the value of the dollar could begin to drive up US inflation.

However, the world's most influential central banker re-iterated his view that the American economy had sufficient flexibility to cope with the twin threats posed by a weak currency and its enormous trade deficit.

Mr Greenspan also suggested that pressure on the US to borrow from overseas in order to fund the current account deficit could ease if the Bush administration heeded the growing chorus of calls for fiscal restraint.

Speaking at the Advancing Enterprise conference in London, the Fed chairman said: "We may be approaching a point, if we are not already there, at which exporters to the United States, should the dollar decline further, would no longer choose to absorb a further reduction in profit margins." This, he said, would result in an increase in import prices although it would also lower the quantity of imports, leaving the overall value of US imports uncertain.

Bob Rubin, the former US Treasury Secretary under President Clinton, later said he feared that America's terrible twins - the budget deficit and trade deficit - would get worse, not better. He warned that this could have serious effects on bond markets and the US currency. He said "tinkering around the edges" would not deal with one of the country's fundamental problems: tax revenues were now equal to just 16 per cent of total output - the lowest proportion since 1960.

The final communiqué from the G7 meeting today will be closed watched by the markets for what it says about exchange rates. Mervyn King, Governor of the Bank of England, told the conference that the G7 needed to bring countries such as China and India into its discussions more if it was to tackle global trade imbalances brought about by divergent exchange rates.