(Reuters)
Updated: 2007-05-24 09:11

Former Chairman of the Federal Reserve Alan Greenspan (L) and U.S. Treasury Secretary Henry Paulson attend the Conference on U.S. Capital Market Competitiveness in Washington March 13, 2007. [Reuters]

Former U.S. Federal Reserve Chairman Alan Greenspan said on Wednesday he feared a "dramatic contraction" in Chinese stocks but said the global economy may be able to shrug off a drop in asset prices.

Addressing a meeting in Madrid via teleconference, Greenspan said the recent boom in Chinese stocks could not last.

"It is clearly unsustainable," he said "There's going to be a dramatic contraction at some point."

The main Shanghai index has nearly tripled in past year and is up 56 percent so far in 2007.

Greenspan also said a correction could cause problems for Chinese personal wealth. Some analysts have speculated that the Chinese government could be tempted to dip into its reserves to bail out any stung investors and avoid social unrest.

Greenspan, who stepped down as Fed governor last year, said cheap Chinese imports were one of the elements stoking world growth, along with Eastern European workers and the knock-on effects on lower inflation and rates.

"In the last five years, the world as a whole is a growing faster than at any time in the world's history," he said. "It can't last and it won't last because it's a one-shot adjustment."

Greenspan said asset prices around the world could fall but that the economy may escape unscathed if it were flexible enough to absorb asset price shocks.

"We will get major declines in certain levels but it need not feed back significantly to levels of employment or the real economy," he said.

Earlier this month, Greenspan reiterated that he believed there was a one-third chance the U.S. economy, the world's largest, would slip into recession this year.

On Wednesday, he said the United States had no problem financing its current account deficit.

"I am ... not particularly concerned about the current account deficit per se. I think that is essentially a market force," he said, adding that the budget deficit worried him more.

Asked about oil prices, which rose strongly last year and were around $70 a barrel on Wednesday, Greenspan said: "The problem of crude oil is not that we're peaking or running out of oil, we're not, the problem of oil is access."

He saw difficulties ahead for world energy markets over coming years if geopolitical issues continued to plague major suppliers and investment remained at insufficient levels.