In his testimony to Congress this morning, Federal Reserve Board chairman Alan Greenspan said that the geopolitical situation is weighing on the U.S. economy.

The Fed chairman’s semi-annual monetary policy report to the Congress before the Committee on Banking, Housing, and Urban Affairs reviews the state of the U.S. economy and the conduct of monetary policy and some key issues related to the federal budget.

In his testimony, Greenspan said that the emergence of a sustained and broad-based pickup in capital spending will almost surely require the resumption of substantial gains in corporate profits. “Profit margins apparently did improve a bit last year, aided importantly by the strong growth in labor productivity,” Greenspan noted.

However, the major political uncertainty is the real external drag on spending, he says. “The heightening of geopolitical tensions has only added to the marked uncertainties that have piled up over the past three years, creating formidable barriers to new investment and thus to a resumption of vigorous expansion of overall economic activity.”

Greenspan said that financial conditions would not seem to impose a significant hurdle to a turnaround in business spending. But, he allows that the economy could be facing inherent troubles of its own, which are just masked by the Iraq situation. “If instead, contrary to our expectations, we find that, despite the removal of the Iraq-related uncertainties, constraints to expansion remain, various initiatives for conventional monetary and fiscal stimulus will doubtless move higher on the policy agenda.”

The Fed chairman also slyly cast some doubt on the current U.S. budget plan, noting, “Faster economic growth, doubtless, would make deficits far easier to contain. But faster economic growth alone is not likely to be the full solution to currently projected long-term deficits … short of a major increase in immigration, economic growth cannot be safely counted upon to eliminate deficits and the difficult choices that will be required to restore fiscal discipline.”

“These are challenging times for all policymakers. Considerable uncertainties surround the economic outlook, especially in the period immediately ahead. But the economy has shown remarkable resilience in the face of a succession of substantial blows,” Greenspan said.

“Critical to our nation’s performance over the past few years has been the flexibility exhibited by our market-driven economy and its ability to generate substantial increases in productivity. Going forward, these same characteristics, in concert with sound economic policies, should help to foster a return to vigorous growth of the U.S. economy to the benefit of all our citizens,” he concluded.