Axel Merk, November 6th 2003
This article was written by Merk Investments before the Merk Hard Currency Fund was launched.

Today, Greenspan warned that the soaring government budget deficit must be brought under control. He lamented that politicians in Washington currently only talk about tax cuts or spending increases, but not about spending cuts. In just 5 years, the first wave of baby boomers reaches the age of 62, the time when about half of prospective Social Security beneficiaries choose to retire. Greenspan warned that government finances must be brought under tight control now to alleviate the inevitable financial burden we will face.

Greenspans strong words remind us of his "irrational exuberance" speech warning of the stock market bubble a few years ago. There are similarities not only because he warned of a building crisis, but also because then, just as now, he only talks about the problem, but does not employ the resources within his power to face the challenges. Greenspan has argued, he couldn't have averted the technology bubble because raising for example margin requirements would only have had limited effect. Well, maybe, but he didn't try until a couple of years later, when indeed he was able to bring the economy to a stall with restrictive interest rate policies.

As we pointed out in our Q2 newsletter, most central bankers would react to the lack of fiscal discipline by making it more difficult for the government to spend money, e.g. by raising the cost of borrowing. Instead, Greenspan has supported Bush's determination to get the US economy going again, at any cost.

Possibly because of a worldwide outcry about the explosion of both budget and current account deficits, and because there are signs that the US economy is on an upward trajectory, Greenspan has taken the foot off the gas pedal for now - M3 money supply growth has slowed significantly in recent weeks.

Greenspan is serving his government; being surrounded by politicians all the time, he has forgotten that he should first serve all Americans. While it would be painful for American consumers and the US government to be forced to be more prudent about spending, Greenspan could do much more to prepare us for the financial burden that we will face when the baby boomers retire.

Interestingly, Australia and the Bank of England just increased interest rates. Australia has a highly commodity-driven economy and is facing inflationary pressures due to the boom in the commodity markets. But even the Bank of England deems it prudent to ensure financial discipline is not lost.

And maybe in the starkest contrast to Greenspan's words, are the actions announced by the German state of Bavaria. The conservative state government recently won a landslide victory achieving a two-thirds majority. Rather than using its powers to pour money into a slow economy, the state of Bavaria has announced an austerity package to prepare the state for the financial challenges of the future. Also today, the German federal government announced that pensioners will receive no increase in their pensions next year. And separately, labor unions in the Netherlands recently accepted freezing salary levels without a fight.

Europe has its set of problems, but for now, structural reforms continue to be implemented, there is an impending cyclical recovery, and select areas are taking their problems very seriously. In the meantime, Greenspan helps to re-inflate a bubble; US consumers will have to pay the price with higher interest rates and a lower dollar down the road.

And the US consumer can ill-afford higher interest rates: the US consumer is getting more "sophisticated" by converting ever more purchases into leases. Recently, the Federal Reserve Bank even revised a key measure of household debt payments to reflect the fact that the US consumer no longer buys, but leases or rents an ever greater array of goods and services. Combined with an extremely low interest environment, this has led not only to a further ballooning of consumer debt, but also to an amplified sensitivity to interest rates. The longer Greenspan lives in denial and only talks about problems rather than addresing them, the more serious the problems are going to be that the US consumer and world economy will have to deal with down the road.