Home > The Merk Perspective > Merk Insights > February 12th 2004

Greenspan: "I hope we will restore fiscal sanity"

Axel Merk, February 12th 2004
This article was written by Merk Investments before the Merk Hard Currency Fund was launched.

Greenspan testified before Senate Banking Committee today - amongst others, he said: "I hope we will restore fiscal sanity to our system." He was urging lawmakers to accompany any tax cuts with spending cuts.

Some tidbits from Greenspan's prepared remarks (emphasis added):

  • Home mortgage debt increased about 13 percent last year. [..] many households took out cash in the process of refinancing, often using the proceeds to substitute for higher-cost consumer debt.
  • Firms' profits rose steeply during 2003 [..] As a result, businesses had little need to borrow during 2003. For the nonfinancial business sector as a whole, debt is estimated to have grown just 3-1/2 percent.
  • The growth of nonfederal debt, at 7-3/4 percent, was relatively brisk in 2003.
  • The Federal Open Market Committee's current judgment is that its accommodative posture is appropriate to foster sustainable expansion of economic activity. [..] such a policy stance will not be compatible indefinitely with price stability and sustainable growth; the real federal funds rate will eventually need to rise toward a more neutral level.
  • The unified deficit swelled to $375 billion in fiscal 2003 and appears to be widening considerably further in the current fiscal year. [..] budget projections [..] indicate that very sizable deficits are in prospect in the years to come.
  • The imbalance in the federal budgetary situation, unless addressed soon, will pose serious longer-term fiscal difficulties. Our demographics [..] mean that the ratio of workers to retirees will fall substantially. Without corrective action, this development will put substantial pressure on our ability in coming years to provide even minimal government services while maintaining entitlement benefits at their current level, without debilitating increases in tax rates.
  • The fiscal issues that we face pose long-term challenges, but federal budget deficits could cause difficulties even in the relatively near term. [..] an appreciable backup in long-term interest rates is possible [..]. Such a development could [..] undermine the private capital formation that is a key element in our economy's growth prospects.
  • Addressing the federal budget deficit is even more important in view of the widening U.S. current account deficit. In 2003, the current account deficit reached $550 billion--about 5 percent of nominal GDP. [..] the large federal dissaving represented by the budget deficit, together with relatively low rates of U.S. private saving, implies a need to attract saving from abroad to finance domestic private investment spending.
  • some governments have accumulated large amounts of dollar-denominated debt as a byproduct of resisting upward exchange rate adjustment. Nonetheless, given the already-substantial accumulation of dollar-denominated debt, foreign investors, both private and official, may become less willing to absorb ever-growing claims on U.S. residents. Taking steps to increase our national saving through fiscal action to lower federal budget deficits would help diminish the risks that a further reduction in the rate of purchase of dollar assets by foreign investors could severely crimp the business investment that is crucial for our long-term growth.

These remarks stand on their own. Greenspan knows very well the risks we are faced with. His remarks are a reminder of the irrational exuberance speech he gave a few years ago: he is warning, but remains highly accommodative to the current trend. He preaches an increase in national savings, but keeps interest rates low to encourage spending. Businesses have taken advantage of the low interest rate environments to get their books in order and lengthening maturities on their debt; in contrast, consumers have taken out more debt, often relatively short-term debt.

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