- The Washington Times - Thursday, November 10, 2005

In what may well have been his final congressional testimony before his scheduled retirement at the end of January, Federal Reserve Chairman Alan Greenspan appeared before the Joint Economic Committee last Thursday.

Mr. Greenspan reviewed the current status of the U.S. economy. “Except for the hurricane effect,” he told the committee, “readings on the economy indicate a continued solid expansion of aggregate demand and production.”

However, it was quite telling that the departing Fed chairman used the end of his prepared testimony to “conclude with a few remarks about the federal budget situation.” Despite the fact that the unified-budget deficit, which includes a Social Security surplus of nearly $175 billion in 2005, had fallen nearly $100 billion from fiscal 2004 ($412 billion) to fiscal 2005 ($319 billion), Mr. Greenspan clearly — and appropriately, in our view — downplayed the “signs of modest improvement” in the deficit. First, as Mr. Greenspan noted, the improvement essentially occurred before Hurricanes Katrina and Rita struck. He added that any further progress in reducing the deficit “will be difficult in light of the need to pay for post-hurricane reconstruction and relief.”

But “even apart from the hurricanes,” he told the committee, “our budget situation is unlikely to improve substantially further until we restore constraints similar to the Budget Enforcement Act of 1990, which were allowed to lapse in 2002” — despite his frantic appeal to retain them. “Even so, the restoration of PAYGO [which required across-the-board spending cuts if new entitlement spending or tax cuts were not offset by revenue increases and/or entitlement reductions elsewhere] and discretionary [spending] caps will not address the far more difficult choices that confront the Congress” — and the White House — “as the baby-boom generation edges toward retirement.” Explicitly warning that “large deficits will result in rising interest rates and an ever-growing ratio of debt service to GDP,” Mr. Greenspan pointedly predicted that current budget trends, unless reversed, “will cause serious economic disruptions.”

Mr. Greenspan managed to save his most dire warning for his answer to what may well have been the final question he will receive in congressional testimony as Fed chairman. It was cogently posed by Rep. Loretta Sanchez, California Democrat. She prefaced her query by (a) alluding to the fact that on-budget deficits, which exclude the Social Security surplus, have averaged well above $500 billion annually for the past three years; (b) reminding those present that the Medicare prescription program, which was originally advertised as costing $400 billion over 10 years, will now cost more than $1 trillion over 10 years; (c) observing that the war in Iraq is costing $1.5 billion per week “with no end in sight”; and (d) noting that two Louisiana senators are seeking “$250 billion just for Louisiana.” Why, Miss Sanchez wanted to know, “haven’t the capital markets told Congress and Washington, D.C., to get their act together? Why are they ignoring what is happening here?”

Acknowledging the congresswoman’s “excellent question,” Mr. Greenspan candidly admitted the uncertainty of his answer. The likely explanation involved the disinflationary forces inherent in the gradual integration of more than a billion workers (many of them highly educated) from China, India and the former Soviet bloc into the competitive world markets. Alluding to a theory advanced by former Fed governor and White House economic adviser Ben Bernanke, who has been nominated to become the next Fed chairman, Mr. Greenspan further explained that an excess of worldwide saving over investment has probably also contributed to the set of forces suppressing long-term interest rates. Together, these forces “have more than offset the expectational concerns that rising supplies of U.S. Treasury debt have out there.”

Then, in what may well be his final remarks to Congress as Fed chairman, Mr. Greenspan unloaded his most dire prediction: “I think that’s going to change. I think that, as I tried to indicate in my prepared remarks, this is a gradually changing process. But I find it utterly inconceivable, frankly, that we can have the type of potential fiscal outlook, which now confronts us over the next 15, 20 years, which unless addressed will not have a significant impact on long-term interest rates. So, I guess the answer to your question is: There are other forces involved [that are] offsetting” worrisome signals that the capital markets otherwise might be sending in the form of higher long-term interest rates. “Or to put it another way,” Mr. Greenspan cryptically warned, “the impact has been delayed.”

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