Former Federal Reserve Board Chair Alan Greenspan, who held that post during a period of of brisk economic growth from 1987 to 2006, sees a number of dangers lurking under the surface of the currently booming U.S. economy. As he told Barron's in a lengthy interview: "Crises gets generated after a period of time when you disregard [something]. Most recently, we’ve disregarded the federal budget. We are going to have a $1 trillion deficit in the next fiscal year." He added: "But when inflation goes up to 4% to 5%, it is politically disastrous. That's when it becomes an issue. But when it starts rising, it’s already too late in the game to stabilize it." The table below summarizes the seven big risks that Greenspan sees.
Greenspan Sees 7 Big Risks
|Ballooning U.S. federal budget deficit|
|Falling U.S. national savings rate|
|Bond market bubble|
Significance for Investors
Greenspan's interview with Barron's roughly coincided with the release of Capitalism in America — co-authored with The Economist's Adrian Wooldridge — which looks at U.S. economic history from colonial days to the present, and tries to draw lessons from the past on how the nation can reverse its current "fading dynamism," as a review in The New York Times states. His comments, which focus on long run trends, were made prior to the stronger-than-expected jobs report for October, which recorded an employment increase of 250,000.
Among the risks that worry Greenspan is the possibility of an acceleration of inflation, followed by a sharp hike in interest rates by the Fed to rein it in, reminiscent of the early 1980s. As he told Barron's: "We are working toward stagflation as characterized by a weaker economy and inflation. During the 1980s, we had an obvious occurrence of that. The Federal Reserve can put a clamp on it. It lasted for two to three years, and it brought it to a halt. I don’t think it will be terribly different [this time.]"
The impetus for this bout of inflation will come from the rapidly growing federal budget deficit, itself the result of rapidly rising entitlement spending, particularly on Social Security and Medicare benefits for retirees. Greenspan notes that the number of Americans aged 65 and older is increasing at twice the rate of increase among working-age Americans, creating the biggest "fiscal challenge" in U.S. history.
Greenspan adds that "$1 in entitlement spending crowds out $1 in savings," and that "savings as a percentage of GDP has declined steadily since 1965." Moreover, he observes, "entitlements are slowing the rate of productivity growth, and that is a critical factor suppressing GDP growth." As a result, with productivity growth now down from historical rates in excess of 2% annually to an average of only 1% per annum in the most recent five years, he says that the Trump administration's goal of 3% annual GDP growth is not sustainable.
This productivity problem is not confined to the U.S., as Greenspan also observes that about half of the world's major economies have seen output per worker sink to annualized rates of around 1%. "These are all fundamentally disastrous numbers," he says.
"[Tariffs] are exactly the same as an excise tax...you are shooting yourself in the foot." —Alan Greenspan
"There are no winners in a trade war," Greenspan asserts. He indicates that tariffs fundamentally are a form of excise tax, raising costs for consumers and thus lowering their standard of living.
The end of quantitative easing (QE) inevitably will force interest rates up, he observes. As the Fed and other central banks around the world unwind the massive balance sheets that they built up to combat the financial crisis of 2008 and stimulate their economies, this prop to bond prices will be removed. Greenspan has been warning that QE has led to a bond market bubble, and thus bonds are a risky investment right now.
In his book, Greenspan warned about fragility in the financial system and financial innovations that increase risk. He told Barron's that increasing capital reserve requirements for banks to a range of 20% to 30% would be more effective in reducing systemic risk than regulations such as the Dodd-Frank Bill.
Expert opinion is split over the future direction of the economy and the securities markets. Echoing Greenspan's bearish views, David Stockman, who served under President Ronald Reagan as director of the Office of Management and Budget (OMB), recently reiterated his prediction of a 40% plunge in stock prices, per CNBC.
An upbeat view is voiced by Mohamed El-Erian, the chief economic advisor at Allianz Group SE. He believes that the U.S. is "in a good place in terms of growth," in remarks to CNBC. El-Erian is a Ph.D. in economics who formerly was CEO and co-chief investment officer (CIO) at Allianz division PIMCO. He elaborated: "We've got three drivers of domestic demand all hitting at the same time: government spending—which is going to get stronger not weaker—household spending and business demand. That takes the U.S. through the next couple of years at least, so it wouldn't surprise me if we get 3% growth for this year and next year."