Budget Deficit Could Make U.S. the Next Greece, Greenspan Warns

greenspanOnce again, Alan Greenspan, the former chairman of the Federal Reserve, is speaking out. This time, he's warning about potential problems with U.S. borrowing in an opinion piece published today by The Wall Street Journal, titled "U.S. Debt and the Greece Analogy." If that comparison makes you uneasy, no doubt, that was his purpose. And he hopes it will trigger government budget cuts.

Greenspan says in the piece that low interest rates give the misleading perception that the U.S. has a large capacity to borrow. But should it need to pay higher interest rates to finance a growing deficit, that perception would quickly be squashed.

"Despite the surge in federal debt to the public during the past 18 months -- to $8.6 trillion from $5.5 trillion -- inflation and long-term interest rates, the typical symptoms of fiscal excess, have remained remarkably subdued," Greenspan says. "This is regrettable, because it is fostering a sense of complacency that can have dire consequences."

Long-Term Rate Concerns

The root of this stems from the financial crisis, which freed private saving to finance the explosion of federal debt, he argues. But beneath the "debt market calm" there are signals that do not bode well for the future, such as the increase of federal debt from 38% of GDP in September, 2008, to to 59% by mid-June, 2010.

As for when the consequences will come home to roost, Greenspan says, "I grant that low long-term interest rates could continue for months, or even well into next year. But just as easily, long-term rate increases can emerge with unexpected suddenness."

He cautions that with a surge of baby-boom retirees around the corner, the current federal debt explosion and the modest size of the post-boomer labor force, the government will not be able to meet its future commitments for the next three decades in real terms. "We cannot grow out of these fiscal pressures," he says.

Greek Comparison

While critics will say now is not the time for major cuts, he says this belief is misplaced and that it's highly unlikely fiscal restraint will unleash deflationary forces. He would like to see cuts, especially in Medicare, but no large tax increase. "The United States, and most of the rest of the developed world, is in need of a tectonic shift in fiscal policy," Greenspan adds.

Greenspan, who retired in 2006 after 19 years as Fed chief, says the U.S. economy cannot afford a major mistake in underestimating the threat of a growing fiscal crisis.

By choosing Greece as the analogy, he has likely picked a sensitive button to push. Unreserved spending in Greece was followed by a sharp increase in borrowing cost, triggering a debt crisis. This scenario would be troubling for the U.S. should it occur here. Greenspan concludes, "Our policy focus must therefore err significantly on the side of restraint."

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