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Greenspan Warns High Budget Deficits May Hurt Economy

Greenspan argued that the deficit, Americans’ low savings rates and the nation’s trade imbalance are troubling even though they have not yet triggered rising interest rates or a steep fall in the value of the dollar.

After posing the question of whether something had fundamentally changed that would allow the country to “disregard all the time-tested criteria of imbalance and economic danger,” Greenspan said, “Regrettably, the answer is no. The free lunch has still to be invented.”

Greenspan told a banking conference in Chicago that the federal budget deficit was a bigger worry to him than the soaring trade deficit or the high level of household debt because market forces can correct those two problems.

“Our fiscal prospects are, in my judgment, a significant obstacle to long-term stability because the budget deficit is not readily subject to correction by market forces that stabilize other imbalances,” he said.

Greenspan noted that the federal deficit will amount to 4.25 percent of the total economy. The administration estimates the deficit will hit a record $521 billion this year.

Greenspan said one of the biggest concerns was that the deficit is preceding the first wave of baby boomers retirements.

“We have legislated commitments to our senior citizens that, given the inevitable retirement of our huge baby-boom generation, will create significant fiscal challenges in the years ahead,” Greenspan said in a speech delivered by satellite to the conference sponsored by the Federal Reserve Bank of Chicago.

Greenspan did not offer a solution to the budget deficit in his Thursday speech, but he has previously suggested in the past that the government trim future Social Security benefits.

Two proposals he has backed are raising the retirement age for receiving full Social Security benefits and reducing annual cost of living adjustments that Social Security recipients receive.

When Federal Reserve policy-makers met Tuesday, they left a key interest rate at a 46-year low but signaled that they plan to start raising rates at a moderate pace in coming months.

Also during his Thursday remarks, Greenspan said he believed soaring housing prices did not represent a bubble that might burst.

“A number of analysts have conjectured that the extended period of low interest rates is spawning a bubble in housing prices in the United States that will, at some point, implode,” Greenspan said.

“A softening in housing markets would likely be one of many adjustments that would occur in the wake of an increase in interest rates,” he continued. “But a destabilizing contraction in nationwide house prices does not seem the most probable outcome. Indeed, nominal house prices in the aggregate have rarely fallen and certainly not by very much.”

Greenspan also predicted China’s economic expansion would slow to a more sustainable pace, in part because the Chinese government’s concerns about inflation had caused it to begin “working assiduously” to slow growth.

He said slower growth there would likely help counter rises in global commodity prices, due in part to strong demand for goods such as steel in China.

The Bush administration has been stepping up pressure on China to stop linking its currency to the dollar and to lower trade barriers as a response to America’s record trade deficit with China.

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