Greenspan: reduce debt before you spur growth

Emerging Markets, September 2011

Former Federal Reserve Chairman Alan Greenspan has called upon the US to prioritize reducing debt over stimulus, calling the debt position “the most extraordinarily difficult fiscal problem the US has ever had.”

“There has never been a question about the quality of American sovereign debt since we started in 1791,” he said. “If we had the luxury of waiting, I would say we could probably find a theoretical construction in which we would stimulate today and pay off the debt later.” But he said waiting was not an option.

“My view is, when confronted with an issue like this, you have to ask yourself in a policy sense what are the consequences if you are wrong?” If the US were to pay down debt and to find it wasn’t necessary, he said, “that is relatively easy to readjust. If, however, we assume we have time to counter this problem and we are wrong, then it is very dangerous.”

“I don’t think we can take the risk of not coming to grips with our debt problem fairly quickly,” he said.

Dr Greenspan said that if the US were to return to recession, it would be a consequence of problems in Europe. “If it weren’t for the existence of the euro problem, I would say it would be very unlikely. Though the American economy is confronted with a high degree of uncertainty, it isn’t the type of uncertainty that creates economic declines: it just suppresses growth.”

He described Europe as “the major problem” in the world economy, and appeared to question whether the euro’s existence had been sensible. “It turns out that 1999 [when the euro was formed] was one of those very rare periods in a boom when everything is working, including the euro,” he said. “I recall when the euro was about to go into play, I said: I don’t believe it, they made it work.” But it was predicated, he said, “on the conventional wisdom that Italians would henceforth behave like Germans. And here, I think, was a gross underestimation.”

“What we’re seeing now is a pulling apart of northern and southern Europe,” he said. “Northern Europe is essentially lending to southern Europe, and the question is, either there is fiscal consolidation – which implies political consolidation – or something breaks.

“Markets are telling us they are fearful that something will break, and Greece is weeks away from default unless there is a new tranche of funding.”

In light of problems with the euro, Dr Greenspan said there were lessons for emerging economies. “I would say it’s essential that they maintain flexible exchange rates,” he says. “If your exchange rate is weakening because investment policy is not good, then adjust that, but don’t try to artificially lock yourself into a stronger currency in expectation that the benefits of the stronger currency will flow to you without cost.”

In other remarks, Dr Greenspan criticized Obama administration policies based around job creation. “I have a problem defining a goal of government policy as jobs in the private sector,” he said.  “Corporations try to keep their workforces as slim as they know how. They work very hard not to create jobs, but to destroy them.” Government should instead create economic conditions in which businesses have to hire people to meet demand.

Asked about the internationalization of the renminbi, he said “I think it’s many years in the future… At this stage I don’t see the Chinese will perceive it to their advantage to do what is required for the RMB to become an international currency.”