Last summer, as the Bush administration was preparing to announce the largest budget deficit in U.S. history, Federal Reserve Board chairman Alan Greenspan came under fire from a number of quarters for his relatively tame criticism of the government's ballooning budget deficit picture. Well, the Maestro isn't being tame any more — he said Thursday that the deficit is a far bigger problem for the U.S. economy than either the trade deficit or the high level of consumer debt. And there are few signs that the fiscal deficit is going to shrink any time soon; if anything, it is more likely that it will increase.
Last July, as Democrats in the U.S. Congress were criticizing President George Bush for pushing the United States from a hefty budget surplus into a multibillion-dollar deficit, many hoped that Mr. Greenspan would support them in their cause. And they had good reason to suspect that he might, given his past comments on the need for fiscal prudence, and in particular how the U.S. needed to be careful given the spectre of looming health-care spending for the Baby Boomer generation. And yet, the chairman seemed loath to criticize President Bush or the $1.6-trillion (U.S.) in tax cuts that helped create the deficit.
"Frankly, for a guy who I basically think does a terrific job on balance, he's walked away from his own long-term commitment to the kind of fiscal credibility, sanity, responsibility that he's been one of the best advocates for," Senator Jon Corzine, a former chairman of Goldman Sachs, told the Washington Post last summer after the Fed chairman spoke to Congress. Others both inside and outside the government also said they were surprised that Mr. Greenspan hadn't been more critical of the Bush government's planned $545-million deficit, the first in what looked to be a string of such massive budgetary shortfalls.
The Fed chairman returned to form somewhat last fall. In a speech to the Securities Industry Association in November, Mr. Greenspan said that budget deficits posed a risk to the economy. While the economic picture in the U.S. looked relatively good, the chairman said, this was "playing out against a backdrop of growing longer-term concern in financial markets about our federal budget." The central banker said he was concerned that a series of deficits could push up interest rates and become a drag on growth.
On Thursday, Mr. Greenspan was even more blunt in his assessment. He called the spiralling budget deficit "a significant obstacle to long-term stability" and said that he was more concerned about the fiscal deficit than he was about either the massive trade deficit or the high level of consumer debt in the U.S. Both of those factors, he argued, can be corrected by market forces — and in fact, he said that the globalization of trade was likely to soften the effects of a large trade deficit on the U.S. However, the budget deficit "is not readily subject to correction by the market forces that stabilize other imbalances," he said.
The chairman warned that the current economic picture might make it easy to become complacent about the long-term effects of large deficits, since they appear to have had no real effect so far — despite a $500-billion shortfall expected for the current year and another similar-sized one expected for next year. As Mr. Greenspan put it, the economy "appears to have been pressing a number of historic limits in recent years without experiencing the types of financial disruption that almost surely would have arisen in decades past."
For example, the U.S. has reached the point where its current account deficit (that is, the shortfall between imports and exports) is 5 per cent of the country's gross domestic product, an extremely high level in historical terms. Despite this, the U.S. dollar is not that far below its historical average in terms of its value relative to other currencies. And despite the fact that the U.S. has "lurched" (to use the chairman's own term) from a budget surplus in 2000 to a deficit that is expected to be 4.25 per cent of U.S. gross domestic product this year, the yield on 10-year government bonds remains relatively low. In most cases, one would expect yields to climb as deficits rise, since the government would be issuing more and more bonds.
"Has something fundamental happened to the U.S. economy and, by extension, U.S. banking, that enables us to disregard all the time-tested criteria of imbalance and economic danger?" the Fed chairman asked during his speech Thursday at a conference organized by the Federal Reserve Bank of Chicago. "Regrettably, the answer is no. The free lunch has still to be invented." By that, Mr. Greenspan appeared to mean that the risks of these kinds of imbalances are still out there, but have been held at bay by the beneficial effects of globalization and innovation. This cannot continue indefinitely, the chairman said, "because there are limits to how far globalization and the speed of innovation can proceed."
In other words, the U.S. government's massive deficits may not be a problem now, but they could easily become one in the future depending on what economic events occur in the meantime. That's something the U.S. needs to be aware of, and — as a country that does more than 85 per cent of its export business with the U.S. — something Canada has an interest in as well.
© The Globe and Mail
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