Greenspan's predecessor, Paul Volcker, provided us some insights on these issues in an article he wrote for the April 10, 2005 edition of the Washington Post entitled "An Economy On Thin Ice," (www.washingtonpost.com/wp-dyn/articles/A38725-2005Apr8.html) excerpts of which are quoted below.
"[U]nder the placid surface, there are disturbing trends: huge imbalances, disequilibria, risks -- call them what you will. Altogether the circumstances seem to me as dangerous and intractable as any I can remember, and I can remember quite a lot."
"We are buying a lot of housing at rising prices, but home ownership has become a vehicle for borrowing as much as a source of financial security. As a nation we are consuming and investing about 6 percent more than we are producing."
"What holds it all together is a massive and growing flow of capital from abroad, running to more than $2 billion every working day, and growing."
"The difficulty is that this seemingly comfortable pattern can't go on indefinitely. I don't know of any country that has managed to consume and invest 6 percent more than it produces for long. The United States is absorbing about 80 percent of the net flow of international capital. And at some point, both central banks and private institutions will have their fill of dollars."
"I don't know whether change will come with a bang or a whimper, whether sooner or later. But as things stand, it is more likely than not that it will be financial crises rather than policy foresight that will force the change."
"So I think we are skating on increasingly thin ice. On the present trajectory, the deficits and imbalances will increase. At some point, the sense of confidence in capital markets that today so benignly supports the flow of funds to the United States and the growing world economy could fade. Then some event, or combination of events, could come along to disturb markets, with damaging volatility in both exchange markets and interest rates. We had a taste of that in the stagflation of the 1970s -- a volatile and depressed dollar, inflationary pressures, a sudden increase in interest rates and a couple of big recessions."
Below are a series of charts illustrating aspects of record U.S. indebtedness. Although I have used most of these charts in various previous commentaries, they are assembled here in one place for your edification. The shaded areas in the charts denote Greenspan's tenure as chairman of the Federal Reserve.
Greenspan kept inflation-adjusted interest rates in negative territory for an extended period of time after the bursting of the NASDAQ bubble.
Low real interest rates have resulted in record leverage in the U.S. economy.
Low real interest rates have led to record household borrowing.
Record household borrowing has led to escalating debt-service burdens despitelow nominal interest rates.
Households spent a record annualized $531 billion more than they earned after taxes in the third quarter o f 2005, continuing the trend of net household deficits that began in the late 1990s.
Household spending is a record high 76% of GDP.
Record household spending has led to household tangible assets rising to a record percentage of our total national stock of tangible assets.
Record household borrowing has led to record household leverage.
While leverage is at record highs, household liquidity is at near record lows.
Mortgage rates relative to house price increases are at record lows.
In a vicious cycle, low "real" mortgage rates have resulted in a record high market value of residential real estate relative to after-tax household income as house prices get bid up.
Record low "real" mortgage rates have resulted in record high leverage in residential real estate.
Part of the increase in housing leverage has resulted from home-"owners" treating their houses as their personal ATM machines.
The U.S. banking system has record exposure to the mortgage market.
The surge in household borrowing has led to record external deficits.
Record external deficits have led to record foreign ownership of U.S. tangible assets, meaning that earnings from these assets will accrue to foreign investors.
The potential adverse consequences of Greenspan's legacy of debt are:
November 16, 2005
Paul L. Kasriel, Director of Economic Research ( plk1@ntrs.com )
The information herein is based on sources which The Northern Trust Company believes to be reliable, but we cannot warrant its accuracy or completeness. Such information is subject to change and is not intended to influence your investment decisions.