February 19, 2013
During his six-decade-long career in financial services, Alan Greenspan was a central figure in seminal events that drove investment markets, from the savings-and-loan crisis to the dot-com bubble to the housing crisis. Now, nearing 87, he rarely speaks in public. But he did so last week, offering his forecasts for the U.S. and European economies.
Greenspan was the keynote speaker at the Annual Market Dinner (formerly called the Annual Market Outlook Dinner) of the Boston Security Analysts Society on Feb. 12. The sellout event drew an audience of 700.
Daniel J. Fasciano, the president of the BSAS, introduced Greenspan and briefly reviewed his credentials. Greenspan’s career culminated in his chairmanship of the Federal Reserve as successor to Paul Volcker from 1987, a couple of months before the great market crash of that year, through early 2006. First appointed by President Reagan, he was reappointed by George H.W. Bush, Bill Clinton and George W. Bush. After leaving office, he founded a new firm, Greenspan Associates, LLC. Greenspan was somewhat stooped with age as he approached the dais. But he spoke with the firmness and command of information of his years at the Fed and with greater directness and clarity than he usually allowed himself in public when he served there.
Fasciano posed a number of questions and allowed Greenspan to respond at length.
Pluses and minuses for the economic outlook
Greenspan said 2013 looked to be an extraordinary year, because he could see very major pluses and very major minuses, which he reviewed and combined to reach a conclusion.
He cited, as one plus, the unquestionable improvement in the economy based on indicators such as the weekly index of industrial production. A second plus was the upturn in the housing market, which, he firmly stated, is real. This is partly a function of a decline in the number of vacant housing units, which is driving up prices. He observed that indices of housing are reported with a delay, and he suspected that housing is actually recovering faster than is being reported.
Another plus Greenspan cited was the state of the equity markets. In his words, equity premiums are now at almost the highest level in American history, which means that the market is pleased with the economic outlook and the downside risk is at a minimum. It was extraordinary, he said, to see how far the markets had gone down by March of 2009, when price-to-earnings ratios were at a level where “human beings don’t allow them to go any further.” Although we’re considerably up from there, there is still the possibility of a further rise, he said.
But the minuses, Greenspan asserted, are horrendous and all related to the federal deficit, which we’re having great difficulty controlling. The problem is a rise in social spending, which is not being covered by pay-as-you–go practices and which looks even worse for the future. We’re about to have a major surge as the baby boomers retire, according to Greenspan.
At the same time, discretionary spending is declining, especially military spending, with the end of the war in Iraq and the anticipated end of the war in Afghanistan. The Congressional Budget Office is projecting that the ratio of military spending to GDP will fall to its lowest level since 1940 and the ratio of overall discretionary spending to GDP will sink to its lowest level in 50 years. So the question he asked is, given that there is little room to cut total discretionary spending, how do we fund these entitlements? And the answer, he said, is “with very great difficulty.” This is why Congress is in an extraordinary deadlock.
Equity markets drive the economy
People don’t realize the significance of equity prices, and asset prices in general, for day-to-day economic activity, according to Greenspan. His research shows that equity markets are not only a leading economic indicator, but, much more important, they are fundamental creators of economic activity. Approximately 6% of the growth in GDP is funded by a rise in equity values, on average, though this varies considerably. As a result, increasing equity values can be even more important for economic growth than fiscal stimulus.
The problem with fiscal stimulus is that we measure it gross, by how much it puts into the economy, but we don’t put debits against it. The evidence is unambiguous, according to Greenspan, that rapid increases in deficits raise the expectation of taxes, engendering uncertainty in the business community and leading to significant declines in private capital investment. This lowers the impact of a fiscal stimulus by one-fourth to one-half and possibly significantly more, depending upon conditions. An equity stimulus doesn’t have this negative aspect. The data after March 2009 make clear that the equity stimulus drove the economy. Greenspan acknowledged that an equity stimulus brings with it an increase in private debt, “but not more than the system can handle.”
He reiterated that we must stabilize debt against the growth of GDP, and then bring it down. He said that there is a deep-seated bias in the political system toward spending. And history is incontrovertible: we always underestimate future deficits.
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