The markets are jittery about a possible recession. The U.S. Federal Reserve’s decision earlier this year to ease off further interest rate increases in 2019 as it keeps a watchful eye on economic signals — after doing four hikes in the previous year — has only buttressed those fears.
But former Fed Chairman Alan Greenspan does not see a recession on the horizon, based on an indicator his firm constructed and tracks. “Right at the moment, that particular series shows we’re still deleveraging. It’s very difficult to envisage that sort of economy going into a recession,” he said during an interview with Wharton professor Kent Smetters, faculty director of The Penn Wharton Budget Model, at a forum focused on Greenspan’s new book, Capitalism in America: A History, which he co-authored with Adrian Wooldridge of The Economist.
Greenspan’s consulting firm developed an indicator that tracks a company’s capital appropriations at the time its board authorizes an investment, instead of waiting for the decision to be reflected in the expenditures report months later. This signal has been an “extraordinarily effective leading indicator of recessions,” Greenspan noted.
Market watchers are concerned about a coming recession because the yield curve has inverted, which is when short-term Treasuries have higher yields than longer-term Treasuries. In a normal yield curve, long-term Treasuries have higher yields to reward investors for holding on to the debt. When this relationship inverts, it historically has served as an early warning signal for recessions, although there have been false signals.
While Greenspan believes that a recession might not be imminent, he nonetheless sees the economy slowing. Not helping matters is the trade war with China. Both sides already have imposed tariffs and threaten to assess more. “Let’s remember what a tariff is. A tariff is a tax,” he said. “If you impose a tax on your border, who’s paying? Your citizens [are paying]” because it makes imported goods pricier.
“Taxes withdraw purchasing power from an economy,” Greenspan continued. “To say basically that we beat China in a trade war essentially means both of us lost in terms of GDP because we put tariffs on our own imports and … the economy will go down.”
“There is no doubt that we cannot keep moving at a $1 trillion deficit without inflation ultimately emerging.”
At least, inflation is under wraps, said Greenspan, a famous inflation hawk. Asked what he thought of the Fed’s 2% inflation target, he said measuring inflation can be complicated. “When new products go on the market, they come in at relatively higher prices. Remember that Henry Ford’s Model T came in at a very high price, and the price went down as technology improved.”
When measuring inflation, “you don’t start to pick up the first level [of higher prices] until well into that declining phase, so there’s a bias in the statistic,” Greenspan said. If inflation is measured at 2%, it’s actually zero for consumers, he added.
But if the U.S. continues to run a big budget deficit, all bets are off. “There is no doubt that we cannot keep moving at a $1 trillion deficit without inflation ultimately emerging,” Greenspan said. “If you print a lot of money, you will get higher prices.”
Looking to Sweden
Social Security is another bugaboo for the U.S. economy. Greenspan pointed to the stark warning in the back page of the Social Security Administration’s annual report: “They basically say right out that in order to get an actuarially sound permanent Social Security system, we have to cut benefits by 24% every year from now on out.” That’s tough because cutting retirement benefits is something no politician wants to do.
Sweden had the same problem in the 1990s. “They were doing exactly what we were doing,” Greenspan said. But in 1994, the Swedish parliament switched to a combination of a defined benefit plan — like a pension — and a defined contribution plan — like a 401(K) where citizens put money into and manage their own accounts, according to a report by the OECD.
The U.S. uses a defined benefit system that periodically has run out of money only to be replenished by general revenues, Greenspan said. “They made the Social Security requirements essentially an application of the American taxpayer,” he noted. That means “you’ve got a new entitlement without a means of funding it.” To make Social Security solvent, the U.S. should move to a defined contribution plan. “Sweden did. Sweden is doing very well,” he said. “If we follow their pattern, we would do fine.”
People might argue that what worked for Sweden might not work for the U.S., which has a much larger economy. But Greenspan disagreed. “Whether you’re a larger economy or you’re a smaller economy, it has to do with the form of your pension fund. If your pension fund is defined contribution, it would never run out of money.” The solution to fixing Social Security’s shortfalls is not “a great mystery,” he added. “The issue … is political will.” Even a democratic socialist nation like Sweden was able to do it, he noted.
“If we follow [Sweden’s] pattern, we would do fine.”
Despite its many challenges, the U.S. economy remains on top. China may be coming close to taking the title, but that will not happen in the near future, if it does so at all, Greenspan said. The total market value of China’s goods and services is “marginally higher,” but on a per capita basis, China is still a third of the level of the U.S., he pointed out. “We had China’s per capita GDP back in 1960. What did we produce back then? Steel, aluminum, coal — all of the things that are essentially obsolescent in today’s markets.”
These key industries withered when technologies related to the transistor emerged. “That is a hugely different concept of what market value is,” Greenspan said. “And so the question is, can China close the gap? The answer is that it is closing the gap, but slowly.” And while China is boosting capital investment to goose its economy, this only serves to increase productivity and living standards at a “very gradual pace,” he said. “I don’t want to say that China will pass us at one point. If they do, [because of the] pace in which the gap is closing, it’s pretty well in the future.”
What has kept the U.S. economy the most resilient in history among large nations? “I say it’s the [U.S.] constitution,” Greenspan said. “The constitution was constructed to maintain a set of rights, basically individual rights, and as a consequence property rights, that gave all sorts of incentives — and in a very short period of time … we bypassed Britain.” By the end of World War II, the U.S. economy “stood alone by an extraordinary gap” above all others, he said. The U.S. even helped Germany rebuild, instead of imposing penalties on a defeated foe, Greenspan said.
The end of the Cold War also put a lid on the debate over which economic system was better, Greenspan said. After the Berlin Wall came down, “East Germany was so obviously inferior to West Germany even when they both started at the end of World War II in a sort of tabula rasa” or a clean slate, he said. Back then, East Germany was the “jewel” of the Soviet system, but achieved only a third of West Germany’s standard of living.
“I don’t want to say that China will pass us at one point. If they do … it’s pretty well in the future.”
As such, Greenspan said it was interesting to see the current socialist tilt in the U.S. Americans are essentially engaging in the same debate that has taken place for decades when the reality is that capitalism raises the standard of living, he added. Fueling the socialist talk is rising income inequality, which Greenspan said “bears a very significant negative on society. It doesn’t work. It’s a major problem.” When new technologies emerge, he said, a small segment of the population master them so they accumulate wealth. Society has to find a way to train those left behind.
But handing out entitlements is not a viable, long-term solution. Greenspan sees the “entitlement expansion in the U.S. as a contractionary force because what the data and statistical analysis show is that every dollar of entitlement increase reduces gross domestic savings in the U.S. by $1. … That’s what the data shows, and the outlook has not fundamentally changed.” Meanwhile, as the population ages “it is draining savings out of the system.”
Political wrangling is blocking solutions from taking root. Lately, politics is even encroaching on the Fed’s independence. But Greenspan pointed to the central bank’s legislative protections that have served it well for decades. “Let’s understand what the Federal Reserve Act in 1913 (which created the Federal Reserve system) really stipulated. It considered the question of politics involved.”
The Act shielded the Fed’s monetary policy decisions from ratification by the president. Congress does not fund the Fed, although it has oversight, and members of the central bank’s board of governors serve 14-year terms to make sure they last longer than any administration. The goal is to keep politicians from using the Fed for political gain. “Policy is working if politics managed to get itself straightened out,” Greenspan said.