Fed warns of growing budget gap
Thursday, November 11, 2004
  Federal Reserve Chairman Alan Greenspan says the growing U.S. budget deficit might destabilize the economy. Fed Governor Susan Bies says Congress spends like it's dipping into "a cookie jar." St. Louis Fed President William Poole says Social Security is in jeopardy.
  In the last two months, Greenspan and at least seven other Fed officials have warned lawmakers about tax and spending policies that have led to record budget and current account gaps.
  As Greenspan begins in January his last year atop the central bank, the comments suggest that Fed members are concerned his successor will have less room to guide an economic expansion should they have to raise interest rates to counter a plunging dollar or surge in spending.
  "If you get to a point of fairly significant long-term structural budget deficits, it begins to impact on the level of long-term interest rates," Greenspan told the House Budget Committee on Sept. 8.
  That means the government must pay higher rates to borrow money, leading to even higher deficits, he said.
  "If you get into that sort of debt maelstrom, it is a very difficult issue to get out of," he said.
  Budget surpluses from 1998 to 2001 helped Greenspan orchestrate the longest economic expansion in U.S. history. When the boom ended in 2001, low inflation allowed the Fed to cut the benchmark rate to 1 percent, the lowest since 1958, limiting the recession to just eight months.
  Then the surpluses evaporated. President Bush, who will choose the next Fed chairman, won passage of $1.85 trillion in tax cuts and raised spending for wars in Iraq and Afghanistan.   Defense spending rose 12.4 percent in fiscal 2004 to $437 billion, the Congressional Budget Office said.
  The budget deficit widened to a record $413 billion in the fiscal year ended Sept. 30, with government spending rising 6.2 percent from the previous year. The deficit amounted to about 3.6 percent of the country's $11.8 trillion gross domestic product, the highest percentage since 1993.
  Yesterday, the Treasury reported a $57.3 billion budget deficit in October, narrower than the $69.5 billion shortfall in October 2003, as spending declined.
  Social Security, the main government-funded retirement program, will spend more money than it takes in starting in 2018, according to a report by the program's trustees. A report by trustees of Medicare, a federal health-insurance program, shows that their hospital insurance fund spending will exceed income by 2012.
  "There are a number of things that are just extraordinary, beginning with the fiscal imbalance," said Rep. Jim Leach, an Iowa Republican and former head of the House Financial Services Committee, which oversees the Fed. "The Fed has less credible discretion the more out of whack fiscal policy gets."
  While crude oil prices slipped to $47.37 a barrel this week, oil is still more than 50 percent higher than it was a year ago.
Janet Yellen, president of the Federal Reserve Bank in San Francisco, said the surge would result in a temporary boost in broad inflation and, as long as prices stay high, a tax on U.S. consumers. Greenspan said that tax amounted to about $88.5 billion this year, equal to 0.75 percentage points of the gross domestic product.
  Former Dallas Fed President Robert McTeer flagged the record $166.2 billion deficit in the United States' current account, the broadest measure of trade, as a threat to stability.
  "The current account deficit is going to cause problems," said McTeer, who resigned Nov. 4 from the Fed to run Texas A&M University in College Station, Texas. "Flows will turn against us, and there will be a crisis that will result in rapidly rising interest rates and a rapidly depreciating dollar that will be very disruptive," he said on Oct. 7.
  Samarjit Shankar, director of global foreign-exchange strategy at Mellon Financial Corp. in Boston, which manages $625 billion, agrees.
  "There's no way of convincing the market additional spending on the war can be paid for if you have a lower tax base," he said. "It's a fundamental mismatch between spending and revenue."
  Greenspan urged Congress on Sept. 8 to rein in spending and return to the "pay-as-you-go" system that was in place during President Clinton's administration, whereby all new expenditures or tax cuts needed to be offset by reductions in other programs or higher fee income from government services.
  "We cannot continue to just go on without saying, 'We can have this, but not this,' and pay-go embodies that mechanism," the chairman said.
  Other fiscal problems loom.
  The costs of Social Security and Medicare are likely to balloon as the 84 million members of the baby-boom generation -- those born between 1946 and 1964 -- begin to retire in 2010, pushing federal government obligations higher, even as the taxpaying work force shrinks.
  "If we have promised more than our economy has the ability to deliver to retirees without unduly diminishing real income gains of workers, as I fear we may have, we must recalibrate our public programs so that pending retirees have time to adjust through other channels," Greenspan said in an Aug. 27 speech in Jackson Hole, Wyo. "If we delay, the adjustments could be abrupt and painful."
  Fed Governor Bies blamed lawmakers for sometimes spending taxpayers' money for political gain during the past four years. "The part of it that has gotten me so upset is that in this whole election debate, nobody's been talking about the spending side," she said last month.