Investopedia - 7 Threats to the Booming Economy: Alan Greenspan

Article by Mark Kolakowski in Investopedia

Former Federal Reserve Board Chairman Alan Greenspan, who held that post during a period of of brisk economic growth from 1987 to 2006, sees a number of dangers lurking under the surface of the currently booming U.S. economy.

As he told Barron's in a lengthy interview: "Crises gets generated after a period of time when you disregard something. Most recently, we’ve disregarded the federal budget. We are going to have a $1 trillion deficit in the next fiscal year."

He added: "But when inflation goes up to 4% to 5%, it is politically disastrous. That's when it becomes an issue. But when it starts rising, it’s already too late in the game to stabilize it."

The table below summarizes the seven big risks that Greenspan sees.

Greenspan Sees 7 Big Risks

Ballooning U.S. federal budget deficit

Soaring inflation

Falling U.S. national savings rate

Falling productivity

Bond market bubble

Undercapitalized banks

Trade wars

Significance for Investors

Among the risks that worry Greenspan is the possibility of an acceleration of inflation, followed by a sharp hike in interest rates by the Fed to rein it in, reminiscent of the early 1980s.

As he told Barron's: "We are working toward stagflation as characterized by a weaker economy and inflation. During the 1980s, we had an obvious occurrence of that. I don’t think it will be terribly different this time."

The impetus for this bout of inflation will come from the rapidly growing federal budget deficit, itself the result of rapidly rising entitlement spending, particularly on Social Security and Medicare benefits for retirees. Greenspan notes that the number of Americans aged 65 and older is increasing at twice the rate of increase among working-age Americans, creating the biggest "fiscal challenge" in U.S. history.

Greenspan adds that "$1 in entitlement spending crowds out $1 in savings," and that "savings as a percentage of GDP has declined steadily since 1965."

Moreover, he observes, "entitlements are slowing the rate of productivity growth, and that is a critical factor suppressing GDP growth." As a result, with productivity growth now down from historical rates in excess of 2% annually to an average of only 1% per annum in the most recent five years, he says that the Trump administration's goal of 3% annual GDP growth is not sustainable.

This productivity problem is not confined to the U.S., as Greenspan also observes that about half of the world's major economies have seen output per worker sink to annualized rates of around 1%. "These are all fundamentally disastrous numbers," he says.

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