Greenspan: Soaring Oil Price, Deficit Pose Grave Risk to Recovery

Friday, 04 Mar 2011 01:58 PM

By Greg Brown and David A. Patten

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Former Federal Reserve Chairman Alan Greenspan says the U.S. economic recovery is for real and is well under way, but that fiscal uncertainty, oil-price spikes, and a “major contraction” in federal outlays pose grave risks that could rattle the economy.

Although Greenspan expressed confidence that the United States is poised for “reasonably strong GDP growth for a while,” he warns that serious storm clouds linger on the economic horizon.

“But I am very much concerned that we are presuming we are going to be able to move from this trillion-and-a-half-dollar annual rate of deficit dramatically to a major contraction . . . after the economy has been running up for quite a long period of time,” he says.

Putting off decisions about the best way to fix the budget deficit would be “much too risky, because it presupposes our ability to forecast, which we just don’t have. If we get that choice wrong, it’s a very major mistake,” Greenspan says. Deciding quickly, without reducing federal spending too much all at once, would be the best course of action, Greenspan appeared to indicate.

Stock-market prices are at a “premium” now, Greenspan says, adding that a number of potential spoilers lie in wait, including the rapidly rising price of oil.

Separately, Greenspan said he believes that the Fed still has the power to erase the multitrillion-dollar buildup of money supply and could do so quickly, but he worries that political action on the federal deficit would be delayed, creating huge new risks for which Fed forecasters cannot accurately account.

The No. 1 problem facing the markets, he said: a fundamental lack of clarity on the budget, which muddies the Fed’s ability to set decisive policies that will affect the economy for years to come. Resolution of the deficit deadlock and a clear path forward on spending reductions are essential, according to Greenspan.

On oil, Greenspan called crude prices a “reliable” measure of future global activity. As events continue to unfold in the Libya, Brent crude for April delivery rose in early trading to $115.41 a barrel. West Texas Intermediate rose as well, to $103.57, per barrel earlier in electronic trading, the highest since Sept. 29, 2008.



“As a leading indicator, global oil prices are a very useful statistic. The only problem is, we don’t know fully where all the channel areas are,” Greenspan said in an interview on CNBC. “My view is, when oil prices get up into this area and start move higher, you do have to start to worry.”

Greenspan went on to detail a number of caveats, including the risk of higher food prices in the near future as growth in emerging markets leads more people to consume meat over grains, pressuring farm production. Food prices seem destined to rise no matter what, because of the lack of producing land, he said.

Yet, minus the well-known debt problems and hot commodity prices, Greenspan said he believes that the United States is moving quickly toward a self-sustaining recovery.

"There is no question that the momentum of this economy, leaving out the oil price issue, leaving out euro problems that have emerged, and very specifically leaving out the budget problems, this economy is really beginning to pick up momentum," Greenspan said.

"The fascinating issue for forecasters is, how do you factor in all the negatives? These are not modest rises here, modest costs here. This is big stuff on the debit and credit side,” he said.

On oil, Greenspan noted that “oil and gold tend to move together. The problem we’re having now is, when we’re talking about the oil price, which oil price?”

Americans get their oil from two sources — Brent and West Texas Intermediate (WTI) — so it’s harder to figure out which price matters most to the U.S. economy, Greenspan said.

“We don’t know what proportion of the oil coming in is priced against Brent and against WTI,” he said. “The answer seems to lie half and half.”

However, Brent crude, the price paid largely in Europe and elsewhere in the world, has become the more relevant price for the U.S. recovery. “When we talk about which price is going to hit us, keep an eye on Brent, not on WTI,” he said.

Diana Furchtgott-Roth, a senior fellow at the Hudson Institute, agrees that rising oil costs could hinder the recovery. “The most direct impact is that they take more money out of people’s paychecks,” she told Newsmax.TV.

“So people have less money to spend on other things, so they can’t go to restaurants as much,” says Furchtgott-Roth, former chief economist for the Labor Department. “That impedes economic recovery through the rest of the economy. It’s a bit like a tax. It’s as though we’ve imposed a 50-cent gas tax all at once.”

“The impact will be a slight slowing of the economy as the prices basically move down the chain.”

Meanwhile, Greenspan said that although stocks were trading at “quite high equity premiums,” it was clear that corporations were now starting to sink money into plants and equipment, a significant indicator of corporate faith in recovery.

U.S. employers added 192,000 workers in February, fewer than the 196,000 expected by economists. Nevertheless, the unemployment rate fell to 8.9 percent from 9 percent to hit the lowest level since April 2009. It had been expected to rise to 9.1 percent.

Greenspan said that he has “considerable trust” in the judgment of current U.S. Federal Reserve Chairman Ben Bernanke, whom he says is watching the money supply carefully and effectively has the tools to mop up the $2 trillion in printed money from the Fed, when the time comes.

“The Fed knows exactly where the risks are. There has been a huge rise in excess reserves. The excess reserves are basically being held by individual commercial banks and other depository institutions at 25 basis points at the 12 Reserve Banks,” Greenspan said. “There is virtually no indication that there has been a secondary move” toward lending the money out, which might spark rampant inflation.

If the money begins to move into the economy, the Fed at this point “is in a position where it can contract its balance sheet, very significantly,” Greenspan said. “The issue is will they do it in proper timing. They think they can,” he said.

As for the economy itself, the bigger risk than the Fed is the deficit, which has the former chairman quite concerned. A stalemate over spending continues in Washington, with the latest offering from the White House to cut spending at $10.5 billion, a small fraction of the $100 billion demanded by the GOP and its activist Tea Party wing.

“We’ve got very strong forces both plus and minus, but there is no question that the plus side is accelerating,” Greenspan said. Of all the negatives out there, “the critical one is the budget issue.”

“If you asked me to put down the best estimate I could of the outlook, I would (say) probably reasonably strong GDP growth for a while,” Greenspan said.


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