Perceptions that the United States has a large capacity to borrow are misleading and the government may soon face larger borrowing costs because of its debt mountain, former Federal Reserve Chairman Alan Greenspan has warned. He added that the U.S. needs a "tectonic shift" in fiscal policy and that a gradual change will not be enough.
"Despite the surge in federal debt to the public during the past 18 months - to $8.6 trillion from $5.5 trillion - inflation and long-term interest rates, the typical symptoms of fiscal excess, have remained remarkably subdued," Greenspan said in an opinion piece for the Wall Street Journal. He said this had fostered a sense of complacency and that it could have serious consequences for the U.S. economy.
The former Fed chief said the U.S. should not underestimate the fiscal crisis developing in Europe and should cut back on its own borrowing. Investors have flocked to the U.S. dollar and Treasury bonds as a safe haven after the European sovereign dent crisis broke out. But the rapid rise in gold prices suggested that investors were seeking a safe haven beyond currency holdings, Greenspan said.
With the government saddled with spending commitments for the next three decades, only politically toxic cuts or rationing of medical care, a marked rise in the eligible age for health and retirement benefits, or significant inflation, can close the deficit, according to Greenspan. "I rule out large tax increases that would sap economic growth and accordingly achieve little added revenues," he said.
Greenspan also disagreed with the perception that cutting the deficit will cause a renewed slump in economic activity and urged the government exercise restraint in borrowing. "Our economy cannot afford a major mistake in underestimating the corrosive momentum of this fiscal crisis," he said.
The U.S. has a budget deficit of around 10% of its one-year national output. It also runs a large annual current account deficit and has a low national savings rate - meaning that it is a net borrower from the rest of the world.
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