Dems were lemmings, Greenspan the cliff

Robert Robb - AZ Republic

Alan Greenspan's status and role as an economic oracle is unfortunate.

The Federal Reserve System is supposed to be setting monetary policy to establish and maintain price stability. Looking to its chairman to be an overall economic "maestro," as Greenspan has been called, is to misunderstand both the function and authority of the position.

Yet, an oracle Greenspan has become. And given that, it's puzzling why Democrats would spend so much time in the Senate Committee on Banking, Housing and Urban Affairs the other day grilling him about Social Security.

After all, Greenspan's support for personal retirement accounts was already known. And his willingness to make the case for that approach, within the limits of Greenspanese, was entirely predictable.

And, indeed, a powerful case he did make.

The existing pay-as-you-go system, in which today's workers pay for the benefits of today's retirees, "is not working," he said.

The problem is demography: there are fewer workers per retiree, with additional declines projected, and retirees are living longer.

Greenspan said he supported personal retirement accounts, in which workers would save to provide their own retirement income. He accurately referred to this as "forced savings."

Such a change, according to Greenspan, would not only better suit current and anticipated demography, but would also benefit the economy, since it would increase the savings rate. The pay-as-you-go system, he said, "basically moves cash around."

Personal retirement accounts would also give more people a larger stake in the economy, he observed, and create estates for lower- and middle-income workers.

Now, none of this was in Greenspan's prepared remarks, which concerned the current state of the economy. (He generally thinks it's pretty peachy, by the way.) Virtually all of it came in response to suicidal questions by Democratic opponents of personal retirement accounts.

There have been, as always, attempts to spin Greenspan's remarks. Some news accounts played up his advice to proceed cautiously in establishing personal retirement accounts, given the transition costs. But, of course, President Bush has already proposed phasing them in.

Greenspan said that it was unknown how financial markets would respond if the transition costs were debt-financed, as they are sure to be.

That is, of course, unknowable until it happens. But there are some factors on which a decent surmise can be based.

If the financial markets believe that the federal government is stretching its debt capacity, interest rates will be a harbinger. The interest rates on long-term Treasury notes remain historically quite low, despite recent hikes by the Fed in the federal funds rate.

Some fret about the amount of federal debt held by Asian central banks, particularly China. But these interest rates suggest no shortage of demand. Moreover, as John Makin, an economist at the American Enterprise Institute, has pointed out, such banks don't have that many options for parking their reserves in places that function as a safe storehouse of value.

In any scenario, the federal government is likely to be borrowing large sums to pay Social Security benefits. Those who claim that there is no need to act quickly to fix Social Security are counting on the federal government redeeming more than $5 trillion in special Treasury notes the trust will hold. Borrowing is the most likely way the federal government will do that.

Markets are far more likely to respond favorably to borrowing that can comfortably be predicted to decline over time, as personal retirement accounts accumulate, than to borrowing to cover up a funding deficit in the pay-as-you-go system that expands over time.

Moreover, as Greenspan and others have pointed out, borrowing simply recognizes an unfunded liability that already exists. Markets are undoubtedly already somewhat factoring this in.

The Social Security debate is careening into unproductive territory. For example, a cottage industry has sprung up calculating what sort of returns personal accounts would have to generate for workers to be ahead. But these are based on reductions in traditional benefits Bush hasn't specified, compared to a current Social Security system that somehow gets miraculously fixed.

Bush has made a strategic mistake in not putting a specific proposal on the table, which has enabled opponents to fill in the details for him.

Greenspan, however, reoriented the debate to its most basic, fundamental truth: "The demographics are inexorable and call for action."

It doesn't get much clearer than that. Particularly from Alan Greenspan.