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Crash Prophets, Part 3

In the previous “Crash Prophets” posts, we examined the U.S. economic outlook of key market watchers and investment legends. Today, the focus is on U.S. government and Federal Reserve officials, both past and present. Specifically, I am talking about former Treasury Secretary Robert Rubin, U.S. Comptroller General and Head of the U.S. General Accountability Office David Walker, and former Federal Reserve Chairman Paul Volcker.

Robert Rubin served as Treasury Secretary under President Bill Clinton. On January 22, Rubin appeared on the Charlie Rose television show and talked about the U.S. economy becoming increasingly unsound, and the need for “excruciating decisions” to be made. He explained, “I think we face [huge] challenges. I think we can do very well in what is really a transformed global economic environment with the rise of China and India. But… I think we’re on the wrong track on almost every front right now, regardless of how you allocate the political responsibility, and what I’d like to see the new Congress do- and I think they’ve gotten off to a very good start in this respect- is to address those challenges.” Rubin added, “I think we’ve got to re-establish sound fiscal conditions… so we have an environment conducive to growth, and also to avoid the dangers that, as [Federal Reserve Chairman] Ben Bernanke said very recently in his congressional testimony, [underlie] unsound fiscal conditions. I think that’s a tremendous threat to the global economy.” Regarding the deficit and its threat to the dollar, the former Treasury Secretary predicted, “If the current account deficit doesn’t change, then at some point something is going to have to give. It seems to me that it’s very likely there’s going to have to be an adjustment of the dollar. The way to minimize the adjustment that you need is to have sound policy.” In a videotaped message for a dinner hosted by the Concord Coalition in New York last November, Mr. Rubin emphasized that the U.S. budget situation needed to be addressed now because the government was just 5 years away from “rapid acceleration” in spending related to Social Security and Medicare.

The tremendous financial burden brought on by entitlements also frightens David Walker, who is basically the nation’s accountant-in-chief. Walker is touring the United States through the 2008 elections, and according to Bloomberg, is “talking to anybody who will listen about the fiscal black hole Washington has dug itself, the ‘demographic tsunami’ that will come when the baby boom generation begins retiring and the recklessness of borrowing money from foreign lenders to pay for the operation of the U.S. government.” His speaking tour includes economists and budget analysts from across the political spectrum. The message they are conveying is that if the U.S government continues to conduct business as usual in the coming years, the national debt ($8.8 trillion as of today) could reach $46 trillion or more, adjusted for inflation. Every year of inaction adds $2 trillion to $3 trillion, according to Walker. With the first baby boomers becoming eligible for Social Security in 2008 and for Medicare in 2011, the expenses for these two programs are about to increase significantly. In addition, the U.S. government has spent the last few years racking up debt and borrowing money from foreign lenders. If overseas investors lose their enthusiasm for purchasing U.S. debt, the result will be higher interest rates in the United States. A large jump in interest rates would be a disaster, in which case some economists predict the federal government would print money to pay off its debt, leading to runaway inflation.

Known for his stance against inflation, Paul Volcker was Federal Reserve Chairman from 1979 to 1987 and the predecessor of Alan Greenspan. At a dinner hosted by the Concord Coalition in New York last November, Volcker predicted that the United States’ dependence on foreign money raises the risk of a crisis in the dollar as soon as the next two and a half years. He said, “It’s incredible people have gone on so long holding dollars… At some point, you will get a situation where people have had enough.” Foreign investors now own about half of the $4.4 trillion of Treasuries outstanding. On April 10, 2005, Volcker talked about the U.S. economy in the Washington Post, and said, “Yet, under the placid surface, there are disturbing trends: huge imbalances, disequilibria, risks— call them what you will… What really concerns me is that there seems to be so little willingness or capacity to do much about it.” He added, “As a nation we are consuming and investing about 6 percent more than we are producing. The difficulty is that this seemingly comfortable pattern can’t go on indefinitely… I don’t know of any country that has managed to consume and invest 6 percent more than it produces for long. The United States is absorbing about 80 percent of the net flow of international capital. And at some point, both central banks and private institutions will have their fill of dollars.” Finally, Volcker speculated, “I don’t know whether change will come with a bang or a whimper, whether sooner or later. But as things stand, it is more likely than not that it will be financial crises rather than policy foresight that will force the change.”

Robert Rubin, David Walker, and Paul Volcker insist that the U.S. government must act now to prevent a U.S. financial disaster. As the former Federal Reserve Chairman recalled, “A wise observer of the economic scene once commented that ‘what can be left to later, usually is— and then, alas, it’s too late.’ I don’t want to let that stand as the epitaph of what has been an unparalleled period of success for the American economy and of enormous potential for the world at large.”