For nearly 20 years, Alan Greenspan was the most powerful banker in the world as chairman of the Federal Reserve Board until 2006. He is the keynote speaker at the International Economic Forum of the Americas/Conference of Montreal to be held from June 11 to 14. This year's theme is "A Global Economy in Transition," and Greenspan spoke with the National Post's Diane Francis on a range of issues. These are highlights of his remarks.
In light of this week's elections in Europe what do you think will happen to the euro?
It's very difficult to see how it's going to be held together. [In the late 1990s] they were trying to replicate the U.S. economy which worked and had a single currency. There was an understanding that cultural differences were important, but markets believed that when all the European countries came together it would work.
If you looked at the lira 10-year note, two or three years before beginning the eurozone, it was selling at five per cent above the German mark. And as time became ever closer to the initiation of January first, 1999, when the euro locked in, that 500 basis point spread had fallen to 20 basis points. In short, the markets presumed the Italians would behave like Germans. In reality, they did not.
That problem is pulling Europe apart. When you can no longer devalue [to reflect true productivity, or lack of it] then what tends to happen is that a country has to get the funding for its non-competitive costs somewhere else. We find throughout this period, northern eurozone countries [and markets] are funding southern European countries. Until [government] deficits come down, there is no way of solving this problem."
So what is the possible outcome?
At the moment northern Europe finances southern Europe. There is tax evasion and illegal commerce in Greece, Italy, Portugal, Spain. The European Central Bank is printing money to finance all the shortfalls in fiscal deficits of southern Europe. This has to stop at some point, and when it stops you are going to have a major confrontation of the euro, and all countries will have to make a fundamental choice. The only resolution is political union of the eurozone countries.
Germany is the big winner with the eurozone due to the lowered value of the euro. What will happen if it is dismantled?
That's the reason why Angela Merkel has been pushing so hard for the euro to be sustained. There are two aspects with respect to Germany. Obviously, if there is a return to the German mark, there will be a significant capital gain, and Germany will be able to pay off all its liabilities both public and private in marks which would be value at a 10 to 15 per cent premium over the euro. But the downside [to dismantling the Eurozone] is Germany's strength, relative to the rest of Europe, finds the nation with a currency which is undervalued and [this enabled it to] become one of the great exporters of the world.
What's your prognosis for the U.S.?
Today we see two economies. One is a set of assets we produced which has a life expectancy of less than 20 years, and that part of the economy is not all that bad and consumption is doing reasonably well. All the loss is in long-term assets [real estate.] This is the problem and has caused the shortfall of construction, which is eight per cent of GDP. Cut that in half: That's [a loss of] four per cent of GDP, and [an addition of] four pre cent in the unemployment rate."
[Businesses] are not investing in these long-term structures, and corporate cash flow invested in long-term assets is at the lowest level since 1935. It's an extraordinary suppression. The result is a build up in cash balances, repaying of debt and seeking out investments. Until we can change that lack of confidence, I cannot see how the recovery will get back to normal."
What happens if there's another budget deficit and default crisis over raising the debt ceiling?
No we're not going to see that. We call that the fiscal cliff. Politics in the U.S. won't allow that to happen. But the difficulty is what will they do about it...We do not have a "plan b:" What will we do if all of a sudden interest rates start to rise? That's what happened in 1979 unexpectedly. They went up four per cent and crushed the economy at the time. We are taking very significant risks here. The obvious solution is the Bowles Simpson bill, an extraordinarily clever deficit reduction vehicle. Something like that will pass eventually because it is the only vehicle that can pass and actually do the job.
Are we going to see a rise in protectionism?
I actually expected much more protectionism to occur four years ago than actually materialized, and I was delighted to see I was mistaken.
What causes you to lose sleep at night?
What could go very wrong if the euro busts up.
You mentioned in 2008 at a congressional hearing that you had placed too much faith into self-correction on the part of markets, so do you think the new regulations will protect the public?
It's doubtful. I was on the J.P. Morgan board where we were acutely aware of maintaining our credit rating and how important that was. I thought all banks thought that way and they would be the best protectors, but I was mistaken. A number of banks allowed significant contraction of capital and indeed, towards the end, Bear Stearns had three per cent capital, unheard of in a banking system. I've had to change my view, and you cannot count on bankers to protect their own equity. This is why I'm strongly supportive of higher regulated capital requirements now.
Are Dodd Frank and other new regulations going to work?
I don't think they're working. Dodd Frank is much too complex; a couple of thousand pages. It looks as though the U.S. Security and Exchange Commission continues to fend off all efforts to put additional rules in place. This would be readily resolvable by a very short bill. You could put it in 10 pages. Outline capital requirements and how one handles collateral. We'll go in that direction eventually, but will struggle to get there.
First published in the Financial Post