Few people can match the economic expertise of Alan Greenspan, former Chairman of the U.S. Federal Reserve. He served as the senior economic advisor to Presidents Ronald Reagan, George H. W. Bush, Bill Clinton and George W. Bush. He set the bar for instructing an often ignorant and easily distracted Congress on matters of intricate economic policy. And he served as the Chairman of the U.S. Federal Reserve.
So when he took the stage as a keynote speaker at KPMG’s 2014 Insurance Industry Conference Tuesday, he came with his bona fides in order, and ready to speak to an audience that was keenly interested in any vision he could provide on 1) where the economy is going, 2) why, and 3) when (if ever) it is likely to improve.
The short answers to those are: 1) nowhere fast, 2) because nobody is willing to invest, and 3) eventually, but nobody can tell when.
As he dug into the issues, he highlighted seven key points on which our economic growth is hung up, and how the insurance industry plays into all of it. Read on.
9. Lack of confidence.
The U.S. economy is in a state of extraordinary change, Greenspan said, the likes of which he has never seen before. The most interesting thing about the current recession and recovery, he said, is that in the 10 recoveries we’ve seen since WWII, every one except the current one was led by construction. This recovery is so sluggish because construction is, as Greenspan delicately put it, “dead in the water.” The reason why construction is dead is due in part to excess capacity built up before the economy crashed in 2008. But more importantly, businesses and households across the board are so skeptical of the future, they’re not willing to invest in it. Nobody is putting money into longer-lived assets, and until they do, the economy won’t really return to form.
Case in point: In the early 1990s, the amount of liquid cash assets companies were willing to invest in illiquid, long-term assets was way higher than it is now. You also see this in the yield spread in five-year U.S. Treasury notes versus 30-year U.S. Treasury bonds, which is the widest in U.S. history. Why? Because people are far more willing to invest on a five-year return than a 30-year one. That speaks to the depth of the worry people have in the future. And that kills growth.
8. Renting instead of buying.
The same is true in U.S. households. The single-family home construction market collapsed in the 2008 crash, and it induced a major shift; many more houses that are being built now are meant not for sale but for rental. Home ownership is way below where it was years ago and, even with rising home prices, there is no evidence that this will change any time soon.
This speaks to the degree of economic malaise in the U.S., Greenspan said. Unless we can change that, then we can’t change the effective demand needed to move the economy forward. And with effective demand several points below where it ought to be — with our economy working well below capacity — that is where our unemployment and overall economic weakness comes from, hanging around like an unwelcome house guest.
7. It’s a global problem.
This is not unique to the United States, Greenspan noted.
The “very tricky fiscal problems” that the United States is facing are fundamentally the same that are being faced by developed economies across the world, from the UK. to Germany and the Eurozone, Ukraine, Japan, and elsewhere. Construction as a share of GDP is the same in these places as in the U.S., essentially, and construction remains down across the board. People are heavily discounting the future, Greenspan said.
One example is in how corporations evaluate the probable rate of return on a specific facility and then wonder what the variance on that return might be. That variance is really what the executive committees of corporation are really interested in, Greenspan said, and if a project is supposed to have a 30 percent yield, but there is a 10 percent chance of it returning a -10 percent yield, then the project will be dead in the water.
In this kind of environment, corporate tax rates become impossible to estimate, and that results in a serious curtailment of expenditures. When people don’t have a clue what the tax rate will be 20 or 30 years from now, and they have projected income from those years, then it drives up the effective cost of current projects.
China is the one part of the world where this isn’t a problem, but that’s about to change …
6. China’s debt bubble is going to burst.
China’s overall level of debt has gone from 140 percent of its GDP to 230 percent of GDP, which Greenspan glibly remarked is a sure sign that the Chinese economy is becoming overleveraged. It is requiring ever-larger amounts of social debt to fuel the country’s growth rate.
Greenspan noted that China has had “a remarkable run” the likes of which have never been seen before in measurable history. But, its gains in productivity and standards of living were all done with borrowed capital and technology. Annual lists of the world’s most innovative companies feature no Chinese companies, and nearly half of those lists are made up of American companies. This is leading to a narrowing productivity gap between China and the U.S. that is putting serious pressure on the Chinese economy.
The reality is that China is hitting the ceiling and its growth rate must slow. But when you have a one-party political system, there usually isn’t a whole lot of out-of-the-box thinking, which is precisely what China needs right now. And since you can’t divorce economic thought from political thought, this does not point toward good things for China. The Chinese hierarchy is acutely aware of this, Greenspan said, and it plans to allow a number of companies go into bankruptcy.
This is big, since most of the institutional lending in China has been backed by the government. There is a substantial amount of shadow banking that operates with the same presumed backing of the government, but that backing is not really there, and the government is about to let some companies know that the hard way. Look for some Chinese defaults in the future, perhaps in its seriously overextended steel industry or elsewhere in its manufacturing sectors.
That said, Greenspan also noted that while bubbles, by definition, burst, not all bubbles are toxic. The dot-com bubble bursting in the 1990s was individually ruinous for many people, but it was not an institutional bubble. The subprime mortgate situation in the late 2000s was an institutional situation. China knows the difference and is doing everything to ensure that when its bubble bursts, it’ll be the first kind of problem and not the second kind. Will they succeed? Who knows.
5. A diminished U.S. military means an unstable world.
Greenspan noted that at the end of the Cold War, the U.S. was left standing as the sole superpower, and it used its military heft to act as the world’s policeman, suppressing conflict in a number of hot spots for a number of years.
Until recently, the share of gross domestic savings from business, households and government as a share of various forms of entitlements remained relatively constant. What we’re talking about here, really, is Medicare and Social Security, which Greenspan described as the “third rail of American politics.” And there is serious growth there that is not going to stop, as the baby boomers get older and as seniors live longer lives. These entitlements, Greenspan noted, tend to rise the most during Republican administrations, but they’re rising across the board, and unless we slow the rate of growth in our entitlements, the reality is that eventually we will have to cut military spending to afford it all.
Greenspan pointed to Russia’s “Czarist” expansionism in Ukraine, and Vladimir Putin’s implication that what would be best for Russia would be to restore the Soviet Union. He pointed to clear commitments to protect NATO nations against Russian aggression. And he pointed to the rise of ISIS in the Middle East, which means that the U.S. will have to get further involved in that region to protect the world’s oil supply — something only the U.S. can do.