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Home > Merk Research > Merk Insights > Febuary 2, 2005

Greenspan: "We can guarantee cash, but we cannot guarantee purchasing power!"

Axel Merk, Merk Funds

Febuary 2, 2005

In his annual testimony before the Senate Banking Committee, Greenspan was grilled on the Bush Administration's plan on introducing private savings accounts to substitute portions of Social Security. The main structural advantage of "forced savings accounts," as Greenspan calls them, is that they provide a fully funded ("owned by the individuals") rather than the pay-as-you-go system ("current working population pays for an ever increasing retired population") currently in place.

The emphasis here is on "structural", or maybe one should say "theoretical;" - Greenspan is quick to point out that the introduction of forced savings accounts by themselves does nothing to increase national savings. National savings can be increased through increased productivity, higher savings or less spending. It's the last item that received the most attention: Greenspan admitted that introducing private savings account is a major risk to the credit markets, as it is not clear how the markets will perceive the financing of such a program, that $1trn - $2trn or more would be diverted from social security. He also admitted that if the markets saw the macro- economic neutrality of financing of such a program, then at best, there is no impact on the markets.

This brought Senator Charles Schumer (D-NY) to the point: wouldn't have a cut in the deficit, or a bolstering of existing retirement accounts, such as the 401(k) accounts, have a much bigger impact on national savings, and thus in assuring our retirees can retain a good standard of living? Answer by Greenspan: yes.

Greenspan believes that one should introduce any forced savings program gradually to be able to gauge how well perceived the program will be by the people and by the markets. He believes that the structural shift towards a fully funded program is worth taking the risk.

Social Security reform faces an uphill battle, and Greenspan took very serious punches in today's testimony. Greenspan has rarely had such a difficult time explaining himself, he sounded more like a rookie messenger than an independent central banker. He ended up trying to appease the Democrats by saying it would help to alleviate the "bifurcation of wealth and income trends". If anything, his policies have greatly accelerated this trend by praising the benefits of a life on credit. Such an environment is beneficial to macro-economic growth, but causes many failures amongst those unable to cope with a life "on margin" as it provides zero safety buffer in times of crises, such as when one is out of a job or has unexpected expenses.

Greenspan may have provided the answer to how reality is going to play out - he said: "We can guarantee cash, but we cannot guarantee purchasing power!" In our view, that's exactly what's going to happen: if we get a reform, it will be gradually introduced, which means there will be plenty of opportunity for gridlock and watering down of any good intentions. The result will be that we will continue to over-spend, will continue to make promises we can't meet. And the way we meet them anyways, at least nominally, is by printing money, by devaluing the dollar. It's not only the politically most acceptable solution, it's the default solution, unless - through some miracle -, we suddenly have politicians agree on fiscal prudence, on increased savings, and the associated recession that will be required for this path to be taken.

Almost unnoticed today was another piece of news that fits into this puzzle: Greg Mankiw, Chairman of President Bush's Council of Economic Advisers, handed in his resignation today. We expect that Fed Governor Ben Bernanke will take his role, so that Bernanke's public profile is raised to have him succeed Greenspan in January 2006. Bernanke is best known for his supply-side views, including his quote that he would not hesitate to drop money from helicopters to keep this economy rolling. This also assures that the newly found fiscal discpline to cut the budget deficit in half, will be achieved as a percentage of GDP, with ambitious GDP growth projections. In our view, what we will achieve is inflation, but income growth cannot keep up with GDP growth in the parameters we have set.

Axel Merk
President and Chief Investment Officer, Merk Investments
Merk Investments, Manager of the Merk Funds

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