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January 25, 2001

Greenspan Warns Against US Surplus Growth
By Peronet Despeignes, The Financial Times

Tax Cuts Won't Come In Time ... Weiss comments

WASHINGTON - Alan Greenspan, Federal Reserve chairman, warned on Thursday that allowing the US budget surplus to grow indefinitely could damage the nation's economic efficiency.

He appeared to lean heavily toward tax cuts and against spending increases.

In a transcript of his testimony to members of the Senate Budget Committee, he said projections of continued budget surpluses "make clear that the highly desirable goal of paying off the federal debt is in reach before the end of the decade."

The decline in the national debt had held down long-term interest rates, lowered the cost of capital and elevated productivity-raising investment. But Mr Greenspan said the government should stop collecting surpluses beyond elimination of the more than $5,000bn national debt since rising surpluses after that point would amount to the federal government accumulating "significant amounts of private assets."

Such a development would "risk sub-optimal performance in our capital markets, diminished economic efficiency and lower overall standards of living than would be achieved otherwise," he said.

He recommended shifting the surplus to the social security trust fund, to prepare for financial burdens of the aging of the baby-boomer generation.

He warned against "a highly rapid and highly undesirable dissipation" of the surplus, but later said that "if long-term fiscal stability is the criterion, it is far better, in my judgment, that the surpluses be lowered by tax reductions than by spending increases."

New spending commitments would be a "drain of resources from the private sector" and "lower the growth potential of the economy."

He encouraged tax cuts that would minimize "distortions, increases efficiency, and enhance incentives for saving, investment, and work."

But he said the short-term stimulative impact of tax cuts to thwart a recession was dubious and had historically "proved difficult to implement," and he warned policymakers to "resist those policies that could readily resurrect the deficits of the past."

In an unusual disclaimer, Mr Greenspan said that he spoke for himself and not for the Federal Reserve.

We're all for tax cuts. Anything that puts a little more cash in our bank accounts is great. But the idea that tax cuts can steer us clear of recession is a big mistake. The reason? Timing. Just this morning, Congress warned President Bush that he better have a budget submitted before he even thinks of proposing a tax cut. That means any tax cut initiative will be pushed back until late summer. By that time, the economy will already be mired in a recession. And even a retroactive tax cut won't reverse the hard times that we'll be facing over the next few months. The only way to stem the recession now would be to implement a tax cut right now.

Don't count on a hefty interest rate cut at the end of the month, either. Fed Chairman Greenspan conspicuously left out any hint of what action the Federal Reserve will take on interest rates next week. There was no mention of disappointing growth, falling consumer confidence, declines in manufacturing, rising inventories, or California's power shortages.

The absence of this certainly indicates that the Fed is not leaning toward a half-point rate cut. They only cut rates on Jan. 3 to catch up with the bond market. Now the bond market is back in line with the Fed, and there's no need for the Fed to make any more drastic cuts.

Following Greenspan's remarks, the odds of a half-point rate cut went down to 20 to 1 in Las Vegas betting pools, but Wall Street was left scratching its head. Here's a hot tip: Come next week, investors won't get the rate cut they're hoping for -- and stocks will drop like a bag of rocks.

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