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94–291 PDF 2004

S. HRG. 108–488

FEDERAL RESERVE’S FIRST MONETARY POLICY

REPORT FOR 2004

HEARING

BEFORE THE

COMMITTEE ON

BANKING, HOUSING, AND URBAN AFFAIRS

UNITED STATES SENATE

ONE HUNDRED EIGHTH CONGRESS

SECOND SESSION

ON

OVERSIGHT ON THE MONETARY POLICY REPORT TO CONGRESS PURSUANT TO THE FULL EMPLOYMENT AND BALANCED GROWTH ACT OF 1978

FEBRUARY 12, 2004

Printed for the use of the Committee on Banking, Housing, and Urban Affairs

(

COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS

RICHARD C. SHELBY, Alabama, Chairman

ROBERT F. BENNETT, Utah

WAYNE ALLARD, Colorado

MICHAEL B. ENZI, Wyoming

CHUCK HAGEL, Nebraska

RICK SANTORUM, Pennsylvania

JIM BUNNING, Kentucky

MIKE CRAPO, Idaho

JOHN E. SUNUNU, New Hampshire

ELIZABETH DOLE, North Carolina

LINCOLN D. CHAFEE, Rhode Island

PAUL S. SARBANES, Maryland

CHRISTOPHER J. DODD, Connecticut

TIM JOHNSON, South Dakota

JACK REED, Rhode Island

CHARLES E. SCHUMER, New York

EVAN BAYH, Indiana

ZELL MILLER, Georgia

THOMAS R. CARPER, Delaware

DEBBIE STABENOW, Michigan

JON S. CORZINE, New Jersey

KATHLEEN L. CASEY, Staff Director and Counsel

STEVEN B. HARRIS, Democratic Staff Director and Chief Counsel

PEGGY R. KUHN, Senior Financial Economist

MARTIN J. GRUENBERG, Democratic Senior Counsel

JOSEPH R. KOLINSKI, Chief Clerk and Computer Systems Administrator

GEORGE E. WHITTLE, Editor

(II)

CONTENTS

THURSDAY, FEBRUARY 12, 2004

Page

Opening statement of Chairman Shelby ................................................................ 1

Opening statements, comments, or prepared statements of:

Senator Sarbanes .............................................................................................. 2

Senator Bennett ................................................................................................ 4

Senator Bayh .................................................................................................... 5

Senator Allard ................................................................................................... 5

Prepared statement ................................................................................... 39

Senator Stabenow ............................................................................................. 5

Senator Bunning ............................................................................................... 6

Senator Carper ................................................................................................. 7

Senator Sununu ................................................................................................ 8

Senator Schumer .............................................................................................. 8

Prepared statement ................................................................................... 39

Senator Crapo ................................................................................................... 9

Senator Reed ..................................................................................................... 10

Prepared statement ................................................................................... 40

Senator Dole ...................................................................................................... 10

Senator Miller ................................................................................................... 33

Senator Corzine ................................................................................................ 35

WITNESS

Alan Greenspan, Chairman, Board of Governors of the Federal Reserve System, Washington, DC ........................................................................................... 12

Prepared statement .......................................................................................... 41

Response to written questions of:

Senator Shelby ........................................................................................... 46

Senator Schumer ....................................................................................... 49

Senator Corzine ......................................................................................... 56

Senator Hagel ............................................................................................ 58

ADDITIONAL MATERIAL SUPPLIED FOR THE RECORD

Monetary Policy Report to the Congress, February 11, 2004 .............................. 61

(III)

(1)

FEDERAL RESERVE’S FIRST MONETARY

POLICY REPORT FOR 2004

THURSDAY, FEBRUARY 12, 2004

U.S. SENATE, COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS,

Washington, DC.

The Committee met at 10:02 a.m. in room SD–538 of the Dirksen

Senate Office Building, Senator Richard C. Shelby (Chairman of

the Committee) presiding.

OPENING STATEMENT OF CHAIRMAN RICHARD C. SHELBY

Chairman SHELBY. The hearing shall come to order.

I am very pleased this morning to welcome Chairman Greenspan

before the Committee on Banking, Housing, and Urban Affairs to

testify on the Federal Reserve’s Semi-Annual Monetary Policy Report to the Congress.

Chairman Greenspan, your testimony and your written report

highlight the significant positive developments in our economy in

2003. Following a blistering 8.2 percent increase in the third quarter, the real GDP increased 4 percent in the fourth quarter of 2003.

On an annual average basis, productivity rose 4.3 percent in the

business sector and 4.2 percent in the nonfarm business sector.

Our economy is much stronger now than it was a year ago, and our

prospects for 2004 are even brighter.

The job market is also showing signs of recovery. Payroll employment increased by 112,000 jobs in January—the largest monthly

gain since 2000—and the unemployment rate fell to 5.6 percent.

These improvements are certainly welcome and should continue at

a healthy pace.

With this improved economic environment, Congress needs to do

its part in achieving the appropriate fiscal policy. The continued

strength of our Nation’s economy will be dependent on how the

Congress goes about achieving this balance. We would certainly

welcome your views, Mr. Chairman, on how to address some of

these issues today.

Mr. Chairman, this Committee will also have the pleasure of

hearing your views on Government-sponsored enterprises in less

than 2 weeks at our hearing scheduled for Tuesday, February 24,

and we look forward to that meeting. I, and my colleagues on the

Committee, are keenly interested in that topic and look forward to

that discussion. The condition of the U.S. economy and the direction of monetary policy should provide us with more than enough

ground to cover in the time that we have this morning.

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Chairman Greenspan, thank you for your appearance today. We

look forward to hearing your remarks. I am sure it will be a lively

and an informative exchange that will follow.

Senator Sarbanes.

STATEMENT OF SENATOR PAUL S. SARBANES

Senator SARBANES. Thank you very much, Mr. Chairman. I am

pleased to join with you in welcoming Federal Reserve Board

Chairman Greenspan back before the Committee on Banking,

Housing, and Urban Affairs to testify on the Federal Reserve’s

Semi-Annual Report to Congress on Monetary Policy.

This Committee took the lead in putting that requirement into

the statute for these twice-a-year reports, and I think it has

worked out very well over the years as a way of, in effect, educating the public, getting a timely review before the Congress, and

it broke us out of the pattern of bringing the Chairman up when

there seemed to be some crisis developing in the economy. I think

it gives us a more orderly and consistent way of reviewing monetary policy.

On Tuesday of this week, the Joint Economic Committee held a

hearing on the release of the Economic Report of the President,

prepared by the President’s Council of Economic Advisers. I will

not comment at this point on the view expressed in the Economic

Report which has gained so much attention over the last few days,

that the outsourcing of U.S. jobs to workers overseas is good for our

Nation’s economy. That is a topic, in and of itself, of some concern,

but there were other aspects of the Economic Report that I want

to mention because they are relevant to Chairman Greenspan’s testimony this morning.

The first is the Administration’s continual lowering of its forecast

for jobs over the past 3 years. The forecast of the number of jobs

that we would have in calendar year 2004, the year in which we

now find ourselves, was 138.3 million in the 2002 Economic Report.

That was lowered in last year’s Economic Report to 135.2 million,

and in this most recent report to 132.7 million. This is total jobs

for the country. And we have now learned that, based on the lower

job numbers for late 2003 and January of this year, the CEA has

now lowered the forecast again to 132 million jobs. So, we have

gone from a forecast of over 138 million, just 2 years ago, to 132

million now. In other words, in just 2 years, the forecast of jobs has

been lowered by more than 6 million jobs. This obviously reflects

the fact that the biggest problem in the economy today is the loss

of over 2 million jobs in the last 3 years and the continued failure

of jobs to grow at a satisfactory rate. In fact, Chairman Greenspan

in his statement this morning notes that ‘‘Progress in creating jobs

has been limited.’’

The Chairman’s statement will emphasize the role increased productivity has played in restraining job growth, and I think that is

an important factor, but the Economic Report of the President

points out that heightened uncertainties can lead to reduced economic growth and, in particular, to reluctance by business to hire.

The Economic Report listed a number of these uncertainties but

it left off the list the fact that for the last 3 years our Government

has been passing tax cuts that generate large and unsustainable

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budget deficits for the foreseeable future. The Congressional Budget Office has forecast deficits totalling $5 trillion over the next

10 years on the assumption that current tax cuts are continued and

spending growth continues. The tax cuts, which the Administration

has trumpeted as the cause of economic recovery, may indeed have

caused people to lose confidence that economic growth can be

sustained.

We have a situation of very large deficits, a more difficult world

environment, and a Government that refuses to face up to the

problem of looming deficits. Any observer would be concerned about

the long-term sustainability of the recovery in these circumstances.

I cannot help but note at this point the testimony that Chairman

Greenspan gave to the Senate Budget Committee in January 2001

in support of the Administration’s first tax cut. We have had others

since, of course. At that time, Chairman Greenspan warned about

the danger of paying off the Federal debt too quickly, and went on

to observe that a tax cut was needed to lower the budget surplus.

Chairman Greenspan stated:

The sequence of upward revisions to the budget surplus for several years now has

reshaped the choices and opportunities before us. The most recent data significantly

raise the probability that sufficient resources will be available to undertake both

debt reduction and surplus lowering policy initiatives. The emerging key fiscal policy need is to address the implications of maintaining surpluses beyond the point

at which publicly held debt is effectively eliminated. The time has come, in my judgment, to consider a budgetary strategy that is consistent with a preemptive smoothing of the glide path to zero Federal debt or, more realistically, to the level of Federal debt that is an effective, irreducible minimum.

I was at that hearing. I remember it as though it were yesterday.

In fact, I recall warning the Chairman that he was taking the lid

off the punch bowl and that there would be severe consequences if

we followed that fiscal path. Regrettably, we are dealing with those

consequences today.

I would like to make a final point. In his testimony today, Chairman Greenspan properly points out that, ‘‘Addressing the Federal

budget deficit is even more important in view of the widening U.S.

current account deficit. Given the already substantial accumulation

of dollar-denominated debt, foreign investors, both private and official, may become less willing to absorb ever-growing claims on U.S.

residents.’’

The IMF, in a recently released report, made this point even

more forcefully:

Against the backdrop of a record high U.S. current account deficit and a ballooning U.S. net foreign liability position, the emergence of twin fiscal and current

account deficits has given rise to renewed concern. The United States is on course

to increase its external liabilities to around 40 percent of GDP within the next

few years—an unprecedented level of external debt for a large industrial country.

This trend is likely to continue to put pressure on the U.S. dollar, particularly because the current account deficit increasingly reflects low savings rather than high

investment.

Although the dollar’s adjustment could occur gradually over an

extended period, the possible global risks of a disorderly exchange

rate adjustment, especially to financial markets, cannot be ignored.

Episodes of rapid dollar adjustments failed to inflict significant

damage in the past, but with U.S. net external debt at record levels, an abrupt weakening of investor sentiments vis-a ́-vis the dollar

4

could possibly lead to adverse consequences both domestically and

abroad.’’

Mr. Chairman, I think it is clear that there are profound underlying problems in our domestic and international financial position

that raise serious questions about our economic prospects and are

contributing to the failure of our economy to produce jobs.

I look forward to hearing Chairman Greenspan’s testimony this

morning and the opportunity to ask him some questions.

Chairman SHELBY. Senator Bennett.

STATEMENT OF SENATOR ROBERT F. BENNETT

Senator BENNETT. Thank you very much, Mr. Chairman.

I am moved to repeat what I said at the JEC hearing and very

often elsewhere. I do not know what the number will be 5 years

from now of the various projections that are being made, but I do

know absolutely it will not be the number that is currently projected. I do not know whether it will be too high or too low, that

is, the current number, but I do know, with absolute certainty, that

the current number is wrong. And I think the review of all of the

projections made by CBO and OMB over the years of where things

would be 5 years from now uniformly supports that. Every single

one of them has been wrong, and we can be certain that every single one of them will be wrong as we go forward.

That does not mean we should not make the projection. We do

the best we can, but we should have a little more humility around

here as we try to forecast what is going to happen in an $11 trillion

economy, in a constantly changing world.

The thing I would like to pursue with Chairman Greenspan during the question period, Mr. Chairman, is a careful look at the unemployment figures, the job creation figures because something is

happening, and I do not know—we have tried to pursue it with the

Bureau of Labor Statistics, they do not know—whether something

structural is happening or whether there is an anomaly that will

fix itself in the few months ahead.

The household survey numbers and the payroll survey numbers

are moving away from each other in a way they never have done

historically. If you look at the payroll survey numbers, we have the

job loss that Senator Sarbanes referred to. If you look at household

survey numbers, more Americans are working today than has ever

been the case in history. And as we go after the Bureau of Labor

Statistics that does both surveys and say, ‘‘Can you tell us which

one is accurate or where the truth lies or where the methodology

is faulty,’’ they cannot. They say they are studying it, and they are

looking at it. I believe them, that they are studying it and they are

looking at it.

At this point, we are basically looking for hunches, and I would

like to ask Chairman Greenspan, at the appropriate time, what his

hunch may be as to what is happening. If indeed there is a structural change in the way jobs are being created in this country, as

the household survey would indicate, then both our measures of

unemployment or employment and our measure of productivity

both are suspect, if there is a structural change going on.

I look forward to the opportunity of pursuing this with Chairman

Greenspan. Because of all of the things that are important around

5

here, the most important one is that we have data that are accurate when we make our policy decisions. And if the data are being

skewed, by virtue of some structural change that is going on below

the surface that has no historic basis and demonstrates something

new happening in the economy, it is very important that we discover that as quickly as possible and try to get accurate data. I

know of no one who has a better sense of smell for these kinds of

structural changes than Chairman Greenspan, and I look forward

to the opportunity of having that discussion with him.

Chairman SHELBY. Senator Bayh.

COMMENTS OF SENATOR EVAN BAYH

Senator BAYH. At the risk of disappointing all of those who have

gathered here today to give an opening statement, I will defer to

Chairman Greenspan.

Chairman SHELBY. Senator Allard.

COMMENTS OF SENATOR WAYNE ALLARD

Senator ALLARD. Mr. Chairman, I think that Senator Bayh has

started a good trend here. I am going to see if I cannot make it

follow through for the rest of the Committee. I have some opening

remarks and would like to make them a part of the record.

Chairman SHELBY. They will be made part of the record without

objection.

Senator ALLARD. I will pass because I am also interested in hearing what Chairman Greenspan has to say.

Chairman SHELBY. Senator Stabenow.

COMMENTS OF SENATOR DEBBIE STABENOW

Senator STABENOW. Thank you, Mr. Chairman. I would like to

make a couple of opening comments because of the fact that I will

unfortunately be having to juggle and move in and out of the meeting this morning for multiple Committee hearings.

I want to welcome the Chairman and thank you for your service.

I have had an opportunity to read your written statement, and I

am hopeful this morning that we will be able to have more of a discussion based on what Senator Sarbanes and Senator Bennett both

have talked about in terms of issues related to employment.

I was particularly interested in your statements that once again

household spending was the mainstay, with real personal consumption spending increasing nearly 4 percent and outlays on residential structures rising about 10 percent. Mr. Chairman, my concern,

is that we are losing, certainly in my State of Michigan, the middle-income, good-wage jobs in our country. I would appreciate your

thoughts on the impacting on household spending and consumption

which is such a mainstay of the economy, as you point out.

I am hopeful that you will also have an opportunity to talk with

us about the fact that employment is not increasing. As you have

indicated, new hires and recalls from layoffs are far below what

historical experience indicates, and I am very interested in your

thoughts on the issues of productivity and employment. I have been

hearing and reading more about outsourcing and how that relates

to productivity numbers where there may in the past have been

100 people doing a particular job, as an example, there are now 80,

6

but 20 are being outsourced to another country, does that show up

in some way, and is that reflected in what we measure as productivity in this country? I would welcome your thoughts on that.

I was deeply concerned about the Council of Economic Advisers’

report earlier this week that indicated that outsourcing jobs to

other countries is good for our economy. It has certainly not been

good for the State of Michigan, Mr. Chairman.

Thank you.

Chairman SHELBY. Senator Bunning.

STATEMENT OF SENATOR JIM BUNNING

Senator BUNNING. Thank you, Chairman Shelby, and welcome,

Chairman Greenspan.

I think it is obvious to everybody by now that I have disagreed

with some of your monetary policy decisions. Sometimes I think I

am the only one who disagrees, but that is okay. Since you called

the emergency meeting in January 2001, I think you have done a

pretty good job, particularly on the policy. Personally, I think you

should have cut the discount rate months before, and you and I

have talked about that, but overall I have agreed with much of

what you have done.

However, I do not think you should have changed your statement

after the last FMOC meeting. I know you like to have ‘‘wiggle

room,’’ but everybody knows the Fed is not going to raise interest

rates any time soon, maybe not at all in 2004. There is no inflation

and no reason to raise rates. But changing your statement brought

uncertainty to the markets. You had to know that changing your

January statement would bring great uncertainty, and you had to

know it would create some havoc in the marketplace. The decision

was made to go ahead and delete those four little words ‘‘for a considerable period.’’ I disagree strongly with that decision.

Mr. Chairman, your words matter, and you know that. You know

what happened when you used the term ‘‘irrational exuberance.’’

You know what happened when you used the term ‘‘wealth effect.’’

You know how volatile the markets can be. You had to have known

what deleting the phrase ‘‘for a considerable period’’ would do.

Yesterday, your words mattered in a very positive way. Your outlook helped the Dow reach a two-and-a-half-year high. Hopefully,

what you say here today will not reverse those gains.

You also must be aware that your words matter when you comment on things that you have nothing to do with and the Fed has

nothing to do with. I have harped about this before. The job of the

Fed is to set monetary policy, and I believe that when the Fed

strays from that into other areas that we get in trouble.

I remember when you testified before the Energy Committee

about natural gas prices. I just do not understand what the Fed

has to do with the spot market for natural gas. I realize that you

were invited to testify, and I realize that you will be asked to comment on a number of things that are not under your purview. Senators and Members of Congress like their questions answered, and

that kind of puts you in a tight spot, but you do not have to answer

those questions, and you do not have to testify on subjects that

really are not part of the Fed’s jurisdiction.

7

We all know that your term as Chairman expires this summer,

and I expect that you will be nominated to serve as Chairman for

the remainder of your 14-year term, and you will probably be approved by the Senate. I am sure you will also not be surprised to

find that I will not be able to support you. A lot of people ask me

why I put you on the spot when you come to the Hill. They think

that we do not get along, that there is some problem. And I try to

explain to them that that is not true at all. You and I have talked

many times. I remember a very nice luncheon we had down in your

office several years ago. I will say to you what I say to them—it

is not personal, it is just business.

I think that the Fed continues to get involved in matters outside

of its charter. I think that the Fed has made several awful decisions in recent years, like when you took too long to lower rates

in the late summer and early fall of 2000. Decisions like these

might seem like ‘‘pie in the sky’’ to some people, but they have real

results and consequences. If the Fed had acted more quickly in

2000, it could have spared us a recession in which we lost 3 million

jobs and just about $7 trillion in stock market value. Mr. Chairman, that is not ‘‘pie in the sky.’’ That is ‘‘bread and butter.’’

Thank you for your time, and for allowing me to speak.

Chairman SHELBY. Senator Carper.

COMMENTS OF SENATOR THOMAS R. CARPER

Senator CARPER. Listening to my friend from Kentucky address

the Chairman reminds me of why he was probably fairly successful

as a pitcher in the American and the National League. And when

he said it is nothing personal, looking at those batters in either

league, in Detroit, and in Philadelphia and other places, I can

imagine you saying, ‘‘Well, it is nothing personal, but I am going

to throw one high and inside.’’

[Laughter.]

Mr. Chairman, I am glad you are here today. My job is not to

lecture or to admonish you. My job is to ask you hopefully some

good questions and maybe to learn from what you have to say.

I do want to just make one brief comment with respect to what

Senator Bennett said earlier. He said one thing we know for sure,

the projections for 5 years down the road, whatever is being projected we know for sure that is not what the number will be, and

that is probably true.

Another thing that we know, I think for sure, is that when my

generation begins to retire, the boomers, and we will start retiring

about the end of this decade, the pressure on Social Security, and

on Medicare and Medicaid are not going to get less. They are going

to get more, and as I look at those numbers down the road, and

the demographics that back them up, and I look at our budget deficit and our trade deficit, this is a worrisome time for me, and I

think for a lot of people. I always look forward to your testimony

here with anticipation and probably no more than today.

So having said that, I will just say in the words of another of our

colleagues ‘‘bring it on, just bring it on.’’

Chairman SHELBY. Senator Sununu.

8

COMMENTS OF SENATOR JOHN E. SUNUNU

Senator SUNUNU. Thank you, Chairman Shelby.

Despite the fact that I am sorely disappointed by Senator Bayh’s

refusal to pontificate——

[Laughter.]

I am pleased to be here to welcome the Chairman. I look forward

to his testimony and to the questions.

Thank you, Mr. Chairman.

Chairman SHELBY. Senator Schumer.

STATEMENT OF SENATOR CHARLES E. SCHUMER

Senator SCHUMER. Thank you, Mr. Chairman, and I would like

my whole statement to be put in the record.

Chairman SHELBY. Without objection, so ordered.

Senator SCHUMER. I would just like to make a brief point here,

and I would like the Chairman to comment on it when he gets a

chance, and it is the issue of outsourcing. Many of us, on this side

of the aisle, have basically supported free trade, not exclusively,

but basically. And I am troubled by the new trends. I do not think

they are the same as the old trends. You have three factors which

we have not had before:

First, the flow of capital goes to all corners of the earth. Ten

years ago our major companies would not have invested in China

and India. Now, they feel confident to do it. That is the least important of the three.

The second is broadband. You can have people working almost

anywhere around the globe and have instantaneous and full communication with them for no cost.

But third, and most important, for the first time in our history,

you will have $50 to $100 million over the next decade, well-educated, well-motivated Chinese and Indians, who are PhD’s, who are

college graduates who can compete for high-end jobs. The theory of

free trade, since World War II at least as it has played out, is the

lower-end jobs, the lower-paying jobs, the lower value-added jobs

would go overseas, but the high-end jobs would stay here.

But if an American company, an international company has an

instantaneous ability to hire someone in India who is asking for

$20,000 and does the job that an American gets $100,000 for, we

have new trouble. The head of a major securities firm told me that

there are 800 people in New York who do the high-end computer

programming. These are the ones who do the programs as the derivatives, with billions of dollars sloshing around, things you understand, Mr. Chairman, I do not. They get paid $150,000 a year.

He told me in 3 years none of them will be working for us. We will

instead hire 800 Indian computer programmers, just as good he

said, who ask for $20,000 a year.

The former head of the American Radiological Society told me

that we will need half the radiologists we have now 10 years from

now because when you break a leg or need a chest X-ray, you will

go back to the technician, and the picture will be beamed overseas

to a Chinese doctor who will be able to read it just as well, but instead of charging $500 to read the picture, they will charge $50 to

read the picture. You will still need radiologists because the more

9

complicated things will be read by Americans, but the typical,

workman-like broken arm, chest X-ray will go there.

So, I think we may have something new here. Free trade works

on comparative advantage, but if, for the first time, at the low end,

the middle end and the high end, other countries have an advantage over our labor force, where are we headed? That is the question I would like. I do not think the classic theory of free trade

works when the means of production can shift in the blink of an

eye. I do not know what the answer is. I do not believe the old

protectionist nostrums are the answer, but I think we are ignoring

the question.

Just one other point, and I will conclude. I feel strongly about

this, and it relates a little to what my colleague from Michigan

asked. Somehow this is related to the productivity numbers, I

think, although again you know much more about this than me.

This is the first time we have had such high productivity and no

job growth. Productivity grew at 3.3 percent between 1948 and

1973, I think it is—maybe 1977—1973, and there was huge job

growth.

In the last 2 years, productivity has grown a little higher, 4 percent, and there is no job growth, virtually no job growth, job loss.

Could it be that the shifting of jobs overseas is causing this? That

when IBM or Intel hires workers to do the same job at one-fifth

the cost, somehow the way we measure productivity—Intel or IBM

is still very productive, but it is not happening here.

Nine percent productivity—I mean I know there are bumps in

this—but overall something is different when productivity, now it

is 2 years, and maybe you will say—and I hope you are right—that

if there is 4 percent productivity growth over 5 years, we will see

job growth, but I think we are in a different world, and I think we

need to look at this differently, and I would ask the Chairman to

comment in general on that specific issue, which I think plagues

all of us. No one has good solutions, but I do not think by just

sticking to the old nostrums everything will be all right. At least

I would like to know a trajectory, a scenario as to how we deal if

our high-end jobs can go to India and China, as well as our lowand middle-end jobs, whether they be blue collar or white collar.

Thank you, Mr. Chairman. I am sorry to take the time.

Chairman SHELBY. Senator Crapo.

COMMENTS OF SENATOR MIKE CRAPO

Senator CRAPO. Thank you very much, Chairman Shelby.

Chairman Greenspan, welcome to the Banking Committee again.

I am going to be very brief as well because I want to get on to your

comments.

I would just say that, as with a number of the comments that

have been made by my colleagues here, my biggest concern right

now is our budget deficit and the trade deficits that we are facing

and what the proper policies we must pursue are as we try to address them. Obviously, they have been raised a little bit today. On

a broad scale, there are those who say, well, it is easy to balance

the budget. Let us just get taxes back up where they will bring in

the necessary revenue, and there are those of us who are fighting

to keep the tax cuts that we have already adopted permanent.

10

Then there is the other side of the question, which I know you

addressed yesterday. I expect we will discuss today in your comments and in some of the questions, as to whether our focus should

be on first trying to address this problem through controlling

spending as opposed to first trying to address it through tax-rate

increases and what consequences those have for monetary policy.

Again, I look forward to your testimony and all of its aspects. If

I am able to be here when the question and answer period comes,

I will probably toss you my regular question about derivatives, but

one way or the other we will get that on the record again as well

because I expect we will be debating that issue at some point again

this year.

Thank you very much for being here.

Chairman SHELBY. Senator Reed.

COMMENTS OF SENATOR JACK REED

Senator REED. Thank you very much, Chairman Shelby, and welcome, Chairman Greenspan.

The currently improving economic numbers should not distract

us from some very disturbing trends that persist in the growing

deficits, and the disappearing jobs, as many of my colleagues have

pointed to, large trade deficits and a weakening dollar, and we

might be picking up economic speed, but we could very well be

heading over the cliff.

And I hope that in the course of your discussion today or your

comments that you can address these issues of the deficit, particularly as we approach the baby boom generation, the impact on, as

Senator Schumer discussed so well, the structural changes that appear to be siphoning off jobs to places around the world that impact

on not only our economy, but also our society, the trade deficit and

all of these issues that are critical to our future.

We appreciate your appearance here today and look forward to

your testimony. And I would ask that my whole statement be put

in the record.

Chairman SHELBY. Without objection, so ordered.

Senator Dole.

STATEMENT OF SENATOR ELIZABETH DOLE

Senator DOLE. Thank you, Mr. Chairman. As you know, I normally submit my statement for the record in the interest of time,

but today, since I have——

Chairman SHELBY. It is your time, Senator Dole.

Senator DOLE. —some conflicts as well, I would like to make a

few statements on the record.

I want to thank you and Ranking Member Sarbanes for holding

this hearing. Welcome, Chairman Greenspan.

According to the payroll survey, 112,000 new jobs were created

in January—the largest monthly increase since December 2000.

Over the past 7 months, the national unemployment rate has fallen

from 6.3 percent in June, to 5.6 percent in January, the fastest

steady decline in nearly a decade. That unemployment rate, according to the household survey, is below the average of the 1970’s, the

1980’s, and the 1990’s. The Nation’s economy is on the right track,

jobs are being created and people are going back to work. This is

11

a result of the economic growth tax relief package that was signed

into law in June 2001, and renewed in May 2003. President Bush

proposed bold tax relief, and its implementation has produced very

positive results.

Chairman Greenspan, I applaud your ability to keep interest

rates down while the President’s tax relief creates liquidity in our

monetary system.

The positive economic trends that the country has enjoyed lately

are certainly a welcome relief, and I expect the positive progress

to continue. But while there are good trends in national unemployment numbers, my home State of North Carolina continues to lag

behind the national average. Indeed, North Carolina has areas that

are severely hurting. The losses of manufacturing jobs, mainly in

textiles and furniture, have been felt throughout the State. This

past summer, North Carolina experienced the largest layoff in the

State’s history when Pillowtex, a huge textile company dating back

116 years, closed its doors forever. The result was 4,400 people losing their job in a single day.

I was able to be on the ground in North Carolina to speak with

displaced workers about the challenges that lay ahead, and it was

a very emotional experience as constituents came up to ask what

they were going to do about paying for health care to treat a husband’s cancer or a child’s illness or what was going to happen to

my 401[k].

Local community college officials with whom I visited explained

the stark reality that many of these recently displaced workers

were not able to read. They were illiterate. They would need the

most basic of remedial education, the equivalency of a high school

diploma before being retrained in a skill.

In Eastern North Carolina, the layoffs and plant closures have

resulted in 2,200 layoffs since the summer, and in just the past 2

weeks, the Western region of North Carolina has lost over 1,100

jobs. These layoffs have produced ripple effects across communities

and throughout the State. One of these effects is a strain on the

State’s community college system. With a vast amount of workers

out of a job and in desperate need of retraining, community colleges have said, ‘‘Look, we do not have enough space. We do not

have enough instructors. We need new programs.’’

I visited with many of the presidents. I am passionate about

their positive role in the State of North Carolina. In short, community colleges are on the front lines in a transitioning economy, and

they must have more support.

Today, President Bush will outline his plan entitled, ‘‘Jobs for

the 21st Century.’’ It dedicates more than $500 million for a series

of measures to better prepare current and future workers for jobs

in the new millennium. It also includes a $250 million proposal to

fund partnerships between community colleges and employers in

high-demand job sectors. I want to express my earnest support for

this plan and highlight its importance to my home State of North

Carolina. But, first, Chairman Greenspan, let me quote you in testimony to the House yesterday: ‘‘I must say to you that the community colleges in this country have been in the forefront of a major

change in the quality of what we are doing with respect to reestablishing skills.’’ I appreciate that support and could not agree more.

12

As I mentioned, North Carolina’s community college system has

been stretched beyond its limits, and I am certain that that is true

in many other States. I have worked very closely with the Administration regarding the need for community college funding, and it is

my hope that the President’s plan will bring timely relief where it

is needed most in my State. This Congress will have an opportunity to increase Pell Grant funding and to address community

college needs through Higher Education Reauthorization—and I

look forward to working with my colleagues to utilize these opportunities to strengthen community colleges. The future of North

Carolina’s economy depends on it.

Chairman Greenspan, I appreciate your willingness to come and

testify today. I look forward to hearing your thoughts on what we

must do to ensure that the benefits of a recovering economy can be

extended to all areas of North Carolina and the Nation.

Thank you.

Chairman SHELBY. Mr. Chairman, we again welcome you to the

Committee. Your written statement will be made part of the record

in its entirety. You proceed as you wish.

STATEMENT OF ALAN GREENSPAN, CHAIRMAN, BOARD OF

GOVERNORS OF THE FEDERAL RESERVE SYSTEM

Chairman GREENSPAN. Thank you very much, Mr. Chairman. I

am pleased to be here today to present the Federal Reserve’s Monetary Policy Report to the Congress. I believe this is the thirty-third

time I am delivering this report. I hope my arithmetic is right. I

have not checked it with staff——

Chairman SHELBY. I bet your arithmetic is right.

Chairman GREENSPAN. I know I am close, somewhere in there.

Senator SARBANES. Mr. Chairman, could you pull that microphone a little closer. I think it would be helpful to everybody.

Chairman GREENSPAN. Is this better?

Senator SARBANES. Yes.

Chairman GREENSPAN. When I testified before this Committee in

July, I reported that conditions had become a good deal more supportive of economic expansion over the previous few months. Still,

convincing signs of a sustained acceleration in activity were not yet

in evidence. Since then, the picture has brightened. Gross domestic

product expanded vigorously over the second half of 2003. Progress

in creating jobs, however, has been limited.

Looking forward, the prospects are good for sustained expansion

of the U.S. economy. At the same time, increases in efficiency and

a significant level of underutilized resources should help keep a lid

on inflation.

In retrospect, last year appeared to have marked the transition

from an extended period of subpar economic performance to one of

more vigorous expansion. Once again, household spending was the

mainstay, while strengthening the capital spending over 2003 contributed importantly to the acceleration of real output.

To a considerable degree, the gathering strength of capital spending reflects a substantial improvement in the financial condition of

businesses over the past few years. Firms’ profits rose steeply during 2003, following smaller gains in the previous 2 years.

13

The profitability of the business sector was again propelled by

stunning increases in productivity. The strong gains, however, have

obviated the need for robust increases in business payrolls. To date,

the expansion of employment has significantly lagged increases in

output. Gross separations from employment, two-fifths of which

have been involuntarily, are about what would be expected from

past cyclical experience, given the current pace of output growth.

New hires and recalls from layoffs, however, are far below what

historical experience indicates. To a surprising degree, firms seem

able to continue identifying and implementing new efficiencies in

their production processes and thus have found it possible so far

to meet increasing orders without stepping up hiring.

In all likelihood, employment will begin to grow more quickly before long as output continues to expand. Productivity over the past

few years probably received a boost from the efforts of businesses

to work off the stock of inefficiencies that had accumulated in the

boom years. As those opportunities to enhance efficiencies become

scarcer, and as managers become more confident in the durability

of the expansion, firms will surely once again add to their payrolls.

The consequence of the rapid gains in productivity and slack in

our labor and product markets has been sustained downward pressure on inflation. Inflation last year was in a range consistent with

price stability.

Although the prospects for the U.S. economy look quite favorable,

we need to remind ourselves that all forecasts are projections into

an uncertain future. We must, as a consequence, remain alert to

risks that could threaten the sustainability of the expansion.

Besides the chronic concern about a sharp spike in oil or natural

gas prices, a number of risks can be identified. Of particular importance to monetary policymakers is the possibility that our stance

could become improperly calibrated to evolving economic developments. But the evidence indicates clearly that our current policy

stance will not be compatible indefinitely with price stability and

sustainable growth. The real Federal funds rate will eventually

need to rise toward a more neutral level. However, with inflation

very low and substantial slack in the economy, the Federal Reserve

can be patient in removing its current policy accommodation.

The outlook for the Federal budget deficit is another very critical

issue for policymakers. As I have noted before, the debate over

budget priorities appears to be between those advocating additional

tax cuts and those advocating increased spending. Although some

stirrings in recent weeks in the Congress and elsewhere have been

directed at actions that would lower forthcoming deficits, to date,

no effective constituency has offered programs to balance the

budget.

Our demographics, especially the retirement of the baby boom

generation beginning in just a few years, mean that the ratio of

workers to retirees will fall substantially. Without corrective action, this development will put substantial pressure on our ability

in coming years to provide even minimal Government services

while maintaining entitlement benefits at their current level, without debilitating increases in tax rates.

14

Addressing the Federal budget deficit is even more important in

view of the widening U.S. current account deficit. To date, the current account deficit has been financed with little difficulty.

Nonetheless, given the already substantial accumulation of dollar-denominated claims, foreign investors, both private and official,

may become less willing to absorb ever-growing claims on U.S. residents. Taking steps to increase our national saving through fiscal

action to lower Federal budget deficits would help diminish the

risks that a further reduction in the rate of purchase of dollar assets by foreign investors could severely crimp the business investment that is crucial for our long-term growth.

The large current account deficits and the associated substantial

trade deficits pose another imperative—the need to maintain the

degree of flexibility that has been so prominent a force for U.S. economic stability in recent years. The greatest current threat to that

flexibility is protectionism. Consequently, creeping protectionism

must be thwarted and reversed.

In summary, Mr. Chairman, in recent years, the U.S. economy

has demonstrated considerable resilience to adversity. It has overcome significant shocks that, in the past, could have hobbled

growth for a much longer period than they have in the current

cycle. Looking forward, the odds of sustained robust growth are

good, although, as always, risks remain. The Congress can help

foster sustainable expansion by taking steps to reduce Federal

budget deficits and, thus, contribute to national savings and by

continuing to pursue opportunities to open markets and promote

trade. For our part, the Federal Reserve intends to use its monetary policy tools to promote our goals of economic growth and maximum employment of our resources in an environment of effective

price stability.

Thank you very much, Mr. Chairman, and I look forward to answering any of your questions.

Chairman SHELBY. Thank you, Chairman Greenspan.

Chairman Greenspan, while the job numbers have improved,

that is of little comfort to those who have been without work for

quite some time or are still underemployed. Are there any, to your

knowledge, any historical analogies to the present situation, where

there has been a similar disconnect between strong economic

growth and job creation or is this an atypical situation?

Chairman GREENSPAN. I think this is atypical or I should put it

more exactly, I do not recall a period even remotely like this. It is

fairly evident what is happening. And as I mentioned in my prepared remarks, the gross separations, that is, layoffs, firings, and

even voluntary job leaving, have gone down quite measurably and,

indeed, it looks pretty much the way you would expect it to look

given the growth rate of the economy.

When you look on the other side of the equation, new hires from

new jobs or recalls from layoffs are extremely subdued, and, indeed, the pattern that you see in the new hires series actually is

a mirror reflection of the productivity growth that we see in our

other sets of data.

In short, what is happening is that as demand has picked up—

and, indeed, it has picked up—businesses have been able to find

ways in which they can increase efficiency such that they can meet

15

new orders and new commitments without bringing on the usual

new hires that in the past we would have seen under comparable

circumstances.

As I said in the House yesterday, it seems likely that the extraordinary pace of productivity is almost surely going to slow,

largely because many of the reasons for it, as best we can judge,

are not continuing; namely, issues that reflect the nature of the

types of investments and the types of inefficiencies that arose in

the boom period which are now being reversed. We have to eventually run out of opportunities to exploit all of those inefficiencies.

So what we are seeing is something new. It is something different. I do not believe it is going to continue. It will continue, in

part, because we think productivity will be above what it has been,

while surely, over the next year or two, well below what we have

seen in the recent quarters.

Chairman SHELBY. Is what is driving the productivity gains, is

that the hard work of the American workers plus technology,

among other things?

Chairman GREENSPAN. Well, looking back, this extraordinary expansion in high-tech equipment in the 1995 to 2000 period probably had a rate of return on it higher than was realized at the

time. In a sense, we have all experienced the situation where we

get a new PC, and our initial use of it is probably 10 percent of

the capacity, and, indeed, the most generally new things about the

PC we do not employ maybe for 6 months or 2 years.

And if you generalize this in the way business is adjusting to the

new technologies, there is a long lag before the efficiencies actually

materialize because they do not know how to use the stuff, and as

they learn, it begins to have a significant impact.

In my judgment, when we look back on this whole period and try

to determine the rate of return off that equipment that was installed in the latter part of the 1990’s, I suspect we are going to

find that the real rate of return was quite a bit higher than we anticipated, either at the point it was being initiated or even 2 or 3

years after it was in place.

Chairman SHELBY. Well, in other words, it has been a sustained

impact.

Chairman GREENSPAN. Indeed, it has.

Chairman SHELBY. In light of what many perceive as job creation

problems associated with productivity gains, could you just briefly

elaborate on the overall and long-term importance of productivity

for the economy. Is it, after all, absolutely critical for long-term economic growth and prosperity?

Chairman GREENSPAN. Yes, Mr. Chairman, I think this is a very

important point you are making. It is very evident from the data

that the improved efficiencies are making it very difficult to get job

growth, and, indeed, a good deal of the job loss that we have seen

is a result of that, but we can scarcely be against improved efficiencies and increased productivity because, at root, that is where

our standards of living ultimately come from.

We will get through all of this problem that we are now engaged

in, and if history is any guide, we will have employment expanding

at a reasonably good clip within a short period of time. But what

is very important for the longer-term outlook for the American

16

economy is how productive we seem to have been able to become.

And while it clearly has a short-term downside, over the long-term,

it is an unequivocal positive factor for our country.

Chairman SHELBY. Thank you.

Senator Sarbanes.

Senator SARBANES. Thank you very much, Mr. Chairman.

Chairman Greenspan, The Wall Street Journal this morning, in

reporting on your testimony yesterday, says, ‘‘Mr. Greenspan’s

warnings on the budget deficit were more urgent than in previous

remarks.’’

I note in your statement that you say, ‘‘The imbalance in the

Federal budgetary situation, unless addressed soon, will pose serious long-term fiscal difficulties.’’ And then a paragraph later you

go on to say, ‘‘The fiscal issues that we face pose long-term challenges, but Federal budget deficits could cause difficulties even in

the relatively near term.’’

Now, I also note in reading a New York Times article on your testimony yesterday, and I am now quoting, ‘‘To the relief of the Administration, though, Mr. Greenspan did not criticize the President’s plan to make his tax cuts permanent. That would increase

the projected deficit by more than $1 trillion over the next 10 years

even if the Government virtually freezes discretionary domestic

spending. Mr. Greenspan did not criticize Mr. Bush’s budget plan,

and because neither Republicans nor Democrats on the House Financial Services Committee asked his opinion about making the

tax cuts permanent, he did not volunteer one.’’

What is your opinion about making the tax cuts permanent?

[Laughter.]

Chairman GREENSPAN. I am glad you asked, Senator.

[Laughter.]

Let me put a little history in this.

Senator SARBANES. And as you answer it, let me just—I am

prompted to do this by an editorial that appeared in The New York

Times last month. ‘‘The recent book about former Treasury Secretary Paul O’Neill makes it clear that Mr. Greenspan even had

qualms about the extent of the Administration’s first round of tax

cuts in early 2001. Mr. Greenspan can no longer keep his worries

to himself. Whether he musters the full authority of his office to

sound the alarm and urges the President and Congress to reconcile

Federal revenues and spending will help determine Mr. Greenspan’s legacy as Fed Chairman.’’

Now what is your view about making tax cuts permanent?

Chairman GREENSPAN. In September of 2002, I appeared before

the House Budget Committee, strongly requesting that the aboutto-expire pay-go and discretionary caps be renewed. They were not.

I am still in favor of pay-go and discretionary caps as a critical

issue in budgetary processing.

As I indicated yesterday, I think that one of the first orders of

business of the Congress would be to restore discretionary caps,

and especially pay-go. And if that is indeed the case, under current

law, you would have to have a pay-go evaluation for any change

in the tax structure. So, I am in favor, as I have indicated in the

past, for continuing the tax cuts that are in dispute at this parVerDate 11-MAY-2000 11:46 Jun 21, 2004 Jkt 000000 PO 00000 Frm 00020 Fmt 6633 Sfmt 6633 94291.TXT GEOW PsN: GEOW
17

ticular stage, but I would argue strenuously that it should be taken

out on the expenditure side.

And let me go further on the question of the issue——

Senator SARBANES. How do you take it out on the expenditure

side if, as this points out, even if you just froze expenditures—and

we have all of these expenditures in Iraq and homeland security—

you would still be running up an additional over $1 trillion deficit?

Chairman GREENSPAN. Let me get to the broader issue which is

what concerns me. Everyone is looking at the issue only of the discretionary spending part of the budget, but I suspect that if we

were to look at the arithmetic and all of the various alternatives

that exist out there, we are going to have to relook at some of the

entitlement spending outlays.

In 1983, when I was in charge of the Social Security Commission,

and we went through a whole series of evaluations of possible

changes, I strongly advocated at the time—and I have done subsequently—things such as indexing the age of eligibility to longevity.

I have argued, on occasion, for getting a better price index to

index various different benefits. And I raise these issues largely because I think we have been looking at, we have constructed a good

deal of the benefit structure over the last quarter of a century without a firm look at whether or not the real resources were there to

meet those benefits.

And I suggest that what we have to do, as difficult as it is going

to be, is to relook at some of these commitments that were made

without any advertence to what the long-term availability of resources is.

I do not know where you come out on that. I do know that the

arithmetic does not work, and I would really suggest that a broader

view of what it means to have such a huge change in the number

of retirees that will inexorably occur over the next decade, and I

think that the sooner we address that the sooner we can assure the

people who will be retiring that the benefits that are being promised will, indeed, be forthcoming.

My real concern is that when the time comes to start to pay

these benefits, we are going to find that we are in very serious fiscal difficulty. I am not saying we are going to renege on any of

those benefits. We cannot, and we will not. But I do think it is important for the people who are retiring to have a sense of security

that what is being promised to them as they retire will, indeed, be

there, and I mean ‘‘there’’ in real resources.

Finance is merely a means by which we exchange physical goods

and services. And when you look at the hard issue of what proportions of the output that we are expected to produce over that period

will be going to retirees, we have to make sure that we can do that.

Senator SARBANES. Mr. Chairman, let me just observe that that

is a very large issue. In the meantime, we are faced here and now

with the issue that is being pressed on the Congress, and very hard

by the Administration—in fact, it is their number one priority to

do further tax cuts by making these tax cuts permanent. They will

undermine our future fiscal strength in terms of dealing with the

very problem that you just spent a few minutes outlining for us.

It is difficult for me to understand why you cannot state very

simply that one way of addressing the budget deficit is to show reVerDate 11-MAY-2000 11:46 Jun 21, 2004 Jkt 000000 PO 00000 Frm 00021 Fmt 6633 Sfmt 6633 94291.TXT GEOW PsN: GEOW
18

straint on both spending and tax cuts, since they both make up the

combination that determines budget deficits.

Chairman GREENSPAN. Oh, I am certainly willing to say that. I

believe that.

Senator SARBANES. Thank you.

Chairman SHELBY. Senator Allard.

Senator ALLARD. Mr. Chairman, I want to talk a little, and ask

you a question about, manufacturing jobs. The loss of manufacturing jobs is not a particularly new phenomena. I think it has

been going on for some time actually. I wondered if you would talk

about that so the Committee is clear that there are jobs created in

the small business sector and then there are the manufacturing

jobs themselves. I wonder if you would comment on that and what

you see happening in the United States, what you see happening

worldwide, and perhaps in some of our competitor nations that

have been mentioned, such as China and India.

Chairman GREENSPAN. Well, Senator, one thing that has been

going on in this economy for generations is a gradual shift from

physical things and manual labor to produce our GDP to ideas and

more conceptual-related types of output. As a consequence of that,

the actual weight of the GDP, in other words, the raw materials

that go into it, has gone up hardly at all. Virtually, all of the increase in our GDP is conceptual ideas, new ways of doing things.

And so it should not be a surprise that the ratio of manufacturing to the GDP has been very gradually going down. It is going

down, I must say, very gradually, not in any pronounced way, but

because the productivity and efficiencies have been so extraordinary, far better than the rest of the economy, what happens is

that with a level of production, which is continuing to rise quite

significantly, you have such exceptional efficiencies that they are

able to produce that output with ever fewer employees. As you

have pointed out, it has been going on for a long number of years.

Senator ALLARD. It seems to me that this has been the case at

least back to 1979—I was talking with Senator Bennett here, and

he thinks that it has been maybe even 50 years that this phenomena has been occurring. Can you give us kind of a range?

Chairman GREENSPAN. I think you are correct. I think it peaked

in 1980, as my recollection serves me, but that process has been

going on for quite a good deal of time. Manufacturing productivity

growth has outstripped the overall productivity quite significantly.

Senator ALLARD. This is a phenomena that is going to happen

with a more modern economy, meaning that which is happening in

the United States. In other countries like Japan and China, for example, I would guess there is probably a loss of manufacturing jobs

because they also are becoming more efficient. Would you make

that assumption?

Chairman GREENSPAN. No, that is a fact. Now, in China, it is a

little bit difficult because, while it is true the manufacturing jobs

have gone down quite appreciably, a lot of that was the excess

staffing that goes on in state-owned enterprises. And so when they

rationalized a number of them, their employment numbers came

down. It is hard. We do not have enough data from them to disaggregate what part of it is merely extracting what was a very odd

way of using people in some of those state-owned enterprises.

19

Whereas, now they are making a lot of progress, but still there is

still a lot of it.

Senator ALLARD. I am concerned about the deficit, as are many

other Members in the Senate and a lot of Americans. In your view,

what is the greatest problem with our deficit? Is it on the spending

side of Government programs or is it our tax cuts?

Chairman GREENSPAN. I have always argued that the problem is

on the expenditure side and that our real danger is that we will

create longer-term commitments which are very difficult to finance.

And one of the problems that commitments have is that it is very

difficult, once you have made them, to reverse them.

So as I argued yesterday and on previous occasions, I think that

in addressing this budget issue, it is crucially important that we

try to find, wherever we can, reductions in outlays before adverting

to the question of revenues to fill in the gap.

As I have been saying for quite a good deal of time, I think the

budget deficit problem needs to be resolved primarily or fully on

the expenditure side. And what I mean by that is that we should

be looking at all of the possible changes, reductions we can make

in expenditures before we find we have no other alternative but to

add taxation to fill in the gap.

The reason for that is we are reasonably certain that if we have

a solution primarily from the expenditure side, if not wholly, that

we have a stable fiscal output. We do not know the extent to which

increased taxes will inhibit the growth of the GDP and, hence, the

revenue base. And we have to be quite careful because it is very

obvious that if you put very substantial tax rate increases in, you

could slow the rate of growth enough so that the revenue base does

not increase anywhere near the amount of expectations when you

raise taxes.

You have to be careful about being unable to close the gap. So,

I think there are far greater risks in failure on the tax side than

there is on the expenditure side. I am not talking about cutting expenditures. I am talking about slowing down the rate of increase.

Senator ALLARD. Thank you.

Thank you, Mr. Chairman. I see my time has expired.

Senator BENNETT [presiding]. Yes. I would like to follow that up

very briefly here, Mr. Chairman. I have quoted you, and I would

like to check and make sure I am quoting you correctly, as having

said, ‘‘Congress can set the level of expenditure just about anywhere it wants, but it cannot set the level of income wherever it

wants. The level of income is a product of the economy, and if

the economy is damaged, you are stuck with the level of expenditure that you have committed, but you cannot guarantee the level

of income.’’

Is that a fair summary of——

Chairman GREENSPAN. I do not remember the words, but I certainly agree with them.

[Laughter.]

Senator BENNETT. I think that is precisely what happened in

California. They had the rivers of cash that came out of the dotcom boom, and the instant millionaires, and all of the capital gains

realizations, and then they built the expectation of that revenue

into their budget and made a series of commitments which, when

20

the bust came, they could not commit because the revenue was

not there.

Let me go back to the issue I raised during my opening statement, and I realize this is always dangerous, but I will give you

an anecdotal example to suggest what I think may be going on.

On an airplane flying from Salt Lake City to Washington, I sat

next to a woman and got into conversation, as you do on airplanes,

and this was her story. She worked for a fairly large company. It

was a high-tech company. The bust came. She was laid off as they

had to downsize their employment. She and a group of her friends

got together, organized a small firm that now has only eight employees. She was flying to Washington because this small firm was

able to obtain a contract with the Department of the Navy. She

was actually doing better financially than she was when she was

with the big company, as were her associates who had formed this

small group.

Now, statistically, the job that she lost would show up as a lost

job in the payroll survey. It would show up as a new job in that

household survey, but as far as the payroll survey is concerned, her

job is lost, and has never been filled and never will be. Is it not

the payroll survey that we use as the base for computing productivity, and therefore would that not indicate that productivity is

overstated if there are enough examples, like this woman, of people

who have left the payroll world, gone into the self-employment or

small business—in her case, it is a small business rather than selfemployed—that, for one reason or another, is not plugged into the

payroll database, and therefore productivity numbers would be artificially high and job numbers would be artificially low with the

Bureau of Labor Statistics?

That is my hunch of what might be going on, but I cannot put

my handle on it in any way. I would be interested in the thoughts

you might have about some structural changes that are going on.

Chairman GREENSPAN. We have looked at that in some detail,

Senator, and we have concluded, for reasons I will give in a moment, that the payroll data do look to be the correct data. Let me

express to you why.

If we take the household data and make all of the adjustments

that are required to make it conceptually equivalent to the payroll

data, we still have this very big difference. In other words, the addition of proprietors and unpaid family workers, the adjustments

for multiple jobs and all of the various things is not the answer to

this discrepancy. It is deep-seated in the data themselves.

We asked ourselves what could go wrong with either series. We

looked first at the payroll data, and we find that it is benchmarked

every quarter to the unemployment insurance data system which

is a full coverage of wages and salaries that are required for unemployment insurance calculations, so that we have a total number

of people which is relatively full coverage for wage and salary

workers only.

The monthly series that we publish is merely a sample which

works off that quarterly series, and for all practical purposes, the

level is relatively a full count. The household series, however, is a

sample of 60,000 households. It is a very big, very sophisticated

sample, but what that does is merely take ratios of, for example,

21

the people in the household, and asks are you employed, are you

looking for a job, are you out of the labor force? And all they have

is a sample of 60,000 which have those data in them.

They create the household employment figures by taking the

ratio of employment to the number of people in the household, and

they multiply it by the population, the so-called noninstitutional

population.

What we did is to take a look at the population projections. We

find that the way they are made is, as you know, they take the

base, which the last base is 2000, they add births, subtract deaths,

and add net immigration.

We then took a look at what the implied population number

would be if we started with the data we had from the unemployment insurance benchmark system. Using the household ratios, we

then added back the proprietors, the type of person that you were

referring to, and the nonlabor force people to get a synthetic, independent estimate of population.

What, indeed, we get is a significantly slower pace of population

which, since we presume that the births and the deaths are fairly

accurate estimates, and the immigration is not, we then presumed

that most of the difference is in immigration. However, we find

that we overexplain the problem, so it is not easily that simply explainable, but it is apparent that a goodly part of the problem is

that the household employment has been overestimated largely because of what we perceive to be an overestimate of population.

It is interesting, in this regard, that in January the population

numbers were revised down by 500,000. Now, we still have not

closed the gap, but the presumption is that with these types of

analyses, plus the fact that 60,000 is a very large sample, but it

still has sample variance in it, we have concluded that, as best we

can judge, the payroll series is the more accurate number. And I

believe that the Bureau of Labor Statistics has come to the same

conclusion.

Senator BENNETT. Yes, they have, and I am not challenging that.

We are aware at JEC of all of the statistical noise in the data that

you have described, and we have tried to do our own adjustments

on the census in the way that you have talked about.

The thing that keeps nagging at me on this issue, and maybe I

am obsessing and should forget it, but, historically, the two have

run fairly close together. The household survey has always been

higher than the payroll survey.

Chairman GREENSPAN. Oh, in level, yes. Absolutely, yes.

Senator BENNETT. But when one moves up, the other moves up

not in lockstep, but they have historically kind of moved in the

same direction.

Chairman GREENSPAN. That is a fair statement.

Senator BENNETT. In this particular recession and recovery period, that has not been the case. They have diverged in a way that

has no historic background, and that leads to the question that I

raised in my opening statement, and I do not want to beat this

horse any more, but simply put it out for you to continue to think

about. Is this sending a signal that there may be some structural

change going on, and can we dig into it to the point, as I said in

my opening statement, where we are more sure about the data?

22

If you ask me which is the more reliable, I would say the payroll

survey is the more reliable, but I am not as convinced that the

household survey is not trying to tell us something as I would be

if the two were moving in a historic pattern.

Chairman GREENSPAN. Oh, I think that is a correct way of evaluating it. One thing, obviously, which clearly caught our attention,

is the issue you raised at the very beginning; namely, that one way

to explain these extraordinary productivity figures is that they are

not real, and, indeed, they are a function of the fact that the denominator is being basically underestimated.

So, we are aware that there may be something not fully explained here because, as I mentioned to you just a moment ago, our

endeavor to reconcile to the population figure does not quite do it.

It overadjusts and implies a decline in immigration to make them

reconciled, which is just not credible.

Senator BENNETT. I agree with that, and we have run into the

same problem in the JEC as we are trying to deal with this.

I have some other questions, but Senators have returned, and I

will wait for a second round.

According to the sheet that we have from Chairman Shelby, I

think, Senator Reed, you are next.

Senator REED. Thank you, Mr. Chairman.

Thank you, Chairman Greenspan, for your testimony. I would

like to follow up on the line of questioning that Senator Sarbanes

began and understand your position on the pay-go rules. You

would, one, favor their reinstatement?

Chairman GREENSPAN. Correct.

Senator REED. Two, these pay-go rules would cover any proposed

tax changes, they would have to be paid for?

Chairman GREENSPAN. That is what they are there for—both

taxes and spending.

Senator REED. Taxes and spending. In that context, would you

think it appropriate that tax provisions be looked at to pay for

other tax provisions, or would you exclusively urge that expenditures be cut?

Chairman GREENSPAN. I do not have a strong feeling one way or

the other. My suspicion is that the success of the pay-go rules—and

they were successful—over the years was more that they locked in

the requirement that the deficit be addressed. I obviously would

prefer it be biased toward reducing outlays, because I think that

is the area where the probability of success is highest in the sense

of its impact on the economy. But I think that the focus has to be

firmly on pay-go in general rather than how it is done.

Senator REED. May I assume, then, that you would at least conceptually oppose provisions that would only make pay-go applicable

to expenditures and exclude or protect any of the tax provisions?

Chairman GREENSPAN. I would like to see the pay-go rules that

expired in September 2002, be reapplied hopefully in precisely the

same way.

Senator REED. In your testimony, you did suggest that because

of the dwindling discretionary spending, and because of some accounts that we frankly cannot touch—Department of Defense,

maybe not in general, but expenditures in Iraq and Afghanistan—

23

you are looking at policy options such as increasing the age of eligibility for Social Security, significant changes——

Chairman GREENSPAN. I might add Medicare would be implicit

in this.

Senator REED. —and Medicare—you just stole my next phrase—

and I think you understand that these are exceedingly difficult

choices to make.

Chairman GREENSPAN. I fully understand that. However, the

other alternative is to have legislation which repeals the laws of

arithmetic.

Senator REED. Well, some of the legislation I have seen lately

proposed by the Administration is proposing to repeal the laws of

arithmetic, so I hope you gave them the advice, too, Mr. Chairman.

One of the issues with respect to arithmetic is timing. These proposals would be difficult in any case, but the sooner we at least

begin to consider them, the better off we will be. I have seen no

leadership from the Administration suggesting proposals of this

order. Would you urge them to begin this process now?

Chairman GREENSPAN. Certainly.

Senator REED. Thank you.

One of the other areas of concern is the time frames where we

look at different dimensions of the budget. We have estimates of 5

years of expenditures and 10 years of expenditures. We look at Social Security in 75-year periods. Do you think it would be helpful

if we looked at these proposed tax cuts in 75-year periods?

Chairman GREENSPAN. I do not even think the 75-year period is

other than an arbitrary number. I think what we should be looking

at is the present value of all outlays and receipts. In other words,

as you are aware, when you get to the 76th year, you go off the

cliff, and it is very often very odd that people do not understand

why, as you go from 1 year to the next with the 75-year pattern,

when you drop off the most recent year and you add the huge deficits that you get in the longer years, the numbers change. I think

that is an indication that you need to look at this in a much more

conceptually appropriate way.

The 75-year number was employed many, many years ago as a

convenience of calculation and explanation, but it is not a mathematically appropriate statistic.

Senator REED. But it seems to give us a little longer perspective,

obviously, than the 5 years and 10 years that we look at tax cuts

and expenditures. I think the same phenomenon seems to take

place if you look at these proposed tax cuts. Some of the deficit

numbers explode beyond the 5- or 10-year period, yet the Administration talks only in terms of these shorter periods. Is that a conceptual failing?

Chairman GREENSPAN. Well, I think as Senator Bennett pointed

out earlier, our forecasts are pretty thin, but while that is true, it

is better to have a forecast than none. You do reduce the risks by

at least looking out into the future and getting some judgments.

But the budget as it affects the economy is ever-increasingly

moving toward a more distant horizon. Remember, we used to have

1-year budgets, then we went to 5-year budgets, now we are going

to 10, with supplementals on 20, 30, and 40. And I think that process will continue largely because of the increasing proportion of the

24

budget which is essentially related to the state of retirement, and

that is something we never had before. The average life expectancy

was not all that great, and the number of retired people was not

that many. But the incredible increase in our standards of living

has enabled us to support very large retired populations, and I

think as a consequence of that, in evaluating our budget process,

our horizon has to move out, and I am not even sure that 10 years

is enough, frankly.

Senator REED. Thank you, Mr. Chairman.

Chairman SHELBY. Senator Sununu.

Senator SUNUNU. Thank you, Mr. Chairman.

Chairman Greenspan, you said that one possible reason—possible explanation—for the high rates of productivity if in fact they

are not real would be an underestimation of the denominator. I

presume that means the denominator is the payroll survey in that

equation?

Chairman GREENSPAN. Well, actually, only in part. The base is

the payroll survey and the hours that are in that survey. But then,

the Bureau of Labor Statistics adds estimates of hours for proprietors and other elements of the overall workforce of nonfarm business, which as you remember is the numerator. So it is not solely

the payroll series, but that is by far the dominant factor in the

denominator.

Senator SUNUNU. But in responding to Senator Bennett’s question, I just want to make sure that was your point——

Chairman GREENSPAN. Yes.

Senator SUNUNU. —that you were suggesting that if the payroll

survey were too low a number, then that would artificially inflate

the productivity number. Is that a correct statement?

Chairman GREENSPAN. That is correct. I do not believe that that

is, indeed, the case.

Senator SUNUNU. No. You were very clear that you thought the

payroll survey was most accurate. I just want to make sure that

I understood the answer that you provided to Senator Bennett.

Chairman GREENSPAN. That is correct, Senator.

Senator SUNUNU. Senator Bennett may have asked—and I apologize if I missed the response—about the degree to which issues

such as the self-employed or contracted workers are taken into consideration in the payroll survey or the household survey. Could you

just touch on that briefly?

Chairman GREENSPAN. I will. Contracted workers will either be

in the payroll series itself—you will remember that temporary employment is part of the payroll series, and the number of contractual types of work are there as well—but to the extent that they

are proprietors, or they are essentially self-employed, they will be

picked up in the denominator of the productivity estimate largely

from the household survey data, which is really the sole source of

self-employed.

Senator SUNUNU. The household data is the only source of the

self-employed numbers; is that what you just said?

Chairman GREENSPAN. That is my recollection, yes.

Senator SUNUNU. So there is no effort to, for example, look at

IRS filings, who is filing as self-employed, doing their taxes, declaring that they are self-employed, to try to draw some correlation?

25

Chairman GREENSPAN. Well, I have looked at those data myself.

And it is probably a superior procedure to do what the BLS is

doing, taking a very large sample survey and estimating from those

data themselves.

Senator SUNUNU. Excellent.

It is my understanding that the Fed just recently announced a

change in policy with regard to the short-term financing of interest

payments on GSE debt. Could you talk about that a little bit, what

the rationale for that policy is, when it might be implemented, and

what the economic impact might be, or the impact to the financial

markets?

Chairman GREENSPAN. Yes, Senator, what you are referring to is

what we call ‘‘daylight overdraft’’ in the Federal Reserve System.

During the day, there are transfers in and out of Federal Reserve

accounts, and there are a huge amount of payments, there are a

huge amount of receipts, and over the years, we have endeavored

to remove what has been an increasing problem, namely, that a

number of the private payers have been paying later in the day,

whereas the Federal Reserve pays a lot of the payments for, say,

the U.S. Treasury and for agency and GSE debt at 9:15 a.m. in the

morning.

The consequence of this is that if you have an owner of a GSE

security, whether it is a depository institution directly or a depository institution acting for a customer, we pay at 9:15 a.m., and the

receipts that we get from the issuer, we usually do not get until

late in the afternoon. So what we are doing is we are paying the

depository institution its interest or repayment of principal far in

advance of the time during the day that we actually get the funds.

We were doing what private sector transfer agents were not

doing—namely, they do not pay out any principal or interest until

the funds are deposited—and it was a convenience for us to do that

early on; it was our decision to do it.

We are now getting to the point where the numbers are getting

so large——

Senator SUNUNU. How large?

Chairman GREENSPAN. Well, it is $145 billion on occasion.

Senator SUNUNU. So that is real money.

Chairman GREENSPAN. It is real money.

Now what we have done is to send out a request for comment

on a rule stating that by July 2006, I believe it is, that we will be

making payments to the depository institutions only when we have

predeposited funds, as is done generally in the private sector.

Senator SUNUNU. Why wait so long? Why wait until 2006?

Chairman GREENSPAN. Because it is going to require the individual depository institutions to find alternate means of financing,

and we do not sense any urgency of it. We think it is something

which has developed over the years on the basis of a policy which

we initiated. Now with the size of the numbers that are appearing,

we decided that it is important not to be giving out inadvertent

subsidies, which is in effect what we are doing, and it will require

of necessity that the depository institutions who have been getting

payments at 9:15 look for alternate sources of finance, as their payment desks do all day long. And we state in our request for comment that there is obviously an alternate need of how these funds

26

are going to be raised, and at some point, it is going to be some

form of permanent financing on their part.

Senator SUNUNU. Thank you.

Thank you very much, Mr. Chairman.

Chairman SHELBY. Senator Bayh.

Senator BAYH. Thank you, Chairman Shelby, and thank you,

Chairman Greenspan.

I have a couple of questions. It seems to me, Mr. Chairman, that

one of the things we have learned over the last several years is to

keep a fair amount of humility when it comes to forecasting too far

out into the future. We have had stock market collapses, unanticipated recessions, wars, terrorist attacks, and all these things have

taken a toll upon the country’s economy and finances. And recognizing that back when we addressed the issue of tax-cutting and

possible entitlement expansion the last time, you had recommended and some of us had embraced the idea of a trigger to try

to ensure that while we were giving it our best shot, if there were

these unanticipated contingencies, we would not go deeply into deficit, in debt, as has, in fact, turned out to be the case.

My question is—and we favored the idea of a trigger at a time

when we were in surplus—wouldn’t it also apply to either further

tax-cutting or entitlement expansions in time of deficit? Back then,

the idea had been to tie it to paying down the debt. Perhaps now

we could tie it to a steady glide path and reducing the amount of

the deficits as the trigger, something like that.

I would be interested in your thoughts about the possible trigger

when it comes to permanency of tax cuts or expansion of entitlements under the current set of circumstances.

Chairman GREENSPAN. Senator, because of the fact that the horizon over which we have to make budgetary policy is continuously

moving out and because, as you correctly state, forecasters are in

need of considerable humility, we have to have some form of mechanism which is a safety valve on the issue of how expenditures can

be controlled—I mean by that when you put out a program, you at

least know what the entitlements are or what the central estimates

are in general——

Senator BAYH. Although we have learned just recently that that

is sometimes subject to variation.

Chairman GREENSPAN. I was about to say in certain things like

Social Security, you can know with some degree of accuracy. Our

estimates of benefits over time have been pretty good and will continue to be. Health care is a totally different type of operation, as

are a number of other things.

But be that as it may, the point at issue is that unless you can

forecast either receipts or outlays with some degree of accuracy,

you need a fallback trigger position to protect the fiscal status of

the system. And over the years, I have argued for two different

types of approaches. I have argued for sunsetting virtually everything. My view is that if a program is desirable, sunsetting it will

be of no problem whatsoever, because it will be automatically renewed, but it does subject the whole issue of governmental programs to an automatic reevaluation.

I think we will be surprised at how many programs will indeed

be sunsetted and not be restored, whereas today they just go on far

27

beyond their original purpose, and I think there is just an enormous amount in our budget which has that characteristic.

Over and above sunsetting, then, is the trigger issue, which I

have in recent years advocated as another safety valve. There may

be others, and indeed, I would be——

Senator BAYH. I am about to run out of time, Mr. Chairman, forgive me. But you think it still has merit?

Chairman GREENSPAN. Oh, I do indeed, yes.

Senator BAYH. My second question—and again, I apologize, but

I have less than a minute—deals with a question of United States

sovereignty.

I was restless one night this week and picked up a publication

of the International Monetary Fund, ‘‘U.S. Fiscal Policies and Priorities for Long Run Sustainability,’’ and before the publication had

its intended effect and I went back to sleep, I did pick up some interesting insights from it. Let me just read you one sentence.

‘‘The United States is on course to increase its net external liabilities to around 40 percent of GDP within the next few years, an

unprecedented level of external debt for a large industrial country.’’

There were other countries that had higher levels of debt, but

they financed it internally through savings; we do not.

My question is as long as we are financing our governmental operations by borrowing from abroad, principally from foreign central

banks, as long as American consumers are sending wealth abroad

through their purchases that deal with our balance of trade situation, in the long run, if we allow this to continue apace, or if it does

continue apace, doesn’t this really affect our sovereignty?

How do we take firm negotiating stances with those to whom we

are deeply in debt, whether it is in the trade realm or even events

on the North Korean peninsula—just a whole raft of things. Is

there not a concern that if we continue apace, it will affect our sovereignty in some other areas?

Chairman GREENSPAN. To the extent that we would be owing

debt to other sovereign governments, in that respect, there is a difficulty. But if it is a private negotiation, I am not sure it has the

same type of problem which you are alluding to. That in no way

says that building up those debts is not a problem, because unlike

the Federal budget problem in which those decisions are made

essentially in the Congress, current account balances get adjusted

by the marketplace in the sense that people accumulate claims

against American residents because they want to. As wealth continues inexorably to increase, you have claims that represent it,

and a very substantial part of the world has chosen to have claims

against the United States as the most secure claims they know how

to have.

Without getting into the detail, I recently made a fairly broad

analysis which suggests that the dispersion of current account deficits because of international financial intermediation is stretching

out, meaning that there are far greater surpluses and deficits now

than existed 20 years ago, and it looks as though that is going to

continue, meaning that as overall wealth, world wealth, increases,

you have to hold it someplace. And what is happening in part is

that because of the nature of our society, property rights, in genVerDate 11-MAY-2000 11:46 Jun 21, 2004 Jkt 000000 PO 00000 Frm 00031 Fmt 6633 Sfmt 6633 94291.TXT GEOW PsN: GEOW
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eral, very strong underlying productivity, we are still the area

where people want to invest.

Now, I certainly can conceive of a situation where even if that

is the case, you get so much in the way of dollar-denominated

claims, you just really want to diversify——

Senator BAYH. You saturate the market.

Chairman GREENSPAN. —so that you will get diversification, and

you will then get pressures in the marketplace to adjust. But I

would not be overly concerned about the issue in terms of delimiting our sovereign capability of acting in the world because of that.

I think that is true only in a very limited sense, and I would be

more concerned about the broader implications of our saving and

investment policies at home as being a crucial issue.

Senator BAYH. Thank you, Mr. Chairman.

Chairman SHELBY. Senator Carper.

Senator CARPER. Thanks, Mr. Chairman.

There is a recurring theme, I am sure you have noticed, to a lot

of these questions, particularly from our side of the aisle, and I just

want to pick up where Senator Bayh has left off.

When we run a deficit in Federal operations in our budget, we

have the ability to borrow from trust funds, and we borrow from

the Social Security trust fund, we borrow from Medicare trust

funds and other trust funds that exist. I think we have pretty well

exhausted all of those. When that is not enough, we look around

the country to see if there are investors in the United States who

are willing to loan the Federal Government some money and buy

our securities, and there are plenty of people and institutions who

are willing to do that.

When we have pretty well brought in those dollars from potential

investors with the interest rates they can yield, then we turn

around and look around the world to see who outside of our borders

will lend this money, and as in the conversation you have had with

Senator Bayh, there are a lot of investors around the world who

are willing to invest in U.S. securities. And so far, so good.

My fear—and I think you touched on it right at the end—is that

we reach a point, almost like on a seesaw, where you start going

in the other direction, and potential investors, whether they are

banks or individuals around the world, look at the United States,

and they look at our securities, and they look at our inability to

balance our Federal deficit or to even come close to managing our

fiscal matters in a responsible way. They look at the exodus of jobs

from this country, not just manufacturing jobs but good-paying

technology jobs, and my fear—and I am by nature an optimistic

person; I almost always see the glass as at least half-full—and I

must say that looking down the road here a few years, especially,

as I said earlier, when my generation starts to retire, when the

boomers start to retire, I will be honest with you, I do not see the

glass as half-full.

I have a fear—and maybe it is misplaced—but a fear that we will

reach a point where the rest of the world will say to us: You know,

if you want us to continue to invest in your securities and to continue to loan money to your country, we will do it, but not at the

interest rates that you are willing to pay.

29

I think you and the Fed have done a masterful job in managing

monetary policy and trying to keep interest rates low and to help

make this recession as shallow as it has been, but I want to tell

you that I worry that the day will come when the rest of the world

says, No, you need to raise your interest rates for us to continue

to make those kinds of massive investments. And when we are

faced with that prospect, the effect on the economic recovery is not

going to be good. Can I just ask you to react to that?

Chairman GREENSPAN. Well, Senator, remember, the way it will

happen is not that somebody abroad is going to say, ‘‘You have to

raise your interest rates,’’ because the major question here is the

private flow of funds. What will happen is that foreign investors,

for one reason or another, will seek non-U.S. type investments.

They are not going to call us and say, ‘‘If you do not raise your

rates, we are not going to invest here.’’ They just will not invest.

And what can happen and what has happened in the past is that

you remove the demand for private securities, and with the same

supply, interest rates of necessity start to rise. In other words, it

is not necessarily an action of the Federal Reserve or anything necessarily that the Federal Government——

Senator CARPER. I have no quarrel with what you have just said.

I agree.

Chairman GREENSPAN. —so the answer is yes, that is clearly

something we have to keep in mind.

Senator CARPER. Again looking down that road another 5 years

or so, could you just talk with us about what are the implications

to our fiscal situation when my generation begins to retire?

Chairman GREENSPAN. We may have humility in forecasting economic and financial issues; we should have none in forecasting that

a very substantial number of people currently in our labor force

will move into retirement starting in 2008. That forecast is probably one of the very few forecasts which we can get with a very

high degree of accuracy.

Also, we have under existing law commitments to those people,

and when you multiply current law times the numbers, you get a

very considerable rise in obligations of this Government. And as I

said earlier, it is very important for us to recognize when and to

what extent we may have overcommitted, and if indeed we have,

it is very important for us to communicate to this group of people

who are looking forward to benefits in retirement that they feel secure that what they have been promised, they will get. And unless

and until we review all of these things, I do not think we really

know what the nature of the problems are out in the longer term.

What we do know is cause for considerable concern.

Senator CARPER. One last quick question if I could. Others have

asked you about restoring pay-go procedures within our budget

process. There are two ways to go pay-go. One is to say that if a

Senator comes in with an idea for raising spending in a particular

program, you have to come up with an offset—either cut spending

somewhere else or raise revenues to offset it.

The flip side of that is to say that when a Senator comes in with

an idea to reduce revenues, there should be an offset of that as

well—either you find another place to cut spending or you find anVerDate 11-MAY-2000 11:46 Jun 21, 2004 Jkt 000000 PO 00000 Frm 00033 Fmt 6633 Sfmt 6633 94291.TXT GEOW PsN: GEOW
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other place to raise revenues to offset the revenue loss that is going

to come from my initiative or anyone else’s.

I think what the Administration has proposed is only the first

half of that plan, pay-go only as it affects new spending. My question is should we just do half-a-loaf, or should the restoration of

pay-go be consistent with what we have done in the past to say

that if you are going to raise spending, you have to come up with

the offset, and if you are going to cut revenues, you have to come

up with the offset?

Chairman GREENSPAN. Senator, I mentioned earlier that I, in

testimony in September 2002, was very concerned about the pending expiration of pay-go, as well as discretionary caps and argued

strenuously that they be restored. My view is that what seemed to

work in the past, what was in the statute prior to September 2002

is needed, and I think just resurrecting that structure, which was

far more successful than I ever imagined it could be, is an essential

element in restoring fiscal sanity to our system.

Senator CARPER. Thank you.

Mr. Chairman, I think he just said a mouthful there, and I hope

we will take that one to heart.

Chairman SHELBY. Thank you.

Senator Schumer.

Senator SCHUMER. Thank you, Mr. Chairman, and thank you,

Chairman Greenspan.

I would like to focus on the area I mentioned at the beginning

which I am very concerned about. When people question whether

free trade is still the way to go, usually, economists and editorial

boards say, ‘‘You are being protectionist.’’ But given the new

changes, there are lots of very—not lots—there are a few very respected economists who are saying we should reexamine because

the world has changed.

Mr. Roach of Morgan Stanley calls it ‘‘global labor arbitrage.’’

I would like to read you a quote from two very respected economists, Ralph Gomory and William Baumol, and get your comments

on that. They are saying what the free trade theory is. This is from

their book, ‘‘Global Trade and Conflicting National Interests’’:

‘‘However, it is also true that in the time since these basic models of international

trade were formulated, there have been major change in the world economy. David

Ricardo’s world of agriculture, slow-moving technology, and tiny businesses has been

replaced by a world dominated by manufactured goods, rapidly evolving technology,

and huge firms. This calls for reexamination of those classical models.’’

There is another paragraph, and then they say:

‘‘However, as modified by us, the theory shows that there are in fact inherent conflicts in international trade. This means that it is often true that improvement in

one country’s productive capability is attainable only at the expense of another

country’s general welfare. An improvement in the productive capability of a trading

partner that allows it to compete effectively with a home country industry, instead

of benefitting the public as a whole, may come at the expense of the home country

overall, and this harm is not the localized damage previously mentioned—loss of

jobs in the immediately affected industry—but an adverse effect that is felt throughout the home country.’’

As I mentioned to you earlier, it seems to me that the Ricardo

theory relied on factors of production that were staying in a country, not in a world with broadband, with an international labor

market that is rapidly changing. And I think I mentioned just two

examples; I have heard many. The head of a major insurance comVerDate 11-MAY-2000 11:46 Jun 21, 2004 Jkt 000000 PO 00000 Frm 00034 Fmt 6633 Sfmt 6633 94291.TXT GEOW PsN: GEOW
31

pany said except for salespeople, who have to deal face-to-face, if

he is doing his job, 80 percent of his workers should be overseas

within 10 years.

Can you comment on both my opening statement and particularly the comments of Professor Gomory and Baumol?

Chairman GREENSPAN. Certainly.

Senator SCHUMER. I do not know a solution here, to be honest

with you, but do you disagree with the view that the basic changes

in the last 5 years perhaps should cause us to reexamine the classical theory of free trade, which is when each country specializes,

everyone does better?

Chairman GREENSPAN. I see no reason to do so, and let me tell

you why. Instead of thinking in terms of trade per se, I think it

is important to start in a different direction and then come back

to trade.

The real question is the question which Adam Smith originally

raised: What causes the wealth of nations?

We have two statistics in this country which we have to explain.

One is that employment has moved in parallel with the adult population for generations. There are aberrations, but in general, it has

happened.

More important, real wages have gone up at all times. And I

might say that both of those trends have occurred irrespective of

whether we have had a trade deficit or a trade surplus, whether

we have had high outsourcing or low outsourcing. If, indeed, the

wealth of the Nation, meaning the United States, is independent

of the degree or nature of trade, then the question is what causes

the wealth of nations. And here, even though we do not have any

recent evaluations for developed countries, there has been an

extraordinary amount of research on less-developed countries

which looks to me wholly applicable to developed countries as well.

You start off with what are the factors which seem to make the

difference.

One is the skill and education level of the indigenous population.

Two is the extent to which there is a rule of law which facilitates

the way that populations trade internally. In that regard, property

rights turn out to be a very critical issue. And the two of those are

sometimes augmented by the degree of natural resources that are

there, but that is a very minor question.

This, therefore, raises the issue of why is it that the United

States has been able to increase our per capita income not every

year, but over a period of time. And it largely comes down to the

fact that our skills, along with our degree of intelligence, is what

determines what our real income is wholly independent of which

particular job we had and what proportion of our total consumption

was imported.

I submit to you that if, indeed, that is the case, then the issue

of trade is constructed in a different context. Then the question is

how do people exchange goods and services, how do you create specialization of labor within an economy, within a city, within a company, to create maximum wealth. In a context of fully free trade,

then, national boundaries are utterly irrelevant to where people

move or not move.

32

Yesterday, I raised the very important issue in this regard of

education. I think our real concern should not be the question of

whether or not trade is increasing internally or externally. I think

we have to be very concerned about the fact that there are very

substantial people who are obviously losing jobs not only because

of trade but also because of internal productivity. That is something which is a public policy question we have to be very much

concerned about, but it should not change our view of what the economic forces are which are moving world events in that regard.

What I am saying here is that if we have, as I mentioned before,

an economy which is increasingly conceptual—that is, the quality

of the goods are more and more—it means that for us to function,

we need a level of skills of our working population which is continuously becoming more conceptual to match the type of goods and

services that consumers want—or, to put it another way, that

workers acting as consumers request. And what we are observing

at this stage——

Senator SCHUMER. Could you comment on 100 million well-educated people added——

Chairman GREENSPAN. —I will; I will exactly do that, because

that is where the critical issue is. In any event, what is happening

in the United States is we are finding that the lesser skills are

turning out to be in surplus supply, and therefore, the real wages

of our lower-income are going nowhere, but the premiums for skills

in the upper areas of our skill area have been rising for the last

two decades, which is another way of saying that we are not moving our younger people through our school system from the fourth

grade through 12 sufficiently quickly to put them into college and

into areas where their capabilities get to a point where the supply

of skills meets the burgeoning demand, which incidentally will

bring down the wage rate and will reduce the inequality of income

which is involved here. And there have been very disturbing international studies that American students in math and science in the

fourth grade are average, maybe even slightly better than average

internationally; by the time they get to the 12th grade, they are

way down below the average.

We do something wrong which obviously, people in Singapore,

Hong Kong, Korea, and Japan do far better than we. There is nothing wrong with our students—they are just as good if not better in

the fourth grade. They are teaching in these strange, exotic places

for some reason far better than we do it. And because we are not

doing it, then the issue you raise, Senator, disturbs me, because

what will ultimately determine the standard of living of this country is the skill of the people. I think we are fortunate in that we

have a Constitution and a rule of law so that people find it sufficiently attractive to invest here, and that has helped us to a very

considerable degree—but unless we somehow resolve the education

problem, then I think the issue you raise about the 100 million Indians, Chinese, and the like is an issue.

I should, however, say parenthetically remember that that was

our concern about Japan in the 1950’s and the 1960’s, and when

the demand for those so-called low-wage workers, highly-educated

workers, began to move, the Japanese wage rates just took off. So

it is not as though Chinese and Indian software engineers, for exVerDate 11-MAY-2000 11:46 Jun 21, 2004 Jkt 000000 PO 00000 Frm 00036 Fmt 6633 Sfmt 6633 94291.TXT GEOW PsN: GEOW
33

ample, are always going to be at a very significant differential. Because of the very large numbers of them, it will be for a while, but

eventually, the gap will close. But whether it closes or not should

not be relevant to us if we cannot solve our education issue.

Senator SCHUMER. Thank you.

Thank you, Mr. Chairman.

Chairman SHELBY. Senator Miller.

STATEMENT OF SENATOR ZELL MILLER

Senator MILLER. Thank you, Mr. Chairman.

Mr. Chairman, thank you. I know you have been at this a long

time already this morning, and we appreciate your generous and

your knowledgeable remarks. I do not want to continue to beat this

horse, but I listened very carefully to what you had to say to Senator Schumer, and I apologize for not being here when Senator Allard asked you about the loss of manufacturing jobs.

I really want to embrace what you are saying, and what you are

saying about education I could not agree with more. However, in

the interim, I get letters like this one. It is from a pre-K school

class in Trion, Georgia. Now, obviously, they are an advanced class

of preschoolers:

‘‘Dear Senator Miller, we are a pre-K class from Trion, a small mill town in northwest Georgia. The main industry in our area is Mount Vernon Mills. The mill has

been in business since 1845 and is a main source of employment in our area. They

employ about 1,900 people. Many of them are our parents.’’

‘‘We are very worried about our mill. They have been on short time more in the

past year than at any time in the mill’s 158-year history. We are and continue to

be the largest producer of denim in one location, but we fear this may change unless

something is done. Back current legislation for 27.5 percent tariffs on Chinese

goods.’’

I told you they were a very advanced class; they know about tariffs and quotas.

‘‘This company is vital to our area. They make regular donations to our schools,

including $1 million several years ago to help build our new school. The old one is

in a floodplain and badly damaged. Without this mill, our town will not survive, and

neither will our school. Won’t you please help save our mill and the American textile

manufacturing industry by putting quotas on Chinese imports? Please help save

our mill.’’

‘‘Ms. Janice and Ms. Cathy’s pre-K class, Trion pre-K.’’

Now, I know that those kids did not write that letter, but I can

guarantee you that those kids have heard that kind of talk around

the kitchen table back home, and they have seen their daddy or

mamma is worried about their job, and that makes them worried

about their future.

Mr. Chairman, assure me again that it is not the end of the

world to lose all these manufacturing jobs. What happens to the

tax base when something like this happens? I know you talk a lot,

and I agree with you on the retraining of workers, but will there

be enough new jobs to employ all the retrained workers, say, in

Trion, Georgia? Can America live on consumption alone?

Chairman GREENSPAN. No, Senator Miller, we cannot, and indeed, I think this is an issue which requires a considerable amount

of attention.

I know there is a gulf between people who are advocating the abstraction of free trade and those confronting the letter that you

have. It is a very difficult public policy question, because the way

34

our system functions is that it is continuously churning—that is,

as a famous Harvard professor said, it is called ‘‘creative destruction’’ in the sense that we are continuously using the resources of

obsolescent technologies to finance cutting-edge technologies, and

the difference in the productivity in the cutting-edge technology

less that of the obsolescent technology is a rise in productivity that

is the source of a rise in our standards of living.

So, economists will tell you that the process is basically one in

which there are lots of losers and gainers in the process, and indeed, if you look at the equivalent in the labor markets, as I have

mentioned previously, we hire a million people every week in this

country, and a million, more or less, are either laid off or quit. But

the important issue here is that there is an extraordinary churning

in the labor market, and there are a very large number of people

in the wrong end of that churn who are in very serious straits.

We have 2 million people who have been looking for a job for

over a year. Now that is a relatively small percent of the 150-odd

million people who are employed, but it is a large number of people, and we have to be very careful to recognize that there are winners and losers here, and I think it is crucially important that we,

one, as I have indicated previously, recognize that if you are going

to get obsolescent technologies or ones that become obsolescent

because we have different patterns of labor and capital—but for example, if you go back 20 or 30 years and look at the textile mills

in the South, and these are absolutely first-rate operations, worldclass—I know, because a lot of them were my clients, and I know

what they were doing—the trouble, unfortunately, is that a number of developing nations have evolved and copied a lot of our

technologies.

It was an American who created the cotton gin. The cotton gin

was the critical issue which enabled a major textile industry to

really start in this country, and up until very recently, we were at

the cutting edge. It was true in steel, it is true in motor vehicles.

And we are finding that we are fading in those areas, and yet fairly

recently, we had 4 percent unemployment, and we have always

been having a very significant increase in real wages.

Human ingenuity is producing ever more useful ways of operating. I think it is important that we do not stop that process, because that is where our standard of living, that is where American

greatness, is coming from. But on the other hand, we should be

very careful to recognize that we are not dealing with averages, we

are dealing with real people. And that is the reason I support community colleges, which are turning out to be by far the most useful

vehicle to retrain people—because if they have an adequate education, you can retrain them.

That is why I am worried about the school system. If you can retrain them, the evidence suggests that to be sure, when you lose

a job, you usually get the next one at a lower pay, but ultimately,

you move up. If you have that situation, you have to craft programs

that get people retrained and, where you cannot get them retrained, find other ways of assuaging their problem, which was not

of their making.

Senator MILLER. Thank you, Mr. Chairman.

35

It is hard, though, to look at the big picture when you are one

of the flesh and blood that is caught up in that little picture.

Chairman GREENSPAN. It certainly is.

Senator MILLER. Eli Whitney was a New Englander who came to

Georgia and invented that cotton gin, by the way.

Thank you, sir.

Chairman SHELBY. Senator Corzine.

STATEMENT OF SENATOR JON S. CORZINE

Senator CORZINE. Thank you, Mr. Chairman.

I apologize for not being here today. I was listening to incredible

minds and public servants. Secretary Powell was in our Foreign

Relations Committee meeting.

This discussion that you are having about the wealth of nations

and its growth through productivity and the capacity expansions is

both spot on given our current situation, but I think the piece—and

you have alluded to it a couple of times, because you cannot talk

about averages and really have this apply to our workforce and income distribution that we have in our Nation. I think one of our

major problems is that we continue to look at averages when we

look at per capita income and some of the metrics that you have

mentioned and others have mentioned, but when you look at it in

the way you just suggested—someone who loses a job, their next

job is at a lower real wage, and you are seeing that happen more

broadly in the economy—whether that is a trend, I think it is early,

but there are a number of studies out that show that in the bottom

80 percentile of American workers, there is beginning to be an erosion of real wages. So, we are getting that offset by what is going

on at the top, and some of this is education, there is no question.

But how long does it take for that adjustment process to occur,

and should there be public policies that actually address that? Obviously, you talked about community colleges and the budget, and

I know we had an initiative talked about in the State of the Union,

but if you look at the real spending on community colleges that is

going on in the other elements of the budget, we are cutting them.

I just do not understand how we can continue to forecast 2.5 million jobs when this process of growing the wealth of the globe as

well as the Nation with the kinds of problems of income distribution. So, I think today’s discussion is extraordinary, but unless it

deals with the distribution of income and talks about something

other than averages, I think we are missing the point with the

broad base of Americans.

Chairman GREENSPAN. Well, Senator, I think the income distribution issue is very critical because we cannot have a significant

inequality of income and expect to have support for the type of institutions which have made this country great.

A point that I am trying to make is that the nature of our production processes, the nature of our capital facilities, are requiring

an ever higher degree of skill on the part of our working population

to staff the plant and equipment. Indeed, we have been doing it.

If you go back to the turn of the previous century when people were

coming off farms, our education system was remarkably effective.

We had created high schools which taught people how to take the

skills which essentially staffed a major expansion in manufacVerDate 11-MAY-2000 11:46 Jun 21, 2004 Jkt 000000 PO 00000 Frm 00039 Fmt 6633 Sfmt 6633 94291.TXT GEOW PsN: GEOW
36

turing. By World War II, we were far ahead of any other country

in our level of general education.

Since then, we have had this continuous requirement for increased skills, but because we have been doing it very slowly, too

many of our people who should have been in college or graduate

school or whatever end up not making it through high school. And

if you just think in terms of what would happen if we had the same

schooling that a number of East Asian countries are having, there

would be a far larger number of people going into high school and

a far larger number of people going from high school to college to

graduate school. We would move the whole population structure

up. We would reduce the excess supply of those in the lower-skilled

areas and those who are still lower-skilled would find their wage

rate would rise, but moving up the population into the higher skills

would create excesses there and lower the wage levels in the upperskilled levels and thereby reduce the degree of income inequality

very significantly.

There is another piece of this which is, of course, immigration,

which has an interesting effect, but the point that I am making is

that this is a problem which is best, and I fear may only be, addressed through education. And if that is the case, it is very important that we focus on what is wrong with our system—why do

fourth graders, who in math and science do as well as the rest of

the world, if not better, find that by the time they get out of high

school, they are way down at the bottom of the ladder? Why is

that? What are we doing wrong?

I think if we could answer that question, we would find the public policies which would solve a good number of problems that are

reflected in the type of letter that Senator Miller just read.

Senator CORZINE. Thank you.

Chairman SHELBY. Chairman Greenspan, you have been very patient with us this morning. I have four questions, and I will submit

them for the record. I am just going to touch on them here.

The first has to do with the sustainability of the current account

deficit. You have talked about that some. I will put that in the

record and get it to you.

The second one has to do with the possible fragility of the Chinese financial system, the banking system, as a lot of us see it.

Then, the third one would deal with the decline of the dollar

versus the euro, the long-term consequences and so forth.

The fourth one deals with price indices and the Federal budget

in reference to some testimony you gave one time dealing with income tax brackets; have they been inflated using the chain-weighted CPI rather than the cost and so forth.

I will get those to you for the record.

The last question I want to ask you is not necessarily here before

us today, and that deals with hedging. The SEC staff recently

issued a report recommending that hedge fund advisors register

with the SEC. What is your perspective on the registration of

hedge fund advisors, and how would it impact the industry? In

other words, do you agree with that recommendation?

Chairman GREENSPAN. No, I do not, Senator. I think that hedge

funds, which I would define as financial institutions in which the

investors are only of high income levels—if I get this wrong, SenVerDate 11-MAY-2000 11:46 Jun 21, 2004 Jkt 000000 PO 00000 Frm 00040 Fmt 6633 Sfmt 6633 94291.TXT GEOW PsN: GEOW
37

ator, please correct me—the value that these institutions have is

to create a very significant amount of liquidity in our system, and

I think that while they have a reputation of being a peculiar type

of financial group, they have been very helpful to liquidity and

hence the international flexibility of our financial system. We have

to be very careful that we make sure that they do not become an

investment vehicle for people in lower and moderate incomes, because that appropriately requires registration and SEC——

Chairman SHELBY. Perhaps on the retail level.

Chairman GREENSPAN. —it requires SEC oversight. I grant you

that registering advisors in and of itself is not a problem, but the

question is what is the purpose of that unless you are going to go

further, and therefore, I feel uncomfortable with that issue.

Chairman SHELBY. Thank you.

Senator Bennett.

Senator BENNETT. Thank you, Mr. Chairman.

I was interested in the same question as the Chairman just

asked and appreciate your answer.

I have no further questions other than just one last shot at the

thing that we are talking about here. One more time, trade is good,

even if it is trade in services as opposed to trade in hard goods.

Trade is good for both sides. Trade is good for this country. Is this

an overall summary that you would be comfortable with?

Chairman GREENSPAN. I would, Senator.

Senator BENNETT. I think it is important that we remember that,

because there are some who say, well, yes, trade in hard goods is

okay, but when we get into services, then trade is not good. And

I appreciated your answer to Senator Schumer when you talked

about the historical impact of trade whether we were in recession

or boom times, whether we were in war or otherwise—just historically, American productivity has produced this benefit.

I tell my constituents that when it comes to trading, we are the

meanest, toughest, biggest kid on the block, and therefore, we want

the most trade we can possibly get. We are not afraid of anybody

as a Nation in trading if we can lower all of the barriers.

So that is the last point I wanted to make, and I appreciate your

comment. Trade is good—let us remember that.

Chairman GREENSPAN. Yes, sir.

Chairman SHELBY. Senator Corzine, do you have a parting statement or question?

Senator CORZINE. Thank you.

I have a couple of quick questions.

First of all, I would just comment on the hedge fund issue. I

think there are some questions about the ‘‘retailization’’—bit big,

crazy word—that people have seen, where you break it up and are

selling——

Chairman GREENSPAN. I think that is where the issue really lies.

Senator CORZINE. Yes. And there are also issues about what the

limits are today versus when rules were promulgated, whether it

is 200,000, and what is a sophisticated investor.

Then there is this continuing element, no matter how you feel

about hedge funds, like in every other walk of life, there is always

the 5 percent or the 2 percent, and they seem to end up being in

38

some of the more reckless and dangerous worlds on a consistent

basis—but for another day.

Let me ask a quick question. You have been an advocate of triggers, and I want to know, actually, if we had taken your advice,

would the trigger have been pulled with regard to the current tax

cuts that are being requested to be made permanent as we go forward now, given the changed circumstances of our——

Chairman GREENSPAN. It depends on the way the trigger was

constructed. It could have been, it could not have been, depending

on what the form of the trigger——

Senator CORZINE. The way you conceived of it, though, when you

spoke to us.

Chairman GREENSPAN. As I conceived of it then, I said in the

2001 testimony, which Senator Sarbanes was discussing, that because forecasts are so difficult, and we could not be certain that the

surpluses were going to be in place, that we would probably need

to take a new look at whether, in fact, the surpluses were dissipating. If, indeed, you took the literal words of the testimony I

gave back then, yes, I think the way you put it would be accurate.

Senator CORZINE. I am going to submit for the record one other

question——

Chairman SHELBY. Without objection, it will be done.

Senator CORZINE. —with regard to the top 10 countries holding

our national debt. I have a particular curiosity about the Caribbean

banking centers and what its implications are with respect to our

concern about funding of all kinds of miscellaneous problems that

could potentially exist. I would love to hear an analysis of what is

driving the fourth-highest concentration of our debt being held by

Caribbean banking centers.

Chairman GREENSPAN. I am sorry—was that a question to me?

Senator CORZINE. That is a question that we can ask, if there

could be an analysis.

Chairman GREENSPAN. You want us to look at it.

Senator CORZINE. Yes, please.

Chairman GREENSPAN. In the context, as you are far more aware

than I, that the amount of information that those individual institutions and those various areas produce is less than we would like

to see. But we will take a look at it and see what we can find.

Senator CORZINE. I think the issue in the funding of global terror, one wonders why so much of the external debt of the United

States is being housed among institutions that we have very little

idea about.

Chairman GREENSPAN. We will see what we can find, Senator.

Senator CORZINE. Thank you.

Chairman SHELBY. Thank you, Senator Corzine.

Chairman Greenspan, again we thank you for your appearance,

and we look forward to your next appearance in less than 2 weeks.

Chairman GREENSPAN. Thank you very much, Mr. Chairman.

Chairman SHELBY. The hearing is adjourned.

[Whereupon, at 12:33 p.m., the hearing was adjourned.]

[Prepared statements, response to written questions, and additional material supplied for the record follow:]

39

PREPARED STATEMENT OF SENATOR WAYNE ALLARD

I would like to thank Chairman Shelby very much for holding this hearing, and

I would also like to join my colleagues in welcoming Federal Reserve Board Chairman Greenspan to the Committee today to discuss monetary policy and the state

of the U.S. economy. I always look forward to the opportunity to hear from Chairman Greenspan on economic issues and those factors that are driving and hindering

economic growth.

I was pleased to hear in your testimony before the House yesterday that the picture of the U.S. economy has brightened since you last testified here in July. I share

your views, and know the people of Colorado have been seeing the improving economic environment as well. I was also pleased to hear that the prospects are good

for sustained expansion of the U.S. economy and look forward to finding ways to

sustain that growth.

Recognizing that fiscal policy is far less powerful than monetary policy in influencing Gross Domestic Product growth and employment, Congress must do its part

by pursuing policies of low taxation, limited Federal regulation and free trade in

order to see the United States improve and prosper with wealth and opportunity.

The President’s tax cuts have played an integral part in helping to sustain the U.S.

economy after the mild recession and terrorist attacks in 2001. Sound monetary policy coupled with wise decisions on fiscal policy will allow Americans to benefit from

the fruits of a flourishing economy.

Chairman Greenspan, once again thank you for appearing before the Banking

Committee today. I look forward to your testimony.

——————

PREPARED STATEMENT OF SENATOR CHARLES E. SCHUMER

Thank you, Chairman Shelby and Ranking Member Sarbanes, and thank you,

Chairman Greenspan, for being here today.

As I travel all across my State I hear one question, one fear, one concern—jobs.

People who do not have them want them. People who have them are just waiting

for the shoe to drop and their job to go overseas in the relentless pursuit for the

cheapest labor.

Who can blame them? Despite historically low interest rates, large tax cuts,

record spending and record deficit levels, our highly stimulated economy again

missed expectations in January with a weaker number of mainly low-paying service

jobs. According to the Bureau of Labor Statistics after the first 10 recessions, jobs

always hit their low point around the end of the recession and never more than 3

months after the recession ended. But this time, the low point in jobs came in August 2003—21 months after the last recession ended.

After the first 10 recessions, there was a complete recovery in the number of jobs

within 2 years after the end of the recession. But this time, the recession has been

over for 26 months and we still have 2.3 million fewer payroll jobs than when the

recession started.

Mr. Chairman, at times it seems some believe we have discovered productivity for

the first time. But the United States has a history of strong productivity—in fact,

productivity has been the key to our strength and high standards of living.

It is true that over the last 8 years, from 1996–2003, productivity growth has

averaged 2.9 percent. And during the preceding 20 years, 1974–1995, productivity

growth was much lower, averaging only 1.5 percent growth per year. But during the

period 1948–1973, productivity growth was much stronger on average, stronger even

than what we have experienced since 1995, averaged 3.3 percent growth per year.

Yet the recessions during the previous high-productivity growth period were not

marked by the continual job losses and jobless recovery that we are in the midst

of today. During those recession and recoveries, jobs returned quickly. In fact, the

two times that the unemployment rate was below 4.0 percent were during the high

productivity periods of the late 1990’s and the late 1960’s.

So to me productivity is not an answer. We have been a highly productive economy for a long time that should not be news to anyone. And in fact, our economic

team should have factored in strong productivity in our stimulus—high productivity

cannot be used as an excuse for the failure to produce jobs.

What is news is that we are now having high productivity but no wage growth.

That is the real story. That is what is puzzling with this economy. And I think that

fact signals the bigger change. I believe what we are seeing is something brand new,

the first stage of a new economic era—a seismic shift—characterized by massive

global labor competition for every job.

40

It is not simply an issue of white collar service jobs moving offshore. That is only

one manifestation of a larger phenomenon.

The real concern is that any job that does not require daily face-to-face interaction

will be moved from high-wage countries like the United States to low-wage countries like India and China where huge amounts of skilled labor is available at a

fraction of the cost.

The proper term for this new era is ‘‘Global Labor Arbitrage,’’ a phrase recently

coined by Morgan Stanley’s Chief Economist, Stephen Roach. In this arbitrage, multinational companies—often U.S companies—source labor from wherever it is most

advantageous to them and shift operations to wherever is most accommodating to

their needs.

In manufacturing industries, factories, plants, and jobs are moved overseas for the

extra margin earned by substituting in skilled, cheap foreign labor for U.S. workers.

In services industries, skilled, foreign, low-cost labor is virtually imported into the

country via the Internet and employees here are left to look for new work. The result of this arbitrage is enormous pressure on U.S. jobs and wages.

In this new age of global labor arbitrage the United States is handicapped by our

past success. Over many years we have fought hard to build industries and create

a system where our citizens enjoy high wages and a high standard of living, as well

as some basic social benefits and worker protections. Now suddenly, United States

workers are being forced to compete with hundreds of millions of skilled Indian and

Chinese workers who are ready, willing, and able to work for a fraction of the cost,

and largely without regulatory controls.

What makes the experience of this new age particularly jarring for U.S. workers

is that it is their own companies who are leading the charge to move jobs overseas.

These businesses are even asking United States workers to train their foreign replacements.

While some argue that the high productivity of the U.S. worker will save the day

by keeping good jobs here and wages high, the facts to date do not support that

case. While labor productivity is, in fact high, wages have been stagnant and job

growth is far behind schedule. Yet corporate profits are near records. In the past,

U.S. workers’ productivity was a result of good training coupled with the ability to

work with the best equipment and technology. But today, armed with United States

technology and capital, and trained by United States workers, a Chinese or Indian

professional can be just as productive as his or her United States counterpart, but

at a fraction of the cost. The company gains efficiency, while the Nation loses productive capacity.

So in my view, the emergence of a new era of global labor arbitrage needs to be

addressed for what it is—a new phenomenon in our economy. We need to face up

to the new reality.

Thank you.

—————

PREPARED STATEMENT OF SENATOR JACK REED

Thank you, Mr. Chairman. The Federal Reserve’s mission is to conduct monetary

policy. But monetary policy doesn’t operate in a vacuum. Sound fiscal policies, like

those we pursued in the 1990’s, complement monetary policy in creating an environment of economic growth and job creation in the United States not abroad. In contrast, large budget deficits like those we experienced from the early 1980’s to the

early 1990’s are a drain on national saving that is harmful to long-term growth.

I am afraid that fiscal discipline has become a fading memory and more tax cuts

for the upper income have become the trend. We now have large deficits and debt

as far as the eye can see. The President’s budget includes $521 billion in deficit

spending just in 2005, a complete reversal from just 3 years ago. At least in the

1980’s, the pressures on the budget from the retirement of the baby boomers were

off in the distant future and there was time to restore fiscal discipline. This time,

however, the biggest tax cuts will be kicking in at just about the same time that

the baby boom starts retiring.

We used to get a clear signal from the Federal Reserve about the importance of

fiscal discipline and the preeminence of deficit reduction and paying down the public

debt over tax cuts as the way to stimulate investment and growth. But that signal

has gotten a little garbled in the past couple of years. I hope that in addition to

discussing his views on the economic outlook, Chairman Greenspan will spend some

time talking about how the choices we make in the coming year about taxes and

other fiscal priorities will affect that outlook.

Mr. Chairman, I look forward to your testimony.

41

PREPARED STATEMENT OF ALAN GREENSPAN

CHAIRMAN, BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM

FEBRUARY 12, 2004

Mr. Chairman and Members of the Committee, I am pleased to be here today to

present the Federal Reserve’s Monetary Policy Report to the Congress.

When I testified before this Committee in July, I reported that conditions had become a good deal more supportive of economic expansion over the previous few

months. A notable reduction in geopolitical concerns, strengthening confidence in

economic prospects, and an improvement in financial conditions boded well for

spending and production over the second half of the year. Still, convincing signs of

a sustained acceleration in activity were not yet in evidence. Since then, the picture

has brightened. The gross domestic product expanded vigorously over the second

half of 2003 while productivity surged, prices remained stable, and financial conditions improved further. Overall, the economy has made impressive gains in output

and real incomes; however, progress in creating jobs has been limited.

Looking forward, the prospects are good for sustained expansion of the U.S. economy. The household sector’s financial condition is stronger, and the business sector

has made substantial strides in bolstering balance sheets. Narrowing credit risk

spreads and a considerable rally in equity prices have reduced financing costs and

increased household wealth, which should provide substantial support for spending

by businesses and households. With short-term real interest rates close to zero,

monetary policy remains highly accommodative. And it appears that the impetus

from fiscal policy will stay expansionary, on net, through this year. These circumstances all should spur the expansion of aggregate demand in 2004. At the same

time, increases in efficiency and a significant level of underutilized resources should

help keep a lid on inflation.

In retrospect, last year appears to have marked a transition from an extended

period of subpar economic performance to one of more vigorous expansion. Once

again, household spending was the mainstay, with real personal consumption spending increasing nearly 4 percent and real outlays on residential structures rising

about 10 percent. Last year’s reductions in personal income tax rates and the advance of rebates to those households that were eligible for the expanded child tax

credit boosted the growth of real disposable personal income. The very low level of

interest rates also encouraged household spending through a variety of channels.

Automakers took advantage of low interest rates to offer attractive incentive deals,

buoying the purchase of new vehicles. The lowest home mortgage rates in decades

were a major contributor to record sales of existing residences, engendering a large

extraction of cash from home equity. A significant part of that cash supported personal consumption expenditures and home improvement. In addition, many households took out cash in the process of refinancing, often using the proceeds to substitute for higher-cost consumer debt. That refinancing also permitted some households to lower the monthly carrying costs for their homes and thus freed up funds

for other expenditures. Not least, the low mortgage rates spurred sales and starts

of new homes to very high levels.

These developments were reflected in household financing patterns. Home mortgage debt increased about 13 percent last year, while consumer credit expanded

much more slowly. Even though the ratio of overall household debt to income continued to increase, as it has for more than a half-century, the rise in home and equity

prices enabled the ratio of household net worth to disposable income to recover to

a little above its long-term average. The low level of interest rates and the large

volume of mortgage refinancing activity helped reduce households’ debt-service and

financial-obligation ratios a bit. And many measures of consumer credit quality improved over the year, with delinquency rates on consumer loans and home mortgages declining.

A strengthening in capital spending over 2003 contributed importantly to the acceleration of real output. In the first quarter of the year, business fixed investment

extended the downtrend that began in early 2001. Capital spending, however,

ramped up considerably over the final three quarters of 2003, reflecting a pickup

in expenditures for equipment and software. Outlays for high-tech equipment

showed particular vigor last year. Even spending on communications equipment,

which had been quite soft in the previous 2 years, accelerated. A growing confidence

of business executives in the durability of the expansion, strong final sales, the desire to renew capital stocks after replacements had been postponed, and favorable

financial conditions all contributed to the turnaround in equipment spending.

By contrast, expenditures on nonresidential structures continued to contract on

balance, albeit less rapidly than in 2001 and 2002. High vacancy rates for office

42

buildings and low rates of capacity utilization in manufacturing evidently limited

the demand for new structures. Inventory investment likewise failed to pick up

much momentum over the year, as managers remained cautious. Firms finished

2003 with lean inventories relative to sales, an encouraging sign for the expansion

of production going forward.

To a considerable degree, the gathering strength of capital spending reflects a

substantial improvement in the financial condition of businesses over the past few

years. Firms’ profits rose steeply during 2003 following smaller gains in the previous 2 years. The significantly stronger cashflow generated by profits and depreciation allowances was more than adequate to cover rising capital expenditures in the

aggregate. As a result, businesses had little need to borrow during 2003. For the

nonfinancial business sector as a whole, debt is estimated to have grown just 31⁄2

percent.

Firms encountered very receptive conditions in longer-term credit markets in

2003. Interest rate spreads on both investment-grade and speculative-grade bond

issues narrowed substantially over the year, as investors apparently became more

confident about the economic expansion and saw less risk of adverse shocks from

accounting and other corporate scandals. Corporate treasurers took advantage of the

attractive market conditions by issuing long-term debt to lengthen the maturities

of corporate liabilities.

As a consequence, net short-term financing was extremely weak. The stock of

business loans extended by banks and commercial paper issued by nonfinancial

firms declined more than $100 billion over the year, apparently owing to slack

demand for short-term credit rather than to a constriction in supply. Interest-rate

spreads on commercial paper, like those on corporate bonds, were quite narrow. And

although a Federal Reserve survey indicates that banks had continued to tighten

lending conditions early in the year, by the second half, terms and standards were

being eased noticeably. Moreover, responses to that survey pointed to a lack of demand for business loans until late in the year.

Partly as a result of the balance-sheet restructuring, business credit quality appears to have recuperated considerably over the past few years. Last year, the default rate on bonds fell sharply, recovery rates on defaulted issues rose, the number

of rating downgrades moderated substantially, and delinquencies on business loans

continued to decline. The improved balance sheets and strong profits of business

firms, together with attractive terms for financing in open markets and from banks,

suggest that financial conditions remain quite supportive of further gains in capital

spending in coming quarters.

The profitability of the business sector was again propelled by stunning increases

in productivity. The advance in output per hour in the nonfarm business sector

picked up to 51⁄4 percent in 2003 after unusually brisk gains in the previous 2 years.

The productivity performance of the past few years has been particularly striking

in that these increases occurred in a period of relatively sluggish output growth. The

vigorous advance in efficiency represents a notable extension of the pickup that

started around the mid-1990’s. Apparently, businesses are still reaping the benefits

of the marked acceleration in technology.

The strong gains in productivity, however, have obviated robust increases in business payrolls. To date, the expansion of employment has significantly lagged increases in output. Gross separations from employment, two-fifths of which have

been involuntary, are about what would be expected from past cyclical experience,

given the current pace of output growth. New hires and recalls from layoffs, however, are far below what historical experience indicates. To a surprising degree,

firms seem able to continue identifying and implementing new efficiencies in their

production processes and thus have found it possible so far to meet increasing

orders without stepping up hiring.

In all likelihood, employment will begin to grow more quickly before long as output continues to expand. Productivity over the past few years has probably received

a boost from the efforts of businesses to work off the stock of inefficiencies that had

accumulated in the boom years. As those opportunities to enhance efficiency become

scarcer and as managers become more confident in the durability of the expansion,

firms will surely once again add to their payrolls.

A consequence of the rapid gains in productivity and slack in our labor and product markets has been sustained downward pressure on inflation. As measured by

the chain-weighted price index for personal consumption expenditures excluding

food and energy, prices rose less than 1 percent in 2003. Given the biases in such

indexes, this performance puts measured inflation in a range consistent with price

stability—a statutory objective of the Federal Reserve and a key goal of all central

banks because it is perceived as a prerequisite for maximum sustainable economic

growth.

43

The recent performance of inflation has been especially notable in view of the substantial depreciation of the dollar in 2003. Against a broad basket of currencies of

our trading partners, the foreign exchange value of the U.S. dollar has declined

about 13 percent from its peak in early 2002. Ordinarily, currency depreciation is

accompanied by a rise in dollar prices of imported goods and services, because foreign exporters endeavor to avoid experiencing price declines in their own currencies,

which would otherwise result from the fall in the foreign exchange value of the

dollar. Reflecting the swing from dollar appreciation to dollar depreciation, the dollar prices of goods and services imported into the United States have begun to rise

after declining on balance for several years, but the turnaround to date has been

mild. Apparently, foreign exporters have been willing to absorb some of the price

decline measured in their own currencies and the consequent squeeze on profit margins it entails.

Part of exporters’ losses, however, have apparently been offset by short forward

positions against the dollar in foreign exchange markets. A marked increase in foreign exchange derivative trading, especially in dollar-euro, is consistent with significant hedging of exports to the United States and to other markets that use

currencies tied to the U.S. dollar. However, most contracts are short-term because

long-term hedging is expensive. Thus, although hedging may delay the adjustment,

it cannot eliminate the consequences of exchange rate change. Accordingly, the currency depreciation that we have experienced of late should eventually help to contain our current account deficit as foreign producers export less to the United

States. On the other side of the ledger, the current account should improve as U.S.

firms find the export market more receptive.

***

Although the prospects for the U.S. economy look quite favorable, we need to remind ourselves that all forecasts are projections into an uncertain future. The fact

that most professional forecasters perceive much the same benign short-term outlook that is our most likely expectation provides scant comfort. When the future surprises, history tells us, it often surprises us all. We must, as a consequence, remain

alert to risks that could threaten the sustainability of the expansion.

Besides the chronic concern about a sharp spike in oil or natural gas prices, a

number of risks can be identified. Of particular importance to monetary policymakers is the possibility that our stance could become improperly calibrated to

evolving economic developments. To be sure, the Federal Open Market Committee’s

current judgment is that its accommodative posture is appropriate to foster sustainable expansion of economic activity. But the evidence indicates clearly that such a

policy stance will not be compatible indefinitely with price stability and sustainable

growth; the real Federal funds rate will eventually need to rise toward a more neutral level. However, with inflation very low and substantial slack in the economy,

the Federal Reserve can be patient in removing its current policy accommodation.

In the process of assessing risk, we monitor a broad range of economic and financial indicators. Included in this group are a number of measures of liquidity and

credit creation in the economy. By most standard measures, aggregate liquidity does

not appear excessive. The monetary aggregate M2 expanded only 51⁄4 percent during

2003, somewhat less than nominal GDP, and actually contracted during the fourth

quarter. The growth of non-Federal debt, at 73⁄4 percent, was relatively brisk in

2003. However, a significant portion of that growth was associated with the record

turnover of existing homes and the high level of cash-out refinancing, which are not

expected to continue at their recent pace. A narrower measure, that of credit held

by banks, also grew only moderately in 2003. All told, our accommodative monetary

policy stance to date does not seem to have generated excessive volumes of liquidity

or credit.

That said, as we evaluate the risks to the economy, we also assess developments

in financial markets. Broad measures of equity prices rose 25 percent in 2003, and

technology stocks increased twice as quickly. The rally has extended into this year.

And as I noted previously, credit spreads on corporate bonds have narrowed considerably, particularly for speculative-grade issues. This performance of financial

markets importantly reflects investors’ response to robust earnings growth and the

repair of business balance sheets over the past few years. However, history shows

that pricing financial assets appropriately in real time can be extremely difficult

and that, even in a seemingly benign economic environment, risks remain.

The outlook for the Federal budget deficit is another critical issue for policymakers in assessing our intermediate- and long-run growth prospects and the risks

to those prospects. As you are well aware, after a brief period of unified budget

surpluses around the beginning of this decade, the Federal budget has reverted to

44

deficits. The unified deficit swelled to $375 billion in fiscal 2003 and appears to be

widening considerably further in the current fiscal year. In part, these deficits are

a result of the economic downturn and the period of slower growth that we recently

experienced, as well as the earlier decline in equity prices. The deficits also reflect

fiscal actions specifically intended to provide stimulus to the economy, a significant

step-up in spending for national security, and a tendency toward diminished restraint on discretionary spending. Of course, as economic activity continues to expand, tax revenues should strengthen and the deficit will tend to narrow, all else

being equal. But even budget projections that attempt to take such business-cycle

influences into account, such as those from the Congressional Budget Office and the

Office of Management and Budget, indicate that very sizable deficits are in prospect

in the years to come.

As I have noted before, the debate over budget priorities appears to be between

those advocating additional tax cuts and those advocating increased spending. Although some stirrings in recent weeks in the Congress and elsewhere have been directed at actions that would lower forthcoming deficits, to date no effective constituency has offered programs to balance the budget. One critical element—present in

the 1990’s but now absent—is a framework of procedural rules to help fiscal policy

makers make the difficult decisions that are required to forge a better fiscal balance.

The imbalance in the Federal budgetary situation, unless addressed soon, will

pose serious longer-term fiscal difficulties. Our demographics—especially the retirement of the baby-boom generation beginning in just a few years—mean that the

ratio of workers to retirees will fall substantially. Without corrective action, this

development will put substantial pressure on our ability in coming years to provide

even minimal Government services while maintaining entitlement benefits at their

current level, without debilitating increases in tax rates. The longer we wait before

addressing these imbalances, the more wrenching the fiscal adjustment ultimately

will be.

The fiscal issues that we face pose long-term challenges, but Federal budget deficits could cause difficulties even in the relatively near term. Long-term interest

rates reflect not only the balance between the current demand for, and current supply of, credit, but they also incorporate markets’ expectations of those balances in

the future. As a consequence, should investors become significantly more doubtful

that the Congress will take the necessary fiscal measures, an appreciable backup

in long-term interest rates is possible as prospects for outsized Federal demands on

national saving become more apparent. Such a development could constrain investment and other interest-sensitive spending and thus undermine the private capital

formation that is a key element in our economy’s growth prospects.

Addressing the Federal budget deficit is even more important in view of the wid- ening U.S. current account deficit. In 2003, the current account deficit reached $550

billion—about 5 percent of nominal Gross Domestic Product. The current account

deficit and the Federal budget deficit are related because the large Federal dissaving represented by the budget deficit, together with relatively low rates of U.S.

private saving, implies a need to attract saving from abroad to finance domestic private investment spending.

To date, the U.S. current account deficit has been financed with little difficulty.

Although the foreign exchange value of the dollar has fallen over the past year, the

decline generally has been gradual, and no material adverse side effects have been

visible in U.S. capital markets. While demands for dollar-denominated assets by foreign private investors are off their record pace of mid-2003, such investors evidently

continue to perceive the United States as an excellent place to invest, no doubt

owing, in large part, to our vibrant market system and our economy’s very strong

productivity performance. Moreover, some governments have accumulated large

amounts of dollar-denominated debt as a byproduct of resisting upward exchange

rate adjustment.

Nonetheless, given the already-substantial accumulation of dollar-denominated

debt, foreign investors, both private and official, may become less willing to absorb

ever-growing claims on U.S. residents. Taking steps to increase our national saving

through fiscal action to lower Federal budget deficits would help diminish the risks

that a further reduction in the rate of purchase of dollar assets by foreign investors

could severely crimp the business investment that is crucial for our long-term

growth.

The large current account deficits and the associated substantial trade deficits

pose another imperative—the need to maintain the degree of flexibility that has

been so prominent a force for U.S. economic stability in recent years. The greatest

current threat to that flexibility is protectionism, a danger that has become increasingly visible on today’s landscape. Over the years, protected interests have often

endeavored to stop in its tracks the process of unsettling economic change. Pitted

45

against the powerful forces of market competition, virtually all such efforts have

failed. The costs of any new protectionist initiatives, in the context of wide current

account imbalances, could significantly erode the flexibility of the global economy.

Consequently, creeping protectionism must be thwarted and reversed.

***

In summary, in recent years the U.S. economy has demonstrated considerable resilience to adversity. It has overcome significant shocks that, in the past, could have

hobbled growth for a much longer period than they have in the current cycle. As

I have noted previously, the U.S. economy has become far more flexible over the

past two decades, and associated improvements have played a key role in lessening

the effects of the recent adverse developments on our economy. Looking forward, the

odds of sustained robust growth are good, although, as always, risks remain. The

Congress can help foster sustainable expansion by taking steps to reduce Federal

budget deficits and thus contribute to national saving and by continuing to pursue

opportunities to open markets and promote trade. For our part, the Federal Reserve

intends to use its monetary tools to promote our goals of economic growth and maximum employment of our resources in an environment of effective price stability.

46

RESPONSE TO WRITTEN QUESTIONS OF SENATOR SHELBY

FROM ALAN GREENSPAN

Q.1. Chairman Greenspan, the U.S. current account deficit and the

offsetting financial holdings of foreign country residents have

sparked concerns among some economists and others. They question how long foreign country residents will sustain the deficit

by increasing their holdings of dollar-denominated assets in their

portfolios.

What factors do you believe are the most important in determining how long such capital flows can be sustained?

What do you believe is the most serious long-term cost to the

U.S. economy that arises from the current account deficit?

A.2. As noted in your question, the U.S. current account deficit is

also, by definition, a measure of the portion of U.S. net investment

in domestic plant and equipment that is financed with foreign

funds, both debt and equity. The impressive productivity performance of the U.S. economy during this period of the widening of the

U.S. current account deficit has motivated global investors (both

U.S. and foreign) to place their funds disproportionately in U.S. assets because of the expectation of higher returns, adjusted for risk,

on these relatively more productive assets.

It is difficult to predict how long global investors will continue

to place their funds disproportionately in U.S. assets. To date, the

U.S. current account deficit has been financed with little difficulty.

Although the foreign exchange value of the dollar has fallen over

the past year, the decline generally has been gradual, and no material adverse side effects have been visible in U.S. capital markets.

While demands for dollar-denominated assets by private foreign investors are off their record pace of mid-2003, such investors evidently continue to perceive the United States as an excellent place

to invest, no doubt owing, in large part, to our vibrant market system and our economy’s very strong productivity performance. In

addition, some governments have added to their official holdings of

dollar-denominated debt as a by-product of resisting upward pressure on their exchange rates.

But the current account deficit, as you state in your question, is

also a measure of the increase in the level of claims that foreigners

have on U.S. assets. As the stock of such claims grows, foreign investors, both private and official, may become less willing to absorb

ever-growing claims on U.S. residents. Taking steps to increase our

national saving through fiscal action to lower Federal budget deficits would help diminish the risks that a reduction in the rate of

purchase of dollar assets by foreign investors could severely crimp

the business investment that is crucial for our long-term growth.

The U.S. economy is best served by following policies that provide the basis for maximum long-term growth with stable prices in

an environment characterized by private, flexible markets. Probably the most serious long-term costs that could arise from the U.S.

current account deficit would come if we followed policies aimed at

reducing this deficit that are inconsistent with our fundamental

policy objectives, in particular, protectionist trade policies that

interfere with the degree of flexibility that has been so positive a

force for U.S. economic performance in recent years. Over the

years, protected interests have often endeavored to stop in its

47

tracks the process of unsettling economic change. Pitted against

the powerful forces of market competition, virtually all such efforts

are counterproductive and have failed. Creeping protectionism

must be thwarted and reversed.

Q.2. Chairman Greenspan, in your speech before the Dallas World

Affairs Council last December, you noted that, even if China’s currency were allowed to float freely and consequently rose against

the dollar, that U.S. employment rates would be unlikely to rise on

account of a shift away from China toward increased imports from

other, low-cost manufacturing countries.

In your speech, you also referred to the potential difficulties the

Chinese banking system would have in the event the currency peg

were precipitously removed.

Could you expand on how instability in China’s financial markets

and banking system caused by the removal of the currency peg

would adversely affect the United States?

What reforms does the Chinese government need to undertake

before removal of the peg is possible? Are they moving in that direction?

A.2. The condition of the Chinese banking system is currently quite

weak. Chinese banks officially reported having bad debts that

amounted to 15 percent of their loans, but market analysts estimate that the true level of nonperforming loans among Chinese

banks is in the range of 40 to 50 percent of all loans. Even the officially reported figure suggests that the banking system’s liabilities

may exceed the value of its assets. Banking systems can operate

in such a weakened state only if depositors, perhaps because they

are content with an implicit government guarantee on bank liabilities, leave their money in their banks. Many in China fear that

removal of capital controls that restrict the ability of domestic investors to invest abroad and to sell or to purchase foreign currency—which is a necessary step to allow a currency to float freely—could cause an outflow of deposits from Chinese banks, destabilizing the system.

U.S. residents do not have substantial claims on Chinese banks,

but financial instability in a major emerging market economy such

as China would present a risk to the global economic outlook.

The Chinese government needs to take a number of steps—some

of which are already underway—to strengthen its banking system.

It needs to strengthen accounting and bank supervisory systems, in

order to assess accurately the size of the problem. Problem loans

that are uncovered will need to be reserved against, and this will

likely require government capital injections (because the alternative is losses for bank depositors and a possible loss of confidence

in the banking system). More important, however, are steps that

eliminate state interference in bank lending decisions and that create the financial discipline and incentives that are a crucial part

of a viable credit system. Banks need to improve their lending decisions, internal controls, and risk management systems. Before this

will happen, bank managers need to be given the training, incentives, and authority to evaluate credit risk and to make loans based

on those evaluations, as well as the authority to take steps to cut

48

costs. In addition, bankruptcy laws and foreclosure policies need to

be strengthened.

As mentioned, the Chinese government seems to be moving to

strengthen the banking system. For example, they have recently

imposed more stringent accounting rules on nonperforming loans.

In addition, several of the largest state-owned banks recently received capital injections from the government, and some reports

suggest that the authorities are encouraging the banks to modernize their operations.

Q.3. Many of our trading partners are concerned about the decline

in the relative value of the dollar and that decline’s implications for

economies dependent upon exports to the American market. For

the past year, the euro has been consistently stronger than the dollar. Yet, our trade deficit with Western Europe for 2003 exceeded

that for 2002. Much has been made of the growth in American exports during the final quarter of 2003, but the trade balance hasn’t

changed because of the continued high level of imports.

If the rise of the euro against the dollar hasn’t resulted in the

kind of shift in trade balance we might have anticipated, what does

this tell us about conventional beliefs regarding the relationship

between exchange rates and trade?

A.3. Trade balances are determined mainly by countries’ relative

incomes, by relative prices, including exchange rates, and by comparative advantage. These determinants are inherently multilateral; the movement of the dollar vs. the euro not only influences

our trade with Western Europe but also influences both U.S. and

European trade with third countries, such as those in Asia. Some

adjustment in our multilateral trade balance has begun to take

place; our trade and current account deficits have narrowed as a

share of GDP during 2003, after widening steadily since 1997, even

though the U.S. economy continues to expand at a faster rate than

our trading partners.

Some analysts might have expected the deficit to narrow more

rapidly, although such adjustment most often occurs over 2 to 3

years. Ordinarily, currency depreciation is accompanied by a rise in

dollar prices of imported goods and services, because foreign exporters endeavor to avoid experiencing price declines in their own

currencies, which would otherwise result from the fall in the foreign exchange value of the dollar. Reflecting the swing from dollar

appreciation to dollar depreciation, the dollar prices of goods and

services imported by the United States have begun to rise after declining on balance for several years, but the turnaround to date has

been mild. Apparently, to date, foreign exporters have been willing

to absorb much of the price decline measured in their own currencies and the consequent squeeze on profit margins it entails.

The currency depreciation that we have experienced of late

should eventually help to contain our current account deficit as foreigners export less to the United States. On the other side of the

ledger, the current account should improve as U.S. firms find the

export market more receptive.

Q.4. In your written testimony to the Committee last year, you

noted that the fiscal year 2002 budget deficit would have been $40

billion smaller if entitlement benefits and individual income tax

49

brackets had been inflated using the chain weighted CPI rather

than the existing cost of living adjustment.

Do you still feel that the cost of living adjustment underlying

OMB and CBO’s budget projections overstates inflation? If so, how

much do you think Congress could have saved had we used the

chain weighted CPI?

A.4. Although the Bureau of Labor Statistics has made significant

changes and very materially improved the cost of living indexes

currently used to adjust taxes and spending, I believe that these

indexes still overstate inflation. One major issue is substitution

bias, which the BLS’s new chain weighted CPI index largely corrects. The other major issue that remains is the incomplete adjustment of quality change in the existing cost of living indexes; it may

be quantitatively more important than the substitution bias.

If, over the past decade, the chain weighted CPI had been used

instead of the current official indexes, the cumulative unified budget deficit and the level of Federal debt would have been reduced

about $200 billion. About 40 percent of these savings are attributable to reductions in indexed spending programs and the remaining 60 percent are attributable to higher taxes (including debt service).

RESPONSE TO WRITTEN QUESTIONS OF SENATOR SCHUMER

FROM ALAN GREENSPAN

Q.1. The President has stated that his tax cuts are leading to job

creation. As I look at the data, that does not seem to be the case.

The record of job creation under his leadership is much worse than

we have ever seen in any past recession/recovery cycle since WWII.

It is startling to me that this recession was shorter than many

but, in fact, has taken much, much longer than any other post-war

period to create jobs. And we still have 716,000 fewer jobs 26

months after the official end of the recession than we had when the

‘‘recovery’’ began. What few jobs have been created are low end

service jobs—restaurant work, temporary work, etc.—not the jobs

that we continue to lose to this day that contribute to an expanding

middle class.

Given that past recoveries—following much steeper recessions—

have been so much stronger than under this President is there any

evidence that his policies have made things better than they otherwise would have been?

Mr. Chairman, do you believe that the President’s tax cut policies have created any net jobs to date in this country?

A.1. As I have stated publicly before, there can be little doubt that

the tax cuts of 2001 and 2003 helped shore up a weak economy,

raising the level of economic activity and employment above what

it otherwise would have been. Of course, quantifying the exact

magnitude of that effect is extremely difficult because of the many

other events that have affected the economy during the past 3

years, among them the terrorist attacks of September 11, 2001, the

corporate governance scandals, and the war with Iraq. Moreover, it

would appear that a larger share of the boost to output was

achieved through productivity gains than typically has occurred in

previous instances of expansionary fiscal policy, with a concomitant

damping influence on employment.

50

Q.2. There has been a great deal of credit for the positives and negatives in the economy given to productivity. However, I believe the

data shows that productivity has also, in fact, been quite high in

past periods. So while I agree with those who argue that productivity is a factor, productivity alone does not seem to fully explain

what is happening in today’s economy.

Specifically, according to the Bureau of Labor Statistics, looking

at the last 10 recessions, jobs hit their low point around the end

of the recession and never more than 3 months after the recession

ended. But this time the low point in jobs came in August 2003—

21 months after the last recession ended.

In the last 10 recessions, there was a complete recovery in the

number of jobs within 2 years after the end of the recession. But

this time the recession has been over for 26 months and we still

have 2.3 million fewer payroll jobs than when the recession started.

It is true that over the last 8 years, from 1996–2003, productivity

growth has averaged 2.9 percent. And during the preceding 20

years, 1974–1995, productivity growth was much lower, averaging

only 1.5 percent growth per year. But during the period 1948–1973,

productivity growth was much stronger, stronger even than what

we have experienced since 1995, averaging 3.3 percent growth per

year.

Yet, as above, the recessions during the previous high productivity growth period were not marked by the continual job losses

and jobless recovery that we are in the midst of today. During

those recession and recoveries, jobs returned quickly.

In fact, the two times that the unemployment rate was below 4.0

percent were during the high productivity periods of the late 1990’s

and the late 1960’s.

So, again, productivity alone does not appear to be the answer.

We have been a highly productive economy for a long time. And in

fact, our economic team should have factored in strong productivity

in our stimulus—high productivity cannot be used as an excuse for

the failure to produce jobs.

Mr. Chairman, do you agree with the data above? What factors

other than productivity should we be considering to explain the differences between this ‘‘recovery’’ and past recoveries?

A.2. The explanations for the surge in productivity over the past

2 years are wide-ranging. One hypothesis is that some of the increase represents a temporary rise in the level of productivity,

reflecting a view that an unusual amount of caution is leading

businesses to press workers and facilities to a greater degree than

can be sustained over the longer haul. By this hypothesis, as that

caution dissipates, employment growth will pick up and the level

of output per hour will drop back.

Another hypothesis is that the level of productivity has undergone a one-time permanent upward shift. This hypothesis builds on

the idea that the heavy emphasis on exploiting new and expanding

markets in the second half of the 1990’s may have diverted management attention from the hard work of controlling costs. The extent to which businesses have succeeded in boosting output with

less labor over the past 2 years or so points up the possibility that

a considerable stock of inefficiencies accumulated in the boom years

and that this stock is still being worked off.

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Finally, yet another hypothesis stresses a more-lasting increase

in the growth of output per hour. This notion focuses on the considerable lag between the introduction of new technologies and their

full integration into production processes and business practices. To

reap the full benefits of technological innovation takes much learning time, especially if there are large synergies through network

effects.

Of course, given the exceptionally high rate of growth in output

per hour recently, some combination of short-term and longer-term

productivity-enhancing forces seems likely to have been at work. In

any event, one consequence of these improvements in efficiency has

been a temporary ability of many businesses to meet increases in

demand without expanding payrolls. Over longer periods of time,

however, productivity should not raise the unemployment rate.

And, I am confident that the same will be true going forward.

Q.3. Mr. Chairman, what is news is that we are now having high

productivity but only meager wage growth. How do you explain

that productivity is going up but wages are almost flat—why aren’t

Americans getting paid for their higher output? Have workers suddenly become worse negotiators on their own behalf for better

wages or is there another factor at work, and if so what is it?

A.3. Employee remuneration has not been flat. During 2003,

wages, as measured by the Bureau of Labor Statistics (BLS) employment cost index, rose 3 percent for workers in private industry;

the hourly compensation, which includes employee benefits, rose 4

percent. An alternative measure of employee remuneration—compensation per hour from the BLS data on productivity and on

costs—increased 3.6 percent during 2003 for workers in the private

nonfarm business sector.

More generally, over the long sweep of time real hourly compensation and productivity tend to track each other. This tendency

is reflected in one of the most well-documented empirical regularities of macroeconomics: The long-run relative stability of the

compensation share of national income. Although the compensation

share of income fluctuates over the course of the business cycle—

typically rising in the latter part of expansion and initial phase of

contraction and then falling during the early part of expansions—

the share shows no distinct trend. It averaged around 61 percent

during the 1950’s and 1960’s and has averaged around 65 percent

since then. This indicates that over time both labor and capital

share the fruits of productivity growth.

Q.4. Mr. Chairman, given our world of free trade and mobile factors of production, some argue that the extraordinary productivity

of the U.S. worker will save the day by keeping good jobs here and

wages high. But the facts to date do not support that case. While

labor productivity is, in fact high, wages have been stagnant and

job growth is far behind schedule. Yet corporate profits are near

records.

In the past, U.S. workers’ productivity was a result of good education and training coupled with the ability to work with the best

equipment and technology.

Given your comments on the strong educational systems in East

Asia, do you agree that it is possible that, armed with United

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States technology, management, and capital, and trained by United

States workers, a Chinese or Indian professional can be just as productive as his or her United States counterpart, but at a fraction

of the cost? Or do you think that one United States worker based

in Rochester, for example, can compete with 4 or 6 or even 10

workers available for the same price in Bangalore?

A.4. As you note in your question, concerns have been expressed

about an increasing number of better paying white collar jobs that

have been lost to foreign outsourcing. There is a sense of unease

that this development potentially will have significant adverse long

run implications for unemployment and the standard of living of

the average American. It is instructive to put the current developments in historical context. Jobs in the United States were perceived as migrating to low-wage Japan in the 1950’s and 1960’s, to

low-wage Mexico in the 1990’s, and most recently to low-wage

China. Japan, of course, is no longer characterized by a low-wage

workforce, and many in Mexico are now complaining of job losses

to low-wage China. That said, however, over the long sweep of

time, the United States has not experienced a net drain of jobs to

other nations. For more than half a century, the unemployment

rate has averaged less than 6 percent with no evident trend, and

the real earnings of the average worker have continued to rise. History clearly shows that our economy is best served by a full and

vigorous engagement in the global economy.

Q.5. Mr. Chairman, I have heard a case made that the President’s

policies have hindered job creation in two ways.

First, some executives tell me there is little confidence in the

President’s fiscal management. People fear the economy could be

driven into a double-dip recession triggered by a currency crisis in

turn driven by a crisis in confidence by foreign purchasers of our

debt and other factors. Deficits and debt are the direct result of the

high spending we have seen under this Administration.

Second, I have been told the major factor weighing on the economy last year was not, in fact, September 11 as some argue, it was

the decision to go to war with Iraq. That process introduced an

enormous amount of uncertainty into the economy which slowed

the natural recovery we were in.

Can you comment on these two points? Are there grounds for

pointing out that the President’s fiscal policies and war policies

may have, in fact, slowed down the recovery? Is it reasonable to

conclude that his policies are holding back the natural recovery

cycle that we have seen in every previous recovery except this one?

A.5. As I have indicated above, several hypotheses have been put

forward to explain the unusual performance of the labor market recently; but the available evidence to date does not provide sufficient guidance on their relative importance.

Q.6. Chairman Greenspan, do you think it is time for a ‘‘budget

summit’’ where we bring in leaders from both parties and we put

everything on the table—tax cuts, spending programs—not just one

side or another. The goal would be to come up with a plan in the

best interests of the country.

I recall you were part of such an effort related to Social Security

two decades ago. Would you support a bi-partisan budget summit?

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A.6. A decision of whether to have a ‘‘budget summit’’ is, of course,

entirely up to the President and the Members of Congress. Nevertheless, the Nation faces enormous fiscal challenges in the coming

years that must be dealt with. As I noted in my testimony before

the House Budget Committee on February 25, 2004, the resolution

of this situation will require difficult choices. One important first

step would be the restoration of the budget enforcement mechanisms. None of the options for resolving the challenge will be easy,

as they all will involve lowering claims on resources or raising financial obligations. It falls on the Congress and the President to

determine how best to address the competing claims. But history

has shown that, when faced with major challenges, the Congress

has risen to the occasion.

Q.7. The papers are reporting that economists at the Fed are ‘‘puzzled’’ by the labor market. It does not square with past recoveries,

as the data shows. I know you believe productivity is a key factor

in that difference. But, as you know, we have had strong productivity in the past, and the labor market recovered more strongly

and quickly than now.

My question is whether you think there could be something else

going on, reflected in the ability of companies to so easily source

cheap and very skilled labor offshore—either by moving plants

overseas or by virtually importing that labor via the Internet?

Could we, in fact, be seeing lots of new jobs being created, just

not here in the United States? Is this new offshoring phenomenon

something worth spending more time on? Could it partially explain

the strange quality of this recovery? Could it explain this strange

disconnect where profits and productivity are up but wages are flat

and jobs are down?

A.7. As I indicated above, over the long sweep of time, the United

States has not experienced a net drain of jobs to other nations. For

more than half a century, the unemployment rate has averaged

less than 6 percent with no evident trend. Moreover, real earnings

of the average worker have continued to rise. Over the past century, per capita real income has risen at an average rate of more

than 2 percent per year, declining notably only during the Great

Depression of the 1930’s and immediately following World War II.

Incomes trended higher whether international outsourcing was

large or small. The reason for this positive long run trend in living

standards appears to be that more fundamental economic forces determine real incomes, irrespective of the specific jobs in which they

are earned and irrespective of the proportion of domestic consumption met by imports.

Q.8. Some have argued that ‘‘protectionist’’ trade policies have a

long history of failure. However, as I have reviewed the recent

studies, that statement appears to be incorrect and contrary to our

own history of development. In short, the United States had a history of protecting what some call ‘‘infant industries’’ as did Britain—until we had captured enough scale that we were ready to

open them up to global competition.

In fact, according to some recent works, protectionist policies

were the case for much of our history and much of Britain’s history

and that protection, according to some, helped to create great naVerDate 11-MAY-2000 11:46 Jun 21, 2004 Jkt 000000 PO 00000 Frm 00057 Fmt 6602 Sfmt 6602 94291.TXT GEOW PsN: GEOW
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1For example, see O’Rourke (2000).

2See Irwin (2002b).

tional wealth. I am referring to data presented in a recent World

Bank Paper and a book called, ‘‘Kicking Away the Ladder,’’ by HaJoon Chang. In other words, the stories of the success of free trade

policies do not square with the historical data. Is the analysis presented in Professor Chang’s book incorrect? If it is, where is it

flawed? And if it is not factually incorrect, could the United States

be guilty of advocating trade policies to the current developing

world different than we ourselves followed in our own developing

years? Advocating a double standard, so to speak.

How do you reconcile the data presented in his book—and other

studies—that show a heavy use of tariffs during our most productive and highest growth years with those who argue that our history shows that tariffs do not work?

Given that Professor Chang and others provide strong data and

specific cases where protectionism has led to economic success for

different industries, can you help provide comparable historical examples—not theory but real history—and comparable data where

protectionism has failed?

A.8. Professor Ha-Joon Chang’s book provides an interesting description of the history of government policies, institutions, and

economic growth in a range of countries. As Professor Chang points

out, history provides important lessons for current policy decisions.

However, Professor Chang’s work does not prove that protectionism enhances growth, for two main reasons. First, although there

have been historical periods during which protectionism and robust

economic growth have occurred simultaneously, such a contemporaneous occurrence does not necessarily imply causality. In other

words, just because some countries have had high tariffs and, at

the same time, have experienced strong economic growth does not

mean that the high tariffs caused the high growth. Second, as Professor Chang himself points out, a wide range of policies support

economic development, so that even his own analysis does not demonstrate that protectionism in and of itself leads to high growth. In

fact, in a number of the cases highlighted by Professor Chang, supportive policies (such as infrastructure development and support of

an educational system) other than protectionism affected growth.

Research has found a positive correlation between tariffs and

growth in the late 19th Century.1 However, a number of studies,

that is, Irwin (2002b), show that simultaneous occurrence of protectionism and growth does not necessarily imply that tariffs promote

growth. In some cases, tariffs were put in place to raise revenue

rather than to protect domestic industry from foreign competition.2

In addition, history provides a number of examples in which inward-looking development policies actually hindered growth. First,

consider the case of Latin America, where some countries followed

development strategies incorporating ‘‘import-substituting industrialization,’’ beginning in the 1930’s. Taylor (1998) argues that

these inward-looking development strategies hindered growth. Taylor (1994) examines the specific case of Argentina, which followed

such an inward-looking import substitution policy. Import restrictions from the 1930’s to the 1950’s led to an increase in the price

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3Taylor (1994), p. 14.

4For example, see Irwin (2002a), Irwin (1998), p. 151, and Crucini and Kahn (1996).

of imported capital goods, thereby dampening incentives for investment. He notes that, ‘‘With this quantitative support, the argument

that Argentina’s retreat into import-substitution policies cost her

dearly in terms of slow growth remains as cogent as ever.’’ 3

India also provides an example in which inward-looking protectionist policies were associated with adverse effects on growth.

Bhagwati (1993) claims that India’s overall inward-looking policies

through the 1970’s (and, to a lesser extent, in the 1980’s) adversely

affected private-sector efficiency and contributed to poor performance in terms of export activity, industrialization, and growth.

Srinivasan and Tendulkar (2003) also discuss the adverse effects of

inward-oriented policies during periods of India’s recent history.

Finally, our own country’s history provides an example of the adverse effects of protectionism. The notorious Smoot-Hawley tariff of

1930 likely contributed to at least some extent to the subsequent

deterioration in U.S. trade flows and economic performance.4

More broadly, a number of studies have found a positive relationship between economic openness and growth, including Dollar and

Kraay (2001) and Edwards (1998).

Thus, Professor Chang’s analysis does not show that protectionism spurs growth. In fact, other evidence indicates that, to the

contrary, inward-looking policies may well impede growth. In addition, his analysis does not clearly distinguish between the effects

of protectionism and the effects of pro-growth policies such as infrastructure development and support of a strong educational system.

It could even be argued that because of these other supportive policies some countries experienced growth despite their protectionist

policies.

References

Bhagwati, Jagdish. (1993) India in Transition: Freeing the Economy. Oxford, England: Clarendon Press.

Chang, Ha-Joon. (2002a) Kicking Away the Ladder: Development

Strategy in Historical Perspective. London: Anthem Press.

Chang, Ha-Joon. (2002b) ‘‘Kicking Away the Ladder: ‘Good Policies’

and ‘Good Institutions’ in Historical Perspective,’’ in Papers from

the First Inequality and Pro-Poor Growth Conference, Topic:

Globalization and Inequality, Washington, DC, June 18, 2002,

available at http://www.worldbank.org/research/inequality/

0618RTPapers.htm.

Crucini, Mario J. and Kahn, James. (1996) ‘‘Tariffs and Aggregate

Economic Activity: Lessons from the Great Depression.’’ Journal

of Monetary Economics. 38(3) (December): 427–467.

Dollar, David and Kraay, Aart. (2001) ‘‘Trade, Growth, and Poverty.’’ Manuscript. Edwards, Sebastian. (1998) ‘‘Openness, Productivity, and Growth: What Do We Really Know? The Economic

Journal. 108(447) (March): 383–398.

Irwin, Douglas. (1998) ‘‘The Smoot-Hawley Tariff: A Quantitative

Assessment.’’ The Review of Economics and Statistics. 80(2)

(May): 326–334.

56

Irwin, Douglas. (2002a) Free Trade Under Fire. Princeton, NJ:

Princeton University Press.

Irwin, Douglas. (2002b) ‘‘Interpreting the Tariff-Growth Correlation

of the Late Nineteenth Century.’’ American Economic Review.

92(2) (May): 165–169.

O’Rourke, Kevin. (2000) ‘‘Tariffs and Growth in the Late 19th Century.’’ The Economic Journal. 110 (April): 456–483.

Srinivasan, T.N. and Tendulkar, Suresh D. (2003) Reintegrating

India with the World Economy. Washington, DC: Institute for

International Economics.

Taylor, Alan M. (1994) ‘‘Three Phases of Argentine Economic

Growth.’’ National Bureau of Economic Research Working Paper

Series on Historical Factors in Long Run Growth.’’ Historical

Paper No. 60. (October). Cambridge, MA: National Bureau of

Economic Research.

Taylor, Alan M. (1998) ‘‘On the Costs of Inward-Looking Development: Price Distortions, Growth, and Divergence in Latin America.’’ The Journal of Economic History. 58(l) (March): 1–28.

Q.9. I agree with your comments on the importance of education

to our national competitiveness and strength. However, that is, realistically, a long-term fix and the job losses are happening each

day. What do we do in the near term to reduce the human toll of

lost jobs to competition from lower wage, skilled offshore labor? As

you said, the problems may not lie with the workers but on our

educational system, how do we make sure they do not pay too severe a price for a systemic failure?

A.9. As I have indicated, we need to increase our efforts to ensure

that as many of our citizens as possible have the opportunity to

capture the benefits that flow from free and open trade. One critical element is to provide ongoing training and education to displaced workers. As you point out, retraining and upgrading skills

take time. Over the shorter term, as I noted in my appearance on

March 11 before the House Committee on Education and the Workforce, a continuation of unemployment insurance benefits deserves

consideration. Moreover, trade adjustment assistance and other income support programs are available to ease the adjustment faced

by some workers.

RESPONSE TO WRITTEN QUESTION OF SENATOR CORZINE

FROM ALAN GREENSPAN

Q.1. With regard to the top 10 countries holding our national debt.

I have a particular curiosity about the Caribbean banking centers

and what its implications are with respect to our concern about

funding of all kinds of miscellaneous problems that could potentially exist. I would love to hear an analysis of what is driving the

fourth highest concentration of our debt being held by Caribbean

banking centers.

A.1. According to the most recently published estimates, as of endDecember 2003, entities located in Caribbean banking centers held

$69 billion in U.S. Treasury securities, making them the fourth

largest holder of U.S. Treasury securities—behind the holdings of

Japan ($545 billion), China ($149 billion), and the United Kingdom

($113 billion), and ahead of Hong Kong ($58 billion). Securities reVerDate 11-MAY-2000 11:46 Jun 21, 2004 Jkt 000000 PO 00000 Frm 00060 Fmt 6602 Sfmt 6602 94291.TXT GEOW PsN: GEOW
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porting systems worldwide, including that of the United States,

have well-known and significant shortcomings in accurately attributing ultimate beneficial ownership of cross-border liabilities.

These shortcomings are especially severe vis-a`-vis financial centers

with large custodial operations and tax havens where conduit investment vehicles are established. Thus, a significant portion of the

Treasuries attributed to the Caribbean are undoubtedly held for

the benefit of residents elsewhere. Although the custodial issue

present in reporting against other financial centers is likely less

severe in the case of the Caribbean, the prevalence of conduit vehicles there significantly obscures ultimate beneficial ownership.

An examination of reports filed with U.S. regulators indicates

that between $7 billion and $18 billion of the Treasuries attributed

to the Caribbean are held directly on the balance sheets of banks

within the Federal Reserve/FFIEC reporting systems. As such, the

direct holders of these securities are familiar to U.S. regulators.

Moreover, because the United States ‘‘Know Your Customer’’ (KYC)

requirements extend to the consolidated entity, those people or entities who hold the claims that form the counterpart liabilities to

these Treasury holdings are subject to the KYC screening. The remaining Treasuries are likely held at banks managed and controlled by non-U.S. residents or other investment vehicles, such as

hedge funds.

The reporting requirements of hedge fund managers/advisors can

be extensive, although they vary considerably with the size and the

nature of the investment. However, the reporting requirements are

almost exclusively related to positions in equities, futures, and options on futures and are generally at the level of the manager/advisor, which can aggregate investments for both domestic and foreign

funds. Thus, the current reporting by hedge funds sheds little light

on the geographic attribution of their Treasury positions.

Of late, Treasury holdings in the Caribbean have not been growing as rapidly as those attributed to most of the other top holders.

Between March 2003 and December 2003, Treasuries attributed to

the Caribbean increased $7.6 billion (12 percent), compared with

increases of $146 billion (36 percent) for Japan, $16 billion (12 percent) for China, $30 billion (36 percent) for the United Kingdom,

and $8 billion (17 percent) for Hong Kong. The increase in Caribbean holdings is similar to that registered by Switzerland (the

tenth largest holder and another prominent financial center) which

increased its holdings of Treasuries $4.2 billion (12 percent) over

the period.

According to the Financial Stability Forum’s ‘‘Report of the

Working Group on Offshore Centres,’’ offshore financial centers

(OFC’s) are used by a variety of firms and individuals for a variety

of reasons, some legitimate and benign, some not. In particular, the

report states that OFC’s are used by:

• International companies, to maximise profits in low tax regimes.

• International companies, to issue securitised products through

special purpose vehicles.

• Individuals and companies, to protect assets from potential

claimants.

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• Investors (individuals, investment funds, trusts, etc.), to

minimise income and withholding taxes and to avoid disclosing

investment positions. • Financial institutions with affiliates in OFC’s, to minimise income and withholding tax and to avoid regulatory requirements

in the ‘‘onshore’’ jurisdictions in which they operate. • Financial institutions, to assist customers in minimising income

and withholding tax. • Insurance companies, to accumulate reserves in low tax jurisdictions and to conduct business in responsive regulatory environments. • Criminals and others, to launder proceeds from crime through

banking systems without appropriate checks on the sources of

such funds and to use local secrecy legislation as a means of protection against enquiries from law enforcement and supervisory

authorities (including foreign authorities), and/or to commit financial fraud.

Some of these activities also happen in other jurisdictions and

the fact that they take place does not necessarily mean that the

OFC authorities approve of such practices (for example, money

laundering, financial fraud). (Financial Stability Forum, ‘‘Report of

the Working Group on Offshore Centres,’’ April 5, 2000, p. 10.)

RESPONSE TO WRITTEN QUESTIONS OF SENATOR HAGEL

FROM ALAN GREENSPAN

Q.1. Could you discuss how the U.S. labor pool will be impacted by

the increasing retirement of the baby boomers? What initiatives

should policymakers be considering to address this issue?

A.1. The baby-boom generation has had a large effect on the labor

force. The growth rate of the labor force was boosted considerably

when the baby boomers began working, and the growth rate is

likely to fall considerably as they retire. Over the next 30 years,

the growth rate of the working-age population in the United States

is projected to fall from about 1 percent per year today to about 1⁄2

percent per year in 2030. One upshot of this slowdown in labor

force growth is that the ratio of working age to total population will

decrease. Increases in life expectancy, while undeniably desirable,

also decrease the ratio of working age to total population. By 2030,

the ratio of working age to total population is projected to be about

6 percent below the level it is today.

In its simplest terms, economic output is determined by the size

of the labor force multiplied by the productivity of that labor. As

the ratio of workers to population declines, then holding all else

constant, per capita output will fall. Of course, everything else may

not be constant. For example, as life expectancy and health status

continue to improve, and as the demand for labor increases, older

workers may choose to delay retirement. Increased work effort by

older workers could have a significant impact on the labor force;

however, the experience to date suggests that, despite the increasing feasibility of work, Americans have not delayed retirement. Indeed, there has been a long-term trend toward earlier and earlier

retirement. While some analysts believe this trend has slowed, few

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ment age for Social Security from 65 to 67 that will be fully phased

in by 2027. Nonetheless, the potential for increased work effort by

the elderly should not be discounted, particularly if policies to encourage such behavior are enacted.

The rate of productivity growth also may be affected by the slowdown in labor force growth. While still quite uncertain, some

research has suggested that by increasing the incentives for laborsaving technologies, an aging workforce may actually spur technological development. Although it is unclear what direct effect policy

can or should have on technological innovation, it is clear that

maintaining the flexibility of our labor and capital markets is key

to our ability to translate improved technology into greater economic output.

Q.2. In addition, does your research suggest that foreigners improve our ability to fund the health and retirement benefits of baby

boomers?

A.2. Immigration is another potential source of labor growth. The

official population projections assume that the current level of immigration will continue indefinitely, and on net, immigration represents about half of the growth of the labor force projected for the

United States. Fully offsetting the effects of demographic change on

elderly dependency by increasing immigration would require a

much larger change in immigration than is currently anticipated.

But as the influx of foreign workers in response to the tight labor

markets of the 1990’s showed, immigration does respond to labor

shortages. The assumption under the intermediate projections of

the Social Security actuaries—that immigration will decline somewhat from today’s level—may prove to be overly conservative.

Q.3. What level of concern do you have for the long-term effects on

the Nation’s economy due to the trillions of dollars of underfunded

obligations that we face? How is the rest of the world perceiving

this risk?

A.3. The aging of the population in the United States will have significant effects on our fiscal situation and our economy. In particular, it makes our pay-as-you-go Social Security and Medicare

programs, as currently constituted, unsustainable in the long run.

The effects on the economy will depend, in large part, on how long

we wait before we make changes to our retirement programs. As

I noted in my February testimony, the budget scenarios considered

by the CBO in its December assessment of the long-term budget

outlook offer a sobering illustration of the potential effects on the

economy of not reforming Social Security and Medicare in anticipation of the baby boomers’ retirement. These scenarios suggest that,

under a range of reasonably plausible assumptions, we could be in

a situation in the decades ahead in which rapid increases in the

unified budget deficit set in motion an unsustainable dynamic in

which large deficits result in ever-growing interest payments leading to ever-growing deficits in future years.

Q.4. Is it not true that the global trend with all industrial countries, including China, has been a loss of manufacturing jobs in

large part due to advancements in productivity and improvements

in information technology and communications?

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A.4. For the industrial economies and many emerging market

economies, manufacturing employment as a share of total employment has been trending down for decades. A primary factor behind

this downward trend has been improvement in productivity supported, in part, by advancements in technology and communication.

Such gains underlie advances in living standards everywhere.

In terms of the number of manufacturing jobs, however, the pattern is less clear. In Canada, Italy, and Mexico, for example, the

number of manufacturing jobs has remained fairly stable or risen

over the past one to two decades. The experience of other countries

is more varied. In the United Kingdom and in Germany after reunification, manufacturing employment has fallen relatively continuously. In Japan, manufacturing employment rose through the

early 1990’s but has dropped off sharply subsequently. Manufacturing employment in China rose through the mid-1990’s but has

since declined, in part reflecting government efforts to reform stateowned enterprises. For the United States, the number of manufacturing jobs generally hovered between 20 and 21 million from 1980

to 2000. It has only been in the most recent downturn that the

number of U.S. manufacturing jobs has fallen significantly below

20 million.

Q.5. The Argentine debt default, the largest sovereign default in

history, caused billions in losses for United States financial institutions, not to mention the losses throughout Canada and Europe.

How will this influence emerging market investments and risk selection among banks in the future?

A.5. Argentina is still in the process of restructuring its debt so the

final extent of creditor losses has yet to be determined. It seems

clear, however, that the Argentine debt default will invoke significant losses on the holders of Argentine sovereign debt. In addition,

foreign financial institutions operating in Argentina, including several United States banks, sustained losses as a result of the actions

the Argentine government took toward the financial system in the

wake of the default.

To date, other than cutting off capital flows to Argentina, the Argentine default appears to have had little lasting effect on overall

performance in the market for emerging market sovereign debt.

However, foreign direct investment flows to Latin America have

been weaker recently. The events in Argentina appear to have reminded lenders and investors of the potential risks of investing in

emerging markets.

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