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The U.S. economy may be in the middle of one of the longest recoveries ever, but Alan Greenspan tells Barron’s that the economy doesn’t look so great—and could well get worse.

The challenges that Greenspan sees are familiar ones, such as the ballooning deficit and the rising costs of entitlement programs like Social Security and Medicare. But the former Federal Reserve chairman says there’s an urgency in tackling these problems as inflation looms, populism spreads, and China’s economic might increases.

Greenspan, now 92, presided over a period of economic prosperity from 1987 to 2006 that earned him rock-star-like devotion by investors, politicians, and even other central bankers; they hung on his often-inscrutable comments about the economy and monetary policy. The financial crisis, however, cast a more critical light on Greenspan’s tenure of low interest rates and his faith in the market’s ability to self-regulate.

Now, a decade later, Greenspan has co-authored Capitalism in America with Adrian Wooldridge, an editor at the Economist. The new book traces U.S. economic history since colonial times to see what has helped the U.S. stand apart, and shed light on why its leadership is in jeopardy today.

The co-authors argue that key to the country’s economic success has been a knack for enabling and tolerating “creative destruction”—a trait facilitated by an entrepreneurial spirit fueled by a country of immigrants and a Constitution that called for limiting federal government reach. But today, the markers of this creative destruction are headed the wrong way: Geographic and social mobility are becoming harder, the rate of new-company creation is the lowest since the 1980s, and consolidation has led to competition falling in three-quarters of major economic sectors.

Greenspan, who is famous for his mastery of data, offers one statistic that sums up the problem today: productivity growth—or more specifically, the lack of it. Barron’s met with Greenspan in his Washington, D.C., office for a wide-ranging talk that covered the increasing threat from anemic productivity growth; the crisis that investors should be watching for; what Karl Marx got right; and why Sweden may hold the answer to making America’s economy great again.

Barron’s: Given the challenges to the U.S. economy you lay out in your book, is the Trump administration’s target of 3% economic growth sustainable?

Greenspan: Noooo.

What is a more realistic growth rate?

I don’t want to put a number to that. But each $1 in entitlement spending crowds out $1 in savings. And gross domestic savings is what historically has gone to finance domestic investments [such as infrastructure like roads and bridges, and private-sector capital spending on things like plants and equipment]—hence, productivity growth.

Has domestic savings declined or entitlement spending increased significantly?

Savings as a percentage of GDP has declined steadily since 1965. This had been mirrored by steadily rising entitlement spending over the same period. Neither are necessarily accelerating, but are becoming ever-larger drags on the fiscal budget and private investment. We used to have fairly substantial productivity growth, over 2% annualized. We are now at 1% for the most recent five-year period. Entitlements are slowing the rate of productivity growth, and that is a critical factor suppressing GDP growth. Entitlements are mandated, and their volume is largely unrelated to overall economic activity. Add that to our borrowing from everyone who will lend us a nickel, and it has put us into a serious straitjacket.

In your book, you note that the number of Americans ages 65 and older will increase by 30 million, while working-age Americans will increase by only 14 million, creating a “fiscal challenge” bigger than any America has faced.

The 2018 report of the Old-Age & Survivors Insurance and Federal Disability Trust Funds [from the Social Security Administration] shows that despite the fact that everyone says we are funding this stuff, the actuaries are saying you have to cut benefits by 25% for [the Trust] to be actuarially sound. It’s such a big news item, they put it on page 296. It’s politically incorrect to talk about it. We’ve run out of money on many occasions [the cost of benefits outstripped tax collection in the 1980s and again in 2010]. Did we cut the benefit? No. We increased expenditures in some form or another and funded it out of general revenue, which contributes to a higher deficit and, by extension, a higher federal debt.

You also say in your book that 90% of social insurance goes to people over the age of 65. You have been in Washington, D.C., for decades; you know that no one has been able to tackle entitlements. What is feasible now, given the political backdrop?

Clearly, entitlements are going to rise further as the population ages. There has never been an inclination to cut the benefit. It’s impossible to get around it, and we are seeing the effects of that [with productivity growth].

Can anemic productivity growth spark a crisis?

[Nods yes]. What it causes is populism. As productivity slows down, GDP slows down and everyone is dissatisfied. It’s not just the U.S. that has a problem: About half of the major economies had annualized productivity growth of 1% or less over the past five years, as measured by output per employee. These are all fundamentally disastrous numbers.

How will this manifest?

The first [discontent] surfaced with Brexit. Nobody even remotely was discussing the issue of disengaging from the European Union until, all of a sudden, GDP slowed down. That’s also what’s happening here. Brazil is the same thing, also Peru and Argentina. The standard procedure is you get a political structure that is populist. And populism by definition is an irrational philosophy, not like capitalism, communism, or socialism, which are structured conceptual ways of looking at world. Karl Marx’s Das Kapital is actually a very thoughtful book. His conclusion that human nature is going to change is a fundamental mistake because it never does, but the premise of his argument was workable.

Populism has contributed to escalating trade tensions with China. How does a trade war affect the economy?

[Tariffs] are exactly the same as an excise tax. If you think you are going to raise the excise taxes in your country to beat the country over here—the people trying to ship into you—you are shooting yourself in the foot. [President Donald] Trump would say that if China loses more than we do, that we won. Well, good luck. Tell that to your taxpayers. There are no winners in a trade war.

As you look out across the landscape, where do you see crisis brewing?

Crises gets generated after a period of time when you disregard [something]. Most recently, we’ve disregarded the federal budget. We are going to have a $1 trillion deficit in the next fiscal year, and there is no screaming and yelling. The reason? There’s this idea that [the deficit] doesn’t affect my pocketbook. You have to wait until the consequences of the deficit emerge.

When do the consequences show up?

No politician gets out on the stump and says to constituents, “Our budget deficit is X trillion dollars.” One person in 100 knows what he is talking about. But when inflation goes up to 4%, to 5%, it is politically disastrous. That’s when it becomes an issue. But when it starts rising, it’s already too late in the game to stabilize it.

What happens then?

We are working toward stagflation as characterized by a weaker economy and inflation. During the 1980s, we had an obvious occurrence of that. The Federal Reserve can put a clamp on it as [then Federal Reserve Chairman Paul] Volcker did. It lasted for two to three years, and it brought it to a halt. I don’t think it will be terribly different [this time.]

You talk a lot about inflation, but it’s not showing up in many of the go-to metrics.

Right. It’s latent.

Because the data are not picking up changes in the economy?

The Bureau of Labor Statistics has some very clever statisticians who are acutely familiar that their published [data] overstate inflation by under a percentage point. We know because of the way data are collected. When a new product comes on the scene at high prices and then drops, BLS doesn’t pick it up until it has fallen some, so they are missing the deflationary pressures in the measure. Therefore, it is biased upward.

There’s a lot of concern about the unwinding of quantitative easing, especially as emerging markets struggle with weakening currencies. Should the Federal Reserve take that into consideration, as you did in the late 1990s?

I don’t discuss what the Fed does.

What’s the ramification of the end of QE?

Interest rates are going up.

What does this all mean for the markets and bonds?

I’ve been saying for a while we have a bond market bubble—and we still have one. It’s the nature of a bubble that it continues to inflate with nothing happening. That’s the problem.

Investors often look to bonds for safety. Should they no longer think that?

People believe there are people on Mars.

That’s not too comforting. In the book, you talk about the fragility of the financial system and the danger from financial innovation that increase risk. There is a push to unwind some of the measures taken after the financial crisis. What do you think of this?

The risk in the banking system would be more efficiently reduced through higher capital reserve requirements—I recommend 20% to 30%—than by regulations [like Dodd-Frank].

Given the challenges facing the U.S. economy, what’s your recipe for making America’s economy great again?

Take a look at what Sweden did in the late 1990s. They were way ahead of us in terms of being behind the curve. And since it’s a socialist state, they were also [in worse shape] than us. They finally ran into a huge crisis; mortgage rates went to 500% for a short period, and the whole system was coming apart at the seams. A new government came in, and Sweden revamped its whole system from a defined-benefits program to a defined-contribution program, like a 401(k), which by definition is self-financing. Now, Sweden has a productivity growth rate of 1.3% annualized over the past five years—not great, but better [than many other countries.] We need to change the structure of all the various social programs that have a trust fund to them and go to a defined contribution rather than defined benefit.

Does our system need to come apart at the seams for action?

Of course! That’s what the danger is. You don’t see these crises arising until it’s at your doorstep.

Sweden is a tiny country with a very different political system. How can its changes work here?

If you want to argue that Sweden can act faster than we can, I have no idea if that will be the case because Sweden behaves in a somewhat more rational way than we do most of the time. But that is a valid concern. Truth of matter is that the numbers will be whatever they are. Remember how I told you about the actuaries saying Social Security needed a 25% cut? The way they publicly handle the benefit calculation currently is that they say the trust fund won’t run out for another X years—as though that is saying it’s terrific! It ain’t. The reason the true actuarial balance isn’t demonstrated is because it’s politically incorrect to do so. But they are basically saying, “We don’t have the capability of maintaining the defined-benefit system.”

That may get people’s attention. What’s one of the things that surprised you in the research of the book?

Only in retrospect did I see the significance of the invention of the cotton gin. There was upland cotton and Sea Island cotton, which was the premier cotton fiber. It was a long-staple cotton and only produced along the coast. [Upland cotton could be grown in the South.] It was just one 15th of an inch and was harder to harvest; it would get tangled up with itself when you tried to get the seeds out of the cotton. What the cotton gin did was find a way to get seeds out of the cotton, creating an explosion of short-staple cotton capability. To profit, you needed more slaves. Jefferson had signed a bill that curtailed the transportation of slaves across the ocean, and the Brits abolished slavery in 1834. We were on that road of eliminating slavery until short-staple cotton. It could have meant no Civil War. There are a lot of small items that change the state of affairs.

That anecdote is in a chapter titled “The Two Americas.” It refers to the North and South, but that’s a phrase used a lot today to describe the current polarization. Are there lessons we can learn from that period in history?

We never learn. The biases of human nature pop out in the other direction.

Thanks, Alan.

This article was originally published on Oct. 16, 2018.