U.S. Federal Reserve Board chairman Alan Greenspan spoke yesterday about the state of the US economy, issuing harsh warnings on the menacing budget deficits.

Greenspan is optimistic about the economy growth rate that is advancing at “a reasonably good pace."
The dollar’s situation that appears most worrisome to most analysts has received mixed guidance from the reputable Fed boss. On the one hand, he is saying that he sees “very little evidence" foreign central banks are planning to get rid of the U.S. dollar, calling the readjustments in the composition of the bank’s currency reserves "technical moves backwards and forwards."

It remains to be guessed whether Greenspan is indeed quiet about the possible impact of a drop in demand for dollar-denominated assets, or he is consciously downplaying the situation trying to ward off the possibility of the plunge that would drag the dollar down, ruining the support for the US deficit that comes to a great degree from Asian central banks. Greenspan did not voice any concern about the possible spike in interest rates if case foreign banks began massive sales of US Treasuries that are now accumulated in their reserves, a statement that is consistent with Greenspan’s recent “no-worry” style.

The deficit was central to Greenspan’s speech. The Fed boss for the first time called the widening gap in the nation’s budget “unsustainable”. He was tough on the Congress insisting that "the consequences for the U.S. economy of doing nothing could be severe."

"You cannot continuously introduce legislation which tends to expand budget deficits because down the road the impact of an ever-rising deficit, especially as a percent of GDP, creates some significant weakness in the structure of the economy," he said.

More seriously, Fed’s Chairman does not contemplate an easy way to managing the threatening gap. Tax cuts in his opinion are not going to remedy the situation as cuts in the size necessary to bring spending in line with revenues would be dangerous for economic growth. Fed chairman has always been known for his preference for cuts in budget expenditures rather than tax increases.

Greenspan offered support for President Bush’s controversial plan to overhaul Social Security and actually backed the creation of private accounts, saying: “We may have already committed more physical resources to the baby-boom generation in its retirement years than our economy has the capacity to deliver." Changes in the system, in his words, are to be made “"sooner rather than later". The plan has raised concerns because of the proposal to cut benefits for current workers for the sake of diverting a portion of their incomes into private retirement accounts invested in a wide array of stocks, thus exposing retirees’ savings to equity market swings. Greenspan backed Bush’s project on the grounds that a rise in retirements may further aggravate the fiscal deficit unless fast changes are implemented.

The impact of Greenspan’s speech has yet to be fully absorbed by the markets. The Fed chief’s claims about the unsustainable nature of the fiscal deficit are certainly boding ill for the dollar. However, the deficit was not altered by these statements, and the proclamation of the strict warnings is another push for the Congress and the Republican administration to reconsider their approach to the US fiscal policy.