In his congressional testimony today, Alan Greenspan said it was impossible to ascertain the effect on interest rates and national savings that will result from the increased budget deficits asociated with privitizing Social Security accounts. His position appears to be based on his assertion that it is impossible to gauge how much long term bond prices are discounted by the more than $10 trillion in unfunded federal liabilities. Without such firm knowledge, he argues, the impact on interest rates of replacing contingent liabilities with actual debt is therefore unknown. Give me a break.

It seems obvious to me that the existence of tens of trillions of dollars of unfunded liabilities have been completely ignored by the bond market. After all, considering that these obligations are so large that they will surely render the U.S. government isolvent, the market obviously either ignores them completely, or has assumed that they will be repudiated. In addition, since the Federal Government itself neglects to include any of these unfunded liabilities in its own calculation of the national debt, why should Greenspan assume the bond market does?

Greenspan’s claim that increasing the deficit to fund private social security accounts will not adversely affect national savings is absurd on its face (unless you assume that all of the money placed in such accounts is invested in government bonds, and that there are no administrative or management fees associated with such accounts). However, as the administration assumes that the majority of this money will be invested in the stock market, national savings could in fact decline dramatically.

Regardless of how the nature of the government’s liabilities change, one thing is certain, un-funded liabilities do not have to be serviced with current interest payments, while funded ones do. Therefore, any transition from contingent to funded debt will immediately increase the net interest expense of the Federal Government. Considering that the funded portion of the national debt is financed with short-term paper, at an average maturity of about 2-3 years, and given that short-term interest rates are likely to rise considerably over time, and that the money needed to make higher interest payments must itself be borrowed, it should be clear that the increased Federal borrowing necessitated by privitazation will put upward pressure on interest rates, and reduce national savings.

Finally, on an unrelated but equally incredulous note, Greenspan also commented that while he knows that one day America’s large external debts will create a problem, he cannot figure out what that problem may be. Perhaps the Chairman would like to give me a call, and I will happily clue him in.