Alan Greenspan's Testimony Before The Senate

Following is transcript of Fed Chairman Alan Greenspan's testimony today before the Senate Banking Committee and keys in on Social Security issues.

SEN. SHELBY: (Sounds gavel.) The committee will come to order. We're very pleased this morning to welcome again Chairman Greenspan before the Banking Committee to testify on the Federal Reserve's Semiannual Monetary Policy Report to the Congress.

Chairman Greenspan, at its meeting early this month, the Federal Open Market Committee, FOMC, raised its target for the federal funds rate by 25 basis points to 2.5 percent, the sixth increase since June of 2004, when the FOMC began raising the target rate from a low of 1 percent. The FOMC has been consistent in noting that its policy is one of accommodation and that changing the accommodative stance will be done in a measured fashion.

The U.S. economy, I believe, has responded well in turn with a continuing expansion. Real GDP increased 3.1 percent in the fourth quarter of 2004. We can now also point to a strong job growth with payroll employment increasing at an average of 181,000 jobs per month in 2004. On the unemployment front, the unemployment rate decreased to 5.2 percent in January, falling half a percentage point from the previous January.

This morning we will have ample opportunity to discuss in greater detail the Federal Reserve's performance in carrying out monetary policies and its views on the future direction of our nation's economy. I look forward to raising a number of issues during our discussion.

Mr. Chairman, again, we're pleased to have you with us, and we look forward to discussing with you the necessary action we must take to ensure that our economy grows and prospers in the coming years.

Senator Sarbanes.

SEN. PAUL SARBANES (D-MD): Thank you very much, Chairman Shelby. I'm pleased to join with you in welcoming Chairman Greenspan before the Committee on Banking, Housing and Urban Affairs this morning to testify on the Federal Reserve's Semiannual Report to Congress on Monetary Policy.

Chairman Greenspan's testimony on the Fed's monetary policy report is always widely anticipated by the Congress, the press, the financial markets and the public, as witness of the large crowd in this room this morning. In addition, I believe this is Chairman Greenspan's first testimony this year before any committee of Congress, so I suspect that that heightens the expectation.

The Federal Reserve Act requires the Board of Governors to submit a report to Congress by February 20th and July 20th of each year on the conduct of monetary policy. It also requires the chairman of the Federal Reserve to testify before the Congress on both of those reports.

Chairman Shelby, I'd like at the outset to take note of a decision announced by Federal Reserve's Open Market Committee on December 14th to expedite the release of the minutes of the FOMC meetings. Beginning with the December 14th meeting, the minutes of regularly scheduled meetings will be released three weeks after the date of the policy decision, as I understand it. The previous policy was to release minutes of the FOMC meeting after the next FOMC meeting, usually a period of six weeks or more. This move is consistent with previous actions by the Open Market Committee to announce its policy decisions immediately after its meetings to provide some explanation of the basis for the decision in the announcement.

In my view, greater transparency in the FOMC's decision-making process is of great benefit both to the operations of the market and to the public. This is an effort which Chairman Greenspan has led during his tenure, and I think it constitutes an important legacy at the Federal Reserve. And, Chairman Greenspan, I commend you and your colleagues for this most recent step.

But, Chairman Shelby, I listened to your review of the economy, and it just -- it all goes to show it's whether the glass is half-full or half-empty and how you perceive it because I actually have concerns about the --

SEN. SHELBY: We're trying to fill it up. (Laughs.)

SEN. SARBANES: -- yeah -- (chuckles) -- the outlook for the U.S. economy, and therefore about the -- our monetary policy, and I want to raise those just briefly this morning.

As you noted, the Fed Open Market Committee raised the federal funds rate another quarter of a point at its last meeting. This was the sixth consecutive quarter-point increase by the FOMC in less than eight months. It's now gone from 1 (percent) to two-and-a-half percent. It seems to me that while the Open Market Committee feels that this -- apparently feels that this pace can be continued, I think there's some cause -- concern.

The GDP growth in the fourth quarter actually slowed to 3.1 percent, well below the rate most experts consider our potential growth rate.

In my view, the labor market remains relatively weak. Employers added 146,000 payroll jobs in January, 157,000 in December, 137,000 in November, all of which are just about enough to keep pace with population growth.

Now while the Labor Department reported last week that the unemployment rate dropped in January to 5.2 percent, from 5.4 percent in December, it was mostly because of a decline in the number of people looking for work. In fact, most of the decline in the unemployment rate over the last year occurred because of a decline in the share of people looking for work, not because of a higher share with jobs.

Capacity utilization in our nation's factories remains at low levels. In fact, figures were released this morning that capacity utilization fell to 79 percent. December's level had been reported at 79.2 percent but had been revised downward by a tenth of a point.

Wages are rising more slowly than inflation. The economy is still in the situation of three-quarters of a million fewer private- sector jobs than existed when President Bush took office over four years ago.

Over 20 percent of those who are unemployed are long-term unemployed. In other words, they've been unemployed for more than 26 weeks. This has been continuous now for the last 28 months, that more than 20 percent of the unemployed are long-term unemployed, which sets a record.

The Fed said, in a statement, "Inflation and longer-term inflation expectations remain well contained." Given this, it seems to me that the Fed should consider now taking a pause from its policy of interest rate increases to see how the economy develops in the first part of this year.

Some expect that economic growth will slow. And given that, it seems to me worth considering -- and I commend it to the chairman -- the possibility of pausing to survey where we are and assuring ourselves that the economy is indeed strengthening and can withstand continuing to raise interest rates.

And I look forward to pursuing that with the chairman in the course of his appearance here this morning.

Thank you very much, Mr. Chairman.

SEN. SHELBY: Thank you, Senator Sarbanes.

Senator Bunning.

SEN. JIM BUNNING (R-KY): Thank you, Mr. Chairman.

I appreciate you coming, Chairman Greenspan, for your second to last Federal Reserve semiannual monetary report.

While some may not believe this, I really do appreciate you coming up here. I'm sure coming up here is like going to the dentist for you, and I'm probably the dentist. (Laughter.) Your testimony is very important before this committee, and we have a lot of people waiting with bated breath to hear your thoughts about the state of our economy. I hope I'll be happy and the people whose lives can be directly affected by your comments are happy when this hearing concludes.

I, like most of the people in this room, will be paying particularly close attention to any insight you may give us about whether the FMOC will continue its current tack of measured accommodation of monetary policy. Of course, that is the $64,000 question, and I'm sure you will do your best not to give us a hint of what the FMOC will do at its next meeting.

Once again, I will be asking about the persistence and presence of inflation in our economy, same question I ask you every time you come before us to give your report. If you don't see any evidence of inflation, I would hope you'd take that into account in a big way during the next FMOC meeting. You don't have to raise rates just because many expect it. Low interest rates are not necessarily a bad thing.

I'll take this opportunity to bring up one other pet peeve of mine, and I do it a lot. You will be asked a number of questions over the next two days that have nothing to do with your job. I know every time you come here you're asked every question under the sun. Just remember, you don't have to answer those questions. You don't have to testify on subjects that are really not part of the Fed jurisdiction. We will try to suck you in, but please don't succumb.

Once again, thank you, Chairman Greenspan, for coming before us today. I look forward to your response during the question and answer period.

Thank you.

SEN. SHELBY: Senator Reed.

SEN. JACK REED (D-RI): Thank you very much, Mr. Chairman. And welcome, Chairman Greenspan.

Four years ago we found ourselves at a crossroads and the administration choose a path that's led from record surpluses to record deficits, both in our fiscal accounts and our current accounts, our trade balance overseas, and much of that is being financed now by foreign central banks.

And we have the opportunity and, I would suspect, the obligation to try to change that course.

The Congressional Budget Office has estimated that the federal budget deficit for fiscal year 2005 will be $368 billion. That doesn't include an $80 billion supplemental for Iraq and more than likely another $50 billion supplemental next year, given the troop sizes we'll have in Iraq. It doesn't include costs of Social Security privatization, whatever they may be, and doesn't include other operations. We've got record deficits, stemming primarily from the tax cuts and from the steadily increasing spending for needed defense and homeland security measures.

Another aspect of the president's budget for 2006 is the cutting of numerous entitlement and domestic discretionary programs without effectively reining in the deficit, and many of these programs go to the heart of building human capital, the education system and other systems that will, I think, over time help increase our productivity. So we're dangerously underfunding those programs.

And once again there are major issues left out: the war in Iraq, Alternative Minimum Tax reform, $1.6 trillion in extension of expiring tax cuts, and associated debt service. So this is a rather bleak picture of fiscal discipline.

You have reminded us already, Mr. Chairman, back in February 2002, that to the extent that we would be owing debt to other sovereign governments, in that respect there is a difficulty. We have a serious difficulty at the moment. You also stated in April 2002, talking about current account deficits, countries that have gone down this path have invariably run into trouble and so would we. Eventually the current account deficit will have to be restrained. And no one is anticipating any restraint at the moment.

Now, given this context for important decisions, we are facing critical choices about extending on a permanent basis expiring tax cuts for wealthy Americans. We're also, according to the president's proposal for security -- Social Security, rather, contemplating borrowing trillions of dollars to create private accounts. I'm deeply concerned about the direction the president's taking in terms of our nation's commitment to providing retirement security to the elderly, and income security to the disabled, widows and surviving families. Many people don't recognize that 30 percent, about, of the recipients of Social Security are not the elderly; they are disabled or widows or surviving families.

We all acknowledge that the long-term fiscal imbalance of the Social Security trust fund must be addressed. However, it's equally critical to recognize that the concept of private accounts being advanced by the president does absolutely nothing to address this imbalance. In fact, deferring payroll tax revenues exacerbates insolvency and accelerates the date of trust fund imbalance.

Now more than ever, Social Security occupies a critical role in ensuring this retirement security, especially at a time when our country is saving so little and fewer employers are offering the security of defined benefit pension plans. Defined benefit pension plans comprised 61 percent of all pension plans in 1980. By 2001, that number had dropped to 25 percent. And this trend is only further exacerbated by the solvency issues faced by the Pension Benefit Guarantee Corporation, which has been absorbing more failed employer- sponsored defined benefit plans.

So Mr. Chairman, we have a serious set of issues before us, and as always, we look forward to your response to these issues.

Thank you very much, Mr. Chairman.

SEN. SHELBY: Senator Crapo.

SEN. MIKE CRAPO (R-ID): Thank you very much, Mr. Chairman.

And Chairman Greenspan, we welcome you here again.

I'm not going to give a long opening statement. I'm going to listen very closely to your comments. We are very interested in your discussion with us about the status and the prospects of the U.S. economy. And whether it's the issue of tax policy or derivatives -- as you know, is a very critical issue to me -- or Social Security or our entitlement spending, I think that the issues that we are prepared to go into with you today are those on which you can provide us some very significant insight. I look forward to it.

Thank you for coming.

SEN. SHELBY: Senator Schumer.

SEN. CHARLES SCHUMER (D-NY): Well, thank you very much, Mr. Chairman.

And I, too, want to welcome my friend and someone who's been just a superlative chairman of the Federal Reserve Board. He has a reputation, deserved, as a straight shooter and somebody who is really brilliant on monetary policy, economic policy. And that's why, when he comes here, we all want to ask him a whole lot of questions, because we respect his judgment.

So my view, Mr. Chairman, is that if we left things to you -- and I think the way you have handled monetary policy in the last few years has been excellent. I think the steps where the market has certainty and knows exactly what you're doing is a very good idea, provided the economy continues to move along at this pace. Senator Sarbanes mentioned that it may not, and then of course it would have to be reexamined.

But on the other -- down the road, on Pennsylvania Avenue, we tend to mess things up, and I am truly worried about the debt and particularly the added debt that Social Security could create in terms of the privatization of accounts. I think they are ideologically driven, frankly. I don't they are -- they fall within the rubric of fixing Social Security; of, as I would call it, mend it, not end it. I think, rather, there are a group of people who want to prove that every government program doesn't work, and therefore they've come up with so-called privatization.

That's what they want to do, is privatize. Now they don't want to call it that because the public doesn't like it, but I think the name has stuck. You know, the junk-bond dealers tried to change the name of junk bonds for years and they're still referred to as junk bonds ten years later. I know they want them to call them high-yield bonds, but these personal accounts, there's privatization and private accounts and they're going to stick.

My view -- how -- you have been a strong voice for restraining our fiscal policies. We've disagreed on some of the tax cuts, but you've always talked about PAYGO and you talked as early as 2001, I believe it was -- it may have been 2000 -- of creating a glide path which reduces the debt to as close to zero as possible. We had that under the Clinton years. We've lost it in the Bush years. My one criticism of your non-monetary aspects of your policy is that you'd speak out strongly, but I will be very interested in your views of privatization and whether the so-called gain of privatization -- having Joe and Jane Smith be able to manage a little bit of their own money in some kind of account -- is equal to the huge amount of debt that it would throw on the shoulders of our already burdened government. We're giving a birth tax to every child born in America now of about $15,000. If we do all the things Senator Reid mentioned, that birth tax will double to $30,000, and I don't think that's good for the newborns, I don't think it's good for the economy. And I'm interested in your views and hope you will give us a straightforward answer about the effects of privatization on debt.

Thank you, Mr. Chairman.

SEN. SHELBY: Senator Dole.

SEN. ELIZABETH DOLE (R-NC): Thank you, Mr. Chairman.

Welcome, Chairman Greenspan.

Two weeks ago, when the Federal Open Market Committee raised its target for the federal funds rate and the discount rate by 25 basis points, the release noted "robust underlying growth in productivity, a gradually improving labor market and moderate growth in output."

All of these, coupled with low inflation, appear to indicate a positive track for economic expansion in the coming years.

While these trends certainly are pleasing, I continue to be concerned about the slower pace of job creation. As you well know, the state of North Carolina has experienced dramatic losses in manufacturing employment. While the whole economy trends positively, we continue to focus special attention on those who lost their jobs due to the inability of their companies to compete with foreign firms that operate with dramatically lower cost structures. We must equip our nation's poorest citizens with the necessary tools to take advantage of new jobs created by the expanding economy.

To this end, I continue to make strengthening our community colleges a top priority. I've spoken before about the work that Senators Enzi, Alexander and I undertook last year. In addition to the president's $125 million proposal to establish a new community college access grant program, our bill provides increased assistance to our community colleges and other institutions of higher learning for training and retraining of students in high-growth job markets. I look forward to working again on this legislation with my colleagues in this session of Congress.

I also remain concerned about high energy prices, the rise in steel prices and the size of our trade deficit. In December, leaders in the city of Charlotte, North Carolina, and I were shocked to discover that the contract for the South Corridor Light Rail construction came in at $30 million over estimates due to the increases in steel and concrete prices. It was explained that this dramatic rise in price was caused by China's growing demand for steel and concrete.

Despite these concerns, though, I'm confident that through increased trade, hard work, global communications and continuing education of our workforce, we will achieve new levels of opportunity and global security for all Americans. And I look forward to hearing from you on these and other matters, Chairman Greenspan.

Thank you for joining us today.

SEN. SHELBY: Senator Stabenow.

SEN. DEBBIE STABENOW (D-MI): Thank you, Mr. Chairman. Thank you, Mr. Chairman.

And welcome, Mr. Chairman. It's wonderful to see you again. And I was to join my colleagues in thanking you for your leadership and service over the last 16 years. We truly have appreciated and relied on your judgments and your thoughts.

And I've appreciated also the opportunity to talk with you, both privately in my office as well as on other occasions, about what we are facing in terms of out-of-control deficits. I know you have warned us since I was in the House of Representatives. And by the way, I was very proud of the fact, coming into the U.S. House in 1997, that we balanced the budget for the first time in 30 years. We unfortunately now have gone from the largest surpluses in the history of the country, projected in 2001, to the largest deficits, and that is deeply, deeply disturbing.

And I am very interested in your current thinking as it relates to our economic environment with the deficit and the sustainability of that, and in fact, the ethic and responsibility that we all have to address that. I view that as a major moral issue.

The president would have us believe that Social Security in 13 years is going bankrupt even though we know that it's not accurate. We do know that there is a gap 40 or 50 years down the road, and I'm confident that working with my colleagues that we will address that. But what we are hearing from the president is that his suggestion as a way to fix it is to hoist an additional $5 trillion of national debt on American families over the next 20 years. And he calls it an ownership society. I would argue that what every man, woman, child will own is an additional $17,000 in debt on top of what we already have as a birth tax right now of $15,000. Every time a child is born that is our gift to them in terms of the current national debt.

So I'm extremely concerned about where we are going and the sustainability of that. Right now it will require decades for this debt to be fully offset, and the projected savings being talked about in terms of the savings and the growth that -- and the market growth in terms of privatization of Social Security ironically is the same growth that would take care of the Social Security gap if in fact it materialized. And so I would be interested in your thoughts about that as well.

I'm very interested in your discussion in terms of the national debt, our chronic deficit, and also what has been raised by my colleagues as a troubling trade deficits, which are exploding, and particularly when we look at China and what is happening in terms of our inability to enforce trade laws and to address the trade imbalances that we have that are causing great havoc in my home state with manufacturers and others that are asking us for a level playing field so they can keep and create more jobs.

So I thank you, Mr. Chairman.

SEN. SHELBY: Senator Bennett.

SEN. ROBERT F. BENNETT (R-UT): Thank you, Mr. Chairman. I'm going to resist the urge to continue the debate that probably should take place on the floor and during morning business. I think perhaps the opening statements are not the place to do that. So I will simply pass and look forward to Chairman Greenspan's testimony.

SEN. SHELBY: Senator Bayh.

SEN. EVAN BAYH (D-IN): Thank you, Chairman Shelby.

I was interested in Senator Bunning's dentist analogy, and not wanting to apply anesthetic to the patient, I will take a pass on my own remarks, Mr. Chairman. I look forward to your comments about the critical issues that face us, and thank you for joining us today.

SEN. SHELBY: Senator Martinez.

SEN. MEL MARTINEZ (R-FL): Mr. Chairman, thank you very much.

And Mr. Chairman, thank you for coming this morning. It's great to see you, and I look forward to your remarks as well.

I'm going to include my statement as part of the record.

I do recall that we worked together on issues in my prior role, and I look forward to any comments you might make that would give encouragement to the housing market in America. I think that in spite of what any might say, of all committees in this Senate, this committee ought to be particularly keen on ownership, private investment, homeownership opportunities -- all of which I think are seeing tremendous record successes in recent days. And so I would look forward to hearing your comments, particularly with an eye towards those issues that might have an impact on my home state of Florida, as well as something I care deeply about, which is homeownership, mortgage rates, and things of that nature.

So thank you, Mr. Chairman, for coming this morning.

SEN. SHELBY: Senator Dodd.

SEN. CHRISTOPHER DODD (D-CT): Thank you, Mr. Chairman.

And I'll join my colleagues in welcoming you, Mr. Chairman. It's a pleasure to have you before this committee again. In the words of Morris Udall, everything has been said, but not everyone has said it here this morning. So let me just associate my remarks briefly with those of Senator Reed, Senator Schumer, Senator Stabenow. I know you're here to talk about monetary policy, but, obviously, because of the high regard in which we hold you and the tremendous respect we have for your knowledge about broader economic issues, while the subject matter is of monetary policy, obviously these other issues are of keen interest to all of us here.

And I can recall only four years ago talking about -- having hearings about the dangers of too steep a glide path on retiring the national debt. It sounds difficult to believe that only four years ago we had that hearing to talk about those issues.

SEN. SARBANES: I remember it as though it was yesterday. (Laughter.)

SEN. DODD: Do you remember it? (Laughs.) But here we are in a very different situation, obviously, with estimates now -- we've had to raise the debt ceiling twice in the last three years in excess of $8 trillion. This is -- and I'm worried as well about the amount of resources of -- amount of this debt being held offshore. And I know you've talked about that in the past, but the numbers seem to be going up. And the concern I see with some of these countries purchasing assets, not dollar-denominated assets, but looking more to the euro and whether or not we ought to be worried about that as a country.

And so I'll be looking forward to your comments on these matters that have been raised by others. And thank you again for your service.

And, Mr. Chairman, I ask consent that a full statement be included in the record.

SEN. SHELBY: Without objection, it will be included in the record.

Senator Corzine.

SEN. JON CORZINE (D-NJ): Thank you, Mr. Chairman.

And I join my colleagues in welcoming Chairman Greenspan, and I truly want to congratulate him and thank him for his service.

That said, we all have questions that many have already been -- most have already been talked about -- the twin deficits. And I'm anxious to hear your remarks and how and whether you believe we can have a smooth adjustment to dealing with them, particularly the trade deficit, which is shockingly large, at least from my perspective.

There are also some issues, though, that haven't been mentioned, which I'm personally quite concerned about. We've had a stagnation of real wages in the country, at least in the last several years; slow absolute growth; and what I believe will ultimately be a real problem for the country, a growing concentration of wealth and income disparity as revealed by statistics; and the share of population that's actually working is declining. There are a number of issues that deal with the health of our labor force, and I think ultimately our broader economy, that sometimes get pushed off of the discussion for good and proper reasons with regard to some of the major issues that we debate every day -- trade and fiscal deficits and, God willing, some discussion on rational reform of Social Security. So I hope that we can not forget about that these underlying economic conditions have real impact on people's lives, and the income disparities are growing in this country.

And I'm certainly anxious to hear the chairman's both views and suggestions on what maybe we need to do to try to at least moderate some of those trends.

I have a full statement for the record.

SEN. SHELBY: Your statement will be made part of the record in its entirety, without objection, Senator Corzine.

Chairman Greenspan, you proceed as you wish. Welcome, again, to the committee.

MR. GREENSPAN: Thank you very much.

Mr. Chairman and members of the committee, I'm, as always, pleased to be here today to present --

SEN. SHELBY: Mr. Chairman, could you bring the mike just a little closer to you? Because we've got a huge audience here.

MR. GREENSPAN: I'm, as usual -- despite the fact that there is a DDS sign in front of the committee, I nonetheless feel it's a privilege to be here, as always, because I do find this an extraordinarily interesting discussion vehicle. And I trust that many of the issues will get clarified, or if not that at least the level of discussion will get heated sufficiently to engage us in considerable discussion, which I have a suspicion it may well.

In the seven months since I last testified before this committee, the U.S. economic expansion has firmed, overall inflation has subsided, and core inflation has remained low. Over the first half of 2004, the available information increasingly suggested that the economic expansion was becoming less fragile and that the risk of undesirable decline in inflation had greatly diminished. Toward midyear, the Federal Reserve came to the judgment that the extraordinary degree of policy accommodation that had been in place since the middle of 2003 was no longer warranted and, in the announcement released at the conclusion of our May meeting, signaled that a firming of policy was likely. The Federal Open Market Committee began to raise the federal funds rate at its June meeting, and the announcement following that meeting indicated the need for further, albeit gradual, withdrawal of monetary policy stimulus.

Around the same time, incoming data suggested a lull in activity as the economy absorbed the impact of higher energy prices. Much as had been expected, this soft patch proved to be short-lived. Accordingly, the Federal Reserve has followed the June policy move with similar actions at each meeting since then, including our most recent meeting earlier this month. The cumulative removal of policy accommodation to date has significantly raised measures of the real federal funds rate, but by most measure -- most measures -- it remains fairly low.

The evidence broadly supports the view that economic fundamentals have steadied. Consumer spending has been well maintained over recent months, buoyed by continued growth in disposable personal income, gains in net worth, and accommodative conditions in credit markets. Households have recorded a modest improvement in their financial position over this period, to the betterment of many indicators of credit quality.

The sizable gains in consumer spending of recent years have been accompanied by a drop in the personal savings rate to an average of only 1 percent over 2004, a very low figure relative to the nearly 7 percent rate averaged over the previous three decades. Among the factors contributing to the strength of spending and the decline in saving have been developments in housing markets and home finance that have spurred rising household wealth and allowed greater access to that wealth.

The rapid rise in home prices over the past several years has provided households with considerable capital gains.

Moreover, a significant increase in the rate of single-family home turnover has meant that many consumers have been able to realize gains from the sale of their homes. To be sure, such capital gains, largely realized through an increase in mortgage debt on the home, do not increase the pool of national savings available to finance new capital investment. But from the perspective of an individual household, cash realized from capital gains has the same spending power as cash from any other source.

More broadly, rising home prices, along with higher equity prices, have outpaced the rise in household -- largely mortgage -- debt and have pushed up household net worth to about five and a half times disposable income by the end of last year. Although the ratio of net worth to income is well below the peak attained in 1999, it remains above the long-term historical average. These gains in net worth help to explain why households in the aggregate do not appear uncomfortable with their financial position, even though their reported personal saving rate is negligible.

For their part, business executives apparently have become somewhat more optimistic in recent months. Capital spending and corporate borrowing have firmed noticeably, but some of the latter may have been directed to finance the recent backup in inventories. Mergers and acquisitions, though, have clearly perked up.

Even in the current much improved environment, however, some caution among business executives remains. Although capital investment has been advancing at a reasonably good pace, it has nonetheless lagged the exceptional rise in profits and internal cash flow. This is most unusual; it took a deep recession to produce the last such configuration in 1975. The lingering caution evident in capital spending decisions has also been manifest in less aggressive hiring by businesses. In contrast to the typical pattern early in previous business-cycle recoveries, firms have appeared reluctant to take on new workers and have remained focused on cost containment.

As opposed to the lingering hesitancy among business executives, participants in financial markets seem very confident about the future and, judging by the exceptionally low level of risk spreads in credit markets, quite willing to bear risk. This apparent disparity in the sentiment -- in sentiment between business people and market participants could reflect the heightened additional concerns of business executives about potential legal liabilities, rather than a fundamentally different assessment of macroeconomic risks.

Turning to the outlook for costs and prices, productivity developments will likely play a key role. The growth of output per hour slowed over the past half year, giving a boost to unit labor costs after two years of declines. Going forward, the implications for inflation will be influenced by the extent and persistence of any slowdown in productivity. A lower rate of productivity growth in the context of relatively stable increases in average hourly compensation has led to slightly more rapid growth in unit labor costs. Whether inflation actually rises in the wake of slowing productivity growth, however, will depend on the rate of growth of labor compensation and the ability and willingness of firms to pass on higher costs to their customers. That, in turn, will depend on the degree of utilization of resources and how monetary policymakers respond. To date, with profit margins already high, competitive pressures have tended to limit the extent to which cost pressures have been reflected in higher prices.

The inflation outlook will also be shaped by developments affecting the exchange rate of the dollar and oil prices. Although the dollar has been declining since early 2002, exporters to the United States apparently have held dollar prices relatively steady to preserve their market share, effectively choosing to absorb the decline in the dollar by accepting a reduction in their profit margins. However, the recent somewhat quickened pace of increase in U.S. import prices suggests that profit margins of exporters to the United States have contracted to the point where the foreign shippers may exhibit only limited tolerance for additional reductions in margins should the dollar decline further.

The sharp rise in oil prices over the past year has no doubt boosted firms' costs and may have weighed on production, particularly given the sizable permanent component of oil price increases suggested by distant-horizon oil futures contracts. However, the share of total business expenses attributable to energy costs has declined appreciably over the past 30 years, which has helped to buffer profits and the economy more generally from the adverse effect of high oil and natural gas prices.

Still, although the aggregate effect may be modest, we must recognize that some sectors of the economy and regions of the country have been hit hard by the increase in energy costs, especially over the past year.

Despite the combination of somewhat slower growth of productivity in recent quarters, higher energy prices and a decline in the exchange rate for the dollar, core measures of consumer prices have registered only modest increases. The core PCE and CPI measures, for example, climbed about 1-1/4 to 2 percent, respectively, at an annual rate over the second half of last year.

All told, the economy seems to have entered 2005 expanding at a reasonably good pace, with inflation and inflation expectations well anchored. On the whole, financial markets appear to share this view. In particular, a broad array of financial indicators convey a pervasive sense of confidence among investors and an associated greater willingness to bear risk than is yet evident among business managers.

Over the past two decades, the industrial world has fended off two severe stock market corrections, a major financial crisis in developing nations, corporate scandals and, of course, the tragedy of September 11th, 2001; yet overall economic activity experienced only modest difficulties. In the United States, only five quarters in the past 20 years exhibited declines in GDP, and those declines were small. Thus it is not altogether unexpected or irrational that participants in the world marketplace would project more of the same going forward.

Yet history cautions that people experiencing long periods of relative stability are prone to excess. We must thus remain vigilant against complacency, especially since several important economic challenges confront policymakers in the years ahead.

Prominent among these challenges in the United States is the pressing need to maintain the flexibility of our economic and financial system. This will be essential if we are to address our current account deficit without significant disruption. Besides market pressures, which appear poised to stabilize and over the longer run possibly to decrease the U.S. current account deficit and its attendant financing requirements, some forces in the domestic U.S. economy seem about to head in the same direction. Central to that adjustment must be an increase in net national savings. This serves to underscore the imperative to restore fiscal discipline.

Beyond the near term, benefits promised to a burgeoning retirement-age population under mandatory entitlement programs, most notably Social Security and Medicare, threaten to strain the resources of the working-age population in the years ahead. Real progress on these issues will unavoidably entail many difficult choices, but the demographics are inexorable and call for action before the leading edge of baby boomer retirement becomes evident in 2008. This is especially the case because longer-term problems, if not addressed, could begin to affect longer-dated debt issues, the value of which is based partly on expectations of developments many years in the future.

Another critical long-term economic challenge facing the United States is the need to ensure that our workforce is equipped with the requisite skills to compete effectively in an environment of rapid technological progress and global competition. Technological advance is continually altering the shape, nature and complexity of our economic processes, but technology and, more recently, competition from abroad have grown to a point at which demand for the least- skilled workers in the United States and other developed countries is diminishing, placing downward pressure on their wages. These workers will need to acquire the skills required to compete effectively for the new jobs that our economy will create.

Although the long-run challenges confronting the U.S. economy are significant, I fully anticipate that they will ultimately be met and resolved. In recent decades our nation has demonstrated remarkable resilience and flexibility when tested by events, and we have every reason to be confident that it will weather future challenges as well. For our part, the Federal Reserve will pursue its statutory objectives of price stability and maximum sustainable employment, the latter of which we have learned can best be achieved in the long run by maintaining price stability. This is the surest contribution that the Federal Reserve can make in fostering the economic prosperity and well-being of our nation and its people.

Mr. Chairman, I request that my full statement be included for the record, and I look forward to your questions.

SEN. SHELBY: Without objection, your complete statement will be made part of the record. Thank you, Chairman Greenspan. Thank you for your wisdom that you shared with us, some of it at times.

Mr. Chairman, President Bush I believe has shown a lot of courage and leadership in highlighting the need to deal with Social Security. The president has proposed establishing, as you well know, personal accounts with a portion of payroll taxes as a means of reducing long- term government liabilities. Some observers, however, have noted that up to $2 trillion -- I don't know if that figure's right -- in new federal borrowing would be needed to make such a transition. If that figure is a valid representation of transition costs, how -- if so, how do -- how do you believe financial markets would react to such borrowings, and it -- and so forth?

MR. GREENSPAN: Well, Mr. Chairman, if I may I'd like to just take a minute to --

SEN. SHELBY: Go ahead.

MR. GREENSPAN: -- put a context around this --

SEN. SHELBY: Absolutely.

MR. GREENSPAN: -- whole problem.

We have to really ask ourselves what the problem we're trying to solve is, and what the problem essentially is is that we have an unprecedented potential increase in the number of people leaving the workforce and going into retirement over the next 25 years. Indeed, those age 65 and over will increase, according to the Bureau of Census, by more than 30 million, and that's an inexorable move as we all age and retire. The problem that that creates is that unless productivity growth increases significantly, the per capita GDP must very significantly slow, and that means either the retirees or active workers, say in the year 2030, must have a significant or experience a significant slowdown in their standard of living.

And what my concern is is that we are putting forward in a number of different programs commitments to be fulfilled in the year 2030 for which the real resources are not being made available. And the way real resources are made available in such a context is for savings to be put aside to be invested in capital assets, and those capital assets, by increasing relative to the labor force, tends to create increased output per hour, and the correlation for that is very close. So that unless we develop the savings to invest or significantly increase our borrowing from abroad, we are not going to be able to create the capital assets to create the amount of goods that are required.

Our problem with respect to retirement has got nothing to do with finance; it's got to do with real assets, real physical resources, and goods and services that people consume. What the test in this context of our individual financial systems should be up against is do they or do they not create savings to create the capital assets? Or put it another way: Are they fully funded or not?

The problem that I think exists with the current systems that we are dealing with is essentially, for example, Social Security as a pay-as-you-go system worked remarkably well for 50, 60, 70 years, largely because a pay-as-you-go system works if population is growing sufficiently quickly and longevity is growing only modestly. Now we've had in recent years some slowing down in population growth, but a remarkable increase in life expectancy after age 65. That's created a very major problem for a pay-as-you-go system, and the reason essentially is by its nature, in the purest form, pay-as-you-go creates no savings; it merely transfers from taxpayers in any particular period to beneficiaries.

Now to be sure, there is some savings involved in the OASI fund in the sense of we have built up a trust fund which is now approximately one-and-a-half trillion dollars, but fully funded would require more than $10 trillion.

SEN. SHELBY: Ten trillion --

MR. GREENSPAN: So we are very far short, and we have very great difficulty in fully funding the existing system. And that's the reason why I think we have the problems that we're running into.

Not to take too much more time, let me just very specifically, in response to your question -- there are basically two models that we're confronting. One is the pay-as-you-go model, which if we can fully fund will work. But it's shown very considerable difficulty in doing that. The other is the forced savings model, which in the current context is not increasing savings because you're switching from the federal government to a forced savings account. But as a general model, it has in it the seeds of developing full funding by its very nature. And therefore, I've always supported moves to full funding in the context of a private account. And I will respond in more detail in response to a number of questions that I'm sure you and your colleagues have.

The issue with respect to the financing is a difficult one to answer because there are things we don't know. The most important -- there are two things which we don't know which are important. And if we knew them we could answer it very explicitly.

First, we don't know the extent to which the financial markets at this stage, specifically those trading in long-term bonds, are discounting the $10 trillion contingent liability that we have. In other words -- actually it's more than $10 trillion now. It was $10 trillion a while back. If indeed the financial markets do not distinguish through to most of that $10 trillion-plus, and say it is just as much of a debt as the $4-odd trillion that is a debt to the public, then one would say, well, if you wanted to go to a private system, you could go fully to a private system without any response in interest rates, because obviously you're not changing the liabilities -- are involved; you're just merely switching the assets to the private sector. But we don't know that. And if we were to go forward in a large way and we were wrong, it would be creating more difficulties than I would imagine.

So if you're going to move to private accounts, which I approve of, I think you have to do it in a cautious, gradual way and recognize that there is yet another problem involved, which is this: Unlike almost all of the other programs with which we deal, moving to a forced savings account technically does not materially affect net national savings; it merely moves savings from the government account to a private account. One can argue at the margin as to whether or not that induces some change in consumer and personal behavior, but it's at the margin. So that the question really is, if it doesn't affect national savings, it should not affect the supply and demand for funds. But again, we don't know how the markets respond to that. It's one thing to say it as an economist, it's another thing to say how the markets are responding.

So all in all, I'm glad that if we're going to move in that direction, we're going to move slowly and test the waters, because I think it's a good thing to do over the longer run. And eventually, because the pay-as-you-system, in my judgment, is going to be very difficult to manage, we are going to need an alternative.

SEN. SHELBY: Mr. Chairman, just to follow up, could we create the personal accounts without any substantial borrowing for the transition? And if so, how?

MR. GREENSPAN: Well, obviously if you raise taxes, you could.

SEN. SHELBY: What about cutting benefits?

MR. GREENSPAN: You could certainly do it that way too.

SEN. SHELBY: One of those two.

MR. GREENSPAN: Yes.

SEN. SHELBY: If one of the -- a goal of reform that you alluded to is to increase savings, real savings, in this country. Would it be desirable to pursue personal accounts as an add-on rather than as a replacement?

MR. GREENSPAN: Well, it depends on how you finance it. We have add-ons. It's called a 401(k) at this stage.

SEN. SHELBY: That's right.

MR. GREENSPAN: And it's not clear to me what you want to do other than perhaps expand the 401(k)s, which I think have become a very popular and, I think, very useful adjunct to our financial system.

SEN. SHELBY: Senator Sarbanes.

SEN. SARBANES: Well, thank you very much, Mr. Chairman. I presume we're going to do multiple rounds here this morning.

SEN. SHELBY: We will.

SEN. SARBANES: Chairman Greenspan, the first thing I want to make clear or try to get clear is you said the increase in net national saving's a very important objective; is that correct?

MR. GREENSPAN: Yes, sir.

SEN. SARBANES: Is the reduction of the federal deficit -- does that translate into an increase in net national savings?

MR. GREENSPAN: It does, Senator.

SEN. SARBANES: So that eliminating the deficit or even running a surplus constitutes a contribution towards raising net national savings; is that correct?

MR. GREENSPAN: It may be the most significant vehicle we have.

SEN. SARBANES: I take it from that that anything that markedly increases the deficit runs directly counter to the objective of increasing the net national savings.

MR. GREENSPAN: That's correct.

SEN. SARBANES: Because I recall four years ago you came before us -- Senator Dodd alluded to that -- and you told us, and I'm quoting you now -- this was when we were projecting over a 10-year period a $5.6 trillion surplus in the federal budget, a $5.6 trillion surplus projected over 10 years.

You stated that inflation and inflation expectations are under control in your statement and your testimony --

MR. GREENSPAN: I said they were contained, I believe.

SEN. SARBANES: All right.

What factors warrant raising interest rates if inflation and inflationary expectations are contained and if there remains a jobs problem? In other words, the Fed has obviously set out on this constant escalator now of taking up the interest rates. Why would we continue to do that if we don't have an inflation problem that we have to confront? Why wouldn't we, as I suggested, pause and take a look at -- and see how the economy strengthens and how we pick up on the jobs side? What is the factor that drives raising these interest rates inexorably meeting after meeting after meeting, and where will it stop or what factor would determine when it stops?

MR. GREENSPAN: Well, Senator, I won't comment about the future because that's up to the Federal Open Market Committee in its meetings, but I will address the issue as to why we have moved from 1 percent to --

SEN. SARBANES: I'm told you're primus inter pares in those Federal Open Market Committee meetings.

MR. GREENSPAN: I'm sorry, the what?

SEN. SARBANES: Primus inter pares; that you sort of speak for the group.

MR. GREENSPAN: I have one vote.

SEN. SARBANES: (Laughs.)

SEN. : (Off mike.) (Laughter.)

SEN. : First among equals, right?

MR. GREENSPAN: But let me say -- let me address why it is that we have moved from 1 (percent) to two-and-a-half (percent). We very purposefully moved the federal funds rate down quite sharply in the context of the financial deflation -- the set of financial deflationary pressures which occurred as the stock market came down and capital investment went down, capital goods spending went down. And so we very purposefully decided to drive the federal funds rate well below what we considered a long-term sustainable rate, and we got down to 1 percent. We had no notion as to how far we would have to go down, but we decided that we went down -- when we got down to 1 percent, we could hold it there for a while.

When it became clear that the excessive accommodation which we purposefully injected into the financial system was no longer necessary, we then proceeded to withdraw it. And the path we have been on is in the context of withdrawing purposefully injected excess accommodation into the system which, had we left it there indefinitely, in our judgment would have engendered significant inflationary imbalances.

So we embarked on, as we called it, a measured pace of increase. And as you know, the response in the marketplace has not been one of significantly rising long-term rates, difficulties in the housing market, and other problems which we had run into in the past in previous increases in rates. So that I would not look at this as a pattern that we were involved in for purposes of addressing what was then going on within the economy, but rather, removing something which we knew had to be temporary, and one tries to remove it as rapidly as possible with the obvious caveat that should the economy show signs of weakening, clearly we would respond. And we've made that statement every time we have issued one following a Federal Open Market Committee meeting.

So we're not oblivious as to what's going on in the economy. Our judgment, as I indicated in my prepared remarks at the moment, is the economy is moving forward at a reasonably good pace.

SEN. SARBANES: Now, does this analysis assume that there's some normal rate of interest, I mean a sort of a figure that you're trying to get to that you say well this is what the normal rate of interest should be? Is there a premise of that sort in this analysis?

MR. GREENSPAN: There is, Senator. We don't know what the actual number is, but it is that interest rate which creates a degree of stability in the economy and removes any sense of excess which would create inflationary pressures.

SEN. SARBANES: Well, now is it possible that that rate would change as circumstances develop? I thought it was commendable that you didn't buy the national accelerating rate of unemployment analysis, which said at a certain unemployment figure, if we go below it, we're going to drive inflation up, and therefore, we start constraining the economy and that costs us jobs, and we don't get back to our full potential. But we're prepared to go against that dogma at the time and move on down the interest rates, give the economy a boost and bring down the unemployment rate well below what had previously been seen as "normal."

Now, I guess the question I'm asking is whether we need to think in those terms again with respect to this normal interest rate.

I mean, what may be a normal interest rate in changing circumstances may be lower than what previously was a normal interest rate. And of course, a lower interest rate stimulates the economy; presumably it makes carrying this debt less costly rather than more costly, and has a lot, I think, a lot of other benefits for the workings of our economic system. So that's why I'm suggesting that we need to reexamine --

MR. GREENSPAN: No, I -- look, we believe that that so-called normative rate, or whatever you want to call it, is not stable. It does move around. And that's the reason I say I don't know where it is. I do know that we have the capacity to examine how the market is behaving in all of its myriad manifestations to be able, as a committee, I hope and believe, to judge where we are at all times. We may not be able to forecast it, but I do think we have enough analytical technology to be able to make a judgment as to where we are at any particular point in time. I'm almost certain that that rate does move around, and we are constantly trying to get the appropriate fix, because that is implicit, as you point out, in the strategy that we started to pursue last year.

SEN. SARBANES: Thank you, Mr. Chairman.

SEN. SHELBY: Senator Bunning.

SEN. BUNNING: Thank you, Mr. Chairman. I'm not going to ask you the obvious question about inflation; you've already answered it.

In the past, it's my recollection you are not as concerned with the current account deficits as you were with other economic figures. Back in November, when the current account deficit reached record levels, you did express concern. But in February your concern eased as the current account deficits decreased. Would you comment on the current account deficit and your concern, or lack thereof?

MR. GREENSPAN: Senator, it's an extraordinary part of a phenomenon which has been going on for the last decade worldwide. Prior to 1995, even though there was a very major grossing up of exports and imports around the world -- and indeed, leaving as a consequence, on average, imports as a percent of GDP growing every year virtually -- we nonetheless did not find that there was any evident increase -- consistent increase in the dispersion of trade or current account surpluses and deficits. In other words, there was what economists call a very considerable amount of home bias, meaning that countries tended to use their domestic savings to very largely finance their domestic investment.

But since 1995, there's been a very pronounced change, in which cross- border use of savings to invest in foreign countries all over the world has increased dramatically, which has meant that the dispersion of current account balances, both as surpluses, on the one hand, and deficits, on the other, in which the United States has the largest deficit, have occurred. That phenomenon has given us the capacity to create a very large deficit. And indeed it has been a major source of financing to our domestic investment.

But as I've also said and, I think, you've pointed out, it just -- over the longer run, it's just not credible that it could go on without change, because you will get an undue concentration of dollar claims on U.S. residents, which -- even though they're considered highly valuable, high rates of return and the like, they lack the diversification of a good portfolio, and foreign investors would therefore start to ease off. And if you can't finance a current account deficit, it won't exist. So that is surely the case.

But I've also said that the degree of flexibility owing to deregulation, owing to technology, owing to lots of innovation, has created a degree of flexibility and therefore resilience in this economy that has in the past and is very likely in the future to defuse this large current account balance without undue negative economic effects on the American economy.

So what I said in the last several weeks is, one, this is a problem. We're going to -- we're approaching it and, I think, coming to grips with it in the marketplace. And the evidence is that for the first time we are beginning to see the impact of stable margins of foreign exporters at very low levels now beginning the produce increases in import prices in the United States, which is the first stage in the adjustment process.

SEN. BUNNING: All right. As you know, the SEC has proposed a new Regulation B to Section 2 of the Gramm-Leach-Bliley bill. The Fed, along with the FDIC and the OCC, wrote a very strong letter to the SEC opposing their proposed regulation. Would you comment on how this proposed regulation could affect bankers?

MR. GREENSPAN: I'm sorry. I don't remember what the specified nature of the regulation was.

SEN. BUNNING: You don't remember what the -- what you wrote?

MR. GREENSPAN: No, no, I don't remember -- I know -- I write a lot of things, but I'm just basically saying I don't -- that somebody --

SEN. BUNNING: The --

MR. GREENSPAN: -- one of my staff will know exactly what I wrote.

SEN. BUNNING: Okay.

MR. GREENSPAN: They'll tell me.

SEN. BUNNING: So will my staff, sir.

(Conferring with staff.)

MR. GREENSPAN: Okay. (Laughs.) (Laughter.)

(Conferring with staff.)

SEN. BUNNING: How you would regulate new bank products.

MR. GREENSPAN: I remember it now. (Laughter.) I didn't remember the name, but I now remember the issue, which is a significant issue. It's a question of --

SEN. BUNNING: Our bankers think it's very significant.

MR. GREENSPAN: It is. No, and in fact I think we are concerned about that as well. And I think that the issue of the resolution of this question is clearly going to have to be completed because the brokerage affiliates within the banks, as such, are integral parts of a process which we perceive to be important to banks overall. And we will get it resolved, I hope sooner --

SEN. BUNNING: Then you still oppose, along with the other people who have written SEC?

MR. GREENSPAN: Yes, sir.

SEN. BUNNING: Thank you very much, Mr. Chairman.

SEN. SHELBY: Senator Reed.

SEN. JACK REED (D-RI): Thank you very much, Mr. Chairman.

Just for context, Chairman Greenspan: You referred to a $10 trillion shortfall in the Social Security trust fund; over what time period is that?

MR. GREENSPAN: This is the present value of the benefits earned by those in the labor force over the years currently, as of right now, plus those who are retired and receiving benefits which they had earned previously. So it's the discounted value of all of the benefits which are to be received by the total labor force and retirees over essentially an indefinite period of time.

SEN. REED: And longer than the 75-year planning phase.

MR. GREENSPAN: Oh, yes. Seventy-five, I think -- if you cut it off at 75, I think it's, like, $3.7 trillion.

SEN. REED: And that's generally the norm in terms of --

MR. GREENSPAN: Yeah, but I think that it's an artificial norm. And most pension fund counting thinks in the full context of what the actual liabilities one has. And it's a convenience that relates largely to a pay-as-you-go system, but it is not consistent with the general notion of how one runs a defined benefit program, which, were pay-as-you-go fully defined benefit, I think many of the objections I raised earlier on would disappear.

SEN. REED: Let me ask you another question, Mr. Chairman. Various administration spokespersons somewhat reluctantly have admitted that the private accounts plan that has been announced will by itself alone do nothing to improve the long-term solvency of the Social Security system.

Do you agree with that?

MR. GREENSPAN: I do, Senator.

SEN. REED: Thank you.

Would you also agree -- and I think this is a follow up, really, to your discussion with Senator Sarbanes -- that the private accounts will basically leave national savings unchanged, since the government is borrowing money to give to individual citizens to invest in the market? Do you agree with that also?

MR. GREENSPAN: Yes, I do.

SEN. REED: Looking at the system, there are various means to make it essentially a pay-as-you-go system. One would be to take a portion of the proposed extension of the taxes the president's talking about and putting that into the Social Security trust fund. Just on a policy -- that would -- that would establish a pay-as-you-go system. Is that correct?

MR. GREENSPAN: It depends. If, in the full context of accounting, it increases national savings, then the answer is yes.

SEN. REED: Yeah, thank you.

MR. GREENSPAN: But the test has got to be looking at how it affects the private sector and the public sector, and if net, on balance, it is constructed in a manner to do that. Then yes.

SEN. REED: Thank you.

In 1983, Chairman Greenspan, you were the chairman of the commission that rescued Social Security from the brink. If this is a crisis, that was a catastrophe back in '83. And your colleagues and yourself joined in saying that, in the words of the report, that "Congress should not alter the fundamental structure of the Social Security programs or undermine its fundamental principles." And part of the fundamental principle of Social Security is it's an insurance program, not just an investment vehicle, and one of the most obvious manifestations of that is that many of the beneficiaries are not retirees at all, but they are disabled Americans, they are children who don't have parents, or they're widows.

The proposals that are being discussed today could alter those principles fundamentally. I think -- I understand also that in '83 you did consider changes that would transform from a defined contribution plan into something else, at least you thought about those things. Do you still believe that we should maintain the fundamental principles of Social Security, as you did in '83?

MR. GREENSPAN: I think we should maintain the principles of Social Security, but I think the existing structure is not working; and that until we can construct a system which creates the savings that are required to build the real assets so that the retirees have real goods and services, we don't have a system that's working. We have one that basically moves cash around. And we can guarantee cash benefits as far out and at whatever size you like, but we cannot guarantee their purchasing power. And this is why the issue ultimately has got to be resolved in terms of do we have the material goods and services that people will need to be -- will need to consume, not whether or not we pass some hurdle with respect to how legal financing occurs because the financing is a secondary issue, and it's the means to create the real wealth, not an end in itself.

SEN. REED: And that goes back, I think, to your fundamental point, that unless you increase national savings, you won't have these resources.

MR. GREENSPAN: Yes, sir.

SEN. REED: And just to follow up on your point before, as the administration has admitted and as you concur today, that the present proposed private accounts will not add to those national savings.

MR. GREENSPAN: It doesn't add, but it doesn't subtract, either. That's correct.

SEN. REED: So it's a zero?

MR. GREENSPAN: Well, let me just say that in any move which we endeavor to create full funding, there is a huge transition cost because we have not built the stock of assets required, and that's the shortfall or the difference between the 1.5 trillion (dollars) and the 10 trillion (dollars) plus in funding assets. And actually, if you go further and you put Medicare in here, we're talking another $60 trillion. So the problem that we have is there is a huge transition cost to get us to a point where we're building the savings adequate to produce the assets. We're not doing that, and any scheme cannot get around the fact that there is a huge hole in the system and we have no choice but to find a way to fill it.

SEN. REED: Well, I'm recalling reading the book of -- Secretary O'Neill's book, in which if you believe it's accurate -- I do -- is that you had discussions with him about solving some of these issues with the surplus, which at time we could fund transition costs. But at this point, running a deficit, we have squandered the opportunity to make a serious transition in terms of both Social Security and Medicare and Medicaid and other programs. And that, to me, is one of the casualties of the administration's policies.

And I thank you, Mr. Chairman.

SEN. SHELBY: Senator Crapo.

SEN. MIKE CRAPO (R-ID): Thank you very much, Mr. Chairman.

And, Chairman Greenspan, I want to continue on this same line of questioning. We are hearing a tremendous amount of discussion in the public today, both among the political leadership here in the U.S. Congress and in the administration, as well as out in the public, about these transition costs that are related to the proposal to move to personal accounts with a portion of the taxes paid in payroll.

And as you have discussed today, I believe I understand your testimony to be that with regard to national savings -- and I assume that means governmental savings --

MR. GREENSPAN: National savings is another word for domestic savings, that differentiated from the fact that we don't include the current account deficit or foreign savings that we borrow in that total.

SEN. CRAPO: And all of this is a discussion of the government's posture and the government's savings; is that not correct?

MR. GREENSPAN: Government savings, both state and local and federal, is part of national savings. Maybe that's a bad term. Probably domestic savings should be used, but that's --

SEN. CRAPO: Does it include the personal savings of individuals across the country?

MR. GREENSPAN: Yes. The way to think about this is that the aggregate of domestic savings includes the savings of households, businesses and governments, and that's the part which we call domestic savings.

SEN. CRAPO: And if we move, then, to a system of personal accounts where individuals were able to save a portion of their payroll taxes, can I correctly assume that the reason you say that does not increase national savings is because it's putting money in individual accounts that would otherwise be in a different savings account?

MR. GREENSPAN: No. I think the problem here is that if we started from scratch -- well, let me -- that's getting a little -- let me see if I can come back at this.

If in its original form we did not have anything other than a requirement that we have a 12.4 percent tax which was put into a private account, in other words, that particular fund coming off the person's income and the employer's income would go into a forced savings account, in the sense private savings would increase by that amount. And the part that the corporation contributed, which would have reduced its undistributed earnings, which would have been savings, would be a negative; but net -- it would, except under a certain number of different conditions, it would be a net increase.

SEN. CRAPO: So the employer's savings would be reduced, but the employee's savings would have gone up and there'd be net zero balance.

MR. GREENSPAN: Yes. In order to get savings, remember, you have to get consumption declining relative to income.

SEN. CRAPO: All right, I appreciate that because I think that there's a lot of misunderstanding about that fact as we discuss this issue. And when we discuss the cost, there's a lot of discussion about the transition cost being -- I've heard the number of $2 trillion; the administration says the number, in terms of its proposal, is more in the neighborhood of the $700 billion to $800 billion over 10 years. Is the same not true about that transition cost, in the sense that those costs are actually related to debt in out years or obligations in out years of the Social Security system that are being borrowed to take care of in earlier years?

MR. GREENSPAN: Well, the president hasn't made a formal proposal.

SEN. CRAPO: I understand.

MR. GREENSPAN: But I gather what he has in mind is, in a sense, that the amounts that go into the private account are offset, after discount, with benefits that would have been paid with those monies in the Social Security system.

SEN. CRAPO: And making that assumption, is it not correct to say, then, that the transition costs, although they would be incurred now and would require some borrowing to pay for them now, are actually relieving an obligation of the Social Security system in out years?

MR. GREENSPAN: Well, the problem is that you cannot commit future congresses to stay with that.

SEN. CRAPO: (Chuckling.) Unfortunately, I understand that!

MR. GREENSPAN: And as a result, the markets will not discount it as though that were the case, even though it's the intention and that's what the law would say; and if you could put it in the Constitution, I suspect you may be right.

But I think the more -- the relevant issue here is that how the markets interpret it is really, in a sense, the important issue, because if the markets correctly or incorrectly make a judgment as to what they think the potential outcome is, we can get interest rates going up or going down, and we have significant effects that we would prefer probably did not occur.

So my caution here is based on not knowing and not knowing how to know in advance how markets will respond. I do know that asking people in the marketplace is of no value at all -- (light laughter) -- because they do not know. They will tell you they know, but I haven't found that a very useful forecast.

SEN. CRAPO: I appreciate your encouragement that we move cautiously in terms of this proposal, but I also appreciate that you had said that you believe that we should look at a personal account.

MR. GREENSPAN: Oh, indeed I do. And --

SEN. CRAPO: Could you give us, just quickly, your reasons for that?

MR. GREENSPAN: Well, basically it's got to do with the issue of personal accounts have far greater probability -- indeed, almost it's built into their nature -- of being fully funded. And the simple form of pay-as-you-go by construction saves nothing. And unless you save, merely basically creating commitments -- dollar commitments in the future without the corresponding real resources to accommodate the claim, you will get more claims on a fixed amount of goods than is good for the inflationary balance of the system. So it's strictly a question of where can we create a system which we get full funding. And it didn't matter 20, 30, 40 years ago, because the ratio of workers to retirees was quite high and that, therefore, the implicit tax per worker for each retiree was very small. But now we have 3.3 workers for every retiree, and that number is falling quickly.

So the current system is ill-suited to the demographics that we're looking forward -- we're expecting to evolve in the future. And while a pay-as-you-go system worked very well -- I thought surprisingly well -- through decades, that was because of the special case of the demographics of the society at that point. It is not a general system in the sense of a defined benefit or defined contribution system which very explicitly indicates what type of replacement rate, so to speak, meaning the amount of income you expect in retirement to get relative to the amount of income you're making in the last years of work.

SEN. CRAPO: Thank you very much.

SEN. SHELBY: Senator Schumer.

SEN. CHARLES SCHUMER (D-NY): Well, once again, Mr. Chairman, thank you for your erudition on this, which leaves us all better educated and maybe more confused, too.

I'd like to go back to these accounts and Senator Sarbanes' questions. You said you can't really tell if net savings will increase or decrease with this private -- a private account system that draws money from the existing Social Security system, because you don't know if the markets have -- how much they have discounted, if at all, the future obligations that we have.

MR. GREENSPAN: If I may, the fact -- whether it actually increases savings or not is a fact independent of what people's opinions are.

SEN. SCHUMER: I agree.

MR. GREENSPAN: So it's not the market. I think the problem here is that we have got a system in which, starting from scratch --

SEN. SCHUMER: Yeah, but for now --

MR. GREENSPAN: -- forced savings will be pay-as-you-go all the time.

SEN. SCHUMER: Right. Right. But a transfer, which is proposed now, is a different issue.

MR. GREENSPAN: Exactly.

SEN. SCHUMER: And we don't know how the markets will regard that transfer.

MR. GREENSPAN: Exactly. Yes.

SEN. SCHUMER: Okay. Now I want to take two cases: one they've discounted for; the other they have not. If they have not, and we go forward with this system that we hear about, where you transfer some money from the existing Social Security system to private accounts -- that would create a real problem, particularly, as you've mentioned, Senator -- to Senator Sarbanes, if the amount is a trillion dollars or $2 trillion or whatever. That's indisputable, I presume.

MR. GREENSPAN: It's a trillion dollars over 10 years we're talking about.

SEN. SCHUMER: Yes, yes, yes.

MR. GREENSPAN: Two trillion (dollars) is indisputable.

SEN. SCHUMER: Okay.

MR. GREENSPAN: A trillion dollars, I think, is right at the margin.

SEN. SCHUMER: Okay.

MR. GREENSPAN: But I don't -- I shouldn't say I know that. That's my assumption.

SEN. SCHUMER: Yup, understood. And we're all guessing here.

MR. GREENSPAN: Yeah.

SEN. SCHUMER: But that could be bad. Let's make no mistake about that.

MR. GREENSPAN: Could be bad, and it could be very good.

SEN. SCHUMER: Right.

MR. GREENSPAN: I mean, I think that my judgment is, we've got a problem in the -- that the existing pay-as-you-go system is not working, and we have to change it and --

SEN. SCHUMER: Well, nobody disputes that.

MR. GREENSPAN: So we have to change it.

SEN. SCHUMER: Yeah.

MR. GREENSPAN: And the question is how.

SEN. SCHUMER: Well, nobody disputes that we need some change. But it seems to me if the markets have discounted all of this, then it doesn't do any harm, but it doesn't do any good, because net savings is not increasing, as you said before. If the market has not discounted a rather large amount of debt being added to the existing debt -- obviously 15 or 20 years ago, this wouldn't have been a problem -- then we have real trouble.

MR. GREENSPAN: No, but if you move --

SEN. SCHUMER: So it's not win versus lose. It's either lose or stay static.

MR. GREENSPAN: No, because if you begin to move significant parts of the existing social insurance system into accounts which begin to create full funding, whereas left where they were, they won't, then you do increase national savings over time.

SEN. SCHUMER: But that's a huge if --

MR. GREENSPAN: Well, no, it's -- no --

SEN. SCHUMER: -- because it will only increase full funding if you dramatically cut a benefit. You have to do other changes than simply move one to the other. What we're trying to get at here is not the overall change that is needed -- and I don't think anyone disputes what you say -- but whether setting up a private account under current conditions, not starting from scratch --

MR. GREENSPAN: No, I'm --

SEN. SCHUMER: -- does anything to alleviate the problem.

MR. GREENSPAN: In and of itself, it surely doesn't alleviate the current problem.

SEN. SCHUMER: Right.

MR. GREENSPAN: Actions have to be taken.

SEN. SCHUMER: Exactly.

MR. GREENSPAN: I'm merely saying that it is -- that if you move to private accounts and --

SEN. SCHUMER: And --

MR. GREENSPAN: -- the financial markets are -- have not -- and the financial markets have at least partially discounted the contingent liabilities --

SEN. SCHUMER: Right.

MR. GREENSPAN: -- then you are in net plus --

SEN. SCHUMER: Right.

MR. GREENSPAN: -- because then you have the capacity --

SEN. SCHUMER: Understood. Okay. But if they haven't, you're not.

MR. GREENSPAN: That's correct.

SEN. SCHUMER: Okay. So it seems to me that what you really are advocating here, without saying it, which would truly increase net savings, is what is called around here Social Security Plus: fix Social Security on its own, and if you want to do private accounts and increase net savings over the present system, you do those in addition, whether it's forced savings or greater incentives, which 401(k)s or whatever mentioned; that -- wouldn't Social Security Plus -- in other words, fix the present system and then do the private accounts, not in replacement but in addition, do more for net savings?

MR. GREENSPAN: Well, it depends on how you finance them. In other words, the question here is, if you're going to expand 401(k)s, I think that's a desirable thing to do.

SEN. SCHUMER: Exactly.

MR. GREENSPAN: If you're going to set up another program which is an entitlement, which the --

SEN. SCHUMER: No, no, no, I'm just saying a 401(k) -- the first. I'm saying the first. That will more to increase net savings than simply shifting some money from the present system to a so-called private account. I think that's indisputable.

MR. GREENSPAN: Well, no, 401(k)s are private accounts. So --

SEN. SCHUMER: I understand, but in addition, as opposed to replacement --

MR. GREENSPAN: It --

SEN. SCHUMER: -- because you'll have more net savings.

MR. GREENSPAN: Yeah. No, no, I'm not disagreeing with you.

SEN. SCHUMER: Okay.

MR. GREENSPAN: I say that that's correct. I just want to make sure that you're not talking about a new entitlement --

SEN. SCHUMER: No, I am not. And furthermore, we'd have a(n) easier time fixing Social Security if our debt went down. It would have been easier to fix it six years ago or in 1983 than it is today, because one of the great problems is all the debt we have right now. Isn't that fair to say, too?

MR. GREENSPAN: I think that's fair to say.

SEN. SCHUMER: Okay.

Let me tell you just -- I know my time is up -- it seems to me that what you're saying here is that moving to the system that's outlined -- that the president may propose is risky.

SEN. CRAPO: Thank you very much.

SEN. SHELBY: Senator Schumer.

SEN. CHARLES SCHUMER (D-NY): Well, once again, Mr. Chairman, thank you for your erudition on this, which leaves us all better educated and maybe more confused, too.

I'd like to go back to these accounts and Senator Sarbanes' questions. You said you can't really tell if net savings will increase or decrease with this private -- a private account system that draws money from the existing Social Security system, because you don't know if the markets have -- how much they have discounted, if at all, the future obligations that we have.

MR. GREENSPAN: If I may, the fact -- whether it actually increases savings or not is a fact independent of what people's opinions are.

SEN. SCHUMER: I agree.

MR. GREENSPAN: So it's not the market. I think the problem here is that we have got a system in which, starting from scratch --

SEN. SCHUMER: Yeah, but for now --

MR. GREENSPAN: -- forced savings will be pay-as-you-go all the time.

SEN. SCHUMER: Right. Right. But a transfer, which is proposed now, is a different issue.

MR. GREENSPAN: Exactly.

SEN. SCHUMER: And we don't know how the markets will regard that transfer.

MR. GREENSPAN: Exactly. Yes.

SEN. SCHUMER: Okay. Now I want to take two cases: one they've discounted for; the other they have not. If they have not, and we go forward with this system that we hear about, where you transfer some money from the existing Social Security system to private accounts -- that would create a real problem, particularly, as you've mentioned, Senator -- to Senator Sarbanes, if the amount is a trillion dollars or $2 trillion or whatever. That's indisputable, I presume.

MR. GREENSPAN: It's a trillion dollars over 10 years we're talking about.

SEN. SCHUMER: Yes, yes, yes.

MR. GREENSPAN: Two trillion (dollars) is indisputable.

SEN. SCHUMER: Okay.

MR. GREENSPAN: A trillion dollars, I think, is right at the margin.

SEN. SCHUMER: Okay.

MR. GREENSPAN: But I don't -- I shouldn't say I know that. That's my assumption.

SEN. SCHUMER: Yup, understood. And we're all guessing here.

MR. GREENSPAN: Yeah.

SEN. SCHUMER: But that could be bad. Let's make no mistake about that.

MR. GREENSPAN: Could be bad, and it could be very good.

SEN. SCHUMER: Right.

MR. GREENSPAN: I mean, I think that my judgment is, we've got a problem in the -- that the existing pay-as-you-go system is not working, and we have to change it and --

SEN. SCHUMER: Well, nobody disputes that.

MR. GREENSPAN: So we have to change it.

SEN. SCHUMER: Yeah.

MR. GREENSPAN: And the question is how.

SEN. SCHUMER: Well, nobody disputes that we need some change. But it seems to me if the markets have discounted all of this, then it doesn't do any harm, but it doesn't do any good, because net savings is not increasing, as you said before. If the market has not discounted a rather large amount of debt being added to the existing debt -- obviously 15 or 20 years ago, this wouldn't have been a problem -- then we have real trouble.

MR. GREENSPAN: No, but if you move --

SEN. SCHUMER: So it's not win versus lose. It's either lose or stay static.

MR. GREENSPAN: No, because if you begin to move significant parts of the existing social insurance system into accounts which begin to create full funding, whereas left where they were, they won't, then you do increase national savings over time.

SEN. SCHUMER: But that's a huge if --

MR. GREENSPAN: Well, no, it's -- no --

SEN. SCHUMER: -- because it will only increase full funding if you dramatically cut a benefit. You have to do other changes than simply move one to the other. What we're trying to get at here is not the overall change that is needed -- and I don't think anyone disputes what you say -- but whether setting up a private account under current conditions, not starting from scratch --

MR. GREENSPAN: No, I'm --

SEN. SCHUMER: -- does anything to alleviate the problem.

MR. GREENSPAN: In and of itself, it surely doesn't alleviate the current problem.

SEN. SCHUMER: Right.

MR. GREENSPAN: Actions have to be taken.

SEN. SCHUMER: Exactly.

MR. GREENSPAN: I'm merely saying that it is -- that if you move to private accounts and --

SEN. SCHUMER: And --

MR. GREENSPAN: -- the financial markets are -- have not -- and the financial markets have at least partially discounted the contingent liabilities --

SEN. SCHUMER: Right.

MR. GREENSPAN: -- then you are in net plus --

SEN. SCHUMER: Right.

MR. GREENSPAN: -- because then you have the capacity --

SEN. SCHUMER: Understood. Okay. But if they haven't, you're not.

MR. GREENSPAN: That's correct.

SEN. SCHUMER: Okay. So it seems to me that what you really are advocating here, without saying it, which would truly increase net savings, is what is called around here Social Security Plus: fix Social Security on its own, and if you want to do private accounts and increase net savings over the present system, you do those in addition, whether it's forced savings or greater incentives, which 401(k)s or whatever mentioned; that -- wouldn't Social Security Plus -- in other words, fix the present system and then do the private accounts, not in replacement but in addition, do more for net savings?

MR. GREENSPAN: Well, it depends on how you finance them. In other words, the question here is, if you're going to expand 401(k)s, I think that's a desirable thing to do.

SEN. SCHUMER: Exactly.

MR. GREENSPAN: If you're going to set up another program which is an entitlement, which the --

SEN. SCHUMER: No, no, no, I'm just saying a 401(k) -- the first. I'm saying the first. That will more to increase net savings than simply shifting some money from the present system to a so-called private account. I think that's indisputable.

MR. GREENSPAN: Well, no, 401(k)s are private accounts. So --

SEN. SCHUMER: I understand, but in addition, as opposed to replacement --

MR. GREENSPAN: It --

SEN. SCHUMER: -- because you'll have more net savings.

MR. GREENSPAN: Yeah. No, no, I'm not disagreeing with you.

SEN. SCHUMER: Okay.

MR. GREENSPAN: I say that that's correct. I just want to make sure that you're not talking about a new entitlement --

SEN. SCHUMER: No, I am not. And furthermore, we'd have a(n) easier time fixing Social Security if our debt went down. It would have been easier to fix it six years ago or in 1983 than it is today, because one of the great problems is all the debt we have right now. Isn't that fair to say, too?

MR. GREENSPAN: I think that's fair to say.

SEN. SCHUMER: Okay.

Let me tell you just -- I know my time is up -- it seems to me that what you're saying here is that moving to the system that's outlined -- that the president may propose is risky.

It's risky because we don't know what the markets have -- what the markets will do if they see it, and at the same time it does not increase overall net savings in of itself. And I know you don't want to say that -- (chuckles) -- but it seems to me it's sort of inevitable and inexorable from what you have outlined here in terms of those two parts. Where am I wrong there?

MR. GREENSPAN: Senator, it is risky doing nothing. It is risky -- doing any other solution to this is risky. We've got this huge hole in our long-term funding problem, and I know of no way to resolve it without some risk. It's a question of which risks are more likely to be --

SEN. SCHUMER: It just seems to me what you're saying is just on the way the privatization accounts are proposed, the risks far outweigh the benefits unless we do something else with it.

MR. GREENSPAN: Well, that's the reason why I think that starting slowly and finding out how it works is a very good direction in my judgment because if it turns out to be something which creates problems or if people don't like the thing -- remember, it's a voluntary issue, and they may just choose not to take it. My own judgment is I think when you have assets which you own, which you can bequeath to your children, and which have your name on it, I think that is a highly desirable thing because you give wealth basically to people in the lower- and middle-income groups who have not had it before because, remember, these private accounts, even though they are forced savings, are indeed owned by the people and they have wealth which they probably would not have had before, so that I can conceive of these being extraordinarily popular accounts. And if they are, I think it has a very important -- it's a very important addition to our society because, as you know, I've been concerned about the concentration of income and wealth in this nation, as indeed the senator, your colleague, has as well. And this, in my judgment, is one way in which you can address this particular question.

SEN. SHELBY: Senator Dole.

SEN. DOLE: I'd like to ask you to discuss the issue of rising health care costs and the impact on businesses. I've heard from a number of North Carolina businesses that rising costs are directly affecting their hiring decisions. Could you give us your views on this area and whether or not you believe it's having a negative effect on wage rates and employment?

MR. GREENSPAN: Senator, I think it's a very difficult issue. And I think that to the extent that we see that benefits are going up and wages have flattened out, relatively speaking, a goodly part of this is the fact that individuals are willing to take health benefits in lieu of wages and salaries, but only in part. So overall, there's no question that the net effect on cost to businesses is rising.

My own judgment is that the Medicare problem is, of course, several multiples more difficult than is Social Security, but I'm also of the belief that we probably ought not to address the medical issue quite yet until we get very far -- much further down the road in the advance in information technology in the medical area where now a number of individuals are looking into -- and indeed, there are members of this body on both sides of the aisle who are focused on this issue. And I think to the extent that we can begin to get major advances in information technology at an encrypted, individual level, I think that best clinical practice is going to change, and it's going to change because we're going to see things that we already suspect, on the basis of certain different types of surveys -- namely that there are all sorts of different types of practices for specific diseases across this country with very varying outcomes. And it's largely the unavailability of all of the information which has made the improvement in clinical practice difficult.

And in my judgment, we have to get to the point where the medical profession, following from the information technology, creates a best clinical practice, at which point I think that an endeavor to address the problems that you're concerned with -- and in the more broader sense, the medical profession generally -- because if we were to do it now or even next year, I'm fearful we would be restructuring an obsolete model and have to come back and undo it.

So I think that people who are saying we ought to do Medicare first before Social Security because it's a much bigger problem -- I agree it is a hugely much more difficult problem, but I'm not sure I would agree with the issue of the sequence, wholly because of the nature of what's now occurring in medicine.

SEN. DOLE: Let me ask you about manufacturing. As I mentioned in my opening statement, and we all know, North Carolina and a number of other states have been hit hard by the loss of manufacturing jobs since 1998. According to the Bureau of Labor Statistics, manufacturing employment has remained level in the last year. Do you see growth in manufacturing in this next year?

MR. GREENSPAN: Senator, it's hard to tell. And the reason why is it's very difficult to judge how fast productivity is going to advance -- as you know, productivity in manufacturing has really been very impressive. The down side, obviously, is it's made -- it's created fewer job opportunities. And we can reasonably assume that the economy is going forward at a fairly good clip and that, therefore, the demand for manufactured goods will continue reasonably significant. But it depends on productivity growth -- or, I should say, the extent to which manufacturing jobs changes one way or the other depends on whether productivity growth goes up or slows down.

And it's very tough to judge. So I couldn't give you an answer because I've tried to forecast manufacturing employment. And I must tell you, my record is not altogether terrific.

SEN. DOLE: Thank you, Mr. Chairman. My time has expired.

SEN. SHELBY: Senator Stabenow.

SEN. DEBBIE STABENOW (D-MI): Thank you, Mr. Chairman. And welcome again, and thank you for your service and for your being with us today.

I want to follow up on Senator Dole's questions on manufacturing. I share her concerns; Michigan has had the same kind of, certainly, challenges as it relates to manufacturing. But I first want to thank you for some insights in your statement that you expand upon in your written statement more than you are able to do as you spoke today as it relates to education, because I think this is critically important, and I appreciate your wisdom of your comments here. And I think they are comments that we should take very, very seriously.

You talk about, quoting you. "The failure of our society to enhance the skills of a significant segment of our workforce has left a disproportionate share with less skills. The effect is a widening wage gap between the skilled and the less skilled." And then you go on to talk about, "In a democratic society, such a stark bifurcation of wealth and income trends among large segments of the population can fuel resentment and political polarization," which I believe is happening today. And I share your concern about the concentration of wealth and really, what I view as splitting of the middle class in this country due to a host of issues. But I think it's important to emphasize that you said that strengthening elementary and secondary schooling in the United States, especially in the core disciplines of math, science, and written and verbal communications, is one crucial element in avoiding such outcomes. I would not expect you to comment on this, but I would just say for my colleagues, putting my budget hat on, this is of deep concern to me when I see that one-third of what has been proposed in the president's budget in terms of cuts are in education. And I think that goes right to the heart of what you speak about here. And I would not necessarily expect you to comment on the president's budget. But I think we should be listening to you, because we have huge wage and skill gaps that will affect us for decades to come, and we need to be investing in skills and education.

Turning to a different subject in terms of our debt, and this actually goes back to my concerns on manufacturing. But it relates indirectly to manufacturing, when we look at our dependency on inflows of foreign capital to finance economic activity. And then I would argue on the other hand our difficulty in enforcing trade agreements against those who own so much of our foreign debt, I think this is going to be making it more and more difficult for us. I would -- I'd welcome your thoughts on that. But when we look at the fact that -- and I have just a small chart, but in the last four years, foreign holdings of U.S. Treasury debt has gone from basically a trillion to $1.85 trillion. And about half of that's owned by China and Japan. And I think people would be shocked to know who else owns our foreign debt as we're talking about financing private accounts through Social Security or other privatization efforts or anything else that we're doing for that matter -- the war, anything else -- that South Korea, Taiwan, Germany, Hong Kong, OPEC, Switzerland; we have a lot of foreign entities that hold our debt, portions of our debt right now.

And I'm wondering at what point, particularly when we're looking at $2 trillion or we're hearing now 20 years down the road, two decades, potentially $5 trillion in new debt added, if in fact privatization in some part goes into effect of Social Security, at what point do you believe that we should be concerned that our foreign financing of our national debt is becoming too great?

MR. GREENSPAN: Well, Senator, we have a difficult problem that people find U.S. Treasury securities the safest in the world. And it's not as though we're forcing them to go buy our securities, nor do I believe we have any legal mechanism to prevent them from buying them in the open market, which is what they do. So I'm not sure how to address this issue because I'm not sure what we can do about it.

The notion, however, that came out, I think, a couple of weeks ago, that there was a significant move towards selling off U.S. dollar instruments by foreign central banks, that actually was not accurate. The extent of holdings remains very heavy for dollars as a share of their aggregate holdings. And part of the decline is -- very small -- is the very fact that if you take a portfolio with dollars and, say, euros, and the dollar's price falls relative to the euro, then the value of euros in dollar equivalents rises and that, therefore, it looks as though the dollar has gone down as a share of total outstanding portfolios, when indeed, it has not. And that's basically what the case is.

But on the broader issue you're raising, I'm not sure how to handle that because I'm not sure what the long-term implications are. You are quite correct at the moment, excluding the debt, U.S. Treasury debt held by the Federal Reserve, half of our debt is owned abroad. And I would assume at some point it has consequences, but I'm not -- I cannot tell you what they are.

SEN. STABENOW: Mr. Chairman, isn't it reasonable to assume, though, that when we add national debt, every time we are adding national debt we are adding opportunity for foreign investors to purchase those bonds? So that one way to stop the foreign holdings increasing would be to stop the national debt from increasing?

MR. GREENSPAN: Well, we almost -- we had -- believed we were going to run the debt down to zero, not that many years ago. That would have solved the problem.

SEN. STABENOW: I remember your being here with us in 2001 when we were talking about the wonderful problem of having too large of a surplus and the question of what we do about that.

I wonder if I might ask one further question? I know my time is up, but just --

SEN. SHELBY: Go ahead.

SEN. STABENOW: Thank you, Mr. Chairman.

One further question. It's similar in terms of what's happening abroad for us.

Would you -- would it be your position that free-floating currency is an essential element of efficient capital markets? And to that end, would you be supportive of mechanisms whose goals are to ensure that nations allow for floating currencies?

MR. GREENSPAN: Well, in general I would say flexibility, which is an extraordinarily valuable asset to the world financial system, is clearly advanced by having essentially a free-floating rate system, which is largely what we have. The difficulty is that numbers of nations find dealing with fluctuating or variable currencies difficult to handle for lots of different reasons, and they choose on their own to lock in against the euro or the dollar or a basket of something and accumulate or decumulate their foreign assets to sustain it. So it's largely actions taken by foreigners, not something which can be mandated by anybody; in other words, I'm not sure the mechanism that, for example, the IMF would be involved in to induce somebody to go from a fixed to a flexible rate -- they could suggest to them that it's in their interest, and indeed we do on numerous occasions, but there's no legal mechanism to create it because they always have the capacity of purchasing or selling dollar, yen, or euro or sterling assets in the marketplace and thereby create a non-floating currency.

SEN. STABENOW: One mechanism -- and I will close, Mr. Chairman. Thank you for your patience. But we do have in the Banking Committee -- I'm sure we will be hearing from Secretary Snow in his yearly report that he's required to give about countries that may be pegging their currency. And certainly many of us on both sides of the aisle have expressed concern particularly about China, and what the impact of pegging their currency has done in terms of the cost of goods and services in our country as well as selling into their country. And so there is a mechanism. If, in fact, the Treasury secretary would just simply certify that it's happening, at least internationally we would have the opportunity to make our case. And I'm hopeful the secretary will do that before the committee later this spring.

SEN. SHELBY: Thank you, Senator.

SEN. STABENOW: Thank you, Mr. Chairman.

SEN. SHELBY: Senator Bennett.

SEN. ROBERT BENNETT (R-UT): Thank you, Mr. Chairman.

This has been a most illuminating morning. Chairman Greenspan, you've helped focus a lot of issues on this debate. The debate, of course, has been primarily on Social Security. I had some questions on the band of interest rates, similar to Senator Sarbanes, but I think you exhausted those with Senator Sarbanes with your stating that the band -- normal keeps changing, and -- normal keeps changing. And I would just hope in the Open Market Committee you might think that around a 3 percent band has become normal in the present economy and not feel the need to go to higher levels, which may have greater historic patterns to them, and I'm encouraged by your comment on that.

But the Social Security debate has dominated the morning, so I will get into it as well and make the general statement that I always make: there's no such thing as repetition in the Senate, I've discovered, so you just keep saying it.

Any economic forecast that goes out more than six months is wrong. I don't know whether it's wrong on the high side or the low side; I just know that the way the economy works and all of the changes that go in, if you get beyond six months, you're getting into difficult territory.

And I believed that about the $5 trillion surplus; I knew that number was wrong. I believe that about the projections of a $4 trillion deficit; I know that number is wrong; it will be different.

The one thing that is not wrong, that is much more inexorable than an economic forecast is a demographic forecast. Demographics are destiny and they change very slowly and over a long period of time.

So I'm delighted to have you in your presentation here, and in your written statement, say that the demographic pressure on Social Security is going to begin in 2008, not 2018, not 2042, not 2052, or whatever, because that's the date when the demographics kick in and say that we are going to have a 30-year period of dramatic increase in the percentage of Americans who are over 65.

I'm delighted to hear Senator Schumer, as you talk about the fact that the present system isn't working, say "nobody disputes that." I can quote some statements on the floor during morning business where there are a lot of people who dispute that and say the present system is working beautifully and we don't need to do anything about it.

And I'm also delighted to have Senator Schumer say, in response -- in your dialogue, that we should have started on doing something about Social Security 10 years ago, and it would be easier if we had started then instead of waiting this long.

With that, let me get, however, to the point once again that you were debating with Senator Schumer, as to whether or not a personal account would increase national savings.

Now, your point here is a block of tax money, 12.4 percent of payroll, and you're saying if that portion which is currently coming out of the employer's side goes to a personal account, it produces no net increase in savings because the employer would save that if he didn't have to pay it, and presumably would invest it in capital stock, whatever, that would increase the productivity and, therefore, the reason you want national savings. So you could increase the national savings by saying to the employer: Don't pay that anymore; invest it.

But that portion that comes out of the individual's side gets invested in capital assets, which is different than how it's being invested now. So doesn't that shift in the investment strategy to capital assets as opposed to an accounting number somewhere in the unified budget mean that you will in fact get some increase in capital investment and, therefore, make a contribution towards increasing the productivity of the economy?

MR. GREENSPAN: Yeah, Senator, I agree with that. Let me just reiterate that what obscures the discussion is how to handle the transition costs, which are the equivalent in one form of a huge unfunded liability. But if you set that aside as a consequence of the past, and you merely ask which type of vehicle has the greater probability of adding to national savings in the example that you gave, clearly, one which is forced savings and, therefore, reduced consumption, will add to household, personal savings and, therefore, to national savings.

If, however, you put it into the existing system, and for the moment leave aside the question of changes in the trust fund, it's essentially a pay-as-you-go system which does not create national savings.

And therefore, the two models are fundamentally different.

And the complexity is how you go from here to a differing system. And to a very large extent, one's capacity to do that does rest with that issue of to what extent of the financial markets, taken the $10 trillion-plus contingent liability, and assumed it's a cost or debt of the government and have set long-term U.S. Treasury interest rates, in the context that that is their target of what the supply of debt is, and hence, that which moves the price, and not the 4 trillion, which is a debt to the public which is what is -- what changes with the unified budget balance.

SEN. BENNETT: Right. Well, I've run a business, and you focus on cash flow. And I remember very clearly the speech by the president of the United States, who said, "We are going to include surpluses in the Social Security account as part of the overall cash flow." His name was Lyndon Johnson, and it was during the time he was discussing the Great Society. And Republicans were claiming that he was running a budget deficit, and he said, "No, we're not running a budget deficit because we have this extra money coming into Social Security." I remember that speech very clearly, because I was in town and involved in that at the time. And ever since we went to a unified budget, on a cash flow basis the surpluses in Social Security have reduced the cash needs of the government to meet its obligations. And starting in 2008, that will begin to stop, as the Social Security surplus will begin to fall in the face of the demographic arrival of the baby boomers.

MR. GREENSPAN: I think that what happens, however, is that the rate of increase falls. And, indeed, that 2018 is the issue of when --

SEN. BENNETT: That's right.

MR. GREENSPAN: -- taxes fall below. But you're quite right in as -- when you get into 2008, you begin to see the leading edge's effect. But because we still have, I think it's 150 billion per year --

SEN. BENNETT: Yeah.

MR. GREENSPAN: -- additions to the OASI surplus, that first has to go to zero. So --

SEN. BENNETT: That -- yes. Sure. That's right. But -- but in terms of the unified budget, the amount that we can get -- "we" being the government as a whole -- the amount we can get from Social Security to deal with the unified budget deficit begins to decrease in 2008.

MR. GREENSPAN: That's -- that's correct --

SEN. BENNETT: And it becomes -- when it gets to 2018 or 2020 -- again, economic forecasts are never exactly accurate -- when it gets to that point, we will already on a unified budget point of view have had to raise our external borrowing, whether it be Senator Stabenow's concern of China or whatever, to make up the amount that we weren't getting from the Social Security. It will begin to produce a cash flow problem. When it crosses the line, we will have to borrow that much more, because at that point the Social Security trust fund will come to the government and say, "Redeem this bond." And the government will have to redeem the bond. It's a legitimate claim on the government. And then the government says, "In order to redeem that bond, we will sell a bond to the Japanese" -- or the Europeans, or whoever -- "so that we can have the money to redeem that bond." At that point, the interest on the bond to the Japanese or the Europeans will hit the unified budget pressure, cash flow pressure differently than the interest on the Social Security bond. Isn't that true?

MR. GREENSPAN: Well, it depends on how the accounting goes. Remember, what is going to happen in 2008, I believe, is you begin to get the extent of the Social Security surplus, which is part of the unified surplus --

SEN. BENNETT: Right.

MR. GREENSPAN: -- that begins to decline.

SEN. BENNETT: Right.

MR. GREENSPAN: And you're quite correct. It means that less and less is being added to the fund which reduces the amount of borrowing that would be required. At the -- 2018, if you believe the number --

SEN. BENNETT: Right.

MR. GREENSPAN: -- what happens is that the Social Security non- marketable issues have to be converted to marketable, and they are sold.

The issue -- I'm -- the issue of interest payment, remember, refers to interest outside the intragovernmental transfers, and I don't think that you get a significant interest rate effect there, but you do get the issue that you're pointing out; namely --

SEN. BENNETT: You don't a significant rate difference, but you get a significant cash-flow difference, because the intragovernment transfers, the interest obligation is an intragovernment transfer, and you don't have to come up with the cash for it. But once you have sold a bond to -- on the public market to replace the bond that's an intragovernment transfer, that interest payment has to be met in cash rather than the intragovernment transfer.

MR. GREENSPAN: That's part of the whole issue of the Social Security system going from accumulating surpluses to then creating deficits. But the point that I think is a more important and critical issue is that even those accumulations of surpluses are far short of anything that requires the full funding, and that while you can be concerned about the mechanics -- I think quite properly -- of what is happening, let's not lose sight of the fact that the real problem is not that we're going from $150 billion annual OASI surplus; the problem is that the number is not hugely larger and building up --

SEN. BENNETT: Well, my time is gone, Mr. Chairman. The only point I want to leave us with is that if we do nothing, as some are suggesting, we've still got to find several trillion dollars of additional cash. And so when we say, gee, if we do the private accounts we're going to have to find some cash, that's a transition cost, the point is, if we don't do anything, we have to find some cash.

MR. GREENSPAN: It's the same cash.

SEN. BENNETT: Yes, thank you.

SEN. SHELBY: Senator Bayh?

SEN. BAYH: Chairman Greenspan, thank you for your patience today and your testimony. I apologize for shuttling in and out. We are having a simultaneous hearing in the Intelligence Committee on global threats to the nation's national security. So we're trying to deal with both our physical security as well as our economic prosperity and security today, and I appreciate your contributions to the latter. And I might ask at the end of my questioning about the intersection between these two things.

My first question deals with the deficit and some comments that you made recently, I think at a foreign forum of some kind, about the voices of fiscal responsibility stirring here in our nation's capital. When I read those comments, I was inclined to think it might be the triumph of hope over experience, but I was interested to you see you state nonetheless.

So my question involves this: There are, as you know, skeptics who might -- have not heard those voices yet. One in fact referred to the budget proposal as a Swiss cheese, more interesting for its holes than anything else. And so I would like to ask you: When we look back on this year and we can quantify the size of the deficit for this year, what number would tell you that it was something more than a siren song, that in fact there was true fiscal harmony stirring? I think the budget deficit this last year was $412 billion. When we look back, you know, a year or so from now, what figure would you look at and you would conclude those voices were more than just rhetoric but in fact had been put into effect?

MR. GREENSPAN: You mean looking at -- well, I mean, it would -- there are two aspects to this. One is the short term -- you know, going out to, say, 2008 -- and then there's the post-2008 issue. The most important thing would be to look at --

SEN. BAYH: I'm just looking for accountability to hold all of us -- the executive branch and the legislative branch --

MR. GREENSPAN: Yeah, I would --

SEN. BAYH: -- to some benchmark of performance.

MR. GREENSPAN: I mean, I've been traumatized by Senator Bennett saying forecasts don't work out for six months, so I'm trying to avoid making a forecast out beyond six months.

I think that first of all that if the deficit as a percent of GDP does not go down, I think we're going into the 2008 forward period poorly positioned. But I wouldn't want to --

SEN. BAYH: Do you have a figure, you know, in terms of percentage of GDP you would look at to --

MR. GREENSPAN: I'd just assume not put a number because I'm not -- it depends on so many different things, and that number in and of itself --

SEN. BAYH: Unlike the rest of us, Mr. Chairman, you will have the luxury of reentering the -- having reentered the private sector by that time, so you --

MR. GREENSPAN: True enough.

SEN. BAYH: -- perhaps have some more liberty to try and quantify these things.

MR. GREENSPAN: I would say that whatever it is we do in the short run, unless we becomes -- start getting serious about the longer-run problems, I think we're going to run into them and be poorly positioned to effectively handle them without very significant problems.

SEN. BAYH: At some point, when you feel comfortable, in some form it really would help us to try and have some benchmarks of performance against which we can judge all of ourselves, both sides of the aisle, all branches of government. As you know, it's easy to talk about these things; it's a lot more difficult to implement them and then hold ourselves to some kind of standard.

MR. GREENSPAN: Well, let me tell you one of the reasons I hesitate, is that the unified budget is not the be-all and end-all of a measure of what government is doing because it's ultimately supposed to give us a judgment of the allocation of real resources essentially preempted by the federal government or, in fact, added if there's a surplus. And the trouble is there are other ways in which government can preempt resources, either by regulation, by guarantees which are not fully accounted for in the budget, by any of a number of different legal forms of preemption, of property and the like. So you can't take only that as a measure of what the overall issue is or its impact on interest rates.

At the end of the day, the standard of how well we're doing really gets to the question of how is the financial system, how have we financed this, and what are we doing? The financial markets will tell you very quickly whether there's something wrong with the budget processes. And rather than say -- get somebody to forecast and say this is the standard, I will assure you the far more useful standard is watching what's happening to our long-term U.S. Treasury rates.

If long-term U.S. Treasury rates are behaving well, it's saying you don't have a significant problem over the maturity of Treasury instruments, most of the maturity. If they start to behave poorly, the markets are sending a signal, which I think it is very crucial that the Congress be aware.

SEN. BAYH: (Off mike) -- agree this is a longer discussion. I'm afraid that if we wait for -- I -- many observers, including myself, have been surprised the markets have not reacted more than they have to date. And I'm afraid, as you know, market psychology being what it is, if we reach that tipping point, it may require more difficult steps to turn around than would be necessitated if we act sooner, rather than later.

But let me get to a second question, Mr. Chairman, and say I think you know what I'm driving at here. I just am looking for some benchmarks in performance against which to try and hold the government accountable when it comes to the deficit, understanding that regulatory policy and other things also contribute to economic performance.

MR. GREENSPAN: Well, one standard is, if the unified budget deficit is 2 percent of GDP or less, it stabilizes the ratio of debt to GDP. So if you're looking at a straightforward numerical type, that's not a bad one. But again, I want to caution you that it's a little simplistic, and I wouldn't want to press it too far.

SEN. BAYH: We should be so fortunate as to get to 2 percent of GDP, and we could argue about the other factors that might come into play. But thank you.

My second question, Chairman -- perhaps you can help me out -- I again apologize; I missed some of the discussion because I had to attend the other hearing, and I'm yet going to have to return to the other hearing -- with some cognitive dissonance I'm having over some of the debate here in Washington, where, as many of my colleagues and, I think, you alluded to quite rightly, we have this tremendous demographic challenge that's going to affect our fiscal position coming along. We have the underlying -- the current budget problem, both of which are going to -- one -- the latter of which necessitates borrowing in the short run; the latter (sic) of which is going to necessitate perhaps, if nothing is done, large and ongoing borrowing in the long run.

So we have that message that we have, you know, serious fiscal challenges that we have to face, that may necessitate large amounts of borrowing.

At the same time, in the president's budget proposal, we have additional tax cuts included. So apparently we're in such good fiscal condition that we can afford additional tax cuts.

As you have convinced me in the past, there is no such thing as self-financing tax cut. We can argue about the percentage of growth that is occasioned by that, but you know, there is a loss of revenue.

How do you -- how do we reconcile these two positions? On the one hand, we're facing large and perhaps ongoing needs to borrow. But on the other hand, we're flush enough with cash, we can continue with additional tax cuts at the same time.

MR. GREENSPAN: Well, I think the issue is -- is that you -- at least the way I would do it is, there are certain of the tax cuts which I view as enhancing economic growth and therefore enhancing the revenue base. I've been arguing, since the PAYGO has been dropped in September 2002, that we should restore it as quickly as possible. The way I would reconcile my own position is that I think maintaining the tax cuts on the -- the reduction in taxes on dividends, which essentially partially integrates the individual and corporate taxes, eliminating part of the double taxation on dividends, I think, is a good thing.

But because I hold to the position that we should be adhering to PAYGO, I think it's necessary to offset it by other means, as is required by the law, were PAYGO still in effect.

But I don't think you can essentially eliminate all tax cuts or increase spending because you're endeavoring to get the budget deficit down. You would probably argue, as I would, that there are a number of things which should be done even if we have this type of problem. But that does not mean that we shouldn't be focusing on the goal of getting the deficit down, especially as quickly as we can, before we begin to run into the really serious problems, maybe 2012, 2014. We don't have a great deal of time to do it.

SEN. BAYH: Mr. Chairman, I have time for just one more -- hurry -- very quickly. We -- I want to ask you about our comparative advantage looking forward, Mr. Chairman. You have been a long-time observer of our economy. I hear shortly you're going to be liberated from the burdens of public responsibility and might have a chance to reflect at greater length. But I was struck in December, when my wife and I were in India, in Bangalore, and visited -- General Electric employs 6,000 people in our state. One of their worldwide innovation centers was located in Bangalore.

There's a biotech company there that heretofore has been only engaged in generic production but is now getting into proprietary discovery. Our economy -- and my state's a good example. A hundred years ago, most people were employed in agriculture. We transitioned into manufacturing, which peaked in the '50s. We've then transitioned into a service sector economy. As succinctly as you can, how would you define, looking forward, our comparative advantage in a world in which our competitors -- India, China and the others -- are rapidly moving up the innovation curve?

MR. GREENSPAN: I think, Senator, the question you're asking is, what creates the wealth of nations? And as best I can judge, our competitive advantage has been a combination of our Constitution and the skills of our workforce. It's not raw materials. It's not anything other than what's in people's heads and the laws of the land -- the rule of law, the protection of property rights -- and a general view on the part of the rest of the world that this is a wonderful place in which to invest because property rights are sacrosanct to the extent that they're not elsewhere. Remember there's an awful lot of investment that has come into the United States. We have moved a lot of our investment abroad, but a lot of investment's been moving here, as well.

But the bottom line is that the only thing we have which maintains our standard of living, that which creates essentially our ability to have a level of income which is (a claim/acclaimed ?) against the rest of the world, the reason we are able to do that is we create things, the ideas that we have, and we have an economic system which capitalizes on the way those ideas function which most of the rest of of the world, indeed perhaps all of it, cannot match.

That's the reason why I've argued that our education problems are serious, because it's right at the root of where our, as you put it, comparative advantage lies.

SEN. BAYH: So our comparative advantage lies in the rule of law that we have and in the quality of our people.

And I would just conclude by thanking you again, Mr. Chairman; and observe, Chairman Shelby, I well recall Chairman Greenspan in my previous incarnation -- and I think, Senator Corzine, this gets to your point and perhaps Tom Carper was there -- I well recall your addressing a meeting of the National Governors Association many years ago on the issue of productivity growth and mentioning that one of the most important things we could do to increase productivity was to enhance the skill level of our people, and that would help us close the increasing gap between the haves and have-nots in our society and indeed improve the comparative advantage of our society as a whole.

So I thank you for your words and the indulgence of my colleagues.

SEN. SHELBY: Thank you, Senator Bayh.

Senator Corzine. Thank you for waiting.

SEN. CORZINE: Thank you, Mr. Chairman.

I want to get to the integration of this issue of wealth disparities or income disparities and the Social Security question. First of all, I've got a couple of just housekeeping things.

Do you recall what the 1983 commission used as far as the time horizon to figure out its suggestions on solving the then Social Security crisis? Was it an indefinite one or was it an actuarial time horizon?

MR. GREENSPAN: No, it was 75 years through 2058.

SEN. CORZINE: As I recall, and so you're now suggesting that that was the wrong -- well, I'm not saying --

MR. GREENSPAN: No, I'm saying that it was wrong back then, but the real problems which would be confronted as a consequence of that were still 25 years off.

SEN. CORZINE: There is a huge difference between 3.7 and 10- whatever, and --

MR. GREENSPAN: Yeah. No, the 3.7 -- let's put it this way. Any defined benefit program goes to perpetuity of necessity. So that the 75-year is an artifice. I'm not sure what it means. We knew that back in 1983, but that was the historical convention --

SEN. CORZINE: Well, it does allow for thinking about financing mechanisms that are within the mindset of most of the people who are in that workforce today, and a whole bunch of them that aren't even born yet. And so it strikes me that, you know, that one could reasonably, and I think actuarials often do, think in some finite time frame so that you're not actually trying to solve some problem that's completely --

MR. GREENSPAN: Well, but, Senator, I think it works fine for the cash pay-as-you-go system, but it does nothing to create the savings, which creates the capital investment, which creates the goods and services that are required.

SEN. CORZINE: Couldn't agree more. I just wanted to know whether in 1983 we were using a 75.

SEN. SARBANES: Jon, would you yield for a quick question?

SEN. CORZINE: Sure. As long it doesn't come from --

SEN. SARBANES: In '83, was the crisis you faced that in a few month's time, the money being paid into the Social Security trust fund would not be sufficient to pay the benefits?

MR. GREENSPAN: Correct. In other words, what happened would be that the trust fund was essentially running down to zero, which statutorily required that we pay benefits only to the extent that revenues came in.

SEN. SARBANES: So that is a situation comparable to what is now forecast to happen in 2050, correct?

MR. GREENSPAN: 2042 or 2052, yes.

SEN. SARBANES: Okay.

SEN. CORZINE: Okay, let me -- I just want to reiterate -- this will only take a second -- but one is not arguing that the financing structure that is being suggested by the president with private accounts is dealing with that solvency issue, whether you use 75 years or you use infiny -- infinity?

MR. GREENSPAN: No, it doesn't. No, the -- you mean the private accounts by themselves, personal accounts.

SEN. CORZINE: Now, when we were dealing with this problem in 1983 -- and I think Senator Reed quoted, "should not alter the fundamental structure of the Social Security program or undermine its fundamental principles" -- fundamental principles being guaranteed benefits for the disabled, child and survivor benefits, and retirement. I want to get at this because the fundamental principle is a social insurance program, not an investment program, not a defined benefit or a defined contribution.

MR. GREENSPAN: No. That's -- the question that you have to answer is whether or not you want to commit to that irrespective of the source or revenue. Indeed, you know, we have actually done that. I cannot believe, and did not believe in 1983, that somehow or some way we would cut benefits. That was not something which, in my judgment, seemed credible at all. Nor do I believe that in -- if in the world were to emerge -- and I think that Senator Bennett's right -- one thing we're sure of is it won't happen the way we're saying. But if it did --

SEN. CORZINE: I think all of us accept that.

MR. GREENSPAN: -- the chances of cutting benefits in 2042, for example, because they're run out, I put that probability close to zero, if I couldn't find a lower number.

SEN. CORZINE: So it depends on how you define that. I think in 1983 you talked about changing the timeframe in which people -- we got onto a(n) extend -- the timeframe before benefits would be received, you know, one person would look at that and say it's a benefit. I don't. It is -- there are -- what I would like to get to is that the fundamental financing structure still has variables that you could adjust to deal with even the $10 trillion debt.

MR. GREENSPAN: Oh, certainly. Oh, absolutely --

SEN. CORZINE: I mean, there are solutions, and they're easier to implement if we do them sooner rather than later, I think is -- and which is what was done in 1983, which was to build up these surpluses -- unfortunately, we turned around them and spent them for current expenses on the cash flow basis that Senator Bennett talked about. But there was a desire to prefund liabilities that was embedded in the recommendations. We have prefunded them, but we -- because of the reality of the unified budget, we've taken payroll taxes to pay for tax cuts or wars or whatever the expenditure or reduction of revenues has been -- if I'm not mistaken, just on an accounting basis. Payroll taxes come in, they go out for some other purpose with a bunch of borrowing going on.

My real question is, because I think the fundamental principles are still sound, that there is a need for social insurance on disabilities, child and survivor benefits and for seniors.

We may have to alter -- and my own view is we may have to deal with the financing structure, and you've had great ideas in the past. But you know, this is going to be hard for you to see, but -- and actually the only thing that really counts -- and I worry about this very deeply -- is that because of a lot of the reasons that you've talked about -- skill sets and others -- real earnings for the bottom quintile or decile in our country have actually declined in the last four years. They are flat for the 25th percentile, they're up a measly two-tenths of 1 percent for the medium percentile, and they're a little bit better for the 75th percentile and the 90th percentile. I wonder what they are for the 1 percent. We didn't have it on this chart. I suspect that real earnings have gone up pretty well for the most skilled in our society.

But aren't we setting up a situation, if we take away guaranteed benefits, that the vast majority of people in this society are going to end up with less savings? I mean, we may have to have broad changes -- maybe we can have broad changes in our education skill levels development in our society, but otherwise we're going to end up with a society that has less ability to save and we're taking away the guaranteed benefit.

MR. GREENSPAN: Well, the guaranteed benefits are, I think, unrelated to this question which you raise, with which I would agree; namely, obviously the lower the level of income, the less you -- capability.

SEN. CORZINE: Well, they're relevant. If the individuals don't have the capacity to save and then we get back to a situation that we've had in other periods in history where those most vulnerable in the society don't have the ability to maintain a(n) above-poverty standard of living, which is where we came from before Social Security was implemented both for children and --

MR. GREENSPAN: But Social Security -- it depends on whether you're discussing the Social Security, say, for retirees, which -- in other words, that's different. What I'm trying to get at is the issue that you're raising with respect to the shortfall of incomes of those below the median or just above the median is --

SEN. CORZINE: Fifty percent of the workforce.

MR. GREENSPAN: Yeah, the active workforce. To the extent that real wages fall in that area, one would presume that their savings rates fall as well because that's what people do when their incomes go down.

I think the question of Social Security and the guarantees and the like I think is a somewhat different issue. But I think there's also a very interesting question here.

SEN. CORZINE: Well, that was the fundamental principle of Social Security, though; it was to provide guaranteed benefits for all. That was the contract.

MR. GREENSPAN: Well, it was mainly for retirees. We now, because we have DI -- I mean disability -- which is a different program, we have a lot of people under OASI -- I'm sorry -- OASI who are below so-called retirement age, but the basic purpose is the retirement program. And I think here --

SEN. CORZINE: And survivorship, too. Survivorship.

MR. GREENSPAN: Here I think that is the basic purpose of it. I mean, the problem here is I think we have to make some decisions on whether we want to make programs as social insurance or means-test programs and make them essentially for people who are in real serious difficulty.

SEN. CORZINE: But that's getting a financial structural solution which you could put into any suggestion. That would be independent of whether you had a personal account.

MR. GREENSPAN: I agree with that.

SEN. CORZINE: And finally, I -- I know my time is up -- you have, and I think appropriately so, said "forced savings" as you've described the private accounts.

MR. GREENSPAN: It's forced in the sense it -- and they'd better be. In other words, in the sense that they should not be available for other than retirement purposes.

SEN. CORZINE: Forced savings is not unlike forced savings at a national level with regard to taxes, I suppose. I mean, they are -- they are roughly the same equivalent with regard to getting to whether we have increased savings. If we run deficits and the government is taking in more -- or, spending more than it's taking in, you end up -- you end up with this declining savings rate, or hole in our savings function. But, you know, you do have choices. And we have avoided those choices pretty clearly as we have built up these deficits in the last four years. And it strikes me that along the lines of what Senator Bayh is talking about, you may not know what the right number is. But if you look at 2009 and beyond, and that's -- this is the point that I want to make -- we keep making decisions. I hear this described as a $743 billion hole in the first 10 years in this transition to private accounts. The fact is, that allows for the fact that we're not doing anything between 2005 and 2009. And then we'll get to 2009 and find out it's a trillion-four, like we found out on Medicare. We need to have some truth in -- or precision in what it is we're comparing and contrasting, when we're comparing these numbers. And I'm afraid that we're using multiple sets of books under the rubric of a unified budget. I guess that's more of a statement than it is a question. But the fact is, is that, you know, somebody's going to say 735 billion doesn't meet the Greenspanian test of serious borrowing, when, in fact, we're just avoiding the first four years, and then it's going to start it in 2009. I just want to make sure --

MR. GREENSPAN: Well, I think the issue essentially is that, to go back to an earlier point which we have to keep in mind, about -- remember, savings, as you know as well as I, doesn't create investment. That is, implicit in all of this is that the incentives for investment are there, and that when you think in terms of taxation and how one creates the savings, it is conceivable that you can create the savings, but regrettably at the same time, so diffuse the incentives to invest that we will not get the capital assets we need to essentially produce the goods and services, so that proper balance here I think is quite important. And I think that -- I think it's an extraordinary complex and difficult issue.

I don't recall as long as I've been here -- we've known about, of course, the demographics for quite a long time. But we've never addressed them. And it's only now that we're beginning to see the significance of how big the size of the hole is.

SEN. CORZINE: Mr. Chairman, I --

SEN. SHELBY: Go ahead.

SEN. CORZINE: That's true. But we have a Medicare problem, a Medicaid problem, a pension benefit guaranty problem. These issues, when you use the 75-year horizon, which I tend to do -- I think there's something in an estimate we heard in the Budget Committee of something like $43 trillion. Even under your -- and with -- using a 75-year horizon, Social Security is 3.7 of that.

So I -- you know, we --

MR. GREENSPAN: Actually, I think I've got that number.

SEN. CORZINE: We need to really make sure we're looking at where the problem really is, if we're going to be intellectually honest about getting at these issues.

SEN. SARBANES: In fact, Mr. Chairman Greenspan, you said before this committee, in February two years ago, the really major fiscal problem is not Social Security, it is Medicare.

MR. GREENSPAN: I agree with that. In fact --

SEN. SHELBY: Senator Carper.

SEN. THOMAS CARPER (D-DE): Thanks, Mr. Chairman.

Chairman Greenspan, welcome. Sometimes when I speak to a group back in Delaware and I'm like the last speaker before they have a meal, I will say to them, "I'm all that stands between you and your meal." Other times when we have a --

SEN. SHELBY: Maybe not. You have the two of us left.

SEN. CARPER: Is that right?

Well, I started to say I may be the only -- when I have a witness who has been sitting in for hours and hours and hours testifying without a break, and I'm the last person to ask a question, I will say, "I'm all that stands between you and a chance to visit the nearest restroom." I won't -- (chuckles) -- I won't say that today, but I might say it on another question.

We talked a lot about Social Security today, and I want to beat a dead horse -- well, actually a live horse. But I want to ask you to go back in time with me about 23, 24 years. And I sit on another committee called Government Affairs and Homeland Security. Last August, among our witnesses were Governor Kean and former Congressman Lee Hamilton. And they had come to us that day to present the recommendations of a bipartisan commission, 10 members, five appointed by the president, five appointed by the Democratic leadership of the Congress. And they recommended to us unanimously that we take 44 different steps as a follow-up to the attacks of 9/11.

And I remember saying to Governor Kean and Congressman Hamilton, I said, "How did you do this? How did you fashion, in a politically charged time and arena, with a diverse group of people on your commission, how did you fashion a bipartisan consensus on all these issues?" And there were literally 10-to-0 votes on all of them.

And they said in response what happened is that the two of them, the chair and the vice chair -- one appointed by the president, the other appointed by Senator Daschle and Congresswoman Pelosi -- said we spent a lot of time together over the last two years and we got to know each other, developed a sense of trust for each other, and friendship. And out of that bond came an environment for the rest of the committee to band together and to join together, setting aside their partisan differences, but just to work to try to do what was right for the country.

Well, I was elected to Congress, to the House, in 1982 and joined a young Mr. Shelby down there in the -- I like to say I knew him when he was a Democrat. We were both on the House Banking Committee; used to work out in the House gym together. Now we work out in the Senate gym together.

But I -- we -- when I joined him, I found out in January 3rd, '83, which was the day I was sworn into the House, that we had a crisis with respect to Social Security and that we needed to do something about it. I'd heard talk about it; talked a little bit about it when I ran in '82 for the House. But I found that in '83 this was real and there's a real crisis, and we faced the possibility of running out of money.

Fortunately, you and a number of other people had been, I think, appointed by President Reagan and by -- I think by Tip O'Neill -- maybe by Robert Byrd, whoever was the Democratic leader of the Senate I think made appointments, to another bipartisan commission that had worked, I believe, throughout '82 and came to us in '83 with a host of recommendations. The way I like to describe it is we sort of joined hands, House and Senate, Democrats and Republicans, and we either jumped off the bride or we drank the Kool-Aid together, and ended up sort of adopting lock, stock and barrel all your recommendations; passed them and set Social Security on a more sound footing for several more decades.

What I want to ask you is really the same question I asked Lee Hamilton and Tom Kean. How were you able to -- and I think you were the chair or the vice chair -- the co-chair of the commission, as I recall -- how were you able to create at that time a unanimity of -- across party lines -- politically charged, difficult issue -- to be able to present to us the consensus perspective and recommendations that we adopted?

MR. GREENSPAN: Well, I would hope so. It was done actually in two ways. The first was that one of the senior commissioners was an expert and appointee of Tip O'Neill, Bob Ball, who is still around --

SEN. CARPER: Yep.

MR. GREENSPAN: -- and I sort of merged in the sense that he would represent the speaker and report back to him about what the various choices were, and I would report back to Jim Baker and President Reagan. And so we kept a line going between the decision makers in the White House and in the Congress as the commission moved forward from position to position, and in a sense, worked concurrently, both within the commission and in the Congress and in the White House, so that we didn't find that at the end of the day the commission came out one place and there was no support back with the speaker or the president. So that occurred.

And then at the end, we came up with a report, and Bob Ball and I went up to the Ways and Committee to testify on the report. And we indicated that it is up or down vote. And I said to Ball, "When the Republicans ask you a question, I will answer it, and I hope you will answer the questions that the Democrats ask me." And it worked remarkably well. And the reason it did is similar to the Kean- Hamilton relationship. There was a belief that the actual program, which was developed -- and remember, we had Pat Moynihan and Claude Pepper and Bob Dole, and I don't know whether Jack Heinz was on that --

SEN. CARPER: He was.

MR. GREENSPAN: But it was a pretty formidable group of people. And what we eventually decided was that the commission report was a compromise and that it was up or down. In other words, we argued that this should not be subject to amendment, because if it did, it would unwind the whole compromise.

And with very minor exceptions, the Congress -- the Senate and the House -- both agreed with that.

And what came out was essentially the commission report pre- agreed to by the speaker of the House and -- I think Jake Pickle was at Ways and Means at that time -- and President Reagan. So essentially, the agreement did not occur as the commission report and then it went to the Congress. I suspect that rarely, if ever, works.

SEN. CARPER: How -- just refresh my memory. My recollection is that President Reagan appointed some of the members, that Tip O'Neill appointed some of the members, and that perhaps the Democratic leader of the Senate appointed some.

MR. GREENSPAN: I think that's correct. It was a national commission, which would be presented in the form that you suggest, Senator.

SEN. CARPER: In my recollection, it was the commission was created maybe in the second half of 1981 and that you worked through '82 and presented your recommendations to us in '83.

MR. GREENSPAN: I think that's probably correct. I don't remember the actual date it began.

SEN. CARPER: Do you think the way that the commission members were selected -- that is, some by the president, Republicans, some by some of the congressional leaders, who in that case were Democrats -- do you think that had maybe some bearing on the fact that you were able to come bring a consensus proposal to us?

MR. GREENSPAN: I think the question is that, as you know as well as I, there was a far greater degree of comity back then. And I think that what we need is a good deal more of that. But primarily what you need is a bipartisan group of people getting together who have the capacity not only to reach a compromise agreement, which means that there are parts of that agreement which everyone in the room disagrees with, and present it as an up-or-down type of issue. And you need a mechanism in which that occurs, because you can't have a particular commission report subject to continuous revision.

I remember on another commission that I was on, one of the members said, "I would like to agree with you at this particular stage, but since this is not the final negotiation, I don't want to state my position at this particular point." And it was a perfectly sensible operation, and indeed we didn't get very far, basically because of that sort of problem.

So you have to figure a way in which the final decisions are made concurrently with the commission and the Congress, because if you leave those types of results, especially things which are compromises, they get amended to death and it unwinds the whole agreement.

SEN. CARPER: Okay.

Mr. Chairman, thanks very, very much.

SEN. SHELBY: Thank you for bringing that up.

Chairman Greenspan, we need to find another Chairman Greenspan in the making out there somewhere to put this type thing together. I have a couple of questions, and I'll try to be quick.

One of the Social Security reforms options -- and there are many out there, and there will probably be many more -- that's been mentioned is changing the way that benefits are adjusted over time are indexing. Today it's my understanding that the indexing is based on wages mainly, as opposed to inflation, you know, -based index. What impact would such a change to inflation-backed index have on the financial soundness of the Social Security program in the years to come?

MR. GREENSPAN: Well, Senator, currently we index the date -- we index the first benefit, the initial benefit --

SEN. SHELBY: Explain how that works, just for the --

MR. GREENSPAN: Well, what -- what they do is they effectively take the -- an average of wages over a long period of time, and they construct effectively a specific benefit --

SEN. SHELBY: Okay.

MR. GREENSPAN: -- that is, the initial benefit, which is then currently indexed --

SEN. SHELBY: For an -- for an individual?

MR. GREENSPAN: -- for the individual --

SEN. SHELBY: Okay.

MR. GREENSPAN: -- which is thereafter indexed by inflation, so that the real benefit doesn't change after retirement, whether it's at 62 or 65. And using the average, trying to get the average wage as the index creates a much higher initial benefit than were you to use retrospectively prices. And the reason is that wages will reflect productivity increases, whereas prices will not. If you, however, now substitute prices for wages in creating the initial benefit, you will have a -- essentially a benefit which will, whereas now its ratio to your previous income has been stable, will begin to fall through time.

SEN. SHELBY: Okay.

MR. GREENSPAN: And if you make a full adjustment, going from a so-called wage-adjusted initial benefit to a price-adjusted initial benefit --

SEN. SHELBY: Initial benefit, is what you're talking about.

MR. GREENSPAN: I'm sorry.

SEN. SHELBY: You're talking about initial benefits.

MR. GREENSPAN: -- initial benefit -- you effectively wipe out all of that $10 trillion that I've been mentioning.

SEN. SHELBY: Over -- over many years.

MR. GREENSPAN: Yes. But, as a number of people have mentioned, the replacement ratio, which is now around 40 percent, as I recall, starts to go down materially.

One of the issues that's involved here is that with the demographics that we are looking at, in most of the scenarios the replacement rate would go down in any event.

SEN. SHELBY: Any event.

MR. GREENSPAN: And the only issue is to what extent. So it's not a question of being capable of holding that 40 percent indefinitely without causing problems in the standards of living of the active working population at that time.

SEN. SHELBY: Chairman Greenspan, what about if you're 55 years of age and you just retired and -- would that affect -- if they were to go to the inflation-based index for the future, what would that do to the retirees? Or let's say you're drawing Social Security now, you're 70 years of age.

MR. GREENSPAN: Oh, you mean -- well --

SEN. SHELBY: Let's say you're drawing Social Security now. What would that do if -- to the future?

MR. GREENSPAN: It would have no effect.

SEN. SHELBY: No effect on the people that are retired?

MR. GREENSPAN: Because the number -- it's -- the initial benefit --

SEN. SHELBY: Initial when you retire, isn't it?

MR. GREENSPAN: I'm sorry?

SEN. SHELBY: When you initially start computing --

MR. GREENSPAN: Yes. I mean, it doesn't effect -- I mean, once you're retired and you're getting a benefit, that is indexed by the consumers price index, and that is not -- that is not involved in this change, as I understand it.

SEN. SHELBY: But it's something that, as things are put on the table, that we all should maybe consider anyway. Is that correct?

MR. GREENSPAN: I think that it's one of the most effective ways of coming to grips at closing the actual gap between expected revenues and expected benefits. There are a lot of other things you can do, but the impact is fairly substantial from that sort of change.

SEN. SHELBY: I want to touch on one last thing. Your written testimony, Mr. Chairman, notes that the low national savings rate could eventually slow the rise in living standards, either by increasing the burden of servicing U.S. foreign debt or by impinging on domestic capital formation. To what extent will the anticipated further increases in interest rates affect this possibility?

MR. GREENSPAN: Well, it has two effects in the sense -- one, if interest rates rise, one would presume that the incentives to invest would fall. I should say real interest rates rising. And it will concurrently, presumably, attract funds into the United States because of the rates of return. I don't think you could make a judgment as to what the overall impact is, but it's one of the issues. Far more important, for example, is the differential growth rates between the trading partners. Clearly, the exchange rate has an impact. Interest rates have a number of different effects, but they're rarely critical in the issue of the determination of the current account balance.

SEN. SHELBY: Mr. Chairman, last week the Atlanta Federal Reserve president, Jack Guynn, in an interview with The Wall Street Journal, said, as I understand it, the central bank could soon remove the words "measured" and the word "accommodation" from the official statement.

What's your view as to whether such a change in the FMOC's message is likely? And what would such an action tell us about the likely course of action in the future as far as interest rate increases or movement?

MR. GREENSPAN: Well, I think what President Guynn said is obvious. We're not going to have the same statement in perpetuity. At some point it's going to change.

SEN. SHELBY: Sure.

MR. GREENSPAN: I can't really comment on --

SEN. SHELBY: I know.

MR. GREENSPAN: -- when and what conditions, because that's a decision that the federal open market committee has to make.

SEN. SHELBY: Chairman, thank you for your appearance here today. And we'll see you a lot probably before the year is over. Thank you very much.

(Gavel.)