Greenspan Calls Treasury Yields ‘Canary in the Mine’

March 26 (Bloomberg) -- Former Federal Reserve Chairman Alan Greenspan said the recent rise in Treasury yields represents a “canary in the mine” that may signal further gains in interest rates.

Higher yields reflect investor concerns over “this huge overhang of federal debt which we have never seen before,” Greenspan said in an interview today on Bloomberg Television’s “Political Capital With Al Hunt.”

“I’m very much concerned about the fiscal situation,” said Greenspan, 84, who headed the central bank from 1987 to 2006. An increase in long-term interest rates “will make the housing recovery very difficult to implement and put a dampening on capital investment as well.”

The yield on 10-year Treasury notes was 3.85 percent at 3:08 p.m. in New York, down three basis points from late yesterday and up from 3.69 percent at the end of last week.

U.S. interest-rate swap spreads declined to the lowest levels on record this week, reflecting investor concerns about the ability of nations to finance rising fiscal deficits.

The rate to exchange floating- for fixed-interest payments for 10 years fell below the comparable-maturity Treasury yield for the first time on March 23. The swap spread reached as low as negative 10.19 basis points yesterday before reaching negative 7.63 basis points.

Record Deficit

The U.S. budget deficit reached a record $1.4 trillion for the fiscal year that ended Sept. 30 amid falling tax revenue from the recession, a bailout of the banking and auto industries, and the $787 billion economic stimulus package.

“I don’t like American politics and what’s happening,” Greenspan said.

Historically, there has been “a large buffer between the level of our federal debt and our capacity to borrow,” he said. “That’s narrowing. And I’m finding it very difficult to look into the future and not worry about that.”

Greenspan said in an interview last year that a consumption tax was a likely response to a widening budget deficit. That may not be sufficient when the gap is caused by a failure to cut spending, he said today.

“I’m not convinced by any means that we can succeed in stabilizing this long-term outlook strictly from a value-added tax,” Greenspan said.

2001 Tax Cut

Greenspan in 2001 supported the first round of tax cuts under President George W. Bush. At the time, the federal government operated with a surplus, and Greenspan told Congress he didn’t think the cuts would lead to a deficit.

He told the Senate Budget Committee on Jan. 25, 2001, that “having a tax cut in place may, in fact, do noticeable good.” The next year he said it would be unwise to unwind the tax cut. As deficits returned, he became an opponent of further tax cuts, telling Congress in 2003 that “fiscal stimulus is premature.”

In today’s interview, the former Fed chairman said the U.S. economic recovery has been driven “to a very large extent” by a resurgence of stock prices. The Standard & Poor’s 500 Index has jumped 73 percent since its low on March 9, 2009. The index was little changed at 1,165.29 at 3:08 p.m. in New York.

“You can see the whole blossoming of finance,” Greenspan said. “As these stock prices have gone up, debt became far more valuable, and you can see this huge issuance, especially of junk bonds.”

A continued rally in share prices could help sustain the expansion, Greenspan said. Still, the unemployment rate could remain “not terribly far from where it is” at 9.7 percent as people re-enter the labor force to take advantage of job openings in a growing economy.

Company Earnings

The U.S. economy expanded at a 5.6 percent annual rate in the fourth quarter of 2009, and corporate profits climbed, figures from the Commerce Department showed today in Washington. Company earnings increased 8 percent, capping the biggest year- over-year gain in a quarter century.

On the Chinese economy, Greenspan said there are “significant bubbles” whose consequences will be hard to predict because of a lack of data.

“There are significant bubbles in Shanghai and along the coastal provinces, but there’s some of that going back into the hinterlands as well,” Greenspan said. “Remember that the bursting of the bubble by itself is not a big catastrophe. We had a dot-com bubble, it burst, and the economy barely moved.”