Greenspan Sees Negative Market Reaction, Warns of Italy

Sunday, 07 Aug 2011 12:06 PM

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Former Federal Reserve Chairman Alan Greenspan says he expects the stock market slide to continue in the wake of a decision by credit rating agency Standard & Poor's to downgrade the U.S. credit rating, even as an S&P official predicted little market impact.

Appearing Sunday on NBC's "Meet the Press," Greenspan said markets will take time to bottom out and that he expects a negative reaction on Monday to the S&P action. He cited a tumble in the Israeli stock market.

Another U.S. recession "depends on Europe, not the U.S. We were doing fine until Italy ran into trouble," he said. “That destabilized the European system, and the crisis re-emerged. Europe is very critical to the United States in the sense not only do we have a fourth of our experts there, but more importantly, significant proportion of the foreign affiliate profits, in fact half of U.S. corporations, are in Europe.”

“And that has been a very important driving force in the overall earnings of U.S. corporations and, therefore, the stock market rise, which has been the most important driver of economic activity in the United States. When Italy showed signs of significant weakness in selling its bonds -- the yield is now over 6 percent, which is an unsustainable level -- it created a massive problem within Europe because Italy is a very large country, cannot be easily bailed out and, indeed, cannot be bailed out.”

Asked on the show if he thought U.S. markets will crash in the wake of the downgrade, he said: “It's difficult to say but they only test we have is the Israeli market and it has tanked. But also, there are protests there [and the market was not open on Friday, so it's playing catch-up], so I don't know whether it's one or the other.”

But Greenspan also says he doesn't see any risk in investing in the United States and says that S&P's downgrade won't change that. 

“My projection is negative. But Treasurys are still safe. The U.S. can pay any debt it has because it always can print more money.”
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The former Fed chairman says the downgrade "hit a nerve" and is damaging to the "psyche" of the country. But he says he can't foresee a scenario in which the U.S. will default on its debts.

He said that U.S. government bonds are safe investments. “Very much so,” he said.

“The S&P hit a nerve that there's something basically bad going on. And it's hit the self esteem of the U.S., it's hit the psyche more than I expected. Because the economics is very clear to me. We're fine. But this was about the debt ceiling, and how Congress negotiated to the brink.”

The Aug. 5 downgrade followed the biggest weekly selloff in U.S. stocks in 32 months, with the S&P 500 Index slumping 7.2 percent to its lowest level since November. S&P’s managing director of sovereign ratings, David Beers, said he doesn’t expect markets to react significantly when they open tomorrow.

“Based on historical experience, we wouldn’t expect that much financial impact,” Beers said today on the “Fox News Sunday” program. “The markets are reacting to a lot of factors, not just what S&P said on Friday.”

Investors seeking a haven amid concerns the global economic rebound is fading have bought Treasurys in recent weeks, even after S&P warned it might lower the U.S. rating. Yields on benchmark 10-year notes closed at 2.56 percent Aug. 5, before S&P announced its decision, down from 3.12 percent a month ago.

Greenspan predicted the economic slowdown would stop short of becoming a new recession. “I don’t see a double dip but I do see it slowing down,” Greenspan said.

For the U.S., he said “raising taxes and spending cuts are necessary measures, but both hurt the economy.”

The U.S. Treasury Department says S&P made a $2 trillion mistake in its calculations. The department said in a statement that “there is no justifiable rationale” for the move.

S&P isn’t ruling out the possibility of a second downgrade. The company has a “negative outlook” on the U.S., signifying a one-in-three chance of a cut in the next six to 24 months, John Chambers, chairman of S&P’s sovereign debt committee, said on ABC’s “This Week.”

“If the fiscal position of the United States deteriorates further, or if the political gridlock becomes more entrenched, then that could lead to a downgrade,” Chambers said.

Two other ratings companies, Moody’s Investors Service and Fitch Ratings, affirmed their AAA credit ratings for the U.S. on Aug. 2, the day Obama signed a bill that ended the debt-ceiling impasse. Moody’s and Fitch both said downgrades were possible if lawmakers fail to enact debt reduction measures and the economy weakens.

Austan Goolsbee, who stepped down last week as chairman of President Barack Obama’s Council of Economic Advisers, said on NBC’s “Meet the Press” that the conflict over the federal deficit was threatening to divert attention from sagging economic growth.  _________________________________________________________________________

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“There is a danger that if we just keep saying the number one thing we have to talk about is all about the short run deficit, we are losing sight of the fact that we’ve got to reignite the engine of job growth,” said Goolsbee, who is returning to his teaching position at the University of Chicago.

Lawrence Summers, former top economic adviser to President Obama, called S&P’s downgrade from AAA to AA-plus “outrageous” on CNN’s “State of the Union” and said that American families “are going to be the losers” because House Republicans “played chicken with America’s creditworthiness.” 

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