Excellent summary of economies weakness. War vs. Iran, cut off of oil,
retaliatory economic moves, could be what he describes as: "Then some
event, or combination of events, could come along to disturb markets,
with damaging volatility in both exchange markets and interest rates."
Or as I say on front page of http://stopthewarnow.net - "the government
could no longer subsidize the US debt, the US would lose big overseas
investors, interest rates would rise, and prices of imported and even
domestic goods could double or triple -- even as the housing bubble
burst -- impoverishing most Americans."
______________
http://www.washingtonpost.com/wp-dyn/articles/A38725-2005Apr8.html
An Economy On Thin Ice

By Paul A. Volcker
Sunday, April 10, 2005; Page B07

The U.S. expansion appears on track. Europe and Japan may lack
exuberance, but their economies are at least on the plus side. China and
India -- with close to 40 percent of the world's population -- have
sustained growth at rates that not so long ago would have seemed, if not
impossible, highly improbable.

Yet, under the placid surface, there are disturbing trends: huge
imbalances, disequilibria, risks -- call them what you will. Altogether
the circumstances seem to me as dangerous and intractable as any I can
remember, and I can remember quite a lot. What really concerns me is
that there seems to be so little willingness or capacity to do much
about it.

We sit here absorbed in a debate about how to maintain Social Security
-- and, more important, Medicare -- when the baby boomers retire. But
right now, those same boomers are spending like there's no tomorrow. If
we can believe the numbers, personal savings in the United States have
practically disappeared.

To be sure, businesses have begun to rebuild their financial reserves.
But in the space of a few years, the federal deficit has come to offset
that source of national savings.

We are buying a lot of housing at rising prices, but home ownership has
become a vehicle for borrowing as much as a source of financial
security. As a nation we are consuming and investing about 6 percent
more than we are producing.

What holds it all together is a massive and growing flow of capital from
abroad, running to more than $2 billion every working day, and growing.
There is no sense of strain. As a nation we don't consciously borrow or
beg. We aren't even offering attractive interest rates, nor do we have
to offer our creditors protection against the risk of a declining dollar.

Most of the time, it has been private capital that has freely flowed
into our markets from abroad -- where better to invest in an uncertain
world, the refrain has gone, than the United States?

More recently, we've become more dependent on foreign central banks,
particularly in China and Japan and elsewhere in East Asia.

It's all quite comfortable for us. We fill our shops and our garages
with goods from abroad, and the competition has been a powerful
restraint on our internal prices. It's surely helped keep interest rates
exceptionally low despite our vanishing savings and rapid growth.

And it's comfortable for our trading partners and for those supplying
the capital. Some, such as China, depend heavily on our expanding
domestic markets. And for the most part, the central banks of the
emerging world have been willing to hold more and more dollars, which
are, after all, the closest thing the world has to a truly international
currency.

The difficulty is that this seemingly comfortable pattern can't go on
indefinitely. I don't know of any country that has managed to consume
and invest 6 percent more than it produces for long. The United States
is absorbing about 80 percent of the net flow of international capital.
And at some point, both central banks and private institutions will have
their fill of dollars.

I don't know whether change will come with a bang or a whimper, whether
sooner or later. But as things stand, it is more likely than not that it
will be financial crises rather than policy foresight that will force
the change.

It's not that it is so difficult intellectually to set out a scenario
for a "soft landing" and sustained growth. There is a wide area of
agreement among establishment economists about a textbook pretty
picture: China and other continental Asian economies should permit and
encourage a substantial exchange rate appreciation against the dollar.
Japan and Europe should work promptly and aggressively toward domestic
stimulus and deal more effectively and speedily with structural
obstacles to growth. And the United States, by some combination of
measures, should forcibly increase its rate of internal saving, thereby
reducing its import demand.

But can we, with any degree of confidence today, look forward to any one
of these policies being put in place any time soon, much less a
combination of all?

The answer is no. So I think we are skating on increasingly thin ice. On
the present trajectory, the deficits and imbalances will increase. At
some point, the sense of confidence in capital markets that today so
benignly supports the flow of funds to the United States and the growing
world economy could fade. Then some event, or combination of events,
could come along to disturb markets, with damaging volatility in both
exchange markets and interest rates. We had a taste of that in the
stagflation of the 1970s -- a volatile and depressed dollar,
inflationary pressures, a sudden increase in interest rates and a couple
of big recessions.

The clear lesson I draw is that there is a high premium on doing what we
can to minimize the risks and to ensure that there is time for orderly
adjustment. I'm not suggesting anything unorthodox or arcane. What is
required is a willingness to act now -- and next year, and the following
year, and to act even when, on the surface, everything seems so placid
and favorable.

What I am talking about really boils down to the oldest lesson of
economic policy: a strong sense of monetary and fiscal discipline. This
is not a time for ideological intransigence and partisan posturing on
the budget at the expense of the deficit rising still higher. Surely we
would all be better off if other countries did their part. But their
failures must not deflect us from what we can do, in our own self-interest.

A wise observer of the economic scene once commented that "what can be
left to later, usually is -- and then, alas, it's too late." I don't
want to let that stand as the epitaph of what has been an unparalleled
period of success for the American economy and of enormous potential for
the world at large.

The writer was chairman of the Federal Reserve from 1979 to 1987. This
article is adapted from a speech in February at an economic summit
sponsored by the Stanford Institute for Economic Policy Research.