The former Federal Reserve chairman, Alan Greenspan, is pessimistic about the medium-term prospects for the US economy. He argues that there is a strong risk of stagflation (the combination of low growth and high inflation). Wage growth is now outstripping productivity, which he sees as a key sign that inflation will start to rise. Indeed, he notes that over the past five years output per hour worked has grown by less than 1% in most of the major developed economies, a dismal amount compared with past growth.
Greenspan has two explanations for this. First, an ageing population is forcing governments to spend more money on entitlements such as pensions. This is crowding out savings, reducing the amount of money available for capital investment. Second, uncertainty about the future, especially over the future levels of corporate taxes, is also discouraging firms from spending money on anything other than short-term investments. This means that while industries such as software and IT are booming, long-term investment in residential property has barely recovered from the crash.
Naturally, slow growth and rising prices are bad news for the bond market. Indeed, Greenspan thinks that yields are too low, saying that since “we get very nervous when the stock price index goes to high price-to-earnings ratios, we ought to be … nervous when the bond rate does the same”. He also notes that the historical evidence suggests that rates on long-term bonds should be higher than the current level of just over 2% (for the 30-year Treasury bond). From the 18th century to recent times, these yields have consistently been between 5% and 10% a year – far higher than today.