Alan Greenspan: The Financial System Is Broke

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MR. GREENSPAN: Yeah, yeah. I, I would say that there's nothing out there that I can see which will alter the, the, the trend or the level of unemployment in this context.

MR. GREENSPAN: Well, the problem there implies that the government has control over those rates, meaning the Federal Reserve and the Treasury Department, in a sense. There is no doubt that the federal funds rate, that is the rate produced by the Federal Reserve, can be fixed at whatever the Fed wants it to be, but which the government has no control over is long-term interest rates, and long-term interest rates are what make the economy move. And if this budget problem eventually merges to the point where it begins to become very toxic, it will be reflected in rising long-term interest rates, rising mortgage rates, lower housing. At the moment, there is no sign of that, basically because the financial system is broke and you cannot have inflation if financial system is not working.

There's nothing like the truth coming from a former Fed Chairman. Greenspan is correct in this case: bond vigilantes will punish the US Treasury bond markets in demanding higher yields on long-dated Treasury bonds, forcing up long-term interest rates. They will also drive down the value of the USDollar, as the US government's ability to pay its obligations will come under question. It's not a matter of if, but when the steepening of the yield curve will occur.

Here is an article addressing the steepening of the yield curve from 2009.

http://www.reuters.com/article/idUSTRE54U1NZ20090531