By Brai Odion-Esene

WASHINGTON (MNI) - Former Federal Reserve chairman Alan Greenspan said Thursday the U.S. government cannot continue to speak out in favor of a strong dollar as long as current budget deficit issues remain "unattended."

He also spoke out against requiring financial institutions to hold more capital against all eventualities, warning that this risks reducing the productivity of those firms.

Speaking at an event hosted by the Council on Foreign Relations in New York, Greenspan was asked to comment on the huge increase in public foreign debt, and said, "I think it is the most worrisome aspect of economic agenda in the United States.

"It is something that you cannot just push under the covers somewhere," he warned.

Greenspan blamed the emergence of budget surpluses in the early 1990s, which he said eliminated all notions of fiscal restraint, and will have implications for inflation.

The deficit cannot be expected to disappear and current numbers cited "are probably under-estimates of what the actual true and most accurate estimate of the long-term prospects are," he cautioned. "This is a far more severe problem."

"When you pump out huge amounts of debt issuance," he continued, pressuring the central bank to be accommodative in one form or the other, "inflation takes hold."

While the rate of inflation will fall going into the first and second quarters of 2010, it will stabilize after and then gradually rise, Greenspan said.

The market's inflation expectations will be reflected in long-term bond yields, rising long-term interest rates and declining exchange rates, he said.

"The 30-year has a very substantial part of its value five to 30 years out."

So while not overly concerned about the recent decline of the U.S. dollar, Greenspan said it will be difficult to make the case for a strong dollar in the future "with the size of fiscal problems which remain to this day unattended to."

He also argued, as he regularly did when he headed the Fed, that the major fiscal problem the U.S. faces right now is not the stimulus but rather unfunded liabilities like Medicare.

The government will have to increase revenue or decrease spending, he advised.

"You can't do it all on tax side," the former Fed chairman said, as such a move would squeeze the economy to point that the tax base declines. "Some benefits have to be cut."

The country has yet to confront the fundamental issues in health care that will lead to a sound, non-inflationary fiscal system 20 years from now, he said.

On the economic outlook, Greenspan noted that unemployment in the United States has gone up faster than it has elsewhere, and attributed it to businesses assuming the emerging crisis "was going to be far more severe than it eventually turned out to be."

The U.S. economy is at a level where the processes by which employment can start to pick up again are emerging, he said, "Because we don't have enough people to staff the level of economic activity we have."

On the matter of financial reform, Greenspan argued that requiring banks to hold higher levels of capital to meet "virtually" all possible contingencies would mean "capital being in place all the time but being useful and productive only extremely rarely."

Financial intermediaries, he added, cannot function "unless they have extraordinary leverage."

Policymakers, he said, must adjust to the fact that they will be confronted periodically with big bubbles -- fueled by protracted periods of prosperity that are preceded by low inflation and low interest rates.

The financial crisis, he said, is the kind of event that occurs "once in a century," and when it does, "It's by definition incapable of being handled by the private sector alone." Central banks have to step in and substitute sovereign credit for private.

"The TARP was very important ... that helped very significantly in stabilizing the financial system," Greenspan said.

There has been a "significant" recovery since then, he added, pointing to the $5 trillion recovery in the equity markets. "The evidence is increasingly the case, that stock price is a leading indicator of economic activity."

It is also a cause of economic activity, he added, as replenishing the market value of capital reversed the disabling of the financial intermediary system and is leading the global economy upwards.

However, Greenspan cautioned against reading too much into the Dow's rise above 10,000 at market-close Wednesday, as it is relevant just as something to place on the front pages of Thursday's newspapers.

** Market News International Washington Bureau: 202-371-2121 **