- The Washington Times - Sunday, December 5, 2004

On Dec. 15, President Bush will convene an economic summit in Washington. This is probably nothing more than a political payoff for business people who contributed to his campaign. But some good may result if it forces him to think seriously about economic policy beyond firing his current batch of economic advisers, who are all on their way out, according to press reports.

The economy appears fundamentally sound for now, but there are many worrisome signs of risk and almost no reason to think it will do better than expected. In other words, the balance of risk is all on the downside. Among the danger areas are these:

Inflation. According to a Dec. 2 Wall Street Journal report, the Federal Reserve has growing concerns about rising prices. While the Consumer Price Index is still well behaved, all early warning signs of inflation are up: Commodity prices like gold have risen sharply, the dollar is down on foreign exchange markets, and industry’s capacity to produce is reaching the limit to what can be achieved without significant new investment.

As economist Richard Berner of Morgan Stanley recently put it, “By any metric, inflation is rising.” For this reason, he predicts continued monetary tightening by the Federal Reserve, which will probably raise its basic interest rate from 2 percent to 21/4 percent next week.

Interest rates. Partly for the same reasons just mentioned, we can probably expect rising interest rates for the foreseeable future. Fed tightening raises rates at the short end of the yield curve, while inflationary expectations raise them at the long end for things like 30-year mortgages.

In addition, the fall in the dollar means foreigners will be less willing to invest here. They have to worry that even if they make a profitable investment, they might lose it all if the dollar falls against their currency. Eventually, U.S. interest rates may have to rise significantly to keep foreign capital coming in.

Then, of course, there is the budget deficit. It has been completely ignored by the White House and Congress for the last four years. To a certain extent, this was justified by the recession and the need to fight the war on terror. But a new drug entitlement program has been created and there is vast pork barrel spending Mr. Bush has not even tried to restrain.

At some point, federal borrowing begins competing with private borrowers such as businesses and homebuyers. At that point, they will demand action on the deficit. Since Mr. Bush and Congress have shown such deep reluctance to curb spending, I fear higher taxes may be their response when the time comes.

Housing. Homeowners have been the biggest winners in our economy over the last several years. Housing prices have risen sharply almost everywhere, greatly increasing the net worth of most families and encouraging many first-time buyers to enter the market. However, this has led some economists to raise fears of a housing price bubble that could burst abruptly as the stock market bubble did.

There is no question rising interest rates will dampen the rise in housing prices. But even if prices don’t fall, it could create problems for those who bought homes expecting continued price increases. Many bought with adjustable rate mortgages that rise automatically and many with little or no down payment, leaving a negative equity if prices fall even a little.

In a worst-case scenario, many homeowners may decide to just walk away from their houses and mortgages if they can’t sell at a price that will cover their debt. This could put Fannie Mae and other mortgage holders in a difficult position.

Pensions. Many big corporations are experiencing more and more difficulty meeting their pension obligations to retirees. Long ago they traded lower wages (and higher profits) in the present for higher pensions in the distant future. Well, the future is now, and many companies are reneging on pension benefits, sometimes declaring bankruptcy to do so. As a consequence, the Pension Benefit Guaranty Corp., a federal agency that insures private pensions, is losing money and may soon need a bailout.

This does not exhaust the list of economic danger areas, but does suggest it would be unwise to be sanguine.

It would be advisable for individuals to take prudent steps now to protect themselves by locking in long-term mortgage rates, getting out of bonds, increasing their saving and cash position.

There is no reason to panic. Economic growth and productivity are still strong, which should keep stocks rising, and most economists expect unemployment to continue falling. But there are risks out there that should not be ignored.

Bruce Bartlett is senior fellow with the National Center for Policy Analysis and a nationally syndicated columnist.

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