Bruce Bartlett Is Also Worrying About "Hard Landings"

He writes:

Bruce Bartlett: Steering clear of a recession: The place where the greatest danger lies is with Fannie Mae and Freddie Mac... even the tiniest mistake by them could roil markets... the impending retirement of Alan Greenspan as chairman of the Fed.... Lastly... [h]uge budget and current account deficits mean that vast amounts of capital flows are necessary to keep them funded. So far, this has gone well... the Chinese have been so accommodating about financing the.... But now the U.S. is strongly pressuring China to stop doing this in order to allow its currency to rise against the dollar. It is hoped that this will reduce China’s production advantage in dollar terms and bring down the bilateral trade deficit. However, the cost to the U.S. economy if this happens could be greater than the potential gain. At least in the short run, any scale-back in China’s buying of Treasury securities might cause interest rates to spike very quickly. This could prick the housing bubble and bring down home prices, eroding personal wealth and putting a squeeze on those with floating rate mortgages. Hopefully, this can all be managed smoothly and without either a recession or a market break. But it will take great skill and a lot of luck to avoid both.

Comments

[Michael Robinson]

Maybe the Chinese government should simply announce they will repeg the RMB on August 1 to a rate specified on or before July 1 by the U.S. Secretary of the Treasury.

I'd pay good money for tickets to that show.

[CalculatedRisk]

Bruce commented a couple of times on pgl's post on the same topic (at Angry Bear).
http://angrybear.blogspot.com/2005/04/bruce-bartlett-utters-r-word.html

[Movie Guy]

Bruce Bartlett said:

"Although these [inflation] factors have yet to seriously impact on consumers, except for the skyrocketing price of gasoline, it is only a matter of time before these fundamental inflationary forces work their way through the system and start raising the Consumer Price Index."

"The Fed wants to nip this in the bud before inflationary psychology sets in."

It's too late.

Consumers demonstrated their reaction to rising gasoline and retail prices before the CPI was released. They get it.

The inflationary psychology is well underway. It's reflected in the latest retail sales report.

Game on.

[howard]

well, we know for a fact that the bush administration lacks the skill, so we're left with hoping for luck....

[anne]

The sense I have is soft or hard landing will depend on long term interest rates staying low while the Federal Reserve raises short rates. We are depending on international capital flows to keep long term rates low; what other way is there with no fiscal reform sighted?

[a different chris]

Did this make anybody else gulp:

>greatest danger lies is with Fannie Mae and Freddie Mac... even the tiniest mistake by them could roil markets

Indications are they have already made a few mistakes, none of them tiny, and we're just waiting to find out what precisely those mistakes were.

[bakho]

The fiscal solution is to raise taxes on the wealthy so we don't have to borrow as much. Clinton proved that top rates could be raised and still have a good economy.

[Kaslsfini]

Movie Guy: "The inflationary psychology is well underway."

Concrete here jumped from $90 to $125 a cubic yard in a couple on months. It's now $135. A sheet of plywood is $29, up from $19 last summer. Gas hit $2.35, up from $1.76 a year ago. Asphalt went from $2.00 a square foot to $2.35 and that price doesn't yet reflect the latest rise in oil prices which will show up later this summer.

It's changes such as these that are creating the illusion of inflation.

Even more alarming, coupons have virtually disappeared from the Sunday paper. An infallible sign a real storm is coming.

[p.lukasiak]

It's changes such as these that are creating the illusion of inflation.

illusion?

although the source of increases in asphalt and gas are obviously, one has to assume that the significant increase in other building material costs is based on demand/scarcity -- and that prices on those products will decline very soon (especially given the recent housing starts numbers.)

[Pathetic]

Richard Russell's comments (subscription only, Dow Theory Letter) on 4/20/05 are interesting (and chilling):

Let's go over a few basic Dow Theory tenets. All bull markets and all bear markets tend to have three phases. In a bull market the first phase is accumulation, the second phase sees the gradual entrance of the public, and the third phase is the speculative distribution phase.

The first phase of a bear market is the decline which erases the excesses of the preceding bull market top. The second phase is the gradual exit of the public from the stock market. The third phase is the "give up" phase in which good stocks are finally thrown in for whatever price they will bring.

[...]

So as I see it, we're in the early second phase of this bear market, and certainly we haven't seen a third phase. But as night follows day, a third phase of this bear market lies ahead. I'm as sure of that as I was sure that a third phase of the bull market lay ahead when I wrote my first Barron's article back in December 1958.

As matters stand, my fear is that Greenspan-Bush "team" has placed the US in such a vulnerable position, that as the second phase of this bear market grinds on, and when the third phase of the bear market arrives, the nation will be dealing with an utter disaster.

[johnchx]

Bartlett: "[h]uge budget and current account deficits mean that vast amounts of capital flows are necessary to keep them funded."

I'd add that even if the federal budget were balanced, the Treasury would still have to borrow immense sums to re-finance existing debt. Re-financing doesn't constitute a flow of capital per se, but it's a good idea to keep in mind that capital doesn't stay put "by default." Without massive "re-borrowing," capital would flow outwards at a brisk pace.

How massive? As of December 31, 2004, the outstanding national debt stood at around $7.5 trillion. Of that, just under $4.0 trillion was marketable. (The rest is mostly owed to federal trust funds like the SSTF, plus a little bit of non-marketable debt held by the public, like savings bonds.) Of that $4.0 trillion, about $1.5 trillion is due in calendar 2005.

That is, about 40% of the marketable debt (or 20% of the entire debt) is due and payable within a 12 month period. About two-thirds of this ($1.0 trillion) is in short term (6 months or less) paper.

My question is this: what the heck does the Treasury think it's doing? Given that there is currently no plan to pay even a penny of the pricipal on this debt ever, shouldn't it be financed with the longest repayment period possible?

My cynical answer is that Treasury is just doing what the whole Administration does: trying to make things look good in the short term, without any regard to the possible future consequences. Borrowing short reduces the immediate, on-budget interest cost, making the annual deficit appear smaller than it would otherwise. The only downside is that federal borrowing costs could skyrocket if the Treasury were forced to re-finance a significant chunk at an inopportune moment. But hopefully that'll happen on the next guy's watch...and besides, we can just "blame the foreigners."

[Lee A. Arnold]

Spike, prick, erode, --Mr. Bartlett should draw Rube Goldberg machines! Thank God for rent control?

[Karlsfini]

"It's changes such as these that are creating the illusion of inflation."

Sarcasm. Daily experience indicates a healthy rate of inflation is already here.

I'm told China's booming economy has as hearty an appetite for concrete as for oil, which may keep prices up. Another great hurricane season in Florida will surely call for lots of plywood.

I've seen prices for a pain chocolat (called a "chocolate croysant" here in Minnesoooda) hit a painful $1.95, and I don't think that's being affected by housing starts. I don't even price napoleons anymore.

[pgl]

A Townhall oped that gets CalculatedRisk, Bill Polley, and me discussing its points has to rate high on their list - and now it is cited here. Bruce is smart to leave NRO to Kudlow & Luskin and have his very good writing grace other conservative webcites. And Townhall was smart to run his piece.

[Ian Whitchurch]

Rather than FannieMae and FannieMac, I'm personally more worried about a rush to the exits on General Motor's commercial paper.

Ian Whitchurch

[Kimmitt]

An acquaintence of mine told me that China is required to float its currency starting in 2006, as per its agreement to join the WTO. Is this correct, or is she confused?

[DOR]

There is no mention in the WTO accession agreement of exchange rate regime, except the standard phrasing about all laws and rules applying uniformly within China and with trading partners.

The 2006 date has to do with reducing specific tariffs.

PROTOCOL ON THE ACCESSION OF THE PEOPLE'S REPUBLIC OF CHINA [http://unpan1.un.org/intradoc/groups/public/documents/APCITY/UNPAN002123.pdf]

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