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Monday, June 28, 2004

Pessimistic Economist Warns: Financial "Storm" Coming


Commander-in-Chief Bush's new ad "Pessimism," contrasts the War President's sunny outlook with Kerry's:
The largest tax relief in history.
1.4 million jobs added since August.
Inflation, interest and mortgage rates low.
Record homeownership.
John Kerry's response?
He's talking about the Great Depression.

Indeed, Kerry has pointed out that Bush has presided over the "greatest job loss since the Great Depression." But for real gloom and doom, you have to turn to economist Bruce Bartlett, who predicts that Bush's huge budget deficits are going to cause a financial meltdown and the largest tax increases in history.
We've gotten ourselves just into a fiscal mess...we're just in the calm before the storm. And I don't know when the storm is going to hit, but I know it's coming. I think it's going to hit fairly soon, perhaps within the next year.

According to Bartlett, some possible risks are:

* The tiniest mistake by Fannie Mae and Freddie Mac (combined mortgage market debt of about $3 trillion) could massively disrupt financial markets.
* A slowdown in foreign Treasury purchases (foreigners now own more than 50 percent of liquid Treasury securities), perhaps due to fears of a fall in the dollar, would also be disruptive.
* A slowdown in the Chinese economy could force the Chinese to stop buying U.S. Treasury Bills and start selling them.

Pretty pessimistic and shrill, huh? Who's Bruce Bartlett? Oh, just a conservative economist who writes for the National Review, Townhall.org, and other right-wing publications. Bartlett has helpfully written a brief version of his article, a short version, and given a longer speech [beginning on page 25 of the 123K pdf] at Brookings.

The speech is the most alarmist. Here's an excerpt:
What I want to talk about primarily is what I think is going to happen if
President Bush is reelected....I think that we've gotten into a fiscal situation that is going to demand some action sometime fairly soon. And I think the main trigger for this is what's probably going to happen at the Federal Reserve next week. It's why they expect that they're going to begin to raise interest rates. They're going to have to raise rates quite a bit eventually, although they'll probably do so gradually a quarter point at a time, every six weeks for some time to come. This could be a little bit like Chinese water torture. But I think it's going to set in motion certain forces that are going to lead unavoidably to some, I'll call it a crisis of some kind, at some point in the future. The problem is, when you start from a ridiculously low-interest-rate situation, you start to raise it, you create a lot of problems in the financial sector because of the same basic forces that got us into the savings & loan problem. Banks tend to borrow short and lend long. And when they get their portfolios out of whack, it creates very, very severe problems.

And I'm very concerned--my expectation is that at some point in the future, perhaps over the next year, we're going to see something happen somewhere in the economy that's going to be a huge wake-up call, something on the order of magnitude of, say, the 1987 stock market crash.
....
So my point is I don't know when or where or how this is going to happen, but I do think that at some point there's going to be a wake-up call. And the history, I think, shows that when these things happen, the first thing that all policy makers, or at least those in Congress, latch onto is we gotta have a budget deal, we gotta do something about the deficit. It doesn't matter whether there's a connection or not. This is what they always do because it's the only thing they can do. They can't very well tell the Fed what to do, they can't very well tell the Chinese to buy more bonds, they can't do anything about inflationary expectations. There's really nothing they can do other than say let's do something about the deficit.

So I think that this is what's going to happen. So the question is what will happen when that day comes. It seems to me, regardless of the makeup of Congress, you're likely to have to see--you're going to have to have a budget deal that is large enough to get the attention of the bond markets. So how big would that have to be? I think it would have to be at least 2 percent of GDP, and I think at least 1 percent of that, half, would have to be on the revenue side. So we're looking at something like a 1 percent of GDP increase. And I pick this number, not casually, but because that was the size of the TEFRA tax bill in 1982. The largest peace-time tax increase we've ever had was about 1 percent of GDP.

...we've gotten ourselves just into a fiscal mess that is--we're just in the calm before the storm. And I don't know when the storm is going to hit, but I know it's coming. I think it's going to hit fairly soon, perhaps within the next year.


 
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