June 28, 2004

Taxes will go up -- and so will interest rates. Quotable: "The Federal Reserve has been pumping money into the economy at a high rate for more than three years now, in order to keep interest rates low and help stimulate investment and growth. Were this policy maintained too long, it would eventually lead to roaring inflation like we had in the 1970s. Therefore, the Fed must tighten monetary policy .. If the Fed is able to keep to a gradual pace of tightening, financial markets should be able to adjust without trouble. But there is always the danger that mistakes will be made or that unexpected circumstances may arise that will trap the unwary and create a crisis situation. Among those risks are these:

Fannie Mae and Freddie Mac are now such huge players in the mortgage market that their combined debt is close to $3 trillion, as millions of Americans have refinanced their mortgages to take advantage of low interest rates and rising housing prices. This also means that even the tiniest mistake by these organizations could have massively disruptive effects on financial markets.

The U.S. is becoming more and more dependent on foreign capital inflows to finance the federal debt and domestic investment. Indeed, foreigners now own more than 50 percent of liquid Treasury securities. Even a slowdown in foreign Treasury purchases, perhaps due to fears of a fall in the dollar, would also be massively disruptive.

Among the largest purchasers of Treasury securities has been China, whose economy has been booming. But some analysts now believe that the Chinese bubble may soon burst, just as the telecom and dot-com bubble of the late 1990s burst here. That could force the Chinese to stop buying Treasuries and start selling them. Once again, this would be massively disruptive .. ".

MORE -- Bruce Bartlett "Get Ready. Taxes have to increase". Posted by Greg Ransom