Rising Prices, Rising Rates

This week’s large jump in retail and wholesale prices caught my eye. The smart money on Wall Street today was betting that the Federal Reserve board will raise interest rates at least a half point when it meets at the end of June. My guess is that it’s just the first of many increases to come.

Amid all the bad news out of Iraq, the Bush administration's next gift to the American people will be the unprecedented phenomenon of a wartime economy heading for a slowdown.

Not that it's been much of a boom. Despite his massive tax cut for the rich, massive fiscal stimulus through war spending and massive fiscal stimulus through negative real interest rates, the unemployment rate has barely budged. And while hiring finally picked up in recent months, employers will pull the plug as soon as interest rates begin their inevitable upward ascent.

Why no more hiring? Rising rates will put an end to the home refinancing and home equity loan booms, which allowed consumers to spend like banshees through a period when their real incomes stagnated. Moreover, some economists (like my friend Dean Baker at the Center for Economic and Policy Research) are predicting a massive collapse of housing prices as rates rise. But even if home prices only stagnate for a few years, the economy will lose its major prop.

Another indicator signaling higher rates is the dollar. Right now, generous Europeans and East Asians are financing the U.S.’s massive budget and trade deficits. But in the past year, the dollar has declined about ten percent against the yen and euro. It’s turned overseas investors’ ultra safe Treasuries (3-4 percent rates) into a depreciating asset. The outlook for the coming year is another ten percent decline in the value of the dollar. The only way to finagle those feckless foreigners into continuing to finance Bush’s war and tax breaks will be through higher interest rates.

Can Greenspan postpone the inevitable, say, beyond the election? I doubt it. The outlook for the next twelve months is pretty much set: Rising interest rates, a falling dollar and rising prices. Unfortunately for Democratic candidate John Kerry, unemployment is a lagging indicator. The denouement of all this bad news -- rising unemployment -- won't hit until about nine months after rates start rising, which is well beyond Election Day.