Economist sees slowing economy, maybe even recession

The next Federal Open Market Committee meeting is Oct. 24-25. If you have a mortgage with an adjustable rate, or if you have tapped into a home equity line of credit that charges a floating interest rate, you should pay attention every time the FOMC meets. This is the Federal Reserve board committee that sets interest rates, specifically a rate called the Federal Funds rate. All other interest rates fall or rise correspondingly.

The last two times the committee met, it decided to hold the rate at its current level (5.25 percent). This is important, because the 17 previous meetings in a row, it elected to raise the rate. Some people are now beginning to say the Fed will lower rates, and the process could start as soon as the meeting later this month. Most people who watch this stuff, however, expect the Fed to hold rates through the end of the year and perhaps begin to lower rates in the first quarter of 2007.

I had an opportunity to listen to Michael Gasior deliver a synopsis of the economy on Tuesday. Gasior is an economist who founded an institutional investment firm called American Financial Services. He thinks the Fed will lower rates early next year, but he doesn’t see that as necessarily good news. He is afraid the economy will need rejuvenation and the Fed will lower rates to stimulate an economy that he sees headed for recession.

Here are the points he made about why he believes the U.S. economy is headed for recession:

*) Foreigners are financing our debt. He noted that since 2000, the U.S. government has issued $1.3 trillion in new debt and foreign investors have bought virtually all of it. Plus, he notes, U.S. private domestic investors have reduced their holdings of U.S. Treasuries by $300 billion. That means foreign investors have actually bought $1.6 trillion in U.S. debt in the last six years. Gasior says it is not a good sign that Americans are unloading their Treasury bonds and that they are not buying the bonds being issued currently.

Gasior noted the uneasiness of the country’s growing dependence upon foreign investors. If the Japanese or Chinese stopped buying U.S. Treasury bonds, bond rates would have to increase, which would make everything in the United States more expensive. This kind of pressure really handcuffs the Federal Reserve. It may want to lower rates to stimulate the economy, but if it does, foreign investors may not be as willing to finance our debt.

*) He doesn’t like the inverted yield curve. When long term interest rates fall below short term interest rates, it almost always leads to recession, Gasior said.

*) Gasior said he does not like the fact that the U.S. dollar is weaker now than it was four years ago. Today, a dollar will buy you 0.78 euros or 117 yen; four years ago a dollar would have bought you a full euro or 134 yen. A weak dollar is a plus for American manufacturers selling abroad, but it makes it much more difficult for foreign companies that attempt to sell their products in the United States. We need those foreign companies to do well, so their economies do well, so they will continue to buy our debt.

*) Gasior said he also is concerned about the contracting real estate market. Particularly troubling is the fact that the contraction is taking place during a relatively good economic period. If interest rates were to rise one or two more times, it would really send real estate into a nosedive.

Gasior concluded: “We are already slowing down, but by the first, maybe second quarter of next year, it will be very evident the economy is slowing, perhaps to the level of recession. I don’t think the Fed is going to wait that long to begin cutting rates. It will have to do something in order to keep things stimulated, to keep things from melting down.”