The WaPo’s Steven Pearlstein is no friend of Rosy Scenario.
The consensus view, in case you’ve been on a beach reading Dan Silva spy novels these past two weeks and missed it, is that everything is going to be peachy-keen in 2006. Economic growth will slow only modestly from last year’s unsustainable spurt; inflation will remain in check; the air will be let out gradually from the real-estate bubble; energy prices won’t get any higher and probably will retreat a bit; the transition at the Fed will be seamless; the trade and budget deficits will shrink; the dollar may drift down, but only a bit; and stocks will post respectable gains.
While the signals coming from the economic pundocracy may be solid green, the ones coming recently from the marketplace are flashing yellow. A middling Christmas season for retailers. A bicoastal housing boom that has already begun to abate, with an initial 10 to 15 percent drop in prices from speculative highs. A stock market that couldn’t sustain a year-end rally despite record profits. A bond-market yield curve that makes it no more expensive to borrow money at a fixed rate for 30 years as for one year.
Other warning signs: A corporate sector unable to find a more profitable use for its record retained earnings than buying up its own stock or overpaying for questionable acquisitions. Hedge funds so flush with cash that they are lending money into a commercial real estate bubble, bidding up the price of gold and financing hostile takeovers. Pay packages for corporate executives and investment bankers up 30 percent in a year in which investors were lucky to eke out a 3 percent gain.
I have a hard time squaring so many disquieting realities with a consensus forecast that has the economy gliding into some magical macroeconomic equilibrium.
A more likely scenario, it seems to me, is a 2006 in which the economic chickens finally come home to roost. Annual growth rates will fall from their current 3.7 percent to somewhere below 2 percent before the final quarter as government deficits are trimmed and households stop spending down their home equity. Inflation will reach 3.5 percent as key workers finally demand their fair share of productivity gains, health care and commodity prices continue to rise, higher energy costs work their way into the economy, and import prices spike in response to another steep drop in the value of the dollar. As economic growth slows, stocks will continue to drift sideways, snuffing out a nascent boom in corporate capital expenditures. Meanwhile, the long bull market in bonds will finally end as interest rates rise — the result of heightened inflation expectations, continued monetary tightening by the Fed and a newfound reluctance of foreigners to invest their trade surpluses in dollar-denominated Treasury bonds.