Hot Off the Presses

John Mauldin is out with his annual forecast this week. John is going out on a limb that most other forecasters aren't this year, the Barron's round table was uniformly bullish, and the Wall Street Journal poll goes as low as one brave soul who (very precisely) forecasts .4% GDP growth: John is forecasting a mild "Goldilocks" recession in 2007.

John is an interesting guy and his weekly newsletter (which you can get here for free) is a great read every Friday.

Essentially John thinks that rising rates on adjustable rate sub-prime mortgages cause monthly mortgage payments to rise for the home owners who are already strapped for cash. This causes these borrowers to default on their mortgages, a higher default rate causes mortgage lenders (investors) to lose money, to prevent losses these lenders are forced to raise lending standards, there is less home equity withdrawn forcing consumers to spend less and presto - we have a mild recession.

Generally I think John has a pretty good scenario, but I would add one more factor, inflation. While wage increases are a good thing in the real world 4.2% pay increases and 3% inflation don't work together for long. Factor in increasing prices for commodities that are crushing incomes for farmers and it won't be long before the price of food starts going up.

In the next year I don't think it is unreasonable to think that the cost of most materials, food, energy, health care and professional services could all grow at double digit rates, eventually these price hikes work their way into the inflation numbers. Oh yeah, and the Democrats want a 40% increase in the minimum wage, which is the base for a lot of union labor rates, so the impact will be broad and quick.

Longer term rates are based on inflation expectations, and if those rates start to rise, the cost of most types of consumer credit will go up in a dramatic way. For a long time I have said that most people buy based on payment, and when the monthly cost of the payment goes up, the amount you will buy goes down. If inflation works its way into the system it is really hard to stop.

One of the factors a lot of people who are optimistic about 2007 have built into their assumptions is the idea that the Fed. will be able to cut rates in 2007 spurring on economic growth. If inflation is tame this could happen, if inflation takes off, then there is no way the Fed. will be able to cut rates. Higher inflation plus a slowing consumer is a nasty scenario for the Fed., and a nasty scenario for us all.

Timothy Burger
timothyb(at)timothyburger.com