Fed's Folly Will Come Due in 2004

Ball of Yarn

So how does the unraveling actually happen in 2004? The illusion of health will continue through most of the year. Bush will get his second term, elating markets for a short spell. Then the full size of the bills that must be paid will begin to really scare people.

But it's a job to know what will go wrong first when a patient is unhealthy in so many ways. It's clear that the breakdown will happen when interest rates go up. That will worsen debt burdens, causing forced sales in the housing market and a crash in that sector. Consumer spending will also get hit. Companies will not pick up the slack.

So what could cause a rise in rates? Perhaps a plunging dollar -- Detox expects $1.45 to the euro by year-end 2004 -- could force interest rates up. The government budget deficit could come in way worse than expected, and the bond market could play a big role in pushing up market rates with such force that the Fed has to follow. There could be an unexpected rise in inflation, due to the amount of money pumped into the economy. It may even be a corporate scandal.

In 2004, the problems at Fannie Mae (FNM), the government-sponsored company that is the backbone of the U.S. housing sector, finally could come to the fore.

It may be another terrorist strike within American borders. Indeed, through its monetary madness, the Fed has made the American economy all the more vulnerable, in the event of an attack.

So where will the indexes end up at the end of 2004? Well, equity markets will be very buoyant for most the year, and then dip only slightly. The S&P 500 will end the year up 15%, around 1,250. The Nasdaq will jump over 20% to around 2350. But enjoy the increases while you can, because those levels won't be seen again for several years.

And the probability that Greenspan gets us out of this mess unscathed? About 5%. The argument from the bulls is that America had similar economic imbalances in the 1980s and emerged healthier. Sorry, bad history. First, Bush isn't cutting taxes to the degree that Reagan did, nor is he pruning back nondefense public spending, as Reagan did.

The Cato Institute recently pointed out that discretionary nondefense spending slumped 13.5% in Reagan's first three years vs. a stunning 20.8% increase under the current president. The current account deficit was never this large in the '80s, so there could be a steeper decline in the dollar.

Detox, gloomy from the start, has never been gloomier.

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