Waiting for a Soft Landing

At the year-end, I usually scan a stack of economic reports to see what lies ahead. Well, folks, according to most forecasts we're headed for a swell year--though it will be boring. Typical is the forecast from the Organization for Economic Cooperation and Development in Paris. In 2006 the American economy should grow 3.5 percent (about the same as in 2005), it says. Unemployment drops from today's 5 percent to 4.8 percent. Inflation remains tame, at 2.5 percent. The world economy also does well; international trade expands 9 percent.

All this good news is, of course, bad for the news business. The sunny predictions suggest two familiar economic catch-phrases: "soft landing" and "Goldilocks economy." The Federal Reserve stops raising interest rates before it causes a recession; that's the soft landing. Economic growth is then fast enough to keep unemployment low and not so fast as to trigger higher inflation; that's the Goldilocks economy (like Goldilocks's porridge, the economy is not too hot or too cold).

Could anything darken the outlook and, coincidentally, feed journalism's appetite for misfortune? Well, yes. Here are five candidates:

Housing goes bust. Higher mortgage rates have already dampened demand and prices. From 5.6 percent in June, rates on 30-year fixed mortgages have increased to 6.3 percent. They may reach 6.7 percent by year-end 2006, says Orawin Velz of the Mortgage Bankers Association. A "bust" would involve sinking prices after some big gains: about 25 percent over the past two years. That could depress consumer confidence and spending. If rates on adjustable-rate mortgages (more than half of new loans in 2004) rose sharply, more homeowners might miss monthly payments. But most forecasts aren't glum. For 2006 the mortgage bankers expect average housing prices to rise 6 percent, almost equaling the increase in personal income.

The dollar "crashes." In 2005 the U.S. trade deficit was $712 billion, estimates Moody's Economy.com. That's up from $624 billion in 2004. The willingness of foreigners--including central banks in China and elsewhere--to invest their surplus dollars in American stocks and bonds raises U.S. share prices and reduces U.S. interest rates. A dollar sell-off could do the opposite, hurting housing (above) and consumer spending. Though plausible, similar warnings in the past never came true.

General Motors files for bankruptcy. Bankrupt Delphi--GM's biggest parts supplier--and the United Auto Workers are negotiating tensely over Delphi's demands for deep wage and benefit cuts. If the UAW were to strike, GM might also shut down (no parts, no cars) and suffer massive losses. A four-month strike could cost GM $20 billion, estimates Jonathan Steinmetz of Morgan Stanley. GM would still have to pay workers and outstanding supplier bills. GM itself might file for bankruptcy. Because everyone--GM, Delphi and the UAW--has so much to lose, Steinmetz doubts a doomsday outcome. Delphi, the UAW and GM will settle.

Oil jumps to $85 a barrel. Energy economist Philip K. Verleger Jr. thinks prices could rise up to 25 percent from 2005's peaks, driven partly by a scramble for low-sulfur oil to meet stiffer U.S. air-pollution rules for cars and trucks. Supply disruptions (from weather, political upheavals, terrorism) or refinery outages could also create scarcities. Still, the U.S. Energy Information Administration predicts steady prices of $63 a barrel for West Texas Intermediate crude--roughly even with the last half of 2005. Nariman Behravesh of Global Insight sees $57 WTI by the year-end.

The "yield curve" of interest rates "inverts." An inversion means that short-term interest rates (say, on three-month Treasury bills) exceed longer-term interest rates (say, on 10-year Treasury bonds). Usually, short-term rates are lower, because the risk of lending for lengthier periods is greater. Since 1965 interest-rate inversions have occurred seven times--and recessions have followed in five, notes Bill Dudley of Goldman Sachs. The reason: an inversion signals tight money. In 2006 Dudley expects another inversion, as the Fed raises short rates. But he thinks we'll escape a recession, because the overall level of rates will remain low.

There are other potential pitfalls. Will China's surging economy produce an unpleasant surprise? Will Ben Bernanke's replacement of Alan Greenspan go smoothly? But the larger story of the U.S. economy has been that it continually overcomes many reasons (in 2005: higher oil prices, hurricanes) for it to falter. Consumers have spent freely, drawing money from appreciated stocks or homes. From 1995 to 2005 consumer spending rose an average of 3.8 percent annually, notes Susan Sterne of Economic Analysis Associates. Now that may cool with the housing boom.

But something else (business investment, higher exports) will fill the gap. So say the standard forecasts. They're often right when predicting small shifts in the status quo. But they usually miss big changes, for good or ill. If something truly bad happens in 2006, you probably won't read about it first. Happy New Year.