"The IMF Would Rate Us as Dangerous"

Economist and author William Wolman is concerned about U.S. trade and budget shortfalls and their potential for driving up interest rates

If the U.S. weren't the strongest country in the world, it would be rated as in fiscal danger by the International Monetary Fund and World Bank, believes William Wolman, former BusinessWeek chief economist who is also an author and TV commentator. Wolman comes to that opinion by adding up the U.S. trade deficit and the budget shortfalls of government at all levels, which produces a ratio of debt to income he thinks the world financial bodies would consider perilous for nations other than the U.S. He recommends that investors diversify their holdings, and he especially cautions against counting on real estate to continue booming.

These were among the points Wolman made in an investing chat presented Oct. 23 by BusinessWeek Online on America Online, in replying to questions from the audience and from Jack Dierdorff and Karyn McCormack of BW Online. Following are edited excerpts from the chat. A complete transcript is available from BusinessWeek Online on AOL at keyword: BW Talk.

Q: I need to invest for income. Are bonds too risky right now?

A:

I think there is some risk on bonds, but I always have the same recommendation on this. That is to say that the average investor should always have some of the government's TIPs, the inflation-protected bonds. These are, to me, about the safest investment around. I do worry, however, about inflation, particularly for the middle classes where the cost of health care, to some extent, and the cost of educating their children have really been soaring. Just as an example, I believe that the rise in tuition in public universities this year was on the order of magnitude of 15%, the biggest number ever, and pretty scary.

Q: The Federal Reserve meets next week. Do you think the FOMC will keep interest rates steady? And for how long can rates stay this low?

A:

I think that the Federal Reserve will vote to keep rates where they are, but I do have concerns about rates in the long run. If you add up America's trade deficit and its federal budget deficit, and state and local deficits, you reach a ratio of debt to income which puts us in the category where the World Bank and the IMF would rate us as dangerous, if we weren't the strongest country in the world but just an average country. Dangers spring from these twin deficits that will end up putting upward pressure on interest rates.

Q: Will a lot more CEOs out there surface as bad guys?

A

: It depends on the intensity with which the feds, and perhaps especially state attorneys general, go after businessmen. I've been reading with great interest, for example, that Wall Street's donations to the Republican Party, which controls the White House, have been very, very high, and the financial sector is now the most important contributor to its campaigns. That may be because of some exceptionally favorable tax legislation in the past year, but it may also be money that is attempting to stay the hand of investigation.

I have no idea whether this kind of money is well spent -- I wish I knew. But I would also cite the fact that state attorneys general have been very active in pursuing corporate and Wall Street malfeasance, and that is not likely to end anytime soon.

Q: What is your feeling about the housing market? Are we in a bubble, especially in places like Manhattan?

A:

It is extremely difficult to forecast trends in the national housing market. The person I know who is best at this, Robert Shiller of Yale, actually consults in this area. His belief is that the housing market, on average, is overvalued. He is extremely reluctant to forecast the timing and scope of any declines that may occur.

I have a house which I use mainly as a retreat, in a hot real estate area. What strikes me is that the housing market around this place is totally central to its culture. You can't go to a party, or have a conversation, in which house prices don't come up.

To me, this kind of thing is an indication that there's at least some trouble in store. That's the way bubbles usually manifest themselves. Having said that, I can only argue that the sensible course is to diversify your investments some, and be realistic about comparing housing as an investment rather than as a place to live, with other kinds of investments whose prices haven't been quite as crazy in the past couple of years. That includes stocks and bonds.

Q: What sector would you put your money into?

A:

That is always a difficult question, and one in which you can easily be very wrong. During the last three or four chats that I have done, I have talked about wireless as an area in which my smartest friends on Wall Street believe the most. I particularly talked about satellite radio. I can't recommend individual stocks, but that is an area which I really like. Remember that China and India are not going to string telephone wires or lay cable. Wireless and satellite technology are just improving too fast.

Q: There's talk in the audience about whether or not stocks are overvalued now. What's your view?

A:

I am generally of the view that it will take a long time for the market to exceed its old highs, and in that sense sudden riches from diversified investments in stocks are not a likely scenario for at least the next five years. On the other hand, the tax treatment of stocks, particularly in 401(k)s, is extremely favorable, and I really believe that everyone must have a diversified portfolio of stocks, particularly in a mutual fund that is not tarnished by after-hours trading -- the revelation of which has blown my mind, not because there are huge returns, but because it is so blatantly sleazy.

Q: So, Bill, adding it all up, what stance would you suggest for investors given the current state of the market and the economy?

A:

My recommendation is to make regular and conservative investments that take advantage of any tax break that you can find. I don't see any great boom in the market, but on the other hand there is no alternative to investing in a broadly diversified portfolio that includes both stocks and bonds. Beyond that, as I always say, if you think the market is fun, relax and enjoy it. It sure beats the hell out of going to Las Vegas.

Edited by Jack Dierdorff

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