There's news from Washington this week, and it's hardly surprising: The federal government is back to deficit spending. After a banner fiscal year in 2000 when the feds recorded a $236 billion surplus, it looks like we'll have a $100 billion shortfall this year.

As a general principle, real estate does best when interest levels are low. One reason for the attractive mortgage rates we've seen in the past two years is that the federal surpluses mean the government has not had to borrow, so there's been less demand pushing interest levels higher. Money that might have gone to buy government securities can be invested elsewhere, say in financial paper that will ultimately become mortgages.

Alternatively, when a huge player like Uncle Sam needs to borrow there's more demand for dollars and thus some pressure for rates to rise.

At this point someone will invariably want to ask how it happened that we now have a cash crunch in Washington.

• The Bush tax cut took too much from the system, some will argue. But where is it written that government must spend as much as it does? Why is it not possible to cut both taxes and spending? The tax cut went through, but what about less government spending?

• The war on terrorism increased government costs. The defense budget was enlarged by more than $40 billion and the airlines received a $15 billion bailout. The defense increase reflects what government does -- it protects the country. As to the airlines, in calmer times it's unlikely that the nation's air carriers would have received as much money or any money, especially since many of their problems were and are the result of poor management. But in the face of September 11th and recognizing that we need a strong air transportation system, it was easy -- and proper -- to write a federal check.

• The economy faltered. We had a recession last year and a declining stock market. The recession has meant reduced tax revenues while the fall off on Wall Street means there have been fewer capital gains to tax.

Will interest rates rise dramatically just because of the federal budget shortage?

Probably not. Interest rates are a result of many factors, not just one ingredient. We have a $10 trillion economy and there's evidence which suggests that a recovery has begun. Economic growth in itself pushes up loan rates because expansion creates more capital demand.

At this time, however, the recovery has yet to prove itself, corporate profits have yet to rise, unemployment is at an 8-year high, and if we have a continuing economic funk we could face deflation and declining asset values. That's what they have in Japan, a country awash in capital but with little incentive for consumer spending because there is no financial necessity to buy -- in a deflationary market if you defer purchasing today you will likely pay less for goods and services tomorrow.

Freddie Mac, the secondary mortgage company, reported that the average interest rate on 30-year fixed-rate mortgages dropped to 6.78 percent last week, the lowest level in six months. A year ago this time, 30-year mortgages averaged 7.14 percent and lots of people inanced and re-financed to get such rates.

In an odd way, a little inflation is a good thing and somewhat higher rates may be entirely acceptable -- especially when you consider the deflationary alternative.

For more articles by Peter G. Miller, please press here.

Published: May 7, 2002

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