3 Oft-Ignored Risks to the U.S. Economy

By Markets Fool.com

At The Motley Fool, we don't spend a lot of time thinking about the macro economy because we think our time is better spent identifying great businesses we want to own over the long haul. Nevertheless, the economy is the environment within which all businesses operate, so, once in a while, we find ourselves pondering the big picture. When we do, we try to identify a "variant perception" -- discrepancies between reality and the consensus view (as we would with an individual stock).

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We asked our writers to come up with risks to the U.S. economy that are often ignored; here are three.

Alex Dumortier: Inflation. When was the last time you heard anyone discuss the risk of rising prices (who was not a goldbug or other hard money religionist)?

There is a sound explanation for which inflation is widely ignored. In the post-crisis era, deflation has been the bigger risk to the economy. In fact, during the 12 months to February, the general price level, as measured by the CPI for All Urban Consumers, has fallen (though, admittedly, this is mainly because of the decline in the price of oil over the same period).

However, as the labor market strengthens and the economy gobbles up the remaining slack, the balance of risk between deflation and inflation is surely changing. Furthermore, the Federal Reserve has been repeatedly overly optimistic with regard to its views on the economy. "Once bitten, twice shy" -- the natural response for policymakers might now be to underestimate the possibility of upside surprises, with the risk of putting off an interest rate hike for too long.

Will excessive inflation materialize in the U.S.? Probably not, in my view, but low probability isn't the same as zero probability. Life at the lower (interest rate) bound is an odd place, after all.

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Dan Caplinger: Many investors don't understand the impact foreign currency fluctuations can have on the U.S. economy. It's easy to think that unless you're traveling abroad, the value of the U.S. dollar compared to other currencies isn't terribly important. But for U.S. companies that do a lot of business overseas, a strong dollar can make their goods and services more expensive in foreign-currency terms, giving their international competitors a pricing advantage that can sap U.S. companies' market share in key industries.

Fortunately, currency impacts tend to be at their largest when the U.S. economy is performing well, as economic strength attracts capital inflows that boost the dollar's relative value. That typically means foreign-exchange headwinds slow an already-rising share price rather than making an established decline even worse. Still, in the long run, a strong dollar can make entire industries less competitive compared to their overseas rivals, and that, in turn, can cause large-scale economic damage that can take years from which to recover.

Right now, the primary danger from foreign exchange is that many governments are engaging in an almost competitive devaluation process, as each country wants to give its respective export sector a leg up on its neighbors. Until the global economy strengthens more broadly, a strong dollar poses a risk to the gains the stock market has produced.

Sean Williams: If you're curious what the biggest under-the-radar risk is to the U.S. economy and investors might be, look across the Pacific Ocean to China.

On one hand, the U.S. is a big supporter of China. One in six of all exports from China were headed to the United States in 2012, making the U.S. a critical component of success for the Chinese economy. However, there are other factors at work within China that few Americans are following, but which could greatly disrupt the U.S. economy.

For example, The Wall Street Journal reported last year that real estate investments and real-estate-related services account for 16%-25% of China's annual GDP. Comparably, 18% of U.S. GDP comes from real estate investments and related services.

According to China's National Bureau of Statistics, new home prices fell in February an average of 5.7% from the previous year, the worst year-over-year comparison since record-keeping began on home prices in 2011. This is a potentially big problem because some Chinese homebuilders haven't been adhering to government regulations requiring buyers put 30% down on a new home. I believe this has the potential to mirror the U.S. housing bubble in magnitude if it were to collapse.

If China's GDP or economy tanks because of a weakened housing market, it could seriously diminish its capacity to purchase U.S. Treasuries. As a reminder, buying bonds helps keep yields down and can strengthen the U.S. dollar. If China suddenly turns to selling U.S. Treasuries to raise cash because of a recession, or even fears of a recession, U.S. yields (and possibly mortgage rates) could rise, and the dollar would likely weaken.

I'd make it a point to keep your eyes closely locked on China.

The article 3 Oft-Ignored Risks to the U.S. Economy originally appeared on Fool.com.

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