In the words of Berkshire Hathaway’s Charlie Munger, “the only way smart people can get clobbered is through leverage.” On Tuesday, Alan Greenspan gave us a clear warning we may want to put a helmet on.

His statements made it clear the interest rate debate isn’t about whether rates are going to rise, but when. Investors in the bond market and other interest-sensitive areas have made it clear since early April that they see a notable rise coming.

Whether the rate increase comes in June or after the U.S. election makes little difference over the long term. The more important question becomes how high will rates go. Those consumers in the States who have taken on massive variable-rate mortgages and other consumer loans should shudder at the comment by respected analyst Jim Bianco that it’s time for rates to move from the Fed’s one-per-cent emergency position established after 9/11 to a neutral position that would take the overnight rate to four per cent.

That would spell a double yikes for people who are leveraged to the hilt. It should also scare Canadians, given that our economic well-being is tied so closely to the States.

The timing of the interest rate hike will resolve itself over the next six to eight months, but the size of the eventual increase will still be debated. My bet is that a couple of small hikes won’t hurt the U.S. economy. In Britain, two quarter-point rises have done nothing in the short term to whet consumer appetites, as mortgage lending in March still grew at a 15-per-cent annual rate.

The big question — and I mean the mucho, mega, supremo question — is at what point will interest-rate increases deter consumers from borrowing. Our willingness to borrow has been a key component to our economic growth. For example, the rising prices in real estate throughout the Western world, including Canada, have not reflected a huge jump in demand through population growth or a major jump in productivity. They are primarily a reflection of the abundance of money available to bid prices up through low interest rates.

Car sales, electronic sales and other major retail purchases have been spurred on by lower rates. So what happens to those industries if rates take a significant jump? Famed investor John Templeton is on record as predicting 20 per cent of home owners will lose their property in the next decline. Whether you buy into the hypothesis that we are in the midst of a real estate bubble or not, most experts agree that a significant rise in rates will be cause for concern.

Certainly the popularity of getting a second mortgage to take advantage of rising home prices — which has been a major source of capital for the purchases of other consumer goods — will also diminish, thereby hurting the economy.

I worry that if investors who have borrowed short term to purchase higher-yielding long-term bonds get spooked, we could see a sharp sell-off in the bond market, which will push rates much higher and faster than the Federal Reserve would like. It’s a dangerous game with massive consequences, which is why the feds have so far erred on the side of excessive monetary stimulus.

Michael Campbell’s Money Talk radio show can be heard on CKNW 980 weekdays from 6 to 7 p.m., and Saturdays from 8:30 to 10 a.m.

© The Vancouver Sun 2004