The Practical Economist

EDITOR'S LETTER - June 12, 2017

EDITOR'S LETTER

We think that, to many readers, this current column may seem funny coming after the most recent content in which we laid out our simplest case why you should expect a slowing economy.

In short, we want to talk about the case for an upturn in the economy.

Please remember: it's about time-frames.  We have consistently said that we cannot use the podium of our forecasting voice to make anything like definitive statements about the economy more than three to six months out.  Anyone who says that they can is someone you should listen to with great caution.

But we're not averse to theorizing about time frames that are further out, based on what we would call ultra-macro economic data points and perspectives.

Did you read the current Investment Outlook?

If you did, you know that we laid out our case for why you should expect long-term interest rates to begin turning north in the medium-term (think six to 12 months' time).  This is a critical juncture to remind that the effects of the factors that create momentum in long-term rates are not felt for at least 12 months' time. 

So, that raises the obvious question: what do rising interest rates hold for us, in terms of the general economy?

It's too easy to simply say that rising interest rates are associated with expanding economies.  Not only is that true, but it's also not necessarily true that the two go hand-in-hand.  As in solving problems of probability, sometimes it's helpful to solve for the opposite of the problem you want the answer to.

If you buy into the scenario that has long-term interest rates rising, under what scenario would you see that happening in conjunction with a downturn in economic conditions?

Again, we're The Practical Economist; anything can happen, but let's stick to the most likely scenarios.

We could see long-term rates rise because inflation begins to rise at a rapid and sustained pace.

We could see long-term rates rise because the creditworthiness of the United States Government drops considerably.

We could see long-term rates rise because of a severe credit and capital crisis that makes the availability of capital severely restricted....a very dear commodity, so to speak.

(We are discounting the scenario in which long-term rates rise because of accelerating demand for commodities due to the outbreak of a protracted military conflict.  Such scenarios do result in inflation, but they are also accompanied by expanding economies.)

And if you're a regular reader, you do know that we have a very large long-term concern about the sustainability of the fiat currency system.  If such a crisis were to occur within the next two to three years, we argue that you'd see other key touchstones indicating larger problems that are looming.  And we do not see those at this time.

How about hyperinflation?  In the context of a central bank that not-long-ago raised short-term interest rates?

We argue that, in context of an economy that has been improving, and a budget deficit that is still large but significantly down from where it was four years ago, a severe decline in the creditworthiness of the United States is possible, but unlikely.

A capital crunch?  Again, we think that there will be signposts indicating that such is afoot, and there is nothing particularly amiss in terms of the economy running "business as usual."

You are permitted license to believe that there are ominous forces that will drive long-term rates high in the two-three year time frame, but it is very difficult to form a sound and reasoned argument for believing that such is going to be the case.

And so, as you would do to solvee a probability problem, we ask to solve now, for 1-X, where "X" is the set of scenarios under which long-term rates rise for inclement reasons. 

What you are left with is a case for understanding that the more likely scenario in the longer time frame is toward an expanding economy, with a sounder currency as its base.

That is our longer-term "soft" forecast.  It is theoretical in nature rather than being driven by the data that informs our economic model.

Of course, if such topics are of no interest to you, there is no compelling obligation to find them so.  But if the answer is an important input to your activities, we argue that it's folly, at the least, to abdicate your responsibility to create an understanding of how you should be forming and altering your investment strategy.

In short, what is the reasoned argument for the contrary position?  We don't think there is any.