God is a Capitalist

Wednesday, February 10, 2016

Year ahead forecast - stormy

Austrian economists are not huge fans of forecasting as are most mainstream economists, especially those who add a decimal point to lure the gullible into thinking the forecast is accurate. But that doesn’t mean Austrians don’t forecast. Hayek wrote in his Nobel Prize acceptance speech that... 
"Without such specific information about the individual elements we shall be confined to what on another occasion I have called mere pattern predictions - predictions of some of the general attributes of the structures that will form themselves, but not containing specific statements about the individual elements of which the structures will be made up."
I call Hayek's concept of forecasting, pattern predictions, or qualitative forecasting vs quantitative. In other words, Austrian economists can tell what will happen next but not exactly when or how much.

That doesn’t mean that Austrian economists don’t ever use numbers in forecasting. Obviously, I have provided a few of those. But I hope readers interpret those forecasts as tendencies and illustrations of theory, not as point-accurate forecasts.
In May of 2014 I predicted that the US could enter a recession without the Fed raising rates, something mainstream economists think cannot happen. I’m personally not opposed to failing at predictions. If weathermen and the Fed economists can be wrong so often, why should I be bashful? So far the Fed has raised its rate a mere 0.25%. Not much. So if we're indeed in a recession then that wasn't too bad of a forecast.

Now here is what I expect to happen this year:

Oil prices will continue to fall, possibly to $20/barrel, because producers will not cut production as rapidly as the world economy implodes. They have barely cut production since oil hit $30. The oil story is not just about shale oil in the US. It’s mostly about state-owned oil that governments need to pay for their socialist policies. As the world economy sinks, the demand for revenue from oil sales will soar so the temptation to pump more oil to make up for the decline in prices will be hard to resist. Also, Iran hasn’t begun dumping its oil into the flood.

The US is probably in a recession now. Keep in mind that the National Bureau of Economic Research can’t tell us that the economy is in recession until we suffer two quarters of decline in GDP. GDP measures mostly consumer goods and the recession hits that sector last. Manufacturing, mining and energy have been in recession for months. When we have seen two quarters of GDP decline, the NBER will announce we’re in a recession, but it will send its gnomes climbing back up the GDP line to date the beginning of the recession from the previous GDP high. So the NBER can only tell us that we have been in a recession when we’re at the bottom.

Being in a recession, the Fed won’t be able to raise interest rates. In fact, it may do QE by buying oil debt from banks in the same way it bought mortgage-backed securities during the latest recession. Mainstream economists had told us that the dry hole in the oil patch would stay in oil, but now it has spread to banks as investors worry about the massive debt they hold from failing oil companies as well as the price insurance they sold in the form of futures and options contracts.

Mainstream economists are in denial, but I remember when the price of oil cratered in 1986. That bankrupted Penn Square Bank in Oklahoma City and that in turn almost took down a large bank in Chicago. Look for banks to suffer a lot again in this recession and mainstream economists to wonder why their macro-prudential measures didn't work to prevent it.

Inflation won't rescue the Fed and it's likely the Fed's worst nightmare will become reality - mild deflation. The Fed will want to weaken the dollar with QE, but the world’s savings will pour in like a tsunami seeking a safe haven in the US. That will keep the dollar value high against other currencies and hurt exporters as well as companies that want to convert foreign profits into dollars. A stronger dollar will also encourage deflation. 

High levels of debt will keep businesses from borrowing while those who might borrow will confront failing or reluctant bankers. The Fed's only salvation would have to come from the federal government borrowing massive amounts and raining it on US consumers, but I expect that to happen in 2017.

Now some of you may be saying to yourself, if he is so confident, is he buying put options or selling futures contracts? The answer is I’m not. That’s because I could always be right on the direction of the economy but off on the timing. Keynes is famous for having said that the markets can remain irrational longer than you can remain solvent. But the market is not irrational. The forecast was just wrong.

If the US is in a recession, as much of the rest of the world already is, then interest rates will continue to fall and people will rush to medium and long term government debt and gold/silver for security.
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