Evidence suggests the mortgage refinancing bubble has finally popped. Mortgage finance provided the fuel for aggressive consumer spending and stock market investment. Consequently, you can expect the next few quarters of economic growth to be disappointing. This will shock and surprise the markets.
Sometimes we over-estimate the Federal Reserve’s abilities to control interest rates and the direction of the dollar. The bond market is bigger than the Fed and, try as they might to keep rates low, the trend to higher rates on the long end may continue no matter what. If so, there’s a lot of pain ahead. At this juncture everyone favors low rates and plentiful money and credit, but that may not be possible. Although most people scoff at the idea, these days we are never far from a financial disaster of epic proportions. If rates ever reach double digits, we will face our severest test since flotillas of Redcoats were landing on our coast.
Personally, I’m making my bets on continued credit expansion and rising inflation. However, the economic advisors that have influenced me the most predict a falling dollar, economic contraction and rising rates. That’s more of a deflationary scenario. It’s entirely possible to have both for awhile. It’s called stagflation. At its worst, stagflation can turn into the dreaded inflationary depression. There’s probably never been a more difficult period for investing. Cash is king in a depression, but a sure loser during inflation. One thing for sure, we have a greater chance of economic pain today than at any time in the past seventy years. The magnitude of our excesses defies description.