Four Economic Scenarios For 2014 -2016

In this post we will examine the probabilities surrounding four scenarios for the global economy over the next three years.

Given the fact that government officials have a propensity toward overestimating growth rates and optimistically announcing economic improvement, we will consider the likelihood that these projections will occur.

From our friends at Consumer Metrics:

BEA's Changing View of First Quarter 2008 GDP

Reported Growth RateReport DateMonths Lag
+0.6%April 30, 20081
+0.9%May 29, 20082
+1.0%June 26, 20083
+0.9%July 31, 20084
-0.7%July 31, 200916
-0.7%July 30, 201028
-1.8%July 29, 201140
-2.7%July 31, 201364

If anyone missed the key point: in the table above all of the BEA's reported growth rates are for the same quarter, the first quarter of 2008 -- the first full quarter of the last recession. The only difference is the lag time between the close of the quarter and the BEA's reporting of its growth. And if the scope of the revisions somehow escaped you, they missed the annualized growth rate in "real-time" by a staggeringly optimistic 3.3%!

Scenario 1 - Muddle Through Growth

In this scenario, growth continues to occur despite the high levels of sovereign debt in most nations, and particularly in developed economies.  The latest IMF projections are in the range of 3.7% annual global growth.  Most Keynesian economists would be in this camp.

Given the fragile state of the fractional reserve banking system and bond markets, this scenario seems rather unlikely.

We assign a probability of 10% to this scenario.

Scenario 2 - Stagnation

Our central forecast is for economic stagnation to take hold as the Federal Reserve attempts to unwind its massive QE program.

In this scenario, inflation continues to occur in most non-discretionary goods and services such as food, gasoline and healthcare.  Property values and durable goods such as vehicle prices stall out and may even fall in value due to tightening of credit by banks.

Developed countries growth rates would approach the zero range and developing countries would grow quite slowly.  Annual global growth would likely be below 3%.

We assign a 50 to 60% probability to this scenario.

Scenario 3 - Debt Deflation

In our view, this is the second most likely scenario.

This situation would occur if property values started to fall due to restrictive credit conditions brought about by higher interest rates, or bank credit tightening to conserve capital and reduce risk.  The first area to be hit would be vacation properties and secondary residences, as they are luxury items and typically are liquidated when the owner finds the ownership costs (taxes & utilities) burdensome.  A domino effect would reach the condo and single family residential market as prices begin to fall.  A self perpetuating cycle begins are prices fall and mortgage defaults begin until prices reach bottom where cash buyers dominate and prices stabilize. The Canadian housing market is in danger of facing this situation as prices have defiantly resisted gravity compared to other housing markets in developed countries.  The US housing market may also be vulnerable to another pullback in prices, after the increases of the last few years.

Inflation may still occur in limited sectors, but at very subdued levels as discretionary consumption items are severely curtailed with spill over into the non-discretionary sector.

Developed countries growth rates would fall below the zero range and developing countries would stagnate. Annual global growth would likely be below 2%.

We assign a 20 to 30% probability to this scenario.

Scenario 4 - Collapse

This, along with Scenario 1 is a low probability event given the facts at the present time.

While we certainly hope this does not occur, it would be wise to prepare for this low probability, high impact event.

Collapse can occur in two forms - Hyperinflation and Hyperdeflation.

While the most common example of collapse is hyperinflation - a period of overall increases in the prices of goods and services that exceeds 50% annually, hyperdeflation is also possible.

Hyperdeflation occurs when the amount of currency in an economy is stagnant or even growing, but the velocity of that currency collapses to very low levels.  To state this another way, the number of transactions per day or month drops very quickly - people and financial institutions hoard their cash.

This is where we need to recall the formula for the Quantity Theory of Money:


Where M is the total money supply
V is the velocity of money

P is the general price level in a given country
Q is the price deflator

We discussed this almost four years ago in a previous post The Dark Root of Deflation.

As velocity of money falls, as we are currently noticing, this neutralizes the increase in the money supply.  If the money supply falls as well, due to a reduction in available credit, the left side of the equation compounds the reduction.  Theoretically this leads to rapidly falling prices on the right side of the equation.

Hyperinflation occurs when both the supply of money and velocity rise quickly.
A current example would be the situation in Venezuela with inflation rising to 57% per annum recently.
Historical examples of this phenomenon include Zimbabwe, Argentina, and Weimar Germany.

While a determined central bank can cause hyperinflation, it seems an unlikely scenario in developed countries who are part of the Anglo American banking system. The evidence for this statement is found in the actions of the Federal Reserve, Bank of England, and other central banks who went to elaborate lengths to preserve the current fractional reserve model during the 2008 financial crisis.  It would take massive money printing placed in the pockets of citizens to create a hyperinflationary scenario.  As this would destroy the banking system by making credit unavailable as interest rates approached infinity, it would be a huge change in direction for the central banks of the developed world.

Therefore, we assign a probability of less than 5 percent to these scenarios under the present circumstances.