One economist predicts interest rates at 8% in 2 years. If you believe him, buy gold. If not, do nothing.
Did today's headline catch your attention?
Last month, Jason Zweig noted in the Wall Street Journal…
"An extreme forecast doesn't merely grab your attention; ironically, it may strike you as even more convincing than a moderate prediction. A classic psychological experiment at the University of Michigan showed that 54% of people preferred an extreme prediction about stock prices to a more-temperate one. They apparently believed that a forecaster must have high confidence and a solid rationale in order to justify making a dramatic prediction."
Extreme forecasts are easy. My headline today could be construed as an extreme forecast. If I was right, I'd expect to be inundated with £1m job offers, TV appearances around the globe, glamorous women hanging off my arm whenever I stepped out in public, and be quoted ad infinitum on Bloomberg and the FT.
But what if I'm wrong? Firstly, my outrageous prediction would be quickly forgotten. Secondly, I could always blame something else, like the government -- today's popular whipping horse -- the Bank of England, buy-to-let landlords, Iran or China. I could take my pick. The list is endless.
Interest Rates Headed To 8%
It's within that context that you must read Andrew Lilico's warning that interest rates may hit 8% in two years. As reported in The Telegraph, Lilico, the chief economist at the Policy Exchange think tank, says the rise in interest rates could happen "as the recovery beds in and Government measures to stave off a recession lead to an explosion in the money supply."
Lilico also says a brief double dip recession early next year is likely, but it "would be quite compatible with a boom thereafter" before another recession in 2013 or 2014.
To be fair, Lilico fully admits his ideas are somewhat extreme, saying "The fact that scenarios such as mine are regarded as bizarrely unlikely is, to my mind, an indication that certain quarters have lost their sense of historical perspective..."
Buy Gold NOW
So what should you do now? Sell up all your shares and buy gold? Buy bottled water? Sell property? Emigrate to China, Brazil or Australia?
I'm doing nothing. Whilst I'm respectful and mindful of such "bizarrely unlikely" scenarios, I simply can't change course every time I read one.
Earlier this month, we featured one such extreme prediction here on the Fool, with Peter Schiff saying the US economy is "going to have runaway inflation and recession simultaneously. I call what we're going to have an inflationary depression, which is the worst possible depression you can have."
Schiff also said "There's no limit to how high gold prices will go. They will rise many times from here -- thousands and thousands of dollars per ounce higher. People will be shocked."
Maybe. But probably not.
Follow Buffett
With investing, you have to play the odds. Warren Buffett has long encouraged people to invest with a margin of safety.
What if we're looking at a period of rampant inflation with interest rates soaring to 8% or even more? Lilico also warned inflation could peak at 20% rather than 10%pc, as in the 1970s.
What if?
I'd suggest the odds are firmly against such a scenario. Gilts markets are currently pricing in deflation, not inflation. The yield on 30-year gilts is just 4%, hardly suggesting we're in for a period of rampant inflation. Quite the opposite, in fact.
Of course, markets aren't always right. Although I'm talking about the yield on 30-year gilts, the bond market really only reacts to today's newsflow and expectations. Today, the bond market is suggesting we'll have a low-growth economy for some time to come.
2007 Revisited
But, it's worth remembering in 2007, markets got it all very horribly wrong, failing to predict the collapse of the stock market and the worst recession of our lifetime. Sometimes, it pays to be a contrarian. Always, it pays to have the courage of your convictions.
I'm not in the game of taking outrageous positions based on scenarios that have maybe a 5 to 10% chance of coming to fruition. It cost me dearly in the recent stock market crash, as my holding in Barclays (LSE: BARC) was smashed and my holding in Lloyds Banking Group (LSE: LLOY) was obliterated. It was disappointing, sure, but I don't have any regrets.
I do take some solace in the knowledge I was not alone in failing to foresee the great crash. Far from it. If I had my time again, I'd probably do the same thing. The global financial crisis, where banks across the world were simultaneously in grave danger of going bust, was simply a once in a lifetime event.
FTSE 10,000? Really? Maybe
You cannot invest for such black swan events. Did you see Warren Buffett, for all his warnings about toxic derivatives prior to 2007, sell out in expectation of a synchronised meltdown of the stock market and the banking system?
Interest rates may, bizarrely, hit 8% in two years. But in response, perhaps the FTSE 100 will hit 10,000. Bond prices will collapse as the yield soars, making equities look by far the better option in such an inflationary environment.
If I'm right, I'll be back. If I'm wrong, you'll never hear FTSE 10,000 from me ever again and it will quietly be confined to the archives of cyberspace, like so many other extreme predictions.
As for my level of confidence about the likelihood of my extreme prediction becoming reality, it may take some time.
More on the economy and the markets:
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