Mea Culpa: Why I Was Wrong on Interest Rates
In December 2007, I wrote an article titled "The Impending Destruction of the U.S. Economy." It was one of the more popular articles I've written for The Motley Fool. Readers cheered along with its message. It received almost no pushback or rebuttals -- a rarity. I still get the occasional laudatory email to this day.
And it was almost entirely wrong.
The article was straightforward: The economy was buried in debt, and the chicken was coming home to roost. That part was right, and late 2007 indeed marked the beginning of a debt-fueled recession that lingers today.
But here's what I anticipated would ignite the mayhem:
How do we keep our foreign investors happy? With a rapidly depreciating currency, there is but one way to keep them enticed: higher interest rates. You heard it: higher interest rates. With the housing and credit markets swimming in turmoil, the idea of higher interest rates sends shivers down the backs of homeowners facing foreclosure.
Bah. The day I wrote the article, a 30-year mortgage cost 6.4%. Today, the same loan runs at around 4%. Short-term interest rates were 4.5% back then. Today, they're 0.07%. Far from rapidly depreciating, the U.S. Dollar Index went on to surge to multiyear highs, and is roughly unchanged four years later.
It was a good example of how you can be right for the wrong reason. Or wrong, in other words.
What happened? Looking back, a few points stick out.
Few saw the recession coming. Even fewer predicted what would happen.
As obvious as the bust of 2008 is in hindsight, very few people saw it coming before, say, 2007. Of those who did, almost none foresaw exactly what would cause the devastation.
Take Peter Schiff. Schiff is widely recognized as one of the few who saw the recession coming before anyone else, bearish before it was fashionable. There's a great video on YouTube of Schiff making the rounds on cable news circa 2006 being mocked as a Chicken Little as he warns of impending trouble. "This is going to be an enormous credit crunch. The party is over for the United States. We cannot continue borrowing to live beyond our means," Schiff warned to audible giggles from other guests in the background. "I don't believe any of it whatsoever," economist Art Laffer responds, laughing.
Schiff got it right. He deserves credit. But was he right for the right reason? That's harder to say. Consider his more detailed predictions, like this one in 2002:
As the dollar falls, you're going to have significant flows out of U.S. financial assets from all around the world. And that is going to send interest rates through the roof. And when that happens, this whole consumer-led, borrow-and-spend economy is going to come tumbling down.
My prediction for the Nasdaq is that it's going to fall to around 500. Right now, it's about 1,700. It's got a long way to go down. The Dow Jones is still above 10,000. It's probably going to fall to between 2,000 and 4,000. But it might go below 2,000.
And in 2007, from TheNew York Times:
Given the state of the U.S. economy, Schiff said, the dollar could continue to fall in the coming years against the euro to $2.50 or even $3. [By 2010, it rallied to $1.19.]
We could see ... $150 to $200 [per barrel of oil] next year ... At a minimum, the dollar will lose another forty to fifty percent of its value. I'm confident by next year we'll see more aggressive movements to abandon the dollar by the Gulf region and by the Asian bloc. [Oil fell to $33 a barrel a few months later, and the dollar rallied to a multiyear high.]
Schiff knew things would end badly. He knew this before most. But he, like myself, misread what would actually push the economy over the ledge. It wasn't hyperinflation and higher interest rates. It was deflation followed by record-low interest rates that would define the recession.
If there's one lesson I took away from this, it's that the more precise a forecast is, the greater the odds are that it will be wrong. Predicting that a debt-fueled economy will end badly is one thing. Claiming to know exactly what's going to happen next is another -- and one that far too many fall for.
The U.S. really is the world's sanctuary
In the early days of the crisis, people looked at how bad America's problems were and assumed they'd be safer somewhere else. The dollar looks bad, so buy the euro, they said. Load up on Chinese stocks. Consider emerging-market bonds. Anything but America and its doomed dollar.
What many (including me) underestimated was that every major nation, not just the U.S., had big problems. Yes, the U.S. runs big budget deficits, but have you seen how the Europeans treat their public finances? Sure, the U.S. has a dysfunctional and inefficient political system, but have you read about China? "If the U.S.'s political situation looks bleak, consider [the] alternative," Ian Bremmer recently wrote. "Our stable government is why foreign investors continue to flood into the dollar." Strength is relative, not absolute, in a global economy, and the U.S. is relatively strong. We are the skinniest kid at fat camp, so to speak.
That implications of that are huge. When hedge funds want safety, they seek dollars. When banks want safety, they seek dollars. Central banks, whether they like it or not, need dollars. Whether you think that's good or not doesn't make it less true. At the peak of every bout of panic over the past three years has been an insatiable, almost manic demand for dollars. That's kept our interest rates at historic lows.
Perhaps counterintuitively, it might continue until there's less, not more, global instability. We really are the world's sanctuary.
Everyone believes it; most will be wrong
I mentioned that my call for higher interest rates received almost no rebuttals or pushback. In hindsight, that should have been a giveaway that I was wrong.
It was so easy in 2007 to say, "the dollar is doomed, interest rates will surge, the rest of the world is going to abandon us." Virtually every talking head on TV was making the same call. It seemed so obvious; so guaranteed to happen. That alone should have given me pause. It was the classic safety-in-numbers, follow-the-lemmings analysis that is almost always wrong.
Phil Tetlock, a U.C. Berkeley professor who has spent his career studying how and why people make bad forecasts, has some advice I try to remember now: "Listen to yourself talk to yourself," he says. "If you're being swept away with enthusiasm for some particular course of action, take a deep breath and ask: Can I see anything wrong with this? And if you can't, start worrying; you are about to go over a cliff."
Which is what I did with my prediction -- went over a cliff. I'm sorry. I've learned from my mistake. Hopefully you can, too.
If you haven't already, check out my latest book, Everyone Believes It; Most Will Be Wrong for your Kindle or iPad. It's one of the best-selling investment books on Amazon's Kindle bookstore, and it can be yours for less than a buck.
Check back every Tuesday and Friday for Morgan Housel's columns on finance and economics.
At the time this article was published
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