We all like to try and predict the future. In some cases, like investing, it's actually necessary to have an idea of what to expect in the future. Investors need to surmise the shape of the economy and have a strategic plan of how to take advantage of changes in order to profit, and a plan of how to protect ones wealth if something goes wrong.

The Federal Reserve Board is charged by Congress with providing a quarterly forecast. And as much as they hate to make predictions, they are very prepared to do so. Believe it or not, I have a great deal of respect for the intellectual capacity of the Fed.

The Fed has in its employment over one hundred PHD's working on problems and projects at any one time. The members that comprise the Federal Reserve Board are the best of the best bankers from the 12 most important regions in the United States. It is a diverse group that moves east to west and transcends political, cultural, and social lines.

They are voted in by their peers, most of them brilliant in their own right, who also conduct research and run their own independent research agencies. All of this brain power is supported by the finest, most up-to-date sophisticated computers in the world. And the programs developed are custom made to fulfill their specific needs by the best computer programmers in the business. This allows them to collect data, build models, and run scenario's and back test them in pursuit of the many possible scenarios that confront them. They can then use these models to extrapolate future trends, risks, and probabilities. They can envision and run any number of scenarios and come up with realistic odds of those scenarios occurring and the risks associated with them and all of this with a huge budget funding their every need. 

I on the other hand am an "arm-chair-economists". I sit in my chair and contemplate the various problems we face. I then identify the solutions of these problems and determine whether the policies we are employing to fix the problems are right or wrong.  If they are wrong, I construct a scenario based on the repercussions of that particular erroneous policy. I turn what everyone calls "unintended consequences” into concrete, foreseeable consequences and I project from there. And if they are correct policies I establish a time-line toward success and how they will manifest themselves in the economy, on various markets, and on various commodities and the stocks of companies. In both cases I’m chasing down cause and effect.

I take into account public sentiment, the political climate at the time, the market values of various markets, commodities and stocks, the various solutions to problems offered, accepted or rejected, and run that information through my own personal computer - my mind. And I run it through my own custom-made filters which are my philosophy, my economic theories, and the pertinent knowledge I've collected over a lifetime.

What I come up with is an educated guess of the future. Don’t laugh – that’s the same thing the Fed and any other economist comes up with.

I have found that the key to being right or wrong about any given question or forecast comes down to proper integration. This is no easy task. "Garbage in, garbage out" as they say. The important thing is to build a logical case by not only inputting non-contradictory information, but assigning priorities and weights to various data points. In my opinion some factors are a lot more important than others, and discerning which are which is key. 

(For example, perma-bears give virtually zero weight to the positives that exist, and a huge priority to the negatives. And perma-bulls do just the opposite by stressing the positives while ignoring the negatives. This is a method that ensures failure.)

Finally, correctly identifying facts is extremely important, but not near as important as recognizing contradictions to one's own opinions and changing one's mind as quickly as one can. That entails re-rating priorities and re-weighting facts as the world changes and new data becomes known. And the world is always changing.

I'm proud of the fact that I as an individual have done very well against one of the best economic and monetary think tanks in the world. Many times I find myself in agreement with the Fed and many times I don't. And the same is true of most my contemporary economists and commentators. I tend to disagree quite frequently with them. In doing so I was one of the only writers that projected low inflation when my peers were insisting that QE would bring on an onslaught of inflation and a crashing dollar.

(It is instructive that my peers believe what they believe due to their understanding of Austrian Economics and their reading of Milton Friedman, Ludwig von Misses, and other Great Masters of the past. They base their opinions on classical free market economic theory. Well, so do I. Think about that.)

I fought the Feds forecasts of progressively higher growth rates following the recession while arguing that we'd achieve only stagnation for years to come, and I fought my peer’s projections of hyper-inflation, depression and financial collapse, during the financial panic and crisis. Both camps were proved wrong. I projected a flat "recovery" with low inflation for as far as the eye can see as we hit a wall of debt that would force us into an era of de-leveraging. And indeed we have suffered through what I think history will deem years of a 2% growth recession with 1-2% inflation, one of the lowest inflation rates since World War ll.

(One of the reasons for the current change away from my “L” shaped economy scenario, to a bullish 2014 forecast is the fact that US deficits are falling at the fastest rate in history at the same time that US and consumers have de-leveraged back to historic norms. Those that disagree with my modestly bullish view of the economy totally ignore these facts -- and I might add, so does the financial press.)

To this day we have not maintained a prolonged period of growth above 2% or an inflation rate that moved progressively higher. The "era of L" scenario I projected has dominated the economic landscape. It is the first time in American economic history that we have had this particular kind of "recovery" after a financial panic or economic recession. The identification of this scenario, which I believe was singular, was not a fluke or an accident. It was predictable through the correct application of monetary and economic theory.

I have a "knack" for being able to make the big calls at the big turning points. I'm not always right -- I happen to be human -- but I'm right more than most. I called the era of stagflation in the 70’s, the end of the bull market in gold at the top in 1980, the beginning of what I dubbed at the time the coming of a “technological revolution” which I said would rival the Industrial Revolution in length and productivity; and predicted the tripling of the Dow within a decade. 

I fought Milton Friedman, one of my favorite economists, in the 80’s when he predicted higher inflation due to the budget deficits Reagan decided to run, and projected instead an era of declining inflation and declining interest rates. I have argued throughout that the dollar would not go to hell in a hand-basket, but stabilize. I then predicted the Euro Crisis, where the euro not the dollar would come under attack. And I just made a call that after 6 years of stagnation and disinflation, that we are ready for a change. I think this will be the year that inflation, growth, and interest rates begin to rise from there anemic levels, and I mean over the next many years, not the next few months. I think the end of the growth recession years are over. It is for this reason that I predicted on December 27, 2013 that 2014 would be the year that gold would turn up once again.

I have actually presented two possible scenario's to replace the now status quo. (If I had to place odds on what will occur they would be 60% chance of a bullish scenario taking hold, 20% chance of a bearish scenario developing, and a 20% chance we will continue along the flat line of stagnation and low inflation we have now.)

I've warned of a "nasty first quarter", (and January certainly started out that way), and a real healing process that I think will follow. I think that a return to normalization will occur and become evident in the second half of this year. Can I be wrong? Of course!  Which brings me to my main point in this article. I want to focus in on the second scenario that is an alternative scenario if my bullish scenario fails to materialize. This is not a high probability scenario, but it is out there and is a realistic possibility. It is the bear scenario instead of the positive resolution which I think is the most probable.

I have no doubt that in my past articles as I laid out the negative case for the economy, a lot of you were saying "yes! yes!". It is an easy case to make and accept. I'm sure most of you believe that the odds are highest for the bear case ahead, not the bull case. The reason the bear case is so popular with so many is that it is in many instances reality based. Much of the negatives the bears point to are true. (But keep in mind this has been the case all during these several years of them being wrong about their overall forecasts.)

For whatever reason, a negative economic case is easier to make and accept than a positive case. The bull case is boring and "so status quo", where the bear case seems so much more captivating and dramatic. For whatever reason, people are always much more drawn to believe things will go wrong than to go right, and there are lots of things that can go wrong. 

I've made my concerns known over cyber-attacks that are ongoing and should worsen in the future.  My concern over the making of a new monetary crisis is real and is unfolding daily in the many regions of the world.  Puerto Rico's debt has been downgraded, yet so far there is no contagion even though such debt is held within mutual funds throughout the world much the same as sub-prime mortgages.

Japan is the 3rd largest economy in the world and its currency has depreciated over 40% in the last year and its stock market has suddenly gone into free fall. You would think it would have had more affect than it has – but it hasn't.  China, the 2nd largest economy in the world is faltering and there are real concerns about its shadow banking system and continued ability to sustain its present growth rates. And our domestic problems here in the US are weighing down this economy and they won't get better anytime soon. A lot has to go wrong for the doom and gloom scenario to occur but there's a long list of things out there the can go wrong.

Let's assume that the US stock market mimics the gold market of the last two years. Historically gold leads other markets and other commodities. It's possible that the US stock market is a couple of years behind the gold market. If you remember, when the gold market began to fall away from the 1900 dollar mark, gold investors said the market was "due for a correction". I sold out 100%, simply on the basis that sentiment was so bullish and prices were so high, that almost everything that could go right for gold was already in the market. I saw GDP and inflation both falling from their recent highs, and as gold turned down I believed gold was beginning to project that. That turned out to be the right call.

This is true of the Dow today. It was the projections of 2000 to 5000 dollar gold that kept most of the gold bugs in the market as it fell. And again today, we hear stock analysts insist that we are going through a long needed correction but just buy the dips, “you can't lose”. Yet, I see GDP having peaked in the third quarter at 4.1 and inflation having fallen to historic lows, and both of these factors reversing.

As gold continued to fall it was called a buying opportunity as it approached 1600, and it did bounce.  In fact we had a good rally back to the 1800 level and the "all clear" was sounded. We may be doing the very same thing in the Dow right now as we bounce back to near old highs. But, then gold tuned down again and inexorably moved back to the mid 1600 support level and broke that support. Over the next year gold fell to 1180 and as investors looked around they found that they were not in a correction at all, they were in a full-fledged bear market.

What if the same thing happens to the US stock market? Most of the best and brightest are willing to endure a market drop, and even buy the dips assuming that we are in for a 7-10% correction and that it will be the buying opportunity of a lifetime?  What if we bounce off the minus 7- 10% level then turn and fall another 15%, then another?

Could it be that the gold market has already telegraphed a deflationary/recession and that the stock market and the economy are just now entering their bear markets and are following the same pattern? If so, we will be facing a world of falling production, falling prices, falling assets, and rising unemployment. Financial panics, currency crises, and bank runs will dot the economic landscape throughout the world in the years to come.

Like I said, I give this scenario small odds of occurring. But one would have to be a fool to ignore the possibility.

 It is impossible to know how gold would perform in such a world. Much would depend on psychology, the flow of funds, and the measures taken to combat such a dire scenario.

Most doom and gloom predictions never materialize or last very long mainly because of the actions that come after a crisis. Bears assume that market forces will take over and take us down the path of least resistance. Yet this is never the case. You can count on the greatest amount of push back known to man by the governments of the world if a scenario as described above began to unfold. Such government actions could be counter-productive, or they could be constructive. The key to any Armageddon scenario is not just the nature of the crisis that develops; that's just half the story. It's what governments do about the crisis that will be the tip off to success, failure, inflation, or deflation and how to invest and survive.

That's where the bears went wrong in this last crisis.  They concluded that the government could not be successful in preventing an all-out collapse. I chose to wait for a reaction from government, an action which was almost inevitable, hold back any opinion, and evaluate the situation through fresh eyes after the government acted.  If we are confronted once again by economic and financial turmoil, my actions will not be premeditated. They will be an appropriate response to what is actually occurring around us; and there is absolutely no way of anticipating what that might be or what the government will try to do to prevent it.

Hopefully my bullish scenario will win the day and by the end of this year we will have a little more prosperity, a little more calm, and a return to some semblance of normalcy. I suggest whether bull or bear, never overestimate the power of the negatives in an economy, and never underestimate the power of the positives -- especially in this land called America.

Paul Nathan
Paulnathan.biz