I want to begin with what can go wrong in 2018 because I'm optimistic about America's prospects in the coming year, and I want to end on the optimistic scenario that should occur next year. But there are huge land mines ahead that could lead to a very different scenario.
The first and foremost is the prospect of a trade war. We are challenging China, Canada, and Mexico -- our three biggest trade partners -- to substantially change the terms of trade between them and us. If they don't, we are threatening to impose tariffs and/or quotas on those countries’ goods. This in effect, would impose a tax on all of us.
Tariffs amount to taxes on imports, and since Americans are the greatest importers in the world, it is we that will be taxed. About nine out of ten economists will tell you that a trade war is a lose-lose proposition. Almost everyone agrees that the trade war of the 1930s was a contributing factor of the Great Depression and the motivation for the attack on us by Japan. So why would we risk such an irresponsible policy?
Personally, I think it's a bluff. I think it is an attempt to get a better trade deal. And even if it is an error in judgement and we actually went the trade war route, I seriously doubt that it would last long. As soon as the Trump Administration saw the results of tariffs on the economy, I think they would reverse course. After all, Trump is first and foremost a pragmatic businessman and has a very low tolerance for economic failure. The goal of the Trump Administration is higher growth rates and lower unemployment rates, and a strong stock market. A trade war would lead to exactly the reverse.
But to the degree we ever move in that direction, expect a major market reaction. The mere threat of a trade war will lead to at least a thousand points shaved off the DOW. However, selective tariffs will not have that kind of effect. Tariffs on steel have been imposed before and they are detrimental but not large enough to affect the entire economy. We can survive those, but we cannot survive a trade war with our largest trading partners.
Selective tariffs may be imposed as a shot across the bow of our trading partners in an attempt to get a better deal, but that's where it should end.
The next biggest potential mistake would be changing the Federal Reserve from an independent discretionary body to a rules-based body. The class of 2017 is about to depart and the class of 2018 is about to take control of the Fed. President Trump will be appointing up to 5 new members to the Fed, and their views on monetary policy will tilt the Fed toward either a loose monetary policy or a tight monetary policy.
A sound monetary policy can foster stability and confidence. An unsound monetary policy can cause major inflation or deflation, recession, or financial chaos. The importance of the upcoming appointments cannot be underestimated. The fact that Trump appointed a known quantity to replace Janet Yellen, and a person that will not change the composition or policies of the Fed much, is an encouraging sign. But it bears watching.
There are rumors that John Taylor may be appointed Vice Chairman of the Fed and he is a rules-based hawk on interest rates. One of the downside threats for 2018 is that the Fed will raise interest rates too fast and too aggressively next year which could lead to a recession.
Also upcoming - and also an event that bears watching - is the future of the money supply. For the first time in history, we could see trillions of dollars pouring back into this country from abroad in a very short period of time. Where this money goes could be a good thing or a bad thing. If the money goes into investments, it could be good. But if a lot of it begins chasing goods and services, expect a burst of inflation.
More money chasing the same amount of goods is the very definition of inflation. A potential burst of inflation will lead to a dramatic rise in interest rates, and that at a time when the deficit will already be rising dramatically. We will be spending billions of dollars this fiscal year paying for the major disasters we have just gone through, increased defense spending, and the lower tax rates beginning in February.
If rates rise, so will the servicing expense of the deficit, which will add even more to the deficit. A burst of inflation and higher interest rates could cause a monetary crisis and lead to recession. The markets are not looking for anything like this happening next year. But it is possible. And on top of this is the stimulative effect of the tax cut (as the economy is already stimulated) and a move to spend even more money on infrastructure, could lead to an artificial boom and a very real bust.
2018 has the potential to turn into a boom and bust economy leading first to inflation and soaring interest rates, and then deflation and recession. That's the downside, to say nothing of the geo-political threats next year and the increasing hack attacks we face (read China, North Korea, Russia and Iran).
The upside next year is simply continuing what is happening today and progressing from here.
I think people underestimate how far a little freedom goes. Decontrolling and deregulating the economy increases economic activity. Leaving more money in the hands of individuals and businesses leads to wiser investments than leaving it in the incompetent hands of governments. Freedom works. It is no coincidence that generally the freest countries of the world are the most prosperous countries and the most controlled countries are the poorest.
We have just turned a corner from eight years of greater government control, to greater freedom from government. We have, as a result, moved from 1.9% GDP to over 3%. If all things remain equal in 2018, we should continue this performance. But things do not remain equal. 2018 will be determined by our choices as a people. To the degree we make rational choices things will improve. And of course, the reverse is true.
The stock market went up over 5000 points this year, more than at any time in history. The reason is simple: we turned away from socialism and chose capitalism instead. To the degree that markets are predictive, they are predicting a continuation of that trend in 2018. So I'm optimistic about 2018 as long as we can avoid the "Big Mistake".
This time next year we will know whether America has turned from being on the "wrong track" to being on the "right track". And Americans will make their judgement when they go to the polls in November as to the effectiveness of the new direction.
As an investor and trader that specializes in gold and silver stocks I am entering the new year fully invested and fully leveraged. I have stops on certain stocks at my buy-in price that if triggered will take me down to a defensive core position with cash on the sidelines.
If things go as I expect, we will see more money chasing goods -- especially materials. That should lead to a rise in inflation and a firming of metals prices. Many precious metal companies have spent the year lowering costs and increasing exploration and production and those are the companies I hold. Even just slightly rising gold and silver prices will issue a huge bang for the buck to these companies. Hence my aggressive position.
But if things go wrong, I will be out quickly and left with a small core position of mines that are long term investments.
In all the years I've been writing my Looking Forward articles, this is the first year I am actually looking forward to the year ahead. I wish you all a bright and cheerful new year.
Paul Nathan