The Virtuous V Economic Scenario

Its impact is real. Consumers have reliquified their balance sheets with one refinancing after another as mortgages have dropped to 45-year lows. Here's the key to the first part of the Virtuous V: Though the nominal debt owed doesn't change -- the homeowner with a $100,000 mortgage still owes $100,000 -- the debt-service burden has dropped like a brick because of lower rates.

For corporations, the story is identical. With interest rates at record lows, companies are tapping the corporate fixed-income market in droves. For example, General Electric (GE - commentary - Cramer's Take), J.P. Morgan (JPM - commentary - Cramer's Take), Citigroup (C - commentary - Cramer's Take) and Goldman Sachs (GS - commentary - Cramer's Take) have together raised several tens of billions of dollars in the fixed-income market.

Even more questionable credits have no problem getting deals done in this friendly market, such as the $2 billion raised a few months ago by Crown (CCK - commentary - Cramer's Take) and Tyco's (TYC - commentary - Cramer's Take) $4.5 billion issuance in January.

The Upward Slope

The second part of the Virtuous V, the upward slope, is the lagging effect that occurs when the Fed pushes too hard: a whiff of inflation. Too much liquidity chasing a relatively fixed amount of goods and services means the purchasing power of a dollar declines; this is also known as inflation.

The implications of this cycle are interesting:

In the initial phase, or the downward slope of the V, interest rates drop, so the debt-service burden drops. For many consumers and corporations, that burden is much lower than it was a few years ago. Debt is still debt, but to the extent that the carrying cost drops, more cash stays in the pockets of debtors.

In the second phase, or the upward slope of the V, a whiff of inflation occurs. It's no longer fair to say that debt is still debt because inflation eats away at the value of a dollar. So while the nominal amount of debt doesn't change -- again, the aforementioned homeowner with the $100,000 mortgage still owes $100,000 -- the "real" amount of the debt does change. It declines in real terms as the rate of inflation rises.

Are you worried about deflation plus the huge consumer and corporate debt load? To the extent that this Virtuous V scenario plays out, you shouldn't be worried at all. The economy will benefit if inflation and interest rates spike a bit, because consumers and corporations that took advantage of lower rates to reduce debt-service burdens will also see their "real" burdens drop as well.

The point of this exercise is not to play economist or forecaster. It's simply to recognize that, first and foremost, our greatest worries and concerns seldom come true. It's the things left unsaid, or not proffered for consideration in the first place, that carry a higher likelihood of actually happening.

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Arne Alsin is the founder and principal of Alsin Capital Management, an Oregon-based investment advisor and portfolio manager of The Turnaround Fund, a no-load mutual fund. At time of publication, neither Alsin nor ACM held a position in any securities mentioned in this column, although holdings can change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Alsin appreciates your feedback and invites you to send it to [e-mail]. Click here to receive Arne's latest favorite stock picks from his newsletter, The Turnaround Report.

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