The Great Crash Ahead: Strategies for a World Turned Upside Downby Harry S. Dent Jr., Rodney Johnson
In his most recent New York Times bestselling book, The Great Depression Ahead, Harry S. Dent, Jr., predicted that the stimulus plan created in response to the first crisis would hit demographic and debt saturation headwinds and ultimately fail. In 2010, the stimulus plan had started to fail, and it was already stalling by the first quarter of/i>/i>/b>
In his most recent New York Times bestselling book, The Great Depression Ahead, Harry S. Dent, Jr., predicted that the stimulus plan created in response to the first crisis would hit demographic and debt saturation headwinds and ultimately fail. In 2010, the stimulus plan had started to fail, and it was already stalling by the first quarter of 2011. The Great Crash Ahead outlines why the next crash and crisis is inevitable, and just around the corner—coming between 2012 and 2014.
With incisive critical analysis and historical examples, this book lays bare the traditional assumptions of economics. Dent shows that the government doesn’t drive our economy, consumers and businesses do; that the Fed does not create most of the money in our economy, the private banking system does; and that the largest generation in history is now saving for or moving into retirement, meaning slowing growth. This is the new normal! Our banking system borrowed to lend for the first time in history with unprecedented leverage and debt levels of $42 trillion, way beyond the massive government debt. But the government’s promises and unfunded liabilities take the cake, at an estimated $66 trillion and growing!
These massive debts will have to be restructured in a time of slowing spending, and this means a deflationary crisis, which is very different from the inflationary crisis of the 1970s and requires very different personal, investment, and business strategies. Dent and Johnson outline these strategies in very practical detail. In the coming years, the greatest surprise will be that the U.S. dollar becomes the safe haven and appreciates just when everyone is calling for it to crash, while the gold and silver bubbles burst along with the stock and commodity bubbles. And real estate will see another round of declines just when everyone thought it could go no lower. The Great Crash Ahead is about making smart, cautious investments—avoiding the sort of high-risk, high-profit investment schemes that sank the world economy.
The road to recovery will be filled with challenges and will require massive change, such as debt restructuring, plans for greater employment, the restructuring of social welfare programs such as social security and health care, budget cuts, and higher taxes—in short, a revision of the kind of lifestyle that characterized the “Roaring 2000s.” The good news is this process will eliminate tens of trillions of dollars of debt and can make way for growth again as the echo boom generation ascends. Or we can continue on our present course and end up like the Japanese, with no growth and high debt two decades later.
John Mauldin, 4 times New York Times best selling author of Endgame and financial newsletter publisher of Thoughts from the Frontline and Outside the Box
“I have watched Harry Dent's unique demographic approach to the economy and his forecasts for over 20 years. He has seen most of the key economic changes way ahead of most. In fact, he forecast the current economic crisis 20 years ago! He has spoken at many of my events around the world and has helped many prepare for the unprecedented economic challenges we are facing today. But perhaps the best thing about Harry is his very human, understandable and common sense approach to economics.”
- Anthony Robbins, Entrepreneur, Author and Peak Performance Strategist
“You can't accuse Harry Dent of being a wimpy thinker. His new book is full of confident analysis and bold predictions. Whether he will be right about all of it, who can say? But his core theme is fascinating and provocative; his book is a delight.”
William Bonner, President and CEO of Agora Inc.; author of Dice Have No Memory and Empire of Debt
“While being one of the most bullish and accurate forecasters for 20 years, Dent has always been warning that this great boom would end around 2008-2009. He now sees a bigger crash ahead and a deflationary environment that could ravage your portfolio. His warnings and predictions are well worth reading and taking seriously.”
David Bach, #1 New York Times bestselling author of Start Late, Finish Rich and Debt Free for Life
“The Great Crash Ahead” sounds ominous, but it doesn't have to be if you know what factors to look at when making new decisions about your career, your investments and your business model. The old remedies won't work anymore, but visionaries Harry Dent and Rodney Johnson provide their unique insight on how to make your future a prosperous one.
Ed Slott, CPA, author, IRA expert, creator of PBS Special “Stay Rich Forever and Ever”
“Dent is the reigning expert in using sophisticated demographic models to see around the economic corner. He saw the boom of the 1990s and warned that a bust would come in 2008 forward. Now he tells us the worst is not over. Harry makes a clear and compelling case for what could be a tough time ahead.”
Robert D. McTeer, Distinguished Fellow, National Center for Policy Analysis, and former president of the Federal Reserve Bank of Dallas
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Read an Excerpt
The Great Crash Ahead
Imagine that someone very close to you, someone who is part of your everyday life and upon whom you depend, is a drug addict. The person goes “cold turkey” one day and inevitably begins to suffer symptoms of withdrawal and detox. Along comes the drug dealer and he begins throwing not just more drugs, but harder, more addictive drugs at this person. Do you chase away the drug dealer and nurse your friend through detox, knowing that this is a difficult period but a necessary part of the process? Or do you welcome the drug dealer and actually cheer as more drugs are taken? This might sound a bit outrageous, but it is exactly what we are experiencing in our economy! The patient/friend is the economy in which we all live; the drugs are debt, interest rates, and printed money; and the drug dealers are central bankers and the federal government. In a strange, perverse world, our markets are cheering as the patient is given more of what caused the illness in the first place!
In The Great Depression Ahead (Free Press, 2008), we forecast a strong rebound in the American economy in response to government intervention quickly followed by a vicious downturn. In October 2010, we shifted our view that the markets would weaken largely as a result of declining economic trends; instead, the markets have been perverted by the massive buildup of government debt, previously unfathomable amounts of stimulus, and ultra-low interest rates. Out of desperation in the face of a total financial meltdown, in late 2008 the US Federal Reserve (the Fed), the central banking system of the United States, dropped short-term interest rates to zero. The Fed also created a first program of “qualitative easing” (QE1), which allowed banks to pledge potentially bad mortgage loans as security so that these lenders were able to borrow hard cash and thereby bolster reserves. The economy continued to fail. As this first stimulus program began to falter in 2010 (as we forecast in The Great Depression Ahead), the Fed brought out a second quantitative easing (QE2), again basically the printing of money out of thin air. The two major devices that the Fed has to stimulate the economy (beyond fiscal stimulus from the Treasury) are: (1) lowering the Fed funds rate, and (2) printing to buy Treasuries or other bonds in the open market, which injects more money into the system.
In normal times, the Fed relies on lowering short-term rates to stimulate borrowing. Think of this as like giving the economy a cup of coffee or even a minor stimulating drug, such as speed. It revs up the system short term but probably won’t do any long-term damage. However, in this latest downturn, the Fed thought it necessary to do even more. Only in exceptional instances will the Fed print a significant number of new dollars to buy, and for good reason. This powerful tool is very dangerous—akin to giving the economy a much more addictive drug, such as crack. The Fed has printed more than $2 trillion in new dollars, and QE3 looks likely in 2012 now that Treasury bond rates are so low with the flight of bondholders out of Europe and into the US.
As part of the qualitative easing in late 2008, the Fed accepted mortgage bonds of questionable quality as collateral from banks in exchange for cash, which the banks used to replenish their reserves. But those pledges had to be paid back in short order. Realizing that banks with large loans from the Fed were in just as bad a shape as banks with mortgage bonds, the Fed changed its approach in spring 2009. Instead of holding the questionable mortgage bonds as collateral, the Fed began a program of simply buying these assets from the banks outright. Overall, the Fed bought from banks $1.4 trillion in mortgage securities, mostly Fannie Mae and Freddie Mac bonds, and bought as much as $0.5 trillion in Treasury bonds. This outright purchasing from banks gave the banks much-needed capital as their loan losses mounted. But that wasn’t enough! After this program ended in April 2010 and the markets began to sputter, the Fed reemerged with its second program, in which it bought an additional $600 billion in Treasury bonds in the open market from November 2010 through June 2011. These purchases increased the total assets and cumulative stimulus from the Fed to about $2.8 trillion! That does not count other stimulus programs, including bailouts, government tax rebates and credits, Cash for Clunkers, housing credits, the cut in the Social Security tax for 2011, and many loan and debt guarantees, the costs of which were in the trillions on their own, although much of the bailout monies have been paid back.
These breathtaking moves may seem like a massive effort to “solve” our economic woes, but they are not; they are window dressing. As our work clearly has shown, the natural order is for booms to be followed by busts. What happens when the economy fails again as demographic trends continue to slow, especially after late 2012, when the top 10% who control 44% of income and peak 5 years later than the average baby boomer in late 2007 drop off in spending as well?
It would be one thing if this injection of money went largely into lending and spending that bolstered the economy, eventually driving up tax revenues to help make up for the debt, but that has not happened. Bank reserves have risen by over $1.5 trillion, while business lending has barely moved off of its crisis lows. Consumer loans clearly have declined as well. Banks (and other investors) who sell their bonds to the Fed simply turn around and invest in riskier assets, like high-yield bonds, stocks, and commodities. Such investments lead only to greater speculation and greater bubbles in all investments outside of real estate! When does it ever end?
Lowering short-term rates merely makes borrowing and lending more attractive without expanding money supply directly. Lower rates also encourage banks to borrow short term and invest in longer-term Treasuries, which keeps rates lower than they would normally be. QE literally prints money out of nothing and currently is being used to buy Treasury bonds and mortgage securities. This activity puts money directly into the system; as a result, longer-term rates are pushed even further down by adding more demand (the Fed’s buying of bonds) in an attempt to bolster borrowing and asset prices. And the Fed has used QE more than once: a second round, QE2 in late 2010, and a third is likely in 2012. Using QE is like using the drug crack, whereas lowering short-term rates is more like using the drug speed.
The first side effect of these drugs is the sudden drop in the value of the dollar, which results in higher import, food, and gas costs for everyday consumers. The second is a return of bubblelike market activity in everything from stocks to junk bonds to commodities. Such bubbles will burst eventually, critically injuring aging investors and retirement funds. The third is lower returns on fixed income, which directly impacts retirement portfolios and affects the ability of the largest segment of aging consumers to spend, forcing them to chase riskier investments. The rise in Treasury bond rates toward 3.5%+ that we have been forecasting has not occurred yet. QE2 was successful in forcing down interest rates on Treasury bonds, and then came the flight in capital from Southern Europe into US Treasury bonds that forced them even lower, to well below 2.0% on 10-year Treasuries despite 3% GDP growth and 3%+ inflation. Such bond yields should be 4%+ in 2012 without QE. A QE3 in 2012 in reaction to likely slowing in growth after QE2 wears off is likely to spark rising rates down the road, first from inflation fears and later from deficit concerns and credit quality as deficits persist and economic growth is disappointing considering this massive amount of stimulus.
The Fed stimulus will continue to fail, Treasury bond rates will ultimately rise as in Europe, and the overarching trends of slowing demographics and debt deleveraging will set back in. The great economic crisis of 2008 will likely return in the summer of 2013 or by mid- to late 2013, at the latest, and will be even worse.
If the Chinese and other foreign governments stop buying our bonds, either the Fed must buy many more of these bonds (out of desperation), or bond yields will rise sharply. Thus far, US bond purchasing by the Fed has greatly outweighed the reduction in buying by the Chinese. But if the Fed keeps buying, you can bet that the global bond markets eventually will see this as a sign of weakness and will force rates up anyway as they perceive rising risks. Again, the biggest risks are in the bubbles in stocks, commodities, and bonds that have been building since March 2009. Such bubbles set up investors and retirement plans for another crash and brutal loss in net worth between 2013 and 2015.
Although QE2 depressed the dollar at first, the dollar, like Treasury bond rates, has been rising off and on since early 2011 into mid-2012, which goes against what most investors expected. This shows that such investors don’t understand the new environment, which will be deflationary. In contrast, we forecast that the dollar and Treasury bonds would appreciate in early 2011, and likely will again from mid-2013 forward.
Our government and most governments around the world have been on the Keynesian plan ever since the early 1970s, when the last long-term boom came to an end. John Maynard Keynes first came up with his theory of the government stimulating to offset private economic slowdowns in the 1930s. Every time the economy slows, the Fed lowers short-term rates and implements fiscal stimulus that it hopes will rekindle consumer and business spending. We have been living off economic “speed” for a long time, since the 1970s, about the same time that baby boomers discovered recreational drugs as well. While drugs failed to resolve the social issues of the 1970s, the parallel economic approach has always seemed to work, because it coincided with the growth of the massive baby boom generation’s demand for spending and credit, especially on housing as baby boomers grew into adulthood and matured.
However, the Keynesian approach has three problems. First, the economy never gets to “exhale” and fully balance out the excesses in debt and expansion from each growth surge, so it gets less efficient and trim—like getting more obese. Second, lower interest rates feed bubbles in asset prices, as we saw first in tech stocks, then in housing, then in emerging markets and commodities. When these bubbles burst, the Fed stimulates again, and that only drives the next set of bubbles. When does it ever end? Our economy just gets more perverse and volatile and less functional—just like any drug addict.
Why the “Great Crash Ahead”? The Fed has now stimulated a third and even more perverse bubble, which is not driven by fundamental trends. At least during the previous bubbles, productivity was growing rapidly, fueled by new technologies and demographic growth. The current bubbles have only government stimulus as fuel because economic trends are slowing, which is why the stimulus has had such disappointing results each time. QE1 got us to 4% growth before it failed. Then QE2 took us to 3% growth in late 2011 before petering out. A QE3 in 2012 is likely to fizzle out at more like 2% growth by early to mid-2013. The current bubbles in stocks, gold, commodities, and junk bonds will burst and bring back the housing, mortgage, and banking crisis even stronger, greatly injuring investors, retirees, and pension/retirement plans again.
Chart I-1: Dow Megaphone Pattern, 1995–2015
Data Source: Yahoo Finance, 2012
Chart I-1 initially came from the March 2012 issue of our newsletter, The HS Dent Forecast, and it is probably the most critical chart for illustrating the actual impact of the desperate Fed stimulus on stocks. It shows three major bubbles that also form a larger megaphone pattern, which indicates a massive fall in the coming years, most likely between mid-2013 and early 2015. In this pattern we see three bubbles with each one peaking a little higher, and with each crash bottoming a little lower. The first bubble was around tech stocks and peaked in early 2000. A huge crash followed, especially in tech stocks, which bubbled the most. The NASDAQ was down 76%. That crash formed the B wave down. Very low short-term rates after the 1990–1991 recession and the S&L crisis helped to fuel that bubble. The second, broader and higher bubble peaked in October 2007, with an early 2006 peak in real estate and a mid-2008 peak in commodities on each side. The greatest bubble here occurred in emerging markets and oil. That bubble was fueled by short-term rates, pushed down to 1% by the Fed. The crash of 2008/early 2009 formed the next D wave down. Now we are seeing a final bubble in stocks (US, Europe, China, and emerging markets), commodities, and bonds (especially junk bonds, which have rallied 90% since late 2008—nearly as much as the 111% rally in the Dow since March 2009). The NASDAQ has rallied 147% and emerging markets have rallied 138% at their top. Gold has rallied as much as 169% since late 2008 and silver a whopping 465% when it topped near $50 in April of 2011. This final bubble is likely to peak at a Dow 14,600 or a bit higher by mid-2013. Then a larger crash, likely triggered by a blow-up in Spain and southern Europe, is likely in early to mid-2013 and the Dow is likely to bottom by late 2014 or a bit later between 5,600 and 6,000. The ultimate bottom in the Dow is likely to be more like 3,300 to 3,800 between 2020 and 2022 before the next global demographic boom begins.
With the Fed keeping short-term and long-term interest rates low, speculators, investors, and pension funds are chasing higher yields on everything from corporate and junk bonds to commodities to stocks. Never have all of these investments gone up at the same time for so long. As in the 2008 crash, when everything goes up together, they then go down together, and there is nowhere to hide and no way to diversify. The US dollar index and US Treasury bonds were the safe haven in the last crash and will very likely be again. Gold and silver will not protect you, as they did not in late 2008!
The ultimate lows between 3,300 and 3,800 by 2022 or so line up with our observations that almost all bubbles either go back to where they started or fall even a little lower. The stock bubble started in late 1994 at 3,800 on the Dow, so we have been expecting 3,800 or lower for an ultimate bottom. The housing bubble started in early 2000. Home prices would have to fall 55% from the top to get back to those levels. The more a bubble grows, the more it attracts investors, but such a bubble also will fall farther, creating another wave of havoc.
It would be one thing if the government’s plan actually worked, creating sustainable economic growth so that high debt and asset prices would not be such a burden. However, the demographic and debt deleveraging trends we face are massive and will make sustaining a recovery even more difficult than for Japan in the 1990s, where a demographically induced crash that started in the early 1990s is still in force. Today the GDP of Japan is little higher than it was in 1990, 21 years ago! The big picture is very simple: adding stimulus and debt always works at first but never works long term. It takes more and more stimulus to create less and less effect, until the economy finally dies or near dies from the side effects—just like an addict on drugs!
Chart I-2 tells the story about as well as anything could. For every additional dollar of debt we have added to the economy since 1958, we have generally gotten progressively less growth in GDP. This graph from the Economist goes only through early 2010. If the graph were updated, we would probably be right near zero effect presently. Hence, as potent as the newer quantitative easing policy is, it is not likely to revive the economy substantially at this late stage of debt abuse. Consumers have not been buying houses even though long-term mortgage rates have been at unprecedented lows, like 3.5% to 4.0%, in late 2011! Why would another 0.5% lower make much difference? Lowering mortgage rates from 8% to 5% makes a big difference, but going from 4.0% to 3.5% doesn’t make as much of a difference. What happens if this bold and aggressive stimulus program starts to backfire, with rising inflation and high deficits coupled with long-term rates rising instead of falling, much as occurred in 2010 in Europe? Rising interest rates will be the final nail in the feeblest housing market since the 1930s, as we have been warning for years in our newsletter. The real impact of QE now is simply to encourage more speculation in asset prices. The money injected into the economy has to go somewhere, and lower long-term rates increase the value of all assets, including stocks, commodities, and real estate. The money clearly is not increasing lending.
A substantial rise in Treasury bond rates will be the first sign that the endless stimuli and QE plans are over. If governments keep stimulating when the bond markets start to worry about inflation and/or credit quality, then rates rise even faster. This checkmates a government much as happened to one country after the next in Southern Europe.
There comes a point at which drug doses a person takes are so high that they could kill the user. Think of Michael Jackson in recent times. He wasn’t partying night after night. He was just trying to get a peaceful night’s rest. The cumulative toxicity from many years of increasing painkillers and drug use caused his body constantly to attempt to “detox,” making it harder and harder for him to sleep. Such high internal activity must have made him feel like he had fire engines inside, always rushing to the next fire. After many years of such drug abuse, only a very potent anesthetic was able to help Jackson sleep, but the high dosage finally killed him.
Chart I-2: GDP per Dollar of Debt
It’s a drag
US GDP growth in $ per additional $ of debt*
Sources: Bureau of Economic Analysis; Federal Reserve; The Economist. *All domestic nonfinancial debt 3-year moving average
© The Economist Newspaper Limited, “Repent at Leisure,” June 4, 2010
Corporations have hundreds of billions of dollars on their balance sheets that they don’t invest in their businesses, as they are uncertain about future growth, taxes, health care costs, and everything else. But lower interest rates give corporations the incentive to borrow money, which they use to finance acquisitions, to buy back equity to create greater earnings per share, or simply to pay key shareholders, which also drives up stock prices. The junk bond trend, which started with Michael Milken in the 1980s, most likely experienced a final, sharp spike in prices (drop in yields) in 2011. The recent surge was fueled by dramatically falling junk bond yields due to QE and the temporary recovery from government stimulus after the spike in junk bond yields in late 2008. Should companies be leveraging up internally in such a dangerous time as today’s economy? Of course not! But low long-term rates are proving irresistible to companies, which then take on more debt, creating greater leverage and risk at a time when they are already drowning in debt. Thus, lower interest rates are not the cure for an economy that is too much in debt. But everyone wants more crack once they are hooked! Corporate credit ratings have continued to decline since 1980 as a result of higher debt.
What happens when the economy finally slows more markedly and these junk bond yields spike again, as they did in late 2008? We already forecast that this will likely begin more seriously as early as late 2012 or early 2013, with stock markets starting to correct again. More stimulus . . . more debt . . . more bubbles . . . When will it ever end? Bubbles always end! The final bursting of this unprecedented world bubble should mean the end of Keynesian economics—finally!
This comes back to our most basic argument. A 25-year trend in rising baby boom spending that we cover in Chapter 2 (1983–2007 on a 46-year lag from rising births from 1937 to 1961) has peaked, and economic growth will slow overall into at least 2020 and perhaps until as late as 2023, especially after 2012, when the richest 10% peak in spending later. This declining wave of spending is not something you can fight with a few trillion dollars in stimulus here and there—and the US government has already gone further than we thought the bond markets would allow, after the European “debt call” in April 2010 by the “bond vigilantes.” A similar rise in interest rates is finally about to come to the United States, as we forecast, albeit later than we originally would have expected. It would take tens of trillions of dollars to offset such natural downward trends and a necessary shift to saving for an aging generation that is the deepest in debt of any generation in history. More important for the near term, the greatest debt and credit bubble in history peaked in 2008, at $56 trillion in private and government debt plus a bare minimum (in the most rosy economic assumptions) of $46 trillion in unfunded liabilities for Social Security and Medicare/Medicaid ($66 trillion, according to private analysts like Mary Meeker). The United States faces a total indebtedness of at least $102 trillion, seven times GDP at the top in 2008 and as much as $122 trillion, or almost 9 times GDP, under more realistic assumptions! By way of comparison, our total indebtedness reached just two times GDP at the top of the Roaring ’20s boom. Our total private credit reached $42 trillion in 2008. This number more than doubled from 2000 to 2008, which means $22 trillion in debt was added to our economy within 8 short years in the private sector alone. In 2008, private debt was more than four times the size of our government debt, excluding unfunded entitlement liabilities. This private debt will continue to deleverage for years to come, and at a faster pace than government debt rises when the economy slows again . . . creating deflation, not inflation.
The seemingly most intelligent and awarded of Keynesian economists around the world, such as Paul Krugman, argue that the government has not stimulated enough. That would make sense in light of the US banking crisis of the 1930s, in which the economy melted down to extremes without help from the government. So why not be smarter this time and stimulate more and sooner? Because it wouldn’t be smart to ignore the crack addiction analogy that occurs in real life. The more the stimulant is applied, the less it works, and it will kill you in the end. You end up worse, not better, before you are forced to crash and go through detox!
Japan has stimulated the equivalent of just over 100% of its GDP since its bubble boom peaked in 1990; that would be the equivalent of about $15 trillion for the United States. Japan’s stock market still fell over 80%, real estate fell over 60%, and the country is still in an on-again, off-again slow growth and recession economy 22 years later. Such stimulus eased the pain but caused government debt to skyrocket to the highest levels by far among the countries in the developed world. Japan has the fastest aging society, to boot. Private debt did not get written off nearly as much as it could have been, so the Japanese system still has too much toxicity and needs to detox further. Therefore, we clearly don’t think that this is the policy that the United States should follow. European governments started moving in the right direction long term—toward austerity—but then joined the stimulus party with their own $1.3 trillion of QE in late 2011 and early 2012.
The Japanese are not public complainers, but they have become very frugal. Japanese lifestyles have been compromised substantially, with no light at the end of the tunnel. Government debt ratios are high, savings rates are plummeting, and government benefit payments are rising, due to the rapid aging of the Japanese population. The New York Times recently featured an article that showed a man who bought a condo 17 years ago for $500,000—after the real estate bubble had burst and was deflating, so not near the top of the real estate market! After paying down his mortgage for 17 years, he sold the unit—and still owed $110,000. The man now is likely to have to go into personal bankruptcy. That’s why we don’t advise you or your kids to buy a home now, despite the recent fall in prices. Why didn’t the Japanese government allow and/or force the banks to write down these debts to sustainable levels? They simply didn’t want to go into detox or admit their mistakes in letting the bubble happen in the first place, much as the US government is doing today, protecting the banking system over the interests of everyday citizens!
In contrast to the long, drawn-out approach used by the Japanese government, the United States responded to the recent economic crisis with a typical “shock and awe” policy, stimulating very strongly right at the beginning. Thus, most of the “ammunition” was used up early on, creating even greater bubbles and imbalances than those that caused the initial crisis—which only feeds the next, worse crisis. But now the United States has less ammunition with which to fight!
We have proposed that the government not use stimulus to try to revive an economy that is already mortally wounded and needs to deleverage and rebalance. Instead, the US government should use government debt to help cover the losses that banks incur from actually writing down loans to their real values. Such a move would have the potential to save more than $1 trillion per year in interest and principal payments by consumers and businesses for decades to come. That is a real stimulus plan focused on the root cause of this economic crisis: an out-of-control debt bubble and the aging of the massive baby boom generation, which has led to a decrease in consumer spending.
Ultimately, whether through years of free-market debt deleveraging, as occurred from 1930 to 1933 (and as has been prevented thus far largely by the government’s stimulus program in the current crisis), or through a government-driven program that actively encourages or forces banks to write loans down to their real sustainable value, the result ultimately will be reduction of around $20 trillion of private debt, mostly mortgages and financial sector debt. This amount will represent 90% of the $22 trillion of private debt created in the debt bubble from 2000 to 2008. At 5% average interest rates, that would save consumers and businesses $1 trillion annually in interest and would reduce principal payments as well. That kind of stimulus keeps on paying. If the government wants to encourage write-offs and keep the best banks from going under, it may have to offer to cover, say, 33% of the loan write-offs, which could create trillions more dollars in stimulus. Having $3 of private debt written off for every $1 in government debt incurred is a great trade-off, especially given that interest rates on government debt tend to be lower than for other kinds of debt.
We will discuss the total debt picture in more detail in Chapters 3 and 4. The largest and most toxic debt we incurred was in the financial sector, which is now deleveraging the fastest; about $3.0 trillion in debt has been written off since 2008. Most of the $17 trillion in this sector went into real estate, in which prices will fall to near where they started or lower, just as in every bubble in history. Thus, the most deleveraging or elimination of debt should happen here. The business and consumer sectors have deleveraged only a little thus far, which clearly demonstrates how far we have to go in mortgage and debt write-downs. Since 2008, the total decline in these two sectors has been close to $1 trillion, for a total of $4.0 trillion in the private sector. In contrast, government debt has grown about $5.0 trillion since 2008. Thus far, the rise in government debt has been offset roughly by the fall in private debt, which is why the United States is sitting at a modest inflation rate, despite the greatest stimulus program in history. When the stimulus fails and the economy goes back into detox—which it really, really wants to do—then the private debt will deleverage much faster and more than the government debt will rise, leading to deflation.
Deflation is the only possible scenario in the decade ahead, albeit after further likely rising inflation first. This will be the Decade of Deflation, much like the 1930s. Why? Because deleveraging and deflation always follow debt and asset bubbles, such as happened in the 1820s, 1860s, and 1920s in the United States and in the 1980s in Japan; there are no exceptions in modern history! It is merely a matter of how long the US government and others can be allowed to keep stimulating to ease the pain and avoid the necessary detox. Rising Treasury bond rates will end the stimulus cycle, likely by mid-2013.
All the king’s horses and all the king’s men couldn’t put Humpty together again.
—from an English nursery rhyme
Here is where we perhaps have the most shocking of our forecasts for the years ahead in this deflationary crisis: The US dollar will appreciate and be the safe haven—not gold, silver, the Euro, or the Swiss Franc. Chart I-3, which graphs the US dollar index from 1980 to 2011, shows that the US dollar was debased in the boom. It peaked in value in 1985 and has fallen nearly 60% in two major crashes. It was the massive creation of $42 trillion in private debt, which grew 2.65 times the growth of the GDP from 1983 to 2008, which created massive amounts of new dollars and devalued the US dollar. Since the financial crisis in 2008, the dollar has only moved sideways to up. During the actual meltdown of the financial system in late 2008 and early 2009, the dollar went up 23%! Gold and silver went down. Oil crashed most extremely. Stocks here and around the world all crashed. Real estate crashed. The dollar was the safe haven in late 2008, and it will be the safe haven for likely many years to come in the period of debt deleveraging ahead.
Chart I-3: US Dollar Index, 1980–2015
Data Source: Bloomberg, 2012
During the periods where there is the perception of a financial crisis, gold and silver rise. But when the crisis actually hits, they fall, and it is the dollar that rises. Why? During a financial meltdown, that massive $42 trillion in private debt will see major write-offs and restructuring, and that destroys dollars. By destroying dollars, you make them scarce and valuable again—you actually reverse the debt and credit bubble—and fewer dollars means fewer dollars chasing consumer goods, or deflation in prices, not inflation! Understanding the difference between deflation and inflation is the key to prospering in a crisis unlike any you have seen in your lifetime.
Deflation could come slowly, as it did in Japan due to high and consistent stimulus over time, or more likely it will come rapidly, as in the early 1930s, when the government did little more than lower short-term rates to stave off the pain of detox. In this cycle, the United States has embraced a “shock and awe” policy that at first was more effective than the policies of Japan but proved more dangerous long term, due to the bubbles the US approach is creating. Now that such an unprecedented, desperate, and aggressive program is starting to fail, it is likely to fail miserably, as it has only made our debt levels worse and has put off the necessary crisis and detox. We have been advocating a policy wherein the government creates only enough additional debt to cushion the write-down of much larger debts in the private sector, which should generate more than $1 trillion in lower interest and principal payments for consumers and businesses for years and decades into the future.
However, that policy is too sensible; it treats the real cause of this debt crisis, not the symptoms. And human nature is all about reacting to and treating the symptoms. Hence, this crisis and shift toward deleveraging debt and deflation will not happen voluntarily, just as any crack addict would not go into painful detox voluntarily. Such a policy will manifest only when the crisis overwhelms the US government and other governments—when the stimulus ultimately fails fully and housing prices and the economy fail again, in all likelihood triggered by the coming long-term interest rate spike.
This crisis is likely to be at its worst by early 2015, or by early 2016 at the latest, and only after stocks crash to between 3,300 and 5,600 on the Dow by the end of 2014, or 2015 at the latest. Home prices will fall by 55% to 65% from the top before this crisis is over. Also, the crash will be worldwide, not just in the United States and Europe, as the dramatic China bubble comes to an end. This book is about telling you how to prepare and prosper now that our long-standing forecast for the next deeper depression phase is beginning to occur. Hold on to your life jacket and climb into the lifeboat. The next few years and the next decade will be the most challenging you have ever seen or will see in your lifetime. The secret to prospering is to understand the very different nature of and rules for deflation, as opposed to the inflationary environment most of us have seen all of our lives. Even gold will not save you in this new deflationary era . . . in a world turned upside down!
You can get free access to Harry’s very popular webinar “Understanding the Economy and What Lies Ahead” by registering at http://www.hsdent.com/webinar.
Meet the Author
Harry S. Dent, Jr. is the president of the H.S. Dent Foundation, whose mission is "Helping People Understand Change." He is the founder of HS Dent, which publishes the HS Dent Forecast and oversees the HS Dent Financial Advisors Network. He is the author of the New York Times bestseller, The Great Depression Ahead, as well as of The Great Boom Ahead, in which he stood virtually alone in accurately forecasting the unanticipated "boom" of the 1990s. A Harvard MBA, Fortune 100 consultant, new venture investor, and noted speaker, Mr. Dent is a highly respected figure in his field.
Rodney Johnson is the president of HS Dent, an independent economic research and investment management firm. He oversees the daily operations of the companies and is a regular contributor to the HS Forecast and the HS Dent Perspective. A graduate of Georgetown University and Southern Methodist University, Mr. Johnson is a frequent guest on radio and television programs to discuss economic changes in the United States and around the world.
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Very good book
In a time when most newsletter experts forecast that Inflation is locked in and unavoidable, this book makes a case for Deflation that demands serious consideration for anyone trying to be prepared. I highly recommend this book.
Dent uses demographic trends and predictable consumption patterns to explain the recession and our economic future. On one hand his predictions for the economy are bleak- slow/no growth, deflation and high unemployment for years - 2020 ish things will change - on the other hand he provides a couple of action items to survive the economic winter and be positioned to thrive in the boom which will follow. Highly recommend for any business owner or for that matter any adult who cares about their economic future