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|Introduction: The Economy on "Crack": The End of Keynesian Economics||p. 1|
|Deflation Is the Trendłand It Changes Everything||p. 17|
|Demographic Trends Are the Key Driver of Our Economy: Why Consumers Matter More Than Government||p. 40|
|The Greatest Real Estate and Credit Bubble in Modern History: Bubbles Almost Always Go Back to Where They Started||p. 61|
|Unprecedented Government Debt: Especially Unfunded Entitlements||p. 91|
|Deleveraging and Deflation: If s All About Money and Restructuring of Debt||p. 114|
|Why the Government Stimulus Plan Will Fail: The Recovery Is Not Real||p. 148|
|Consumers Are Too Much in Debt: The Credit Cycle Will Not Come Back||p. 182|
|The Last Great Bubble in China: Excess Capital Investment Means Global Deflation and an Emerging World Downturn||p. 201|
|How You Can Survive and Thrive: Strategies for Investments and Careers||p. 222|
|Expanding Your Business's Dominance in a Time of Slower Growth: The Ultimate Long-Term Strategy||p. 254|
|Government Needs a New Approach: Focusing on the Causes, Not the Symptoms||p. 270|
|The Greater "Network" Revolution Ahead: Like the American Revolution in Democracy and Industrial Revolution 250 Years Ago||p. 298|
|Table of Contents provided by Ingram. All Rights Reserved.|
The Economy on “Crack”:
The End of Keynesian Economics
Imagine 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 program of “qualitative easing” (QE) that 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 rarely used and potent tool: quantitative easing (QE), 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 this is in addition to its normal currency creation.
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 another 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 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 2011 when the largest numbers of baby boomers move past age 50 and begin making and spending less and less money?
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! 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, was implemented in late 2010. 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 4.5% that we have been forecasting is finally happening. The Fed’s own QE2 stimulus program has actually driven rates up due to rising growth and inflation expectations to the point that they threaten already weak home sales, home prices, and the recovery of the economy as a whole, much as has been happening in Europe since April 2010. Rates on Treasury bonds have been rising since QE2 began in late 2010! The stimulus was supposed to reduce such interest rates but has increased rates instead, which indicates the bond market’s disapproval of the policy.
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 2012, or 2013 at the latest, and will be even worse.
Purposefully devaluing the US dollar not only raises the costs of imports and commodities like oil and food to everyday consumers who are already struggling, but also tends to set off trade wars among our global trading partners from Europe to China, as a falling dollar gives us an edge in pricing. This devaluation comes after we lectured the Chinese on keeping their currency too low! In the early 1930s, the Smoot-Hawley Tariff Act raised tariffs and set off trade wars, worsening the global downturn. Trade wars today over currency devaluation could have a similar effect. Perhaps more dangerous is that foreign countries and investors that have been buying US Treasuries (despite rising and vocal concerns against our deficits and stimulus programs) may decide that a falling dollar makes owning US Treasuries too risky. The Chinese use their trade surplus to purchase securities. Traditionally they have bought US Treasuries, but recently they have shifted their purchases more toward commodities and the bonds of other countries rather than US bonds. If the Chinese 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 began accelerating in early September 2010. Such bubbles set up investors and retirement plans for another crash and brutal loss in net worth between 2012 and 2014.
Although QE2 depressed the dollar at first, the dollar, like Treasury bond rates, has been rising since early 2011, 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 bond rates would rise in early 2011.
The Keynesian Drug: Invented in the 1930s, Adopted in the 1970s
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 the first bear market bubble we have ever seen. At least during the previous bubbles productivity was growing rapidly, fueled by new technologies and demographic growth. The current bubbles only have government stimulus as fuel because economic trends are slowing, which is why the stimulus has had such disappointing results this time. 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 initially came from the July 2010 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 “head-and-shoulders” pattern, which indicates a massive fall in the coming years, most likely between late 2011 and late 2014. A “head-and-shoulders” pattern is a chart pattern that reflects a small rise and fall as the left shoulder, a larger rise and fall as the head, and then a final rise and fall as the right shoulder. The left shoulder and head fall back to what is called the “neckline,” but the right shoulder is usually followed by a dramatic drop. This is why recognizing such a pattern is important. 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%. The bubble formed the left shoulder of the head-and-shoulders pattern. 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 peak formed the head. That bubble was fueled by short-term rates, pushed down to 1% by the Fed. Now we are seeing a bear market bubble in stocks (US, Europe, China, and emerging markets), commodities, and bonds (especially junk bonds, which have rallied 83% since late 2008—the same as the S&P 500 since March 2009). The NASDAQ has rallied 110%, and emerging markets have rallied even more, 135%. Gold and silver have rallied 105% and 185%, respectively, since October 2008 and are reaching new highs, forming one last perverted bubble. The fear surrounding the desperate stimulus programs, reflected in the size of the programs themselves, is a sign of the coming end of all bubbles, as we warned in the paperback edition of The Great Depression Ahead! This bubble is forming the right shoulder that now looks as if it could peak between October 2011 and April 2012. The Fed helped fuel this bubble with 0% short-term rates and an unprecedented QE program.
Data Source: Yahoo Finance
With the Fed keeping short-term and long-term interest rates low, investors are chasing higher yields on corporate and junk bonds as well as stocks. The natural fall in the dollar at first lifted commodity prices. (Commodities trade in US dollars, so a falling dollar means such goods cost more to us, as do all imports.) This rise in commodities prices has been especially pronounced in the gold and silver markets. People fear the debasement of the US dollar and fear a potential domino effect, as other countries react and devalue their own currencies to remain competitive with the United States.
This third bear market bubble projects a fall in the Dow to approximately 3,300 sometime between late 2013 to late 2014, according to our cycles. This lines 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 nearly dies from the side effects—just like an addict on drugs!
Debt and Stimulus Is Like Any Drug: It Takes More to Create Less Effect
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 4.5% in late 2010! 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 now that this bold and aggressive stimulus program is starting to backfire and long-term rates are rising, 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.
Data Source: © The Economist Newspaper Limited, “Repent at Leisure,” June 4, 2010
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 anesthesia was able to help Jackson sleep, but the high dosage finally killed him.
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, who 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 2011, 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 2011. 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 $122 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 . . . 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 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-and-off slow growth and recession economy 20 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 as fully as it could have, 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 are already moving in the right direction long term—toward austerity—despite the short-term pain and riots.
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 that is 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 will 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, 20% of the loan write-offs, which could create trillions more dollars in stimulus. Having $5 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 $2.5 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 near $3.5 trillion in the private sector. In contrast, government debt has grown about $3.5 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. 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—and that policy now, finally, looks likely to fail, as we forecast it would.
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 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.
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.
Data Source: Bloomberg
Deflation could come slowly, as it did in Japan due to high and consistent stimulus over time, or it could 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 2014, or by early 2015 at the latest, and only after stocks crash to between 3,300 and 5,600 on the Dow by the end of 2013, or 2014 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 onto 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
© 2011 H.S. Dent Publishing