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This week Bruce Norris is joined once again by Harry Dent. Harry is the president of the H.S. Dent Foundation, which publishes the H.S. Dent forecast. His mission is to help people understand change. He is the author of many books, which include The Great Boom Ahead 1992 and The Roaring 2000s and The Great Depression Ahead.
The title The Great Depression Ahead is gutsy. This book came out in 2009. Harry finished writing the book in the first half of 2008. However, we had some significant events occur at the end of 2008. The only thing that really surprised Harry was the stock market rally. He assumed that the economy would get worse, and as it got worse, the government would stimulate it. Harry predicted the stock market would bounce to 9800 and maybe even 11,800. We are right in the middle of that zone right now. Short term indicators predict that we might go even higher in the near future. However, he thought this stock bounce would begin and end earlier. Harry does not believe the recovery will last, because the baby boomers will go from spending to saving.
Harry defines a depression as an extended downturn in which you also see a deflation in prices. The reason why prices go down is because banks and loans are failing. This destroys credit and money. The deleveraging of credit causes deflation. In a depression, everything goes down. In an inflationary downturn like the 1970s, real estate goes up. Real estate does well during inflation. The failure of the banking system is the biggest shock an economic system can have. Harry believes that later this year and in 2011 we will go into a depression.
Alan Greenspan once said, “I watched my whole intellectual education fall apart in 2008”. That took a lot of guts to say, and it was astonishing to think that someone like Greenspan had studied economics for 50 years but still estimated incorrectly. Economists can look at a chart and come to two completely different conclusions.
Anyone who has studied business cycles throughout history knows that human greed takes over every time. Anytime you have low regulation, low interest rates, and bubbles building, people go nuts. People start thinking that the market will never go down, and the banks will lend to anyone. If bubbles go on for long enough, anyone will buy into a bubble. Its not a matter of intelligence, it’s a matter of understanding human nature, and that is where economists fall short. All economists look at is statistics.
There are no exceptions to the cycle of economics. The economy always goes from summer to fall, from inflation to disinflation. In the fall season is when you get bubbles, and when you get bubbles, the government always claims it can fix the problem, but they cannot and they have proven this over and over again. Bubbles have to deflate. We don’t want real estate to be so expensive that young people cannot afford it.
The bigger the boom the bigger the bust. Fortunately, we have a tool that tells you how long a boom will last approximately, and when it will wind down. Harry predicted how the economy would change by looking at the birth index. Booms always lead to excesses, and excessive lending and business expansion.
Japan had a real estate bubble similar to ours. They had excessive lending and unaffordable real estate prices. They had a demographic boom peak before the rest of the world, because they were the only major country who did not have a baby boom after WWII. Japan went through their downturn while the rest of the world was in the greatest boom of history. They didn’t have as much deflation as we will have, and their export industries can still be working at 120 percent. Japan also entered their crisis as a net creditor to the world. Almost all their debt was financed by their own citizens, so they had more capacity to stimulate and keep stimulating.
The U.S. is entering this downturn, and the whole country is going down with it. Baby boom demographics are down around the world. The world has also had a banking crisis and real estate bubble. We’re dragging people down with us, but they would have gone down anyways. The U.S. is the biggest net debtor in the world. We owe trillions of dollars to other countries. 50 percent of our debt is financed by foreign investors. This is contributing to the world downturn.
In 2011, Harry believes debt will overwhelm the banking system. This will cause the deficit to reach about $22 trillion. Harry thinks the debt will encourage our government to borrow even more, and we will pay for it. Japan tried to do this, and they will be sorry for it. Their debt to GDP ratio is 2.5 times what ours is. The only reason why they are surviving is because they are still paying interest rates on that debt at less than 2 percent. In the next decade, they will have to pay market rates like the rest of the world. Japan never truly deflated their bubble. They deflated their businesses, but they didn’t deflate their financial institutions. They have no way to easily get themselves out of this trouble.
Harry believes that Europe is going to start having debt trouble as well. When this happens, France and Germany will have to pick up the tab, but they won’t want to have any part in that. They will demand that the other countries cut their spending and raise taxes to cover their own debt.
In the United States, healthcare and social security expenses are already at costs above what we can afford, and we are now looking to expand that. Company and government pensions are unrealistically generous. Once we get to the point where we have to cut those pensions, people are going to go nuts. There may be riots. Bruce agrees with Harry on this issue. $46 trillion in unfunded medicare, Medicaid, and social security liabilities have already been promised to people. That is 4 times as much as the current government debt. We can’t afford the healthcare we have, and now they are trying to pass another healthcare bill.
The government will have to confess its inability to pay the baby boom generation its social benefits around 2012 or 2013 when the crisis will be at its worst. We will not get out of the mortgage and housing crisis until 2012. Harry believes that Obama will not be reelected, because he became president at a bad time.
We are going to have an enormous amount of debt in the next couple years, which is part of the reason why Harry does not support the new health reform bill. We will not be able to sustain the cost of this new program, and Bruce doubts that Congress has fully read through this health care bill.
When you have deflation, it exaggerates the current debt level. Harry believes that this will cause the government to scale back on age limits for social security and health care. Private debt will scale down substantially. All the debt ratios will get worse. Many businesses will go under or merge with other businesses. Banks will have to write off trillions in loans. Deflation works to restructure debt, rather than pay it off. If we had to pay all that debt off with deflated dollars, it would be much more difficult. At the end of this deflation period, we will be much stronger. Stronger companies will take over weak companies, costs get cut, and real estate goes down.
There are very few properties for sale in California right now, and it is easy to resale. The default rate has doubled in the last 12 months, but the foreclosure numbers have been cut in half. Banks are not foreclosing on people, because they do not know what to do with so many properties. Despite the 6 percent GDP, which Harry does not believe will last, defaults will continue to increase and foreclosures will continue to hit the market. This will suppress real estate prices. Banks will eventually have to write off a lot of those loans and foreclose. This is what will kill the recovery. Once the banks realize that real estate won’t recover, we will see the next banking crisis.
There is a psychology attached to exaggerated events like booms. When booms occur, people rationalize their decisions and the same thing happens in a down cycle. When things go down, people develop a pessimistic attitude towards the future. Baby boomers have not yet had a major downturn in both the real estate and stock market at the same time. This crash is going to cause retirements to disappear for baby boomers, and this loss will cause them to save even more. They will have to work longer but they may not be able to get jobs, because older people cost more in benefits. Harry is forecasting 15 percent unemployment.
Harry believes interest rates will increase this year. However, the bond market will eventually notice that the economy is slowing and then interest rates will decrease. This is what happened in 1931 when the crisis was building. We had a great boom market in bonds from 1932 to 1940 when interest rates were falling. In the next decade we will see deflation. If you want to buy long term bonds, Harry encourages people to wait until later this year or early next year. If you want to refinance, you may want to wait until interest rates come back down. This downturn in interest rates will happen between 2011 and 2013.
Bruce never thought he would see interest rates go down this low. Bruce began his real estate career in 1981 when he refinanced his house at 17.5 percent. Now we are at sub five percent rates, and we may see rates go even lower. Harry agrees and claims we may see rates go down to 3 to 4 percent.
