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A Decade of Volatility: Demographics, Debt, and Deflation

September 11, 2012

Harry Dent gave a speech I listened to a while back, and I got him to transcribe it for this week's Outside the Box. One thing about Harry is, you are never left wondering what he thinks about a topic. He sees inevitable demography-caused deflation in our future and makes some very intriguing arguments that deserve pondering.

At the end is a link to another report and a way to subscribe to his letter, if you are interested in more of his perspective. But first, I suggest you read this straightforward, informative presentation. There is also a link to the actual video of him speaking, should you prefer that.

This evening I am still in Carlsbad, California, where it has been an absolutely marvelous night. Rather than go back to Dallas before I have to be in Palo Alto on Thursday, I am staying in California and splitting my time between resorts in Carlsbad and Palo Alto. Tough life on the road and all that.

I got to spend the evening with my great friend David Brin (Science Fiction Hall of Famer, whose latest book, Existence, is totally a boffo experience – get it!), along with Doug Casey and Doug Hornig (a serious writer of about ten books, including a few sci-fi books, and now works for Casey Research). The topics ranged all over the spectrum. It was one of those nights you live for. And the next few days are going to be solid, as well. I get to see some cool new stuff and some old friends in Palo Alto while waiting to speak on Thursday at the Altegris event there. And then it's back to Dallas on Friday, where I get to write another letter for you. Until then, have a great week!

Your wanting Southern California weather in Texas analyst,

John Mauldin, Editor
Outside the Box

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A Decade of Volatility: Demographics, Debt, and Deflation

To watch a video version of this presentation by Harry Dent,
please click on the following link:

Most of you reading this expect inflation in the years ahead, right? Well, I don't. In fact, I am firmly in the deflation camp.

Just think about it. What has happened after every major debt bubble in history? What happened after the 1873-74 bubble? Or after the 1929-32 bubble? Did prices inflate or deflate?

We got deflation in prices… every time.

This time around, with the latest bubble peaking in 2007/08, the outcome will be exactly the same. There is deflation ahead. Expect it. Prepare for it.

But the bubble-bust cycle that history has allowed us to see is not the only reason I'm so certain we're heading for deflation and a great crash ahead. I have other, irrefutable evidence…

For one, there is the most powerful economic force on Earth: demographics. More specifically, the power of the number 46. You see, that's the age at which the average household peaks in spending.

When the average kid is born, the average parent is 28. They buy their first home when they're 31… after they had those kids. When the kids age into nasty teenagers, the parents buy a bigger house so they can have space. They do this between the ages of 37 and 42. Their mortgage debt peaks at age 41. And like I said, their spending peaks at around 46.

From cradle to grave, people do predictable things… and we can see these trends clearly in different sectors of our economy, from housing to investing, borrowing and spending, decades in advance.

This demographic cycle made the crash in the '30s and the slowdown in the '70s unavoidable. Now it is happening again... with the biggest generation in history – the Baby Boomers.

Consumer spending makes up more than two-thirds of our gross domestic product (GDP). So knowing when people are going to spend more or less is an incredibly powerful tool to have. It tells you, with uncanny accuracy, when economies will grow or slow.

Why Deflation Is the Endgame

Think of it this way: the government is hellbent on inflating. It's doing so by creating debt through its quantitative easing programs (just for starters). But what's the private sector doing? It's deflating.

And the private sector is definitely the elephant in the room. How much private debt did we have at the top of the bubble? $42 trillion. How much public debt did we have back then? $14 trillion.

That looks like a no-brainer to me. Private outweighs public three to one. And the private sector is deleveraging as fast as it can, just like what happened in the 1870s and 1930s. History shows us that the private sector always ends up winning the inflation-deflation fight.

Now, I will concede that this is an unprecedented time. Today governments around the world have both the tools and the determination to fight deflation. And they are desperate to keep it at bay because they know how nasty it is (they, too, are students of history).

How bad is it? Think of deflation like what your body would do with bad sushi. It would flush it out as fast as possible. That's what our system is trying to do with all the debt we accumulated during the boom years. It's what the system did in the 1930s. Back then we went from almost 200% debt-to-GDP to just 50% in three years. It hurt like hell. The government doesn't want this painful deleveraging.

The problem is, the longer the government tries to fight this bad sushi, the sicklier the system becomes. I know this because it's what happened to Japan…

Japan's bubble peaked in the '80s. When the unavoidable deleveraging process began, the country did everything in its power to stop it. How is Japan doing today, 20 years after its crash? It is still at rock bottom. Its stock market is still down 75%.

Japan has gone through everything we'll go through in the next few years. Does Japan have an inflation problem? That's a rhetorical question. Did its central bank stimulate frantically? Also a rhetorical question.

Think of it another way: what is the biggest single cost of living today? Is it gold? Oil? Food? It's none of these. It is housing. And what is housing doing? Dropping like a rock. It can't muster a bounce, despite the lowest mortgage rates in history and the strongest stimulus programs anywhere… ever.

The Fed is fighting deflation purposely. It will fail.

Why the Fed Will Fail in All Its Efforts

There is simply no way the Fed can win the battle it's currently waging against deflation, because there are 76 million Baby Boomers who increasingly want to save, not spend. Old people don't buy houses!

At the top of the housing boom in recent years, we had the typical upper-middle-class family living in a 4,000-square-foot McMansion. About ten years from now, what will they do? They'll downsize to a 2,000-square-foot townhouse. What do they need all those bedrooms for? The kids are gone. They don't visit anymore. Ten years after that, where are they? They're in 200-square-foot nursing home. Ten years later, where are they? They're in a 20-square-foot grave plot.

That's the future of real estate. That's why real estate has not bounced in Japan after 21 years. That's why it won't bounce here in the US either. For every young couple that gets married, has babies, and buys a house, there's an older couple moving into a nursing home or dying.

I watch this same demographic force move through and affect every other sector of the economy. The tool I use to do so is my Spending Wave. This is a 46-year leading indicator with a predictable peak in spending of the average household.

Here's how it works: the red background in the chart above is the Dow, adjusted for inflation. The blue line is the spending wave, including immigration-adjusted births and lagged by 46 years to indicate peak spending. If you ask me, that correlation is striking.

The Baby Boom birth index above started to rise in 1937. It continued to rise until 1961 before it fell. Add 46 to 1937, and you get a boom that starts in 1983. Add 46 to 61, and you get a boom that ends in 2007.

Today demographics matters more than ever because of the 76 million Baby Boomers moving through the economy. That's why I don't watch governments until they start reacting in desperation. Then I adjust my forecasts accordingly.

Don't Hold Your Breath for the Echo Boomer Generation

But all this talk about Baby Boomers inevitably births the question: "Surely the Echo Boom generation is coming up right behind their parents. They'll fill the holes, right?"

Let me make this clear. If I hear one more nutcase on CNBC say, "The Echo Boom generation is bigger than the Baby Boom," I might go ballistic. They are wrong. The Echo Boomer generation is NOT bigger than the Baby Boom generation. In fact, it's the first generation in history that's not larger than its predecessor is, even when accounting for immigrants.

It's not all doom and gloom, though. We will see another boom around 2020-23. But for now, all the Western countries will slow, thanks to the downward demographic trend sweeping the world. Some are slowing faster than others are. For example, Japan is slowing the fastest (it actually committed demographic kamikaze, but that's a discussion for another day). Southern Europe is next along in its decline. Eastern Europe, Russia, and Asia are following quickly behind.

Which brings me back to my point: there is no threat of serious inflation ahead. Rather, deflation is the order of the day. The Fed thinks it can prevent a crash by getting people to spend. To that I say, "Good luck." Old people don't spend money. They bribe the grandkids, and they go on cruises where they just stuff themselves with food and booze.

Do you know how to tell if you're buying a car from an older person? It's going to be ten years old and have only 40,000 miles on it. They drive 4,000 miles a year. They just go down the street to get a Starbucks coffee and a newspaper. Then they go back home. How do you know you're buying a car from a soccer mom? It's driven 20,000 miles a year, carting the kids around all day… to school, soccer practice, whatever. This is the power of demographics.

So let me tell you what causes inflation. It's young people. Young people cause inflation. They cost everything and produce nothing. That's inflation in people terms.

Why did we have high inflation in the '70s? Because Baby Boomers were in school, drinking, spending their parents' money. While this was going on, we experienced the lowest-productivity decade in the last century.

Do you remember the 1970s? We had worsening recessions as the old Bob Hope generation began to save more while the Baby Boomers entered the economy en masse… at great expense. It costs a lot of money to incorporate young people, raise them, and put them into the workforce.

Then suddenly, in the early '80s, like some political genius did something brilliant, the economy started growing like crazy, and inflation fell. You know what that was? That was the largest generation in history transitioning en masse from being expensive, rebellious, young people to highly productive yuppies with young new families. It was the move from cocaine to Rogaine.

The correlation between labor force growth and inflation is crystal clear…

When lots of young people come into the labor force, it's inflationary. When lots of old people move out of the labor force and into retirement, it's deflationary. Right now, where is the highest inflation in the world? It's in emerging countries. Do they have more old people or young people? They have more young people.

We saw it in the 1970s, we see it in emerging markets, and we'll see it ahead as the Baby Boomers head off into the sunset. First, there was inflation. Ahead is deflation. No doubt about it.

Harry Dent, the editor of Boom & Bust, has put together a free report for John Mauldin's readers, called: Survive and Prosper in This Winter Season: Take These Steps Now... Before Dow 3,300 Arrives. You can access this free report by clicking on this link: http://www.boomandbustinvestor.com/reports/current/BoomandBustInvestor_WinterSeason.pdf

Discuss This


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Ronald Nimmo

Sep. 15, 2012, 9:22 p.m.

Dent’s thesis no doubt has some validity, but the example of the 1980’s he gives contradicts his own theory. He says that an increase in the labor force is always inflationary, but had had just previously pointed out that in the 1980’s the baby boomers joined the labor force in a big way with increased productivity and reduced inflation resulting from that. I am embarrassed for Mr. Dent that he failed to notice something so obvious in his own article. Robbie Watkins makes a great point about the care of older people being a major cause of deficit spending—which usually fuels inflation.

David Oldham

Sep. 15, 2012, 8:03 p.m.

Yep, I too am gettin fed up with hearing about deflation. This guy sounds like Robert Prechter after the 2000 bull mkt bust—-pedling his deflation theory and he has never stopped since.

I can only speak for the UK where I witness very much higher inflation than the official stats claim. The average working guy (my sons and daughters) has been crippled both ends of the curve with zero wage increases and high inflation. And guess who is charged with subsidising their families, yes right—the baby boomer generation. Most my friends also claim to be the bank of daddy right into their 70’s.

So it’s silly to say the boomer generation do not spend money—-most their money is spent into the economy through the younger generations, their children and grand children. And when we die guess where any remaining estate is bequeathed and that too is spent by our offspring into the economy, after paying further taxes on the estate.

I see nothing but rampant inflation since the 2000 bear mkt commenced. (I blame Greenspan and Brown) This has become even more intensified from the 2007 bust. That’s 5 years ago now so just how long is Mr Dent’s timeframe for a start to deflation?

As for real estate deflation in UK we had a modest correction from 2007 to 2009 at c.20% worst case scenario. Right now prices are almost recovered, 10% down in some areas with London doing extremely well. Young people cannot afford to get onto the ladder at all without the help of boomer bank of daddy.

I listen patiently to JM on this subject and of course a defationary environment for a few years makes infinite sense (possibly as long as 15 yrs in my book) BUT IT SIMPLY AINT HAPPENING.

I say to Mr Dent—- go to the back of the class, you are out of touch with the real world we are living in. Yes the theory is right but the practice is something different. This boomer is working harder than ever at age 68 to ward off the effects of inflation upon his children (and poor returns on savings). Don’t tell me this money isn’t spent into the economy. Why don’t you do something more useful and study the rich/poor divide curve.

Herewith ends the rant.

David Kondner

Sep. 14, 2012, 12:55 p.m.

Let’s assume for a moment that our policies don’t change, the economic fundamentals continue to deteriorate over a long period of time, and QE3 becomes the long term status quo.  What would eventually break first and how would that breakage become manafest?  This article seems to suggest that inflation (the easiest way out politically) won’t happen.

Brett Spurr

Sep. 12, 2012, 8:39 p.m.

I’m starting to doubt JM’s judgement.. Harry Dent? When has Harry been right about anything? Answer: never! His work no longer even deserves the benefit of the doubt. Broken clocks have more value. I could go on, but why?

Stephen Bolton

Sep. 12, 2012, 4:51 p.m.

From the description of the Spending Wave chart:

“Here’s how it works: the red background in the chart above is the Dow, adjusted for inflation. The blue line is the spending wave, including immigration-adjusted births and lagged by 46 years to indicate peak spending”

Actually the red is the spending wave, it goes out to 2058 which we have birth data for(2058 - 46 = 2012), and the blue is the Dow, the daat stops at 2012.  Q.E.D.

Steve Bolton

Tom Paine

Sep. 11, 2012, 4:41 p.m.

This is the same guy that predicted Dow 36,000 by 2010. Demographics certainly have an effect on how things have gone but it’s not tradeable. I predict the “peak” spending age is going to change significantly as the echo boomers are lagging their parents in terms of having kids and life in general.

Eugene Mannacio

Sep. 11, 2012, 4:27 p.m.

Unfortunately, Mr. Dent’s analysis treats the U.S. in isolation from the rest of the Global Economy. So, the emerging markets, most notably China and India are entirely left out of the equation.  While they have been principally exporting economies this is changing and China is now an important consumer of American cars.  Another failure of his analysis is a commodity that the older generation consumes in much greater quantities than the younger generation: Health Care.  Is there anyone who sees Health Care getting cheaper?

Perhaps there is a better way to measure the Global directionality than Mr. Dent has chosen and I would argue it is through Energy Consumption.  Generally speaking, the increase in Energy consumption reflects the growth of the world economy.  When the world economy is growing there is ALWAYS inflation and globalization makes it difficult for this phenomenon to be substantially different across international borders for very long lest the cost of foreign goods becomes either too cheap or too expensive.

Whether debt is private debt or government debt it is always in the interest of the debtor to see the debt inflated away. Even when the velocity of transactions has been substantially reduced, activist central banks can offset the slower velocity by increasing the money supply.  In prior episodes of debt bubbles, when Gold was still the universal currency, it was more difficult for central banks simply to print money.  The U.S. certainly couldn’t when it was on the Gold standard.  That situation was naturally deflationary.

We are no longer on the Gold standard, we are now a global economy, and central banks can (if they are not too afraid to do so) increase money supply to the extent required.  For all these reasons I think Mr Dent is mistaken.

Tom Fogarty

Sep. 11, 2012, 2:51 p.m.

This is gibberish.

“Inflation is always and everywhere a monetary phenomenon.”  Milton Friedman

All other price changes are caused by the interaction of supply and demand.  For instance, a pig in the python bulge of young adults entering the labor force is probably more deflationary than inflationary. Just think about what the effect of adding emerging market labor to the global economy has done to wages in the US.  When supply exceeds demand, prices go down.

Robert Watkins

Sep. 11, 2012, 2:02 p.m.

One question, in all of the other deflationary periods, have we ever had so much public debt in the form of entitlements to such a large group of people? Wouldn’t this be a game changer?

Nick Jacobs

Sep. 11, 2012, 12:38 p.m.

Interesting and informative, but the argument about deflation is flawed, because it treats pre-1971 and post-1971 data identically, whereas there was a break in that year: namely, the US government can now guarantee to stop deflation, whereas before 1971 it could not.

Today’s US government can stop deflation by printing money. Before 1971, there were constraints on how much money it could print. Today there are none. Bernanke has stated that the government has the tools to stop deflation, and he is right.

As far as I’m aware (someone please correct me if I am wrong), the only reason the US government doesn’t simply eliminate its debt by printing money to pay it off is that it fears this would cause inflation. It follows that if ever policymakers became convinced that inflation was no threat, and the US was experiencing deflation, the money-printing would start. Therefore there is not going to be deflation.

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