In a recent book by Harry S. Dent Jr., titled “The Great Depression Ahead,” the author makes an interesting case that we are at the end of a great bubble that will burst and, when that happens, it will set off a monumental crash of the stock market, bottoming out sometime in 2011, followed by a very slow growth that won’t turn into a boom until sometime in 2023.
This sounds very bleak, I know, but what is interesting is how the case is built in this book and the caveats Dent suggests. Dent has been a successful prognosticator of this kinds of things in the past, including the 2000 tech bubble and its subsequent burst, but more precisely, his models usually fare as follows:
• Definitely correct in direction;
• Reasonably correct in timing;
• Often wrong in magnitude
While I don’t necessarily agree with Dent’s complete analysis, I do believe that it indicates several things that we can expect during the next couple of years.
First, domestic growth of U.S. consumption will slow, but not nearly enough to create a depression lasting into the early ‘20s. Dent believes that the so-called “Baby-Boomer” generation will be exactly like the generation before it in terms of average retirement age and average decline in spending, but there seems to be abundant evidence this will not be the case. Notably, a new model of life-cycle spending patterns developed in 2008 by McKinsey & Company shows, for the average “early Boomer,” spending peaks at age 62 (not 47), having roughly doubled from the ages of 30 to 55. Then it drops by about 20 percent over the course of retirement.
Second, the low cost of capital due to “the global savings glut” will be good for business, but bad for investors. The cost of capital—interest rates—will remain historically low because U.S. Boomers will be saving right along with the Chinese, Japanese, and Europeans. This will enable businesses to accelerate investment in productivity-enhancing technology, as well as research and development. Coupled with a global skills shortage, this will mean bigger returns flowing to labor and lower returns flowing to capital.
This will create even greater incentives for Baby Boomers to keep their jobs and remain in the workforce. This, in turn, will keep productivity growing briskly, albeit in varied sectors over time. Also, don’t worry about the rumors that global money-savers might abandon the dollar—money from all over the world has been flooding into American markets even in this crisis, sending the dollar to its highest levels, and bond yields to their lowest.
Third, mechanisms for rapid consumer de-leveraging are coming into play ahead of the demographic downturn to limit the long-term effects.
Aggressive handling of the financial crisis will enable the global economy to quickly rid itself of speculative excesses that might otherwise take a decade to resolve. The beginning of Japan’s depression in the ‘90s closely resembles today’s crisis in the United States: A real estate bubble collapsed, wiping out an enormous chunk of nominal wealth. However, while Japan’s banks refused then to acknowledge the reality, mark-to-market accounting is forcing U.S. banks to address the problem. A number of actions will soon restore these banks and enable the free flow of cheap credit to businesses and individuals. Four of these six actions are particularly beneficial.
To ensure that banks have plenty of cash, the Fed has expanded its lending facilities.
The U.S. Treasury has injected money into the institutions via equity purchases to ensure that they meet capital requirements.
Bad Collateralized Debt Obligation (or CDO) tranches will be moved to some sort of “bad bank,” where the government will accept the downside risk and a portion of any upside.
New foreclosure abatement programs will be put into place to write-down underwater mortgages, without going through the disruptive foreclosure process. This will bring consumers back into the housing market and help to revive consumer spending.
Fourth, future affluence will depend on the global spending wave rather than America’s domestic spending wave. While consumer spending represents 70 percent of the U.S. economy, it’s only a third of China’s. U.S. consumer spending is vital to global economic growth because it drives exports for so much of the rest of the world. Today, a shortage of high-end skills still limits much of the developing world while a shortage of consumers and low-end skills is likely to plague the developed world.
Because Asian economies are so dependent on the U.S. to provide the consumers for their goods, while investors in the European Union are so dependent on investments in the U.S., international efforts will focus on bolstering consumer spending in America, while proactively encouraging consumer demand in developing countries.
Fifth, as Dent predicts, housing prices will drop as much as 60 percent from the 2006 peak in some places, but most of this drop has already occurred. As of November 2008, the affordability of existing homes had already reached the best levels since 1993. Fortunately, much of the excess inventory, and consequently the biggest drops in prices, were located in regions that will benefit from internal migration. In addition, homebuilders will change strategy by directing their efforts at first-time buyers, as well as toward plans in which renters can become buyers.
Sixth, adaptability, resilience, and flexibility will be routinely required at levels rarely seen in the past three decades. Americans have proven themselves to be very adaptable in the face of adversity over the history of our country. It will be no different in the future. There is no question that tougher times are upon us. This means that we will have to adjust the way we do business and respond calmly and rationally in the face of challenges.
By introducing new ways of doing business in a more sustainable manner, the booms and busts of the future will be smaller. And as a result, there will be less likelihood of the excesses that caused the present crisis.
