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Equities logo Exclusive: Harry S. Dent, Jr. on the Coming Decade of Debt, Deflation and Volatility

Harry S. Dent, Jr. is no stranger to bold predictions. The prominent economic researcher and market prognosticator  is the author of bestsellers such as The Roaring 2000s, The Great

Harry S. Dent, Jr. is no stranger to bold predictions. The prominent economic researcher and market prognosticator  is the author of bestsellers such as The Roaring 2000sThe Great Depression Ahead, and his most recent, The Great Crash Ahead, each detailing the boom and bust cycles of the economy. In the late 1980s, he developed the Dent Method, a widely used forecasting tool based around his research. What makes Dent’s methodology unique, however, is his emphasis on using demographic trends and tracking consumer spending cycles.

He compares the typical 80-year economic cycle to that of the seasonal changes in climate. The four phases of Innovation, Growth Boom, Shake-Out, and Maturity Boom correlate with the four seasons of summer, autumn, winter, and spring. Essentially, technological innovation sparks the beginning of a new cycle. As it gains acceptance, a rapid growth rate occurs and economic expansion is at its peak. This leads to over expansion and a correction that results in a massive “shake-out” or depression. had the opportunity to interview Mr. Dent to discuss his thoughts on the future of the U.S. economy, the Federal Reserve’s monetary policies, the fiscal cliff, and much more.

EQ: Can you start off by discussing the Dent Method and what it can tell us about the future of the market and economy?

Dent: To really summarize it, we show that demographic trends are the biggest factor driving modern economies like the U.S. and other developed countries. This is contrary to what any normal economist would think. Economies boom when a new generation like the baby boomers move in increasing numbers into their peak spending years, and when they peak—which happened in 2007–they’re not going to spend more no matter how much the government stimulates or lowers interest rates. The last thing they’re going to do is spend more money on housing, especially after we had the greatest housing bubble and debt bubble in history. So that’s something we  predicted 20 years ago with a simple 46-year lag on the birth index. hen a generation peaks, they’re not going to spend more no matter what.

Young people are inflationary because they really cost a fortune to raise without productivity. Older people, on the other hand, downsize everything from their housing, investments in their kid’s college funds, and spending on major purchases. They save for their retirement and spend down their savings. The big curve for people is when they enter the work force around age 20 on average, and earn and spend more money and then become more productive workers as they’re raising their kids. Again, this is all distilled down to averages. We’re all different but we know that the average person in the U.S. spends the most money at age 46, and then they spend less the rest of their life.

So you have a government trying to stimulate an economy, getting people to spend more and borrow money, and they’re just shocked that the stimulus is only going into inflating stocks, commodities and financial assets. It’s not going into lending and economic expansion because everybody’s in too much debt now, and almost all the debt comes between the age of 27 and 42 in the consumer life cycle anyway.

So that’s exactly what we expected to see because we can see demographic trends developing decades in advance. We’re not talking months and years in advance but actual decades. So for us, demographics is the most important driver in the economy. You also have to look at debt accumulation and debt bubbles and other things, but it’s the primary trend. The good thing about demographics is that we can see booms and busts, inflation, dis-inflation, deflation, etc. in advance because people do predictable things as they age, and we can predict what people will do at what age a long time out in the future.

EQ: As the aging baby boomer population begins to decrease their spending power, it will have a major negative impact on economic growth. How steep will that decline occur given that its largest population our nation has ever seen?

Dent: Well, it is the largest generation in our history, and if you look back in history, you will not see a stock market advance over two-and-a-half decades that will beat the one we saw from the late 1980s to late 2007 because the size of the generation caused everything to grow and bubble up faster. The same thing is true on the reverse side. It’s a large generation whose decline in their spending power will be even greater than the last generation, which caused a long stock decline from late ’68 to ’82. However, we show that this decline will be similar to past generational stock declines. The stock market went down from late ‘29 to early ‘42 during the Great Depression after the Henry Ford generation and the Roaring ’20s peaked. It went down in late ’68 to late ’82 after the Bob Hope generation too. That was 14 years. Now the demographic trends project stocks in this economy will generally slowdown from 2008 into 2022-23. So again, another 14-year slowdown. The slowdown will be the same, but if anything, the declines in the economy and the declines in the stock market will be steeper and deeper than what we saw in the recessions and stock corrections of the 1970s.

EQ: Will the Echo Boomer generation be enough to save the economy and help recover from this downturn?

Dent: We think they will because they will generate another boom, but older people in their 40s earn and spend the most money. So the baby boomers still dominate the work force, and the echo boom generation is still only about one-third into the work force. They still have to continue to enter the work force over the next decade or so until there is enough echo boomers to offset the continued decline of the baby boomer generation on the spending curve. That’s what happens during these 12- to 14-year downturns in between generations. It’s when the younger generation takes a while to get strong enough and increase the spending momentum again to have a boom because the older generation will never spend more. So the echo boomers are going to create a boom from the early 2020s through the decades to follow. But since that generation didn’t take us to new heights in births and immigrants, it’s not going to take the economy to substantially new heights. The next boom will not be as dynamic or strong as it was from 1983 to 2007, but we will boom again when this generation is rising in their family cycle. They’re going to earn and spend more money, buying houses, borrowing and all the things the baby boomers were doing. You just won’t see a big of an advance.

EQ: If we are going to go through the 10-year period or so of a market downturn, when do you expect this to begin to take effect? Could it happen as early as the first quarter of next year? 

Dent: Well, it’s better to call it a decade of volatility. Like from ’29 to ’42, and ’68 to ’82, where basically a bubble comes into it, then it crashes, then the government stimulates and it bubbles again. The economy never gets as strong and it crashes. That’s what we saw in the 1930s. You saw big crashes in 1932, and then you saw an unbelievable bear market bubble in 1937. Stocks went up 300-some percent in five years. Where can you get those types of return? Then there was another crash in the late ‘30s and early ‘40s before we came out of it with the next generation spending in World War II. So it’s better to think of it more as a roller coaster market.

I just look at the market very simply. We had the first bubble in the early 2000s, which was a big crash. Then we had the whole housing bubble, combined with commodities and the emerging markets where China, India and Brazil went up every bit as much as, if not more than, tech stocks did in the bubble before. Then that crashed. Now in this case, we have an artificially stimulated economy bubbled by the Federal Reserve and all this money pouring into the banks that doesn’t get lent or spent. Instead, the money goes into financial speculation, often in high leveraged hedge funds and investment bank activity, and we’re just creating another bubble that’s going to burst. So this bubble looks to us like it’s ready to burst again. We just had QE3, and we’ve seen each stimulus program having less of an impact. I think this is going to have little impact and a short fuse, but it’s still likely to drive stocks up to slight new highs. The pattern we’re seeing is called a “megaphone pattern”.

It’s ultimately the most bearish pattern because each bubble takes us to new highs in stocks, and each crash takes us to lower lows. So we’re expecting that by late this year and early next year, with QE3 and some stimulative moves in Europe, you’ll get a rally to about 14,600, maybe a little higher on the Dow, but then the next crash takes you to at least 6,000. But the last crash of 50 percent, this one’s going to be 60 percent plus. The markets are just going to get more volatile, and investors are going to have to accept that. If you’re going to be in the markets, you’re going to have to sell more and protect yourself more and hedge. The more they bubble up, and then when they crash, you turnaround and buy again. We say the next long term bull market and economic expansion is not going to start until the early 2020s, they’re probably going to be incredible opportunities to buy stocks, commodities, and other risk on assets again somewhere between late 2014 and early 2015. We also have a very interesting chart where we compare European stocks and US stocks with Japanese stocks on an 11-year lag, and that was pretty much the difference between when their demographic and generational trends peaked.

It’s the same cycle, same crashes and rallies. Japan’s stocks always went to new lows on the next downturn and they did that for many years despite endless quantitative easing, which is what we’re doing today. So the quantitative easing keeps you from having an all out depression and bank collapse. It eases the pain but it allows debt to keep building up in government rapidly, not to de-leverage in the private sector, which is very important for lifting a burden on an economy long term, so you kind of never really come out of it strongly. Japan is now 23 years into their downturn, stocks are still near their lows, and housing and real estate is still at their lows, and they’ve never really come out of this. Why? Because they didn’t let their debt de-leverage. They eased the pain and basically took more and more drugs to ease the pain, and now they’re addicted to the drugs and now they’re going nowhere. We don’t like what we see here but even if we continue to stimulate like Japan, stimulus only works so long before it kind of wears off and stretches the system so far and just makes it fall into a collapse. So we think the number one reason that’s going to kick off the next crash is going to come from southern Europe.

It’s going to be Greece and Spain, they’re trying to hold this thing together, and you get bigger and bigger riots in these southern European countries, you get more and more revolts in the northern countries that are bailing them out, and there’s going to come a point where it just breaks and blows and that falls apart and then just like our subprime crisis in the U.S. stimulated the crash around the world last time, even in countries that didn’t have recessions, we think southern Europe, Spain in particular, basically stimulates the next blowup and stock crash around the world.

EQ: In a way, the Fed has even acknowledged the fact that with QE Infinity, they’re essentially punishing savers. Why is that not going to work?

Dent: It does, but what we see is a lot of everyday investors keep leaving the market. It’s just brutal. It’s too bubble and burst. Everyday people can’t play that. You have to be a sophisticated trader to play swings like this. I’ve been writing a newsletter for over 20 years, and this is the most difficult environment to call short-term trends I have ever seen over the last five years. So it gets harder and harder for normal investors and even traders, so more of them just kind of give up. Then these hedge funds and computer-driven models and investment banks leverage up at 30, 40, 50 times and they just take over more and more of the volume and duke it out. So it just makes the market more volatile. The one thing we know, just looking at this megaphone pattern that we described where you can draw trendlines to the tops of the major bubbles and the bottoms of the major crashes, we’re getting near the top of that megaphone. All we have to do is hit the S&P 500 of 1580 to 1600 and the smart money is going to start shorting the market and basically mark the end of the bubble. You can only go so high. So the Fed can only push stuff up and encourage pension funds and traders and hedge funds and stuff to keep piling into the market, but at some point the smart money turns against you and they lead the trends down. Once it goes down, everybody starts running again and you have to realize just like in the oil market’s collapse and other bubble crashes, these hedge funds and investment banks are so leveraged, when they have to start selling, they got margin calls, they’re not selling on any fundamental analysis, they’re selling because they have to. So these bubbles go up, pushed up by the Fed with very low interest rates and speculation, and when they burst, they’re almost impossible to stop.

EQ: Many investors are speculating on high inflation, but is deflation the bigger threat?

Dent: Yes, we really have both and here’s the game. We’ve got $16 trillion now and rising of government debt. It was only $10 trillion in debt when the bubble peaked in 2008, but what people don’t realize is we built up $42 trillion in private debt. This includes the banking sectors, consumers and corporations, so that’s three to four times larger than the government debt bubble. What’s happening here is that a dynamic where in late 2008, the private banking system started to melt down, especially in the financial industry because of the financial sector’s debt. That actually created 6 percent deflation until the government stepped with TARP and QE1, literally trillions of dollars to offset that and re-inflate. So when the government does QE and runs deficit and adds to the debt, that has an inflationary impact on the system. But when private debt deleverages, and remember it’s three to four times greater, when you get into a meltdown, the private debt is going to overwhelm the government debt. Of course government debt is going to go up, they’re only going to have bigger deficits and plan another big stimulus plan, but the private debt will deleverage faster. So that’s why you get an off and on inflation. We only get mild inflation when the economy is reflating because we’re in a deflationary environment and even though the government has added $6 trillion in debt, the private sector has shed $4 trillion. So net-net that’s only $2 trillion and only mild inflation. But we think in the next downturn, we will shed $10 trillion-plus in private debt and even if the government debt goes up $2 trillion or $3 trillion, that’s going to be a deflationary net effect. So you have to understand the play of private and government debt. Most analysts only focus on the government debt, which is by far the smallest sector of debt.

EQ: Are you concerned about the coming fiscal cliff?

Dent: Yes, I am. Everybody knows about it and everybody knows there’s consequences, but you’ve got two parties that are more polarized than they’ve ever been and for very good reason. They both see the economy differently. Republicans see debt as the biggest problem, and you can’t solve debt with more debt, and I agree with that. The Democrats say, “Hey man, the banks and the top 1 percent created this bubble and made all the profits, so why should the everyday person be taking all the pain?” So they keep stimulating and trying to help and believe if they can stimulate long enough we can get the economy back to normal. The Republicans believe that if they cut taxes and get businesses going they can get the economy back to normal. Neither strategy is going to work in my point of view, so these parties are not going to agree. Republicans would rather commit hari-kari than to let this debt go from $16 to $18 to $20 to $25 trillion. I’ll tell you, in the next decade at the rate that we’re going, that’s exactly what’s going to happen. They would rather die than to do that. They think that’s the death of the economy. The Democrats would rather die than to have a crisis like the early 1930s where the average person faces the highest unemployment, further home losses, and homes underwater. But the truth is you have to go through some type of crisis and period of austerity to get debt down to normal levels and housing prices back down to where young families can afford them. The government can help do that in a more civilized way, but instead they’re just kicking that can down the road.

So I don’t agree with either party, but I agree more that you just can’t solve debt with more debt. As Romney kind of said, it’s not just wrong; it’s immoral to do this. You can’t just lay the greatest debt in history on the next generation of private and public and justify it by saying it’s for the good for the short-term economy. No, I’m like after watching the Iron Lady about Margaret Thatcher, we need someone like Margaret Thatcher in here. We need someone with balls that comes out and says we have a big debt crisis, we have to man up and face this thing and deal with it. Yes, it’s going to be painful and there’s way we can ease the pain some, but we have to deal with this or else it’s going to be like a drug addict taking more and more of the drug to keep from coming down off the high until they just literally just crash and fall to the ground and die as they hit bottom. That’s what we’re heading for, and it’s kind of scary.

EQ: What would you do if you were in control?

Dent: The cause of this crisis is two things. Greatest generation in history moving from spenders to savers, so the economy is going to slow whether the Fed likes it or not. It’s going to take more and more stimulus, which creates less of an effect, until you get the most perverted economy in all of history, and secondly the greatest debt bubble in history. The way to attack that is to say, we’re not going to infuse money in the banks and give them basically free money, which is what QE is, to basically cover their loan losses and allow them money to speculate again instead of lending so they can keep going. We’re only going to give backs in proportion, so the government would only take 30 percent of the hit for example. It would be proportion to the loans that you actually write down in market value for businesses and consumers. So if they did write down $10 trillion of private debt, and I think you could write down $20 trillion before this is all over. The government would take about $3 trillion of that, which the government has committed to QE, but consumers and businesses would save $10 trillion in debt, and massive amounts—hundreds and hundreds of billions a year in principle and interest—so if you don’t get the debt back down to pre bubble levels, and you don’t let housing prices fall to prebubble levels—and they’re still not there except for a few markets—but most cities are still not down to levels that houses were just at the beginning of 2000 where the bubble really took off. So if we don’t get housing prices affordable and get down this debt, our standard of living, especially for the young new echo boom generation, it will be compromised forever. We will never have the same standard of living as people did in the past. So that’s what I’d say. For every dollar you’d write down, the government creates money and takes on 30 cents of that, and that’s the trade off. At least we end up with net less debt every time we stimulate rather than more debt every time we stimulate. The better banks are going to survive and the worst are going to have to be restructured or taken over by other banks. But that has to happen. My goal, if I were president of the United States, which I would never want to be or will be, we created $22 trillion in private debt in eight years, and now in five years we have to get it back down to $20 trillion. We have to eliminate $22 trillion of the $42 trillion of debt. Then our debt will be at more sustainable, prebubble levels. That, writing down $22 trillion in debt, would save about $1.5 trillion a year. That’s a lot. That’s 8 percent of our economy. That’s the size of our entire government deficit, $1.5 trillion a year in principle and interest payments for consumers and businesses. So it would stimulate the private economy, and it would be a stimulus that would keep paying off year after year for decades, because most of this debt mortgage debt is long term.

EQ: Considering what the market environment looks like near-term. If you’re investing over a decade of deflation and debt, where do you put your money?

Dent: There is no buy and hold except for T-bills because everything bubbles. Gold, commodities, oil bubbles up and crashes, stocks here and around the world bubble up and crash, junk bonds has one of the biggest bubbles and they’re going to crash. Even bonds, even normal 10-year treasuries have been pushed down to below inflation levels. They should be at 4 percent today, and they’re at anywhere from 1.4 to 1.7 percent recently. This is a problem. People are fleeing just because they have no place better to go. All these bubbles will reverse because they’re artificial and over inflated. So you either have to say you’re going to sit in cash and buy only when there are crashes, or invest in stocks and gold and other assets. Right now, I still see stocks going higher after QE3 for a couple more months, but once they go up to kind of high levels and you start to sell, and if you’re more aggressive, you start to short the market. Now, over the next two to four months, now is the time to be selling everything from stocks to gold to commodities, and waiting for a bigger correction couples years to follow and then again, we see stocks around 6,000, we’ll be telling people to buy again. You’ll probably see another two to three year glorious rally, and when they get too bubbled up, we’ll tell people to sell again. There’s no way to pick that perfectly, but you have to have that bias that if you’re going to be in stocks and commodities, you have to think more like a smart money trader. You have to sell when they’re way up and everybody is finally piling in, and then you have to buy when they crash and nobody wants to touch it with a 10-foot pole.

EQ: Can you tell us more about how readers can learn more about your HS Dent and your newsletters?

Dent: Basically, the best entry news letters are Survive and Prosper and Boom and Bust, and we do this for sovereign society and one of the Survive and Prosper is free so you can get an idea for how we think. Boom and Bust is inexpensive and then we have a higher suite of forecasts around the HS Dent Forecast for more sophisticated and active investors. So we have a whole level of newsletter offerings.

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