Tuesday, September 11, 2012

Harry Dent and the Certainty of Deflation

The following is taken from a speech given by Harry Dent, transcribed and reprinted in John Mauldin’s “Outside the Box” newsletter.

Harry Dent is certain we are facing a future of deflation. In the introduction, Mauldin notes “[Dent] sees inevitable demography-caused deflation in our future and makes some very intriguing arguments that deserve pondering.”  There is nothing in Dent’s “intriguing arguments” that will survive a basic understanding of monetary history and the tools available to a persistent central bank. 

Let’s begin where Dent begins:

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.

Let’s consider…what has possibly changed in the years since 1874 or 1932?  What could it be?  What institution was established in, say, 1933 that might have a slight impact on the validity of this comparison made by Dent?  Does Dent offer even a clue?

For a hint, think about the roots of inflation / deflation in a fractional reserve lending system backed by a cartelized central banking system protected by a government enforced monopoly.  What is a key feature in such a system that will lie at the root of the monetary impact on prices based on leverage?

It is the banks.  Most specifically, it is the deposits in the banks.  Maintaining and increasing bank deposits begins the process of fractional reserve lending.  As long as depositors are protected, the public does not concern itself with bank solvency – therefore cash doesn’t get withdrawn from the system and stuffed in mattresses.

Now with that in mind, what institution was established in 1933 that gave such assurance to the depositors?  The Federal Deposit Insurance Corporation.  Since the inception of this organization, no crisis has brought on banks runs that typified earlier banking calamities.  Even in this latest period, with hundreds of bank closures, where are the stories of bank runs brought on by customers pulling deposits?  There aren’t any.  The insolvent bank closes on Friday, opens on Monday under new ownership, and no customer deposits have been hurt in the making of this film.

As long as customers feel deposits are safe, the reverse of the fractional reserve multiplier will not take place.  This is the key question to deal with when discussing the possibility of deflation returning and pointing to pre-1933 periods to prove the case.  Not even addressing it poorly, Harry Dent doesn’t even mention this point.

If deflation is to come, it will be for reasons different than those that caused previous episodes of deflation (pre-1933).  An interesting note: according to Dr. North, since World War II the United States has experienced just one year of price deflation.

Dent points to demographics as the key to understanding why we are headed toward price deflation:

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.

He uses charts to demonstrate we are now facing such a spending cliff.  This seems to be Dent’s different reason, although is argument is not consistent – he does nothing to tie this demographic concern to the previous two episodes of deflation that he cites.  Was there the same demographic pattern in 1874 and 1932?  I don’t know, but it isn’t my argument to make.  Dent is making it and he ignores the question.

Dent then jumps back to money and credit being the cause for the deflation – pointing to the significant private debt, and the apparent shrinking of this debt at a clip faster than the growth in public debt. 

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.

Dent doesn’t provide (at least in this speech) evidence to back this claim.  He should, if he wants his argument to be built on something credible.  However, even if his facts are correct, it matters not a whiff in this discussion.

The Fed will take actions to produce inflation as long as the inflation as measured by CPI remains low.  Those actions will become more frantic as the CPI falls below 2%, and they will become other-worldly if the CPI approached 0%.  Of this there is no doubt.  There is not one iota of evidence to the contrary, and unlimited evidence supportive of this.

Dent, and others of his persuasion (Mish Shedlock is one) believes the Fed is powerless in the face of such forces:

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.

No statistics for savings rates are provided, but in any case again would be irrelevant.  If Baby Boomers are saving, this money – one way or another – ends up as deposits in a bank.  Therefore it is money available for lending via the fractional reserve process.  Money saved does not disappear into thin air – only a mattress can cause such magic – again, think 1932 bank runs: the depositors pulled cash and held it.

Dent suggests that, as Boomers retire, they won’t spend.  They will sell their houses.  Young people spend.  They buy beer.  We are moving to a state of more old people and fewer young people. Voila- deflation!

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.

I will come later to the “success” of Dent’s predictions in using his 46-year “Spending Wave” leading indicator.  In the meantime, forgive my repetition: The Fed will take actions to produce inflation as long as inflation measured by CPI remains low.  Those actions will become more frantic as the CPI falls below 2%, and they will become other-worldly if the CPI approached 0%.  Of this there is no doubt.

Dent sees the Fed as powerless when faced with these demographic trends:

…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.

I will agree, in the long run the Fed is powerless to avoid the bust caused by the Fed-induced boom, but the Fed is not powerless to create inflation.  However, a bust does not automatically mean consumer price deflation will come with it.

The argument made by some deflationists is that, while the Fed can create base money, it cannot force banks to lend nor can it force individuals to borrow.  Banks look around and see a slowing economy and bad credit risks.  Individuals have taken on too much debt and will not easily take on more.  This is the basis of the deflationist argument.

Too bad it isn’t true.  Keep in mind, the Fed will fight price deflation with every tool known and unknown.  The Fed can certainly cease paying interest to banks on excess reserves.  The Fed can begin charging banks to hold excess reserves.  If the banks are charged 1%, might they not qualify a few more borrowers?  What if the charge was 10%?  25%?  Instead of a guaranteed loss of 25% per year, the bank would do whatever it could to make a loan, I imagine.

Congress can pass any law it desires to pull the debt into the system.  If individuals will not take on the debt, rest assured the government will take it on and spend it – state government budgets will be funded, government pensions – federal, state, and local will all receive federal support.  Individual debt may not increase, but who will stop the federal government from funding the local police department pension?

The present value of unfunded liabilities in the United States is estimated at anywhere between $60 trillion and $220 trillion dollars.  This is at the Federal level.  What of the promises at the state and local level?

If deflation even hints at coming to the surface, we will see federal deficits in the multi-trillions to combat this.  Does Dent think that the Fed will not monetize debt in the face of biting price deflation?  Does Dent believe Congress will suddenly demonstrate fiscal discipline and voluntarily curb spending with the Fed monetizing the debt, and with the cost of borrowing at close to zero percent?

There will continue to be pressure on prices in certain sectors – likely those sectors that have benefitted most from the fractional reserve lending process and from favorable legislation – housing is the poster child for this.  But there will be no deflation in consumer prices.  Anyone waiting for this will have to wait for the government to not fund the FDIC.  Of all government programs, this one will be the last to be de-funded, as it is at the base of ensuring that the banking-government alliance can stand.  If this pillar falls, the powerful lose all power.

I mentioned earlier that I would come to take a look at Dent’s track record, utilizing his 46-year “Spending Wave” leading indicator.  Following is a list of books authored by Dent in the last fifteen years, with descriptions from Amazon:

The Great Crash Ahead (2011): …outlines why the next crash and crisis is inevitable, and just around the corner—coming between 2012 and 2014.

Too early to tell on this one.

The Great Depression Ahead (2009): Dent, author and consultant, predicts the economy is moving toward a major depression, with the deflation of bubbles in stocks, real estate, and commodities between mid- to late 2009 and mid- to late 2012, and it could last for a decade or more.

The depression part I can agree with.  As to the deflation: other than housing prices, this has not happened, likely due primarily to the intervention of that supposedly powerless institution, the Federal Reserve.  Remember, in the early days of the bust the Congress immediately raised FDIC limits from $100K to $250K? Congress and the Fed – a powerful tag team against deflation.

The Next Great Bubble Boom (2006): In taking a look at past booms and busts, Dent compares our current state to that of the crash of 1920-21, and the years ahead of us to the Roaring Twenties. Dent gives advice on everything from investment strategies to real estate cycles, and shows not only how bright our future will be but how best to profit from it.

Look at the date of publishing.  At a time when many Austrian economists were predicting the bust to come, Dent was still seeing green lights all the way.  Whoops.

The Roaring 2000s Investor (1999): Dent shows how to cash in on this boom, then prepare for the worst when the downturn finally hits in the latter part of the decade. Dent believes that the best investment opportunities exist in the stock market--specifically technology, financial services, health care, and leisure stocks. But watch out after 2008, because that's when he thinks the bottom falls out. For these tough times, Dent recommends a shift away from stocks to out-of-favor investments such as bonds and commercial real estate.

This one is a whopper – stocks of all stripes crashed shortly after the publishing of this book, contrary to Dent’s predictions.  The best opportunities thereafter came not where Dent predicted, but in the next Fed induced boom – real estate. 

He finally sees the bottom falling out for the first time in 2008 (this was the second bust, not the first, post the writing of this book); yet in the book previously listed, written in 2006, he sees financial happy days ahead.

The Roaring 2000s (1998): … he looks ahead to the new millennium and claims that the Dow may reach as high as 35,000 within the next decade, due in large part to the changing demographics of baby boom investors.

No comment necessary.

Such is the value of the system deployed by Dent.  Not just wrong, but in most cases disastrously wrong.

But don’t worry, price deflation is coming.  Listen to Harry.


  1. Good article. Dent is like the psychics in the tabloids who make a million predictions then only trumpet those that happen to be correct, while ignoring the fact that most of them turn out to be incorrect. Yet somehow, Dent has been able to keep his forecast industry going for years.

    You quote Dent as claiming: " 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." Then you correctly point out that the net unfunded liability of the fed gov has been estimated to be as high as $200+ trillion and that this does not include state or municipal debt.

    I would also point out that Dent has ignored the multiplier effect of our fractional reserve banking system. Here is a paraphrase from Plossner of the Phila. Fed (http://www.economicpolicyjournal.com/2012/09/hot-fed-prez-spills-beans-on-excess.html): "there is approximately $1.5 trillion in excess reserves, given that the multiplier for reserves and money supply (M2) is now roughly 100, there is no way the Fed can allow that amount of excess reserves to get into the system. It would mean an increase in M2 of $150 trillion! On a current base of only $10 trillion."

    Clearly $150 trillion dwarfs $42 trillion in private sector debt that Dent quotes to support his argument for deflation.

    I agree with your assertion that in a fractional reserve banking system with deposit insurance to prevent bank runs, it is always inflation that is the primary concern.

    1. Thank you for the thoughtful reply.

      I apologize for leaving your comment un-posted for so long - trouble with the help....