Debt Crisis 072010

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www.hsdent.com

Copyright 2010, HS Dent Publishing

The Debt Crisis Ahead: Late2010 Late 2012 . . .

How You Can Prepare Now to

Survive and Prosper

Clear Demographic Trends MakeOur Debt Issues Even More

Pressing

The Process: Reduced Spending

and Debt

The Deleveraging of Debt in the

1930s

The Ticking Time Bomb Despite the Recovery, RisingMortgages Underwater

Deflation, not Inflation Despite

the Massive Stimulus

2

2

3

5

6

Table of Contents

Special Report

March 26, 2010

Harry S. Dent, Jr.Author of

The Great Depression AheadThe Next Great Bubble Boom

The Roaring 2000s

The Great Boom Ahead

Compiled and Edited By:

Rodney JohnsonPresidentHS Dent Publishing

www.hsdent.com

HS Dent Publishing

The government is racking up debt at a record pace. The goal is to

stave off an economic crisis brought on by the greatest spending, real

estate and debt bubble in modern history. Unfortunately, the

government is doing exactly the wrong thing! Instead of trying to prop

up inflated real estate values and company and consumer debt, the

government should be embracing a painful but necessary period of

debt restructuring. It is the ONLY SOLUTION to our currenteconomic problems.

The Federal debt mushroomed from $5 to $12 trillion in the pas

decade, and is forecasted, even under the best scenario, to reach $20

trillion in this decade. But are you aware that private debt has swelled

to $42 trillion? If you include government debt our total is $56 trillion

and growing (Chart 1). Add in unfunded liabilities for social security

and health care of $46 trillion (Chart 2), our total debt balloons to

$102 trillion, or seven times the value of everything we make in the

US in a year (715% of GDP)!

This is truly unprecedented. Before the Great Depression, total U.S.

debt was 170% of GDP, the 40% fall in GDP caused that ratio to rise

to 270% in 1932. If you had debts totaling $500,000 while you earned

$70,000 a year, would you feel good about your future?

0

10,000,000,000,000

20,000,000,000,000

30,000,000,000,000

40,000,000,000,000

50,000,000,000,000

60,000,000,000,000

1977 1982 1987 1992 1997 2002 2007

Federal Govt Trust FundsFederal GovtState and Local GovtFinancial SectorForeign

CorporateHousehold OtherConsumer CreditHome Mortgage

Government$14Trn

Financial

$17Trn

Corporate$11Trn

Consumer$14Trn

Total:$56 Trn !

Total U.S. Debt, 2008

Chart 1Source: Federal Reserve Flow of Funds Report

10

20

30

40

50

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009

Addition of MedicarePart D

Includes Social Securityand Medicare

$46 trillion

Unfunded Entitlement ObligationsIn $Trillions

Chart 2Source:The White House, US Treasury

$46Trillion!

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Does adding debt to an economy that is plagued by excessive debt really sound like a solution? A 10-

year-old could figure that out! We must recognize the full magnitude of DEBT in the U.S. and that these

levels are not healthy nor sustainable. Rather than having the government try to stimulate us out of

this crisis, the only real solution is to have financial institutions, households, and businesses

restructure debt back to pre-bubble levels.

Clear Demographic Trends Make Our Debt Issues Even More Pressing

Imagine that you earn $70,000 and have debts of $500,000, you are 50 years old and your income will actually

decline substantially as you move toward and into retirement. Or if you got laid off and now only earn $50,000

in your new job? It makes the $500,000 burden even more insurmountable. This is the situation the U.S. is

facing today. Our GDP is going to decline substantially in the next few years making our unprecedented debt

burden even higher 800% to 900% of GDP!

Are you aware that the Baby Boomers have peaked in their spending cycle and will be spending less, earning

less and saving more in the years ahead? As Boomers move on to becoming empty nesters and retirees, theywill no longer need those big houses, big cars or all the clothes, food and daily spending that went along with

raising children. The Boomers will match their consumption pattern to their new stage of life. This massive

economic slowdown will have a dramatic effect on our economy because there simply are not enough

consumers coming in behind them in the next decade to fill that void. Exactly how is massive government

stimulus going to work when our biggest group no longer needs larger houses, cars, etc.? What is it,

specifically, that the government believes it is going to stimulate? Just ask the Japanese after the peak of

their baby boom and housing bubble they tried unsuccessfully to stimulate in the last two decades.

We must acknowledge the predictive power of DEMOGRAPHICS. The power to forecast economic

change is at our fingertips! As a society we know exactly when consumers will spend, save and borrow

as they go through stages of life. HS Dent has been forecasting for 20 years using the Spending Wave(Chart 3) that the U.S. economic engine, driven by the consumption spending of Baby Boomers, would

peak around late 2007 (also see The Great Boom Ahead, 1994, p.35).

After that, this previously free-spending group would be

more focused on saving and paying down debt as they

prepare for retirement. Our readers were warned many

years in advance of a seismic shift in how our economy

operates! We also forecasted a 12- to 14-year downturn in

Japan in the late 1980s when most economists thought

Japan was the country of the future.

The Process: Reduced Spending andDebt

We have already entered what we call the winter season

in our economy marked by lower consumer spending and

falling prices with the following turn of events:

Consumers spend less and borrow less.


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2,200,000

2,700,000

3,200,000

3,700,000

4,200,000

4,700,000

5,200,000

1956 1966 1976 1986 1996 2006 2016 2026 2036 2046 2056

Immigration-

adjusted Births

Lagged for Peak

Spending

The Spending WaveBirths Lagged for Peak in Family Spending

Chart 3Source: HS Dent

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Businesses sell less, so they borrow less, employ fewer people and pay less in wages.

Falling spending, falling wages, rising unemployment and declining debt levels lead to deflation in prices

and reinforce the lower spending cycle.

This cycle cannot be fully broken by stimulus spending as Japan has proven. The government did not create

this boom the Baby Boomers did as they raised their families. Hence, the government cannot stop the naturaldecline in spending and the restructuring of unsustainable debts. We must work to make the decline and

restructuring as quick and painless as possible, not try to stop it.

This movie attacking a slowdown in consumer spending with stimulus spending by a government has been

made before. After a major real estate and debt bubble in the 1980s that was fueled by the growth of their own

Baby Boom generation, the Japanese tried to endlessly stimulate their economy. They are still trying today.

Its been 20 long, miserable years, and they are still in the tank! Their government debt (not including

retirement issues like Social Security and Medicare) is now 210% of GDP and climbing fast versus the U.S. at

87% of GDP (not including Social Security and Medicare). Is that where we want to be a decade from now? The

notion that stimulus spending is the key ingredient to jumpstart an economy is not just flawed, but is based

on a myth that this approach worked in the U.S. in the 1930s.

The Deleveraging of Debt in the 1930s

Many economists and market pundits point to stimulus spending as the way the U.S. pulled out of the Great

Depression. ITS NOT TRUE. Stimulus spending in the 1930s eased the pain of the day, but it did not cause

a recovery. It was the rising spending wave of the Bob Hope generation from 1942 1968 along with lower

costs and lower debt levels that ultimately led to a sustainable long term boom. During the 1930s the U.S.

went through a painful process that eliminated a massive amount of private debt. Because private debt was

brought down to manageable levels, once we emerged from World War II the U.S. was in a fabulous position

to grow. Chart 4 shows how extensive the restructuring of business debt was in the 1930s.

Despite the rise in government debt, overall debt ratios fell dramatically and that was a good thing. This time,

however, much more of the debt is consumer debt, and even more is debt for leveraging investments in our

financial institutions. That is why you see massive defaults on mortgages and the sudden meltdown of so

many major banks and financial institutions in addition to

credit card charge-offs and other reductions in consumer

debt.

There will be a much greater financial meltdown to

come between late 2010 and late 2012 thats why

you need to protect yourself now!

The Ticking Time Bomb Despite theRecovery, Rising Defaults fromMortgages Underwater

The economy has been recovering since the summer of

2009 due to the direct and indirect government stimulus

programs. But unemployment remains near 10%, and

worse, more homes continue to fall below their mortgage


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U.S. Debt Since 1929as a percentage of GDP by category

Chart 4Source:SG Global Strategy, Bloomberg, US Federal Reserve

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value leading to continued rises in defaults. Deutsche

Bank estimates that the number of mortgage holders who

were underwater in the first quarter of 2009 was

approximately 26%. By the first quarter of 2011, it

estimates that number will grow to 48%! By 2011 28% ofmortgage holders will be severely underwater, 20% will be

mildly underwater and another 20% will be borderline

(Chart 5). Given that we predict the economy worsens we

expect these numbers to be substantially higher.

The trigger for this ticking time bomb will be rising

adjustments or resets to risky mortgages later this year.

Chart 6 shows the estimated number of mortgages in

different categories that are due for an interest rate

adjustment, or reset, from 2006 through 2012. Just as

sub-prime mortgages caused so much havoc in 2008 andearly 2009 when they were resetting, it will be option

adjustable rate mortgages (option ARMs) and Alt-A

mortgages (no documentation loans) that cause problems

in late 2010 and 2011.

These resets, with their higher interest rates, along with

the devastating level of unemployment and the continued

drag of foreclosures, will combine to push values further

down and leading to an even greater avalanche of

defaults. The next big surge hits between July and

October of 2010, with an even larger surge into Septemberof 2011.

The last banking crisis and meltdown seemed to come

from nowhere in 2008. The next such crisis is likely to

emerge equally as suddenly between August and

October of 2010. You need to be selling stocks and real estate ahead of this debt crisis!

Understanding this combined debt and demographic storm is only part of the equation. To prepare and

prosper in the years ahead, we must have an understanding of how this crisis will be resolved. The answer is

deflation. Most people assume that a period of deflation is a simple opposite to inflation; therefore, deflation

is a time of falling prices. While that is true, it does not convey the immense power of a deflationary period.

In a period of deflation, the prices of most consumer goods as well as investment assets across the board like

real estate, stocks, commodities, oil and even gold, go down. It is a time of conservation and the survival of

the fittest.

Consumers see their investments fall, business owners have less revenue, and companies employ fewer people

and pay those they do hire less. Deflation requires very different investment and business strategies than

what we would do during inflation. Most of us have never experienced deflation. Our issues have always

centered on lower or higher rates of inflation, which over time meant that assets like investments and real

estate tended to go up. That period is over. Deflation, with all of its complexities, is not just a forecast but is

as inevitable as winter following fall.


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Positive Equity34%

Modest Equity18%

BorderlineNegativeEquity23%

NegativeEquity13%

Severely NegativeEquity 13%

Positive Equity21%

Modest Equity12%

BorderlineNegativeEquity20%

NegativeEquity20%

SeverelyNegativeEquity 28%

DB estimates that 26% of homeownersare currently underwater

and sees the percentage rising to 48%by 2011.

Homeowners Underwater

Chart 5Source:Deutsche Bank August 5, 2009 Report

Mortgage Resets

Chart 6Source: T2 Partners

We arehere

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Why is this the case? As the U.S. went through a long-term growth season in the economy, many different

forces began working together to feed our growing consumption. One of the areas that saw the biggest change

was real estate. The price of real estate, which is the biggest cost of living for most consumers, on average

doubled from 2000 to 2005, putting a new home out of reach for the new generation of families entering oureconomy. How can our kids have the American dream of owning a home if it costs $700,000 for a starter home

in California or Miami? This exploding bubble in prices came from an unprecedented expansion in household

borrowing power (home equity loans, no money down, cash out refinancing, very low interest rates, loose

lending standards) and coincided with a demand for spending and very low interest rates. The borrowing

capacity of the average household almost tripled. Lenders went nuts as they thought real estate could never

go down, so there was no risk in lending against real estate. This was the mistake the Japanese banks made

in the 1980s. This should not have been allowed to occur in the U.S., but it did!

This process of a bubble in prices and then a crash is not new. In the late 1990s stock prices got unreasonably

high, peaking in early 2000 and then crashing back down to reality from 2000 - 2002. The real estate bubble

in Japan peaked in 1991 and then crashed, never to return to past levels. The same is happening now withreal estate prices, energy prices and stocks, especially in emerging markets like China. Unfortunately, because

the last and largest part of our bubble was fueled with massive amounts of debt, the pain of the bursting

bubble will be much greater than anything we have experienced in the last 75 years!

One way to illustrate the thirst for borrowing is to look at the ratio of debt to discretionary spending (Chart

7). In the 80s, this measure was about 65%. As we go through the 90s consumers took on even more debt. By

the time we get to the 2000s the measure of debt to discretionary spending is more than 130%! As Baby

Boomers reached the peak of their spending cycle, we borrowed at a feverish pace. Now, the reality is setting

in, and its not pretty.

Deflation, not Inflation Despite the Massive StimulusWhen assets deflate in price we have three choices: the loans have to be paid as structured, canceled

(foreclosure) or written down (modified). Because there is not enough income generated to pay these debts

outright, we are left with cancellation and modification, which creates incredible pain for the lenders, the

banks and investors who fueled the boom. On the positive side, this removes or reduces the debt from the

books of companies and consumers, which brings the cost

of real estate, living and doing business back down to

affordable levels. After this deflationary process, the

general standard of living begins to grow again, which is a

good thing for your kids and grandkids!

Deleveraging is the same as a business going through

debt reorganization. This process happens when a

business is viable, but is currently unable to pay its

bills. Doesnt that sound like a lot of the U.S. today -

the leading economy in the world, but debt-laden?

Businesses seek reorganization to restructure their

debts and avoid an all-out liquidation. That is where

we are as a nation and many other countries face a

similar crisis.


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0%

20%

40%

60%

80%

100%

120%

140%

Yea

r

1950

1955

1960

1965

1970

1975

1980

1985

1990

1995

2000

2005

Household Debt as % Disposable Income1946 - 2009

Chart 7Source: Federal Reserve Z1

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We need to restructure and write-off debts that are no longer in line with the underlying assets, such as the

commercial real estate and homes that they were lent against. Trying to treat the problem of excess debt by

taking on even more debt is like trying to take more heroin to kick a heroin addiction detox is the only

solution you have to get the heroin out of your system first!

Our government is trying to convince us to spend more, borrow more and take more of the drug that has

caused us so much pain. Its reasoning? So that the country will not have to go through the painful detox

process of deleveraging from too much borrowing, no matter how unrealistic or unsustainable this effort is.

Our forecast is that the U.S. government and many others will be forced to stop stimulating in such an

irresponsible manner. Their massive stimulus programs will fail in the second half of 2010 losing the

confidence of an already skeptical public, and many foreign governments and investors like China will balk at

funding continually increasing massive U.S. deficits.

From studying centuries of credit and asset bubbles, we are able to arrive at a very conclusive forecast: by late

2010 we will go back into the process of deleveraging in order to deal with the massive credit bubble, and we

will suffer through the ensuing deflation in prices and assets. The only question is, Do we take our medicinesooner by greatly reducing our stimulus spending, or do we drag this out for many years and make it worse

by continuing to try to prop up these inflated asset prices and debt with even more borrowing? But recall that

a deflationary environment requires very different investment and business strategies from an inflationary

environment like the 1970s. We want to help guide you through a brief economic period that will be unlike

anything you have seen in your lifetime.

At HS Dent our mission is to help people understand change. We show you how you can see key

economic trends that will impact your life, your business, your family and your investments over your

lifetime. We specialize in providing a unique type of long term insurance against major negative

economic surprises by providing you with clear research and forecasts we develop by using our unique

forecasting tools. We alert you to the opportune times as well.

We accurately forecasted the peaking of the

housing bubble in 2005/2006 and the peaking of

our economy between late 2007 and early 2010.

This same approach allowed us to alert readers to

major new growth areas and opportunities in The

Great Boom Ahead in 1993 at a time when most

economists and books were bearish. Our analysis

has led us to forecast the next global boom from

2020 2035 and the ultimate rise of India over

China in the decades to come. In Chart 8 we

outline a rough forecast of the Ticking Time

Bombs that are likely to generate a very sharp

stock crash in the Summer and Fall of 2010. The

Dow could go as low as 3,800.


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October

September

August

June

April

March

February

January

May

July

Accelerating

Mortgage Defaults

Very Disappointing

2nd Qtr GDP

China / India

Tighten

China Bubble Bursts

Iran Tensions,

Terrorist Strikes,

Oil Spikes

Mildly

Disappointing1st Qtr GDP

Further Default Threats in Europe

Austerity Programs

Greece Default Threat

2010

Minefield ofTicking Time Bombs

Chart 8Source: HS Dent

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Summary

We see a number of ticking time bombs that point towards a crisis in the 3rd quarterof 2010:

1. Mortgage defaults accelerate due to rising mortgage loan resets between July and October

of 2010

2. Rising geopolitical tensions and terrorist events into the summer, especially around Iran

3. Consumers slow again as stimulus fades with disappointing GDP report for 2nd quarter

GDP

4. Continued threats of government defaults in Southern and East Europe as the recovery

there continues to fail

5. Continued rising long term interest and mortgage rates into late 2010

6. The unprecedented bubble in China bursts after the U.S. and Europe slow again

We see a number of big surprises just ahead:

1. Another Major Stock Crash between August and December of 2010

2. The Second Major Real Estate Crash to Follow between Late 2010 and Late 2012

3. Gold falls and the U.S. dollar rises

4. Rising Tax Rates for Years to Come

5. The Sale of a Lifetime on Stocks, Bonds and Real Estate Ahead

Cash, cash flow and good credit will be the key for prospering from this once-in-a-lifetime deflationary

downturn wherein you can buy real estate, companies, stocks, boats, cars, etc., at the lowest prices you may

ever see. It takes patience, research and analysis to arrive at the conclusions that can financially secure you

and your familys future. Please join us by signing up for our monthly newsletter, 7 CD course, webinar, andtwo-day seminar. The future starts now! Learn how to protect and prosper!

(PLEASE SEE THE NEXT PAGE FOR A SPECIAL OFFER!)


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Debt Crisis 072010