This article was posted on Thursday, Nov 08, 2012

If you’ve missed some of the prior articles, basic “beginner” guidelines on successful investing are in my book “Stairway to Wealth” available at

We’ve been preparing ourselves for significant inflation once all this Qualitative Easing is no longer quite so fashionable, but we may have been wrong. The reason is that demographics – the retirement of the Baby Boom generation – may overwhelm all of Mr. Bernanke’s best efforts.
Deflation (the inflation rate sinks below 0) is, naturally, the opposite of inflation (the inflation rate is above 0). With deflation, prices fall. Folks don’t want to buy because the product (or services) will be cheaper tomorrow. That means stores stock less inventory because if they have to keep stuff in their storerooms the shopkeeper fears prices may drop so much that it would have to be sold for a loss. So stores keep less inventory. Less inventory at the retail level means fewer employees at the manufacturing level. But it’s not only that employment drops, other facets of the economy are also impacted. For example, fewer people take out loans because the principle will have to be repaid in dollars that are more valuable than the ones they borrowed. That crushes the single family real estate market. Your home is now worth less than you paid for it.  Welcome to deflation.

Not long ago John Mauldin ( published a thoughtful article written by Harry Dent. The article (“A Decade of Volatility: Demographics, Debt, and Deflation”) explores the possibility (Dent would say “certainty”) of long term economic deflation along the lines that Japan has been experiencing for most of a generation.
Deflation is something we’ve discussed only briefly in these pages. Our fear has been rampant inflation. But this article argues that inflation will reduce to less than zero (deflation) due to the Baby Boomers retiring. Elements of Dent’s hypothesis, in pretty much his own words, follow. If you wish to read the entire article – and you really should – well, Google is your friend.
Dent considers only middle class people in his article because there are a lot of them and, together, they are the biggest source of discretionary income. If you’re receiving government assistance, this doesn’t apply to you. If you were a trust fund baby and somehow kept your inherited wealth, this doesn’t apply to you. Dent’s only talking about the demographic group that, cumulatively, has most of the money.
Remember when you had your first child and took her for her regular doctor visit? Nothing was wrong, it was all just precautionary. When she had her 18 month checkup, the doctor asked you if she knew five words, remember? The doctor was checking developmental milestones. At 18 months toddlers should know five words to be peer group equivalent. The doctor understood that most infants grow at about the same rate and pass milestones at about the same ages. Documenting the milestones is an important part of pediatric guideline.

Middle class people – not everyone, but the vast majority – cross life milestones almost in lockstep, starting with learning five words. From birth to death all of us walk the same path: we’re just on different parts of it. Dent provides several examples. Among middle class families the average age of the parents when the first child is born is 28. Their first house is purchased when the parents are 31. Eight or nine years later, when the kids start to become teenagers, the parents move the family to a bigger house. Mortgage debt peaks at age 41; spending peaks around age 46.
Notice that middle class people do predictable things at predictable times in their lives. These things establish trends that affect sectors of our economy decades in advance. There’s a “Baby Boom” and thoughtful people recognize that in six years maybe we’ll need more elementary schools. In 18 years we’ll need blue collar jobs. Four years later, when the middle class college kids graduate, we’ll need white collar jobs, or, depending on the political party in power, at least a good excuse. A few years later we’ll need new subdivisions in Palmdale. Then it’s an old folk’s home and, finally, a pretty urn above someone’s fireplace.
Obviously, Dent is not troubled by a normalized birthrate, where population growth remains relatively steady. An example of normal population growth begins when 100 kids take their peanut-butter sandwiches to Sister Mary Theresa’s first grade. When they graduate from UCLA 22 years later, Sister Mary has 117 new six year olds to civilize. That rate of growth pretty much reflects United States population growth from 1990 (248,710,000) to 2020 (308,745,000). The normal rate of growth in the United States from all sources was about 0.72% per year, compounded, immigration included.

What Dent is talking about is a more dramatic birthrate, something like the Baby Boom of 1946 – 1964 when 79,000,000 new babies were born. Ok, I know the Baby Boom happened over an 18 year period but that’s still (cumulatively) a bunch of diapers, peanut butter sandwiches, prom dresses, dorm fees, bail money, new cars, and houses. And these items happen sequentially at roughly predictable intervals. It all requires money, and young parents are responsible for the tab. Young people (under 46, on average) spend money, often big money, raising a family. Most of it is financed, which makes it all possible.
Young people cause inflation first as babies, later as parents.
The Federal Reserve is our country’s central bank, and for all the obvious reasons prefers inflation. Just by itself, a 7% inflation rate over the next 10 years would reduce that troublesome national debt by half. So the government can be expected to seek a politically acceptable level of inflation. “Politically acceptable” means as much as they think they can get away with. The government sector is biased towards inflation, but according to Dent the private sector, with about 2/3rds of the economy, is deflating. The government’s 1/3rd share is expanding, but the larger private sector is contracting. The reason is that the 79,000,000 Baby Boomers, every one of them, are over 46. They no longer are financing the expenses associated with young people with families. They have arrived at middle age, seen the specter of an underfunded retirement twenty years away, reflected on how quickly the past 20 years have evaporated, and now are desperate to work out a way to save as much money as possible. That starts with spending as little as possible.

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At the peak of the real estate bubble private debt was somewhere around $42 trillion. Public debt was about $14 trillion. Public debt, the $14 trillion, was 25% of total meaning private debt exceeded public by three times. But because all those WWII babies are now running towards austerity the private sector has recently begun to deleverage. Here’s where it starts to get interesting. After the Boomer’s children (the Gen X’ers) graduated the Boomer’s – predictably – begin preparing for retirement. Downsize the house. Put more into the ol’ retirement account. Call Klarise for an apartment loan.
Why would someone want to buy an apartment building if there’s deflation? Because the tenants pay it off. It doesn’t get any simpler than that. Because the tenants pay it off. With a little planning we can adjust to a deflating economy. We can live with loan payments made in ever-more-valuable dollars. The reason we can accept these things is that someone else is paying off our apartment buildings. We don’t pay them off. The tenants do. Hypothetical example: If you buy a $1,000,000 building and the tenants pay it off in 20 years, even if there isn’t a nickel of cash flow that entire 20 years, even if the property doesn’t appreciate a dime, when the tenants make that last payment you’ll have the *unmortgaged* cash flows from an eight unit building to ease your declining years. Go sit on the front porch and wave at the cars, Buttercup. I’ll bring your mint julep.

The most recent census (2010) reported the US population at 308,745,000. Boomers are about 25% of the total (79 million divided by 309 million = 25.6%) and the Boomers are quickly paying off debt. That means that those folks are not meaningfully contributing to the economy (if you’re paying something off, you’re not buying a new one . . . and only new ones count). We can’t look to the Gen X’ers for salvation. The Gen X’ers are the first generation in history that’s smaller than its predecessor.
The crux, Dent says, is housing. First, it shows the extent to which the government will go to inflate. Witness a series of the strongest stimulus programs anywhere, anytime and nothing happens. Witness the lowest mortgage rates in history, and nothing happens.
The reason nothing happens is that old people don’t buy houses. In their middle age, Dent says the typical middle class couple with teenagers is living in a 4,000 sq.ft. McMansion. The kids leave home and the parents downsize to a 1,500 sq.ft. condominium. What do they need all those bedrooms for? The kids don’t even visit anymore. Fifteen years later the parents are in a 200 sq.ft. room in a nursing home. Another decade after that there’s that comfortable urn we talked about.
Boomers are not buying living area. They’re selling it. Dent says downsizing is the future of real estate, in America as in Japan. For every young couple having babies there are one or more older couples drifting into a nursing home.

Ok. So Dent’s hypothesis appears to be this: We have more thrifty old people than spendy young people, so the economy will continue slipping, perhaps for a long time. Look at Japan. There’s nothing the government can do about it. Look at the failures of QE I, II, and III. Demographics triumph.
So, if this is the future – and I’m not saying it is, I’m just quoting a thoughtful observer (Dent) – it may be something you and I need to plan around. What can we do about it?
Here’s one idea for liquid funds: Not all nations are as demographically challenged as Japan and, recently, America. What would happen if you put some of your liquid (stock) money into low cost international index funds? Malkiel (“A Random Walk Down Wall Street”) has some recommendations on page 398 (hardcover edition).
Here’s an idea for non-liquid investments: Even if adverse demographics impact property values, it’s probably unrealistic to assume that all areas will be affected at the same time and in the same way. Google to find high per capita income and growing population areas. The odds are these pleasant trends will continue.
I know. I know. Just because certain areas had high income and high population growth the last 30 years doesn’t mean they’ll have them the next 30 years. But do you think you’ll have better long term prospects in an area of fewer and fewer people with less and less income?
Some towns / cities / metropolitan centers will grow while other areas decline, so select the areas you think will best hold their value. Even in California, I’d expect that property in Manhattan Beach, even if it’s inland and not directly on the water, will be a better long term investment than, well, Frazier Park. “But, but, property is cheaper in Frazier Park!” I know, Buttercup, but regardless of what your manicurist tells you, sometimes things are cheap for a reason.  So buy in high income growth areas. We’ve covered all this before under ‘Archipelagos’.
If Mr. Dent is right, we will allow demographics to work for us.  Let others be fearful.

Klarise Yahya is a Commercial Mortgage Broker. If you are thinking of refinancing or purchasing five units or more, Klarise Yahya can probably help. Find out how much you can borrow. For a complimentary mortgage analysis, please call her at (818) 414-7830 or email [email protected].

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