Gary Shilling

The US faces 10 years of slow growth and deflation that could rival Japan’s “lost decade” – two words which Gary Shilling did not utter but which unmistakably characterize his forecast.

Shilling laid out his deflationary forecast along with his investment recommendations at last week’s Strategic Investment Conference, held in San Diego and hosted by Altergis Investments and Millennium Wave Investments.  Shilling is founder and President of the New Jersey-based economic consulting firm A. Gary Shilling & Co.  His talk was titled “Investment Strategy for an Era of Slow Growth and Deflation.”

Our GDP will grow by a mere 2% annually over the next decade, Shilling said, and further growth will be impossible while we “socialize our debt” – transferring financial sector and household liabilities to the federal balance sheet. 

“This deleveraging, in my estimation, is going to take at least a decade, and that’s the good news,” he said.  “If it were to happen in a couple of years, it would make the Great Depression look mild.” 

Deleveraging has not and will not proceed smoothly.  As one crisis subsides, another will emerge, Shilling said.  That sequence has so far played out in the sub-prime crisis, the Bear Stearns and Lehman failures, US consumer debt problems, and now the perilous situations in Greece and other parts of Europe.

The next crisis in this unfolding saga could come from commercial real estate, China, or Japan, Schilling speculated. 

The byproducts of deleveraging are slow growth and deflation – a potent combination that Shilling said is very hard to combat.  Japan has famously fought this battle for the last two decades and lost, and he expects the US will fare no better.

Deflation drivers

Over the last 25 years, the US consumer has saved less while borrowing and spending more.  Consumer debt service as a percentage of after-tax income has doubled, and consumer spending as a percentage of GDP grew from 62% to 71%, Shilling said. 

Shilling calculated that higher borrowing and lower savings contributed 1% annually to GDP growth.  That profligate binge will reverse and subtract 0.5% each year from GDP growth going forward, creating a net swing of 1.5% slower GDP growth.  US real GDP grew 3.7% annually during the last quarter century, and that 1.5% deficit means it will grow just 2.2% per year over the next decade.

Three factors underlie this consumer retrenchment, according to Shilling.  First, consumers have “run out of borrowing power,” he said, as the equity portions of their portfolios have been ravaged by two declines of 40% or more in the last decade.  Only two other declines of this magnitude have occurred since 1900.

“This has shaken people’s confidence in stocks,” he said, noting that in 2009 investors pulled $53 billion from equity mutual funds while putting $375 billion into bond funds.