The Lesson From Cyprus: Europe Is Politically Bankrupt
TUESDAY, MARCH 26, 2013 9:18 PM
Over the past week, Europe, or rather the present EU leadership, has done damage to itself it will never be able to repair.
It seems to escape everbody, but that doesn’t make it any less true: people from Portugal to Spain to Italy to Greece to Cyprus and Ireland are worse off today than they were when they first adopted the euro. Moreover, their economies are all getting worse as we speak and projected to plunge further. The once highly touted blessings of the common currency are by now lost on most of southern Europe; for them, the euro has been a shortcut to disaster.
Until Cyprus, the EU had always maintained two prime objectives (and spent €5 trillion over 5 years to prove it): keeping all members in the eurozone, and guaranteeing all bank deposits under €100,000. These objectives exist from now on only in words. Brussels has threatened to both grab deposits of small savers and throw Cyprus out of the monetary union. Two watershed moments in one.
The membership of the European Union, the subsequent introduction of the euro and the seemingly endless flow of credit that came with these "privileges" provided the region with a temporary illusion of increasing wealth and new-found prosperity. Today it knows that none of it was real, or earned; it was all borrowed. It’s time to pay up but there’s no money left. It needs to be borrowed. From the European core and its banking system.
The EU’s financial scorched earth strategies have left its Mediterranean members with highly elevated unemployment rates, fast rising taxation levels, huge cuts to pensions, benefits and services and above all insanely high debt levels, personal, corporate and sovereign. And now, as ironic as it is cynical, their savings. The only thing that keeps the nations from going bankrupt is more debt, largely in the form of ECB loans.
What sets Cyprus apart from the other victims of Brussels’ expansion hunger is the timing. The country (actually only the Greek-Cypriot 59% of the island of Cyprus) was only allowed entry in the EU in 2004, and it didn’t introduce the euro until 2008. At that point, total bank assets were already well over €80 billion, or a very unhealthy 450% of GDP, and kept on rising with a vengeance. Four years later, in early 2012, the EU/ECB/IMF troika forced €4.5 billion in losses on the Cyprus banking system through the haircut on Greek sovereign debt. Now, one year after that, the same troika forces Cyprus to cough up €5.8 billion. No great math skills required: Cyprus was essentially pushed under the bus in order to – temporarily – save Greece.
The EU, with all its 1000s of highly paid employees and its multiheaded leadership structure, time and again fails to do its overseeing job, and then conceals this by turning around and bullying the victims of its failures. Of course they knew what state Cyprus was in when it switched to the euro, and the country should never have been allowed to enter. And of course the EU and ECB leadership knew all along what happened in Cyprus between 2008 and now, or at least should have. It’s their job to know. Hence, the leaders should be fired either for not knowing or for knowing and not acting. They just cost taxpayers yet another grab bag full of billions, and they should be held accountable for that.
The problem is they’re not accountable to anyone for anything they do, other than in name. Or put it this way: people like Van Rompuy, Barroso and Olli Rehn are not accountable to anyone but themselves, each other and Angela Merkel’s entourage. There’s a great word in the English language to describe their attitude; the ancient Greek "hubris". Add a side dish of arrogance and incompetence and you have a lethal combination.
By the way, here’s how European democracy works: when the whip comes down, everybody will do what Berlin wants. Germany has some 24% of the EU population, and Angela Merkel’s ruling party (through a coalition) has maybe a third of all votes. That means perhaps 20 million Germans, or at best 6% of the 332 million people in the Eurozone, decide what goes and what does not.
Hubris makes stupid (or, granted, it could be the other way around). That’s why we saw the following over the past week:
1) The announcement of the initial Cyprus plan, the one that included a 6.75% tax for all deposits below €100,000. It doesn’t matter that it’s no longer in the final plan, the "deposit grab" genie has left the bottle and will never return. It’s like breaking an egg; restoring confidence is no longer an option. No European small saver will feel safe again for decades, and many will take much of their deposits out of their banks, which will push banks over the edge, requiring more bailouts, rinse and repeat.
The troika, joined by German finance minister Schäuble, went out of their way to put all the blame for this on the Cyprus government (the ball was in their park), but given the obvious potential consequences (the devastating loss of trust), they should never have allowed either the responsibility or the blame to be there; it was theirs to take. That they didn’t, leads to point 2:
2) Brussels and Frankfurt can neither oversee nor control the consequences of their actions. The trust issue is just one of many topics that have made this clear. And as long as the present leadership structure remains in place, what happened in Cyprus will keep on happening, because:
3) They don’t care. They don’t care that the entire southern part of their union is falling over the edge. They don’t care what happens to the people in the streets of Nicosia, or Porto, or Sevilla, their jobs, their savings, their well-being, their children. They’re not accountable to those people. They’re untouchables as far as democracy goes in all but the most cynical definition.
Imagine you’re a cleaning lady or a primary school teacher, or you have a small grocery store or a bakery, in a town somewhere in Spain or Italy or Portugal. At home, you’ve already been hit with huge tax rises and budget cuts. But there’s one thing you can count on to stand between you from things getting real bad: the savings in your bank. And then you see on TV what’s happening in Cyprus. Where people had the same deposit guarantee you had, until from one day to the next they didn’t. What would you do with what’s left in your bank account?
People with bank accounts in Cyprus no longer have access to their money. They’ll be stuck in a repeat of Argentina’s early milennium capital controls for months. People in Spain and Portugal still have a choice. Maybe not for long, because at the first hint of capital flight to the backyard bank, control over your own money will very rapidly become a thing of the past.
The only reason for Europe’s Mediterranean nations to remain in the eurozone and the EU will be bullying from Brussels and Berlin. It’s this bullying from the core, from those who preach union above all else, which will be the undoing of the entire project, but after a lot more pain of the same kind that now hit the Cypriots will have spread north (the rot won’t stop).
Unless first one country and then inevitably others – soon – decide to leave, say thanks for all the fish, and (re-)build their own nation. That would be by far the best choice for all of southern Europe. Staying in the union has nothing positive to offer anyone anymore, except for those presently in power in Brussels and in the capitals of the rich core nations. The dissolution of the union is inevitable. Unfortunately, given the hubris in the core, so is the bloodshed that will pave the way there.
Statistics: Posted by yoda — Tue Mar 26, 2013 10:15 pm
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Portugal May Become the First of Europe’s Bankrupt Welfare States to Stumble upon a Genuine Recovery Formula: Less Spending AND Lower Tax Rates
Daniel J. Mitchell
There aren’t many fiscal policy role models in Europe.
Switzerland surely is at the top of the list. The burden of government spending is modest by European standards, in part because of a very good spending cap that prevents politicians from overspending when revenues are buoyant. Tax rates also are reasonable. The central government’s tax system is “progressive,” but the top rate is only 11.5 percent. And tax competition among the cantons ensures that sub-national tax rates don’t get too high. Because of these good policies, Switzerland completely avoided the fiscal crisis plaguing the rest of the continent.
The Baltic nations of Estonia, Lithuania, and Latvia also deserve some credit. They allowed spending to rise far too rapidly in the middle of last decade – an average of nearly 17 percent per year between 2002 and 2008! But they have since moved in the right direction, with genuine spending cuts (unlikely the fake cuts that characterize fiscal policy in nations like the United States and United Kingdom). Yes, the Baltic countries did raise some taxes, which undermined the positive effects of spending reductions, but at least they focused primarily on spending and preserved their attractive flat tax systems. No wonder growth has rebounded in these nations.
The situation in the rest of Europe is more bleak, particularly for the so-called PIIGS. To varying degrees, Portugal, Italy, Ireland, Greece, and Spain have lost the ability to borrow, received bailouts, and been mired in recession.
The silver lining is that the fiscal crisis has forced them to finally cut spending. All of those nations implemented real spending cuts in 2011 according to European Commission data, bringing spending below 2010 levels. Final figures for 2012 aren’t available, of course, but the International Monetary Fund estimates that spending will drop in every nation other than Italy (where it will climb by less than 1 percent).
That’s the good news. The public sector finally is being subjected to some long-overdue fiscal discipline.
The bad news is that politicians also imposed very significant tax increases on the private sector. Income tax rates have been increased. Value-added taxes have been hiked, and other taxes have climbed as well. These penalties on productive activity undermine potential growth.
The politicians say that this is a “balanced approach,” but this view is misguided, First, as Veronique de Rugy has shown, it generally means lots of new taxes and very little spending restraint. Second, it is based on the IMF view of “austerity,” which mistakenly focuses on the symptom of red ink rather than the underlying disease of too much spending.
What Europe really needs is a combination of lower spending and lower tax rates.
Portugal may actually be moving in that direction, according to a report in the Wall Street Journal.
The Portuguese government is seeking to cut its corporate tax rate for new businesses to one of the lowest in Europe as part of a plan to attract investment and revitalize ailing industries, the minister of economy said. The government is in talks with the European Commission’s competition agency in Brussels to get approval to cut the tax on corporate income for new investors to 10% from the current 25%, the minister, Alvaro Santos Pereira, said in an interview. …”We want to make Portugal one of the most attractive countries in Europe for new investment,” Mr. Santos Pereira said. “We believe that by providing very strong fiscal incentives to new investments we will safeguard the budget side and at the same time become a lot more competitive,” he added. …While wealthy euro-zone countries and the IMF are beginning to recognize the need for measures to boost growth in austerity-hit countries, they have been reluctant to endorse tax cuts in countries under bailout programs. If implemented, the proposed tax cut would be a departure from a series of tax increases that countries including Portugal, Greece and Spain were forced to take as part their bailout conditions.
Before getting too excited, it’s important to note that the Portuguese proposal is a bit gimmicky. It’s not a corporate tax rate of 10 percent, it’s a special rate of 10 percent for new investment, however that’s defined.
But at least it might be a small step in the right direction. As the article indicates, it “would be a departure from a series of tax increases.” And Portugal definitely has been guilty in recent years of raping and pillaging the private sector.
To be fair, though, this chart shows that government spending in Portugal did decline last year. And the IMF is projecting that it will fall again this year and next year.
But the key to good fiscal policy is reducing government spending as a share of economic output. And if tax increases keep the private economy in the dumps, then the actual burden of government spending doesn’t change much even when nominal outlays decline.
A pro-growth policy is needed to boost economic performance. Portugal’s corporate tax rate proposal, by itself, won’t make much of a difference. But if it’s the start of a trend, that could be significant.
By the way, it’s amusing to see that one of the bureaucrats from the European Commission is pouring cold water on the plan, implying that a decision to take less money from a company somehow is akin to government assistance.
“We would want to be sure that anything proposed would help the competitiveness of the economy,” said spokesman Simon O’Connor, “but at the same time it would have to be in line with state aid rules,” referring to EU regulations that limit the assistance governments can give to the private sector. “There really isn’t any scope for them to reduce revenue,” he added.
But I guess that’s not too surprising. Along with their tax-free colleagues at the Organization for Economic Cooperation and Development, the European Commission has been trying to undermine tax competition and make it easier for nations to impose bad tax policy.
Returning to our main topic, what’s next for Portugal?
Your guess is as good as mine, but Portugal’s leaders already have acknowledged that Keynesian fiscal policy is ineffective. Perhaps they’ve gotten to the point where they realize punitive tax systems also are destructive.
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It was early on the federally funded (taxpayer funded) green jobs train and now for A123 that train has ground to an abrupt halt. But that’s not before it funneled some of the taxpayer funds it was given back to lawmakers and lobbyists. If your business plan is a federal subsidy these are your number 1 customers.
But even with lots of taxpayer funded buddies in Washington DC success was out of reach for the company whose products had a tendency to ignite at inopportune times, such as under the hood of expensive Finnish sports cars. On Tuesday A123 died, like, well, an old battery.
(From The Washington Guardian)
Even as advanced battery maker A123 Systems struggled for financial viability, it played the Washington insider game, where political money and access go hand in hand.
The Massachusetts firm dished out nearly $1 million to hire a powerhouse lobbying firm with close ties to President Barack Obama between 2007 and 2009, and two of its top executives made personal donations to several high-profile Democrats in Congress as it won federal funding for its efforts to build the next generation of lithium batteries for electric vehicles.
And its president and CEO, David Vieau, an early financial backer of President Barack Obama, scored five invitations to the White House in 2009 and 2010, including a meeting he attended with the president, White House logs show. And when the company opened a new Michigan plant, Obama made a high-profile call to congratulate.
(The Washington Guardian, 10-18-2012)
The post Michigan’s Solyndra, Battery Maker A123, Bankrupt after a $250 Million Grant appeared first on AgainstCronyCapitalism.org.
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Guess who’s bailing out bankrupt western governments now…
Tim Staermose on JULY 5, 2012
July 5, 2012
Fourteen years ago during the Asian financial crisis, Indonesia endured a currency collapse, a severe 2-year recession, and an embarrassing IMF bailout.
Western bureaucrats wagged their fingers incessantly at Indonesia, lecturing the country about the dangers of excess and fiscal irresponsibility.
How sweet the irony is. In a stunning rags-to-riches story, Indonesia contributed US$1 billion to the IMF last week in order to help bail out bankrupt Western nations.
As I’ve written before, unlike Japan, the US, and Europe — which all seem to think the answer to an economic bust brought on by a debt-binge is to borrow and spend even more money– Indonesia took its medicine when its economy collapsed back in 1998.
The government cut spending. The economy was de-regulated and thrown open to more foreign investment.
The banking system was restructured, and after a difficult and admittedly very painful two years, the foundation was laid for new economic expansion, which continues to this day.
To be sure, the 1998 collapse of the Indonesian economy cost the incumbent political elite here their cushy positions. President Suharto’s three-decade long iron-grip came to an ignominious end. There were riots in the streets, and he was literally turfed out of office.
But so what? That’s EXACTLY what was needed. Part of the renewal process should always be to ship out the dead wood.
Wandering the streets of Menteng this week, Jakarta’s most up-market residential suburb, it’s as though the Suharto era never existed. The street where he used to live is just another non-descript, quiet, residential street in this leafy inner-city suburb.
Ironically, US President Barack Obama spent some of his childhood in this same suburb of Jakarta.
Unfortunately, as he pulls out all stops to cling to power for a second term, the kind of tough decisions that could help the US emerge from its economic malaise have no chance of being made.
Lest anyone accuse me of being “anti-Obama” or, shock-horror, FOR the Republicans, let me state emphatically that the PROBLEM is not one side of the aisle or the other. In fact, whoever coined the terms “Demopublicans” and “Repulicrats,” is right on the money in my book.
It’s the ENTIRE system that’s the problem. And that goes for nearly every Western, “free market,” democracy out there.
I use the term “free market” reluctantly, because these economies are anything but. There has not been a true free market economy anywhere in the Western world for many decades.
The most important price of all — that of MONEY — is completely rigged by a small band of dark-suited men who sit around an impressive boardroom table and DECREE what interest rates should be. It is a farce.
Moreover, politicians from opposing sides of the political spectrum may disagree in public and harangue each other in the press.
But, at the end of the day, they’re generally all members of the same club– a cabal of privileged, self-righteous individuals who think they know how to spend your money better than you do.
This system has a vice grip on society, and nothing short of a revolution– such as what Indonesia experienced in 1998– will force any change.
That leaves most people with a rather interesting choice—stay at home in a declining, bankrupt, insolvent nation and hope that a social and political revolution comes quickly…
… or head to greener pastures, to a place that’s stable, thriving, and has already swallowed its medicine.
Here at Sovereign Man, we strongly urge you to come on in. The water’s fine, and the view is much better from this side.
Chief Investment Strategist
Statistics: Posted by yoda — Thu Jul 05, 2012 10:07 am
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How to bankrupt a generation of young Americans in four steps – young Americans living at home surges by 50 percent from 2005.
Posted by mybudget360 in bailout, debt, economy, Employment, recession, student debt, student loans, wall street
The viable pathway for success for many young Americans seems to have gotten very narrow in the last decade. The opportunities for many young workers have become mired with an economy that is largely in a deep recession with limited quality positions. Many are saddled with debt and taking on employment positions that may not even utilize the very expensive college education some have taken on. Education is important but doing it intelligently has become tougher since we are living in a student loan bubble. Many young Americans have been forced to move back home to live with mom and dad because of the shoddy economy even if they have a job. Each point of data suggests that we will have a less affluent generation coming forward yet this is the generation that is largely going to shoulder the burden of unsupportable government debt? The bill is largely coming due but many younger Americans are already starting with a negative net worth.
Step 1 – Access to higher education saddled with massive student loan debt.
The outsourcing of many blue collar jobs is not a new thing. What is new however is that for the viable white collar jobs a college degree is nearly mandatory. Yet many are being lured into student loan debt by subpar institutions and are finding themselves in unmanageable debt:
This isn’t exactly a chart you want to be seeing especially when incomes have gone stagnant for younger Americans. The issue as well is that most of this debt is being saddled on the backs of recent graduates:
This is not a good alignment. High student debt and fewer job prospects. In other words, the higher costs are not being reflected on a return on investment (ROI). You have young Americans entering a very weak economy with massive levels of debt. This leads us to the employment side of the equation.
Step 2 – Very few jobs in current economy
If we look at the employment side by age, we see a recession for older Americans and a near depression for young Americans:
This is a troubling chart and shows that the brunt of the recession in terms of employment losses were shouldered by the young. Many of those with jobs are not even utilizing the full potential of their college degree:
53 percent of those with college degrees under the age of 25 are either jobless or underemployed (working in fields that do not even require their expensive college education). Part of this is occurring because older Americans are holding onto positions more tightly but also have experience in certain fields to build professional knowledge. A young worker each year they are not working or not utilizing their degree will only put them that much further away from making it into the middle class. Many are simply taking on massive student debt and drop out of the statistics for employment.
Step 3 – Balance entitlements of older Americans on poorer young Americans
The problem with some of our major expenses coming down the pipeline (for example, Medicare) is that we are facing a smaller pool of workers earning less money yet the expense side is going to soar because of retiring baby boomers:
The above is a scary chart. The participation rate is projected to fall for the next 30 years while expenses for the retired and non-working is soaring. Young Americans have barely anything to their name to begin with:
The median net worth for those 35 and younger is slightly above $2,000 or the price of two months of rent in many places in the US. We are going to face some significant challenges moving forward with these demographics.
Step 4 – Move back home with mom and dad
So it shouldn’t come as a shock that many young Americans have moved back home with parents. The number of Americans moving back home has ascended since the recession hit:
Source: Sober Look
The number of young Americans living at home, those 25 to 34 has increased by over 50+ percent since 2005. This is interesting because it shows that the massive debt was already having an impact two years before the official start of the recession. The housing bubble also probably pushed many of these people out of contention for purchasing homes.
The challenges are large for our nation but a big brunt of this recession has been put on the backs of young Americans. In fact, for the young this is still a recession when it comes to the low-wage employment market and the massively inflated higher education market. If you wanted to develop a recipe on how to bankrupt the young this is likely how it would look.
Statistics: Posted by yoda — Thu May 10, 2012 12:00 am
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Hidden Gold Taxes: The Secret Weapon Of Bankrupt Governments
By Daniel R. Amerman, CFA
What if there was a hidden tax that most gold and silver investors were simply unaware of? A tax where the government would take a big chunk of your starting net worth if gold went to $2,000 an ounce, leaving you poorer than you started with? A tax that rises with inflation, so that $100,000 an ounce gold could cripple your net worth?
This tax already exists, as we will demonstrate in step by step detail using three easy to follow examples. All but a few investors are unaware of this tax and its devastating implications. Simply put, when we assume that gold acts as “real money” and perfectly maintains its purchasing power during rapid inflation, then the higher that the rate of inflation rises, the higher the percentage of the average gold investor’s starting net worth that ends up belonging to the government.
Knowledge is power. Conversely, a time of severe monetary crisis could be the most dangerous time in our lifetimes to be uninformed. Investors who are unaware of this profoundly unfair tax, or who choose to ignore it, necessarily become helpless victims of the government. When investors become aware of perhaps the number one danger to long term precious metals investment, and adapt their strategies to deal with this danger – then they can unlock the true investment power of gold during times of currency crisis. And turn potential $10,000 or $100,000 an ounce gold prices into the once-in-several-generation wealth creation opportunities that they should be.
$2,000 An Ounce Gold
In the first step of our illustration, we will consider a situation and how it affects the life savings of two investors. The situation is that 50% of the value of the dollar gets destroyed by inflation. This is not a radical assumption, as with modern symbolic or fiat currencies the value of money is always destroyed by inflation. The only question is one of speed, and if we look at the United States, 80% of the value of the dollar was destroyed by inflation between 1972 and 2007 as measured by official government statistics. For this illustration we will assume there is a smaller loss in value of the dollar, but that it happens much faster – because the US is in much worse shape right now than it was in 1972 in some key ways.
Kate is well educated, keeps up with the newspapers, and is concerned that the global financial crisis may get worse. So she liquidates her riskier investments, and to play it “safe”, moves her money into a $100,000 money market account.
For our illustration we will assume Kate’s money is safe – but the value of her money is not protected. Inflation destroys 50% of the value of the dollar. Kate still has her full $100,000, but it will now only buy what $50,000 used to. Kate has lost 50% of the value of her investments to inflation (for simplicity, we’re leaving out assumptions on interim money market interest payments).
Jack also reads the mainstream media, but reads more widely as well, and believes that high inflation is the logical outcome of the financial crisis. Jack therefore takes his $100,000 and buys 100 ounces of gold at $1,000 an ounce (using round numbers for ease of illustration).
We will assume that gold performs exactly like many investors hope it will. That is, it acts like “real” money and maintains its purchasing power in inflation-adjusted terms. Now, if the dollar is only worth half of what it used to be, and gold does maintain its purchasing power, there is only one way for gold to do so, and that is for gold to sell for twice the number of dollars per ounce than it did before.
Therefore, gold goes from $1,000 an ounce to $2,000 an ounce. Those dollars are only worth fifty cents (in today’s terms), so we multiply $2,000 times 50%, and we end up with $1,000. Jack’s 100 ounces of gold at $2,000 each will buy exactly same amount of real consumption, of real goods and services, as gold used to buy for him at $1,000 an ounce. Some would say that this is an example of a perfectly successful inflation hedge, where gold has performed exactly like it is supposed to.
The powerful advantages of having your money in an inflation hedge when entering a period of substantial inflation, can be seen in the chart below, which compares what happened with Jack and Kate.
Through placing her money in what is conventionally considered one of the safest possible investments, during a time of high inflation, Kate has lost 50% of her net worth. This is terrible, of course, but at least she should be able to get a nice tax deduction out of this $50,000 loss. Except that when it comes time to fill in her tax return, she starts with $100,000 in her money market fund, and ends with $100,000 in principal in her money market fund. As far as the government is concerned — there is no loss to be deducted. Kate still has every dollar she started with.
Jack decides to lock in his gains by selling his gold investment, redeploy most of his newfound wealth into some new investments, and maybe take a little out to reward himself for having made such a brilliant investment. When it comes time for Jack to fill in his tax return, it shows that he bought his gold for $100,000 and he sold it for $200,000, thereby generating a $100,000 profit. Effectively, the government looks at Jack’s having dodged the its destruction of the value of the nation’s money, and says “Great move Jack, you made a lot of money! Now give us our share.”
Even in bullion form, gold is currently taxed as a “collectible” in the US, with a 28% capital gains tax rate, or almost twice the long-term capital gains tax rate on investments that the financial industry and government prefer. We’ll call it 30% to allow for some state capital gains taxes, and to keep the numbers round. However, this rate is not sufficient to cover government spending, as the federal government is currently running enormous deficits, as are the states and municipalities (particularly when we take into account not only declining tax collections but the pension fund crisis). So it is reasonable to expect potentially much higher taxes in the not-too-distant future, both in the US and other nations. For illustration purposes then, we will assume a 50% future combined capital gains tax rate on gold – which is not unrealistically high from a historical perspective.
So for Jack, as shown in the chart below, paying a 50% tax rate on $100,000 in profits means $50,000 in required tax payments, and subtracting those taxes leaves Jack with $150,000.
Our final step is to adjust for a dollar being worth 50 cents, so we multiply $150,000 by 50%, and we find that Jack’s net worth after-inflation and after-tax has fallen to $75,000. When it comes to what matters, the purchasing power of what our money will buy for us, then Jack didn’t double his money, instead he lost a quarter of what he started with. Jack just met what are known as “inflation taxes”. And they ran him over.
Turning Gold Into Lead
From a gold investor’s perspective, $2,000 an ounce gold may seem like a dream come true. And when we look at the results, $100,000 turning into $200,000, gold does look like a great investment. Until we remember that the reason gold went to $2,000 an ounce was because of inflation and we adjust our investment results for inflation. We break even. While not a net improvement relative to today, this outcome is highly desirable compared to what happened to Kate. Gold did indeed act as “real money”.
Unfortunately, we then run into one of the most deeply unfair and little understood aspects of inflation and investing in anticipation of inflation. Government fiscal policy destroys the value of our dollars. Government tax policy does not recognize what government fiscal policy does, and is blind to inflation. This blindness means that attempts to keep up with inflation generate very real and whopping tax payments, on what is from an economic perspective, imaginary income.
These taxes turn gold from a shimmering dream to a lead weight around our neck, and mean even a successful inflation hedge can lead to a devastating loss in net worth in after-tax and after-inflation terms.
So how do we deal with this lead weight of inflation taxes around our neck, trying to pull us down under the water? Does all of this mean that we just need to swim harder, to try to overcome taxes?
$5,000 An Ounce Gold
What if gold goes much higher than $2,000 an ounce? What if the dollar falls in value to twenty cents, and we assume that gold again performs as a perfect inflation hedge, and keeps its value? If the dollar drops to 1/5 its value, then the only way gold can keep up is to rise to 5X the dollar price, which means $5,000 an ounce gold.
First let’s take a quick look at Kate. She still has $100,000 in her money market account, each of those dollars are now worth twenty cents, and the real value of Kate’s “safe” investment is now down to $20,000. Kate has taken an 80% hit to the purchasing power of her net worth.
Meanwhile, Jack has enjoyed some fantastic investment results from his investment acumen. With 100 ounces of gold at $5,000 an ounce, Jack is now half way to being a millionaire!
Jack is ecstatic, at least until he tries to spend some of that half million dollars, and finds out what it will buy for him after he has paid his taxes. Let’s repeat our chart from above, but with gold at $5,000 an ounce. When it’s time to file his tax return, Jack now has a $400,000 profit to report. Jack therefore has to write the government a check for $200,000 for taxes due, leaving him with $300,000.
When we adjust for a dollar being worth twenty cents, then Jack’s real after-inflation and after-tax net worth, what he can buy in today’s dollar terms after paying the government, is down to $60,000.
The difference between gold going to $5,000 an ounce, and gold going to $2,000 an ounce, is that Jack loses more of his real net worth. Jack loses 40% of the purchasing power of his net worth at $5,000 an ounce instead of 25%.
The lead weight of inflation taxes is still around Jack’s neck, heavier than ever, trying to pull him and his net worth deeper and deeper underwater. Perhaps Jack just isn’t working hard enough, and he is going to have to swim like a wild man if he’s going to stay afloat, as he will not only have to outpace inflation, but also inflation taxes.
$100,000 An Ounce Gold
Let’s explore what happens if there is hyperinflation and a dollar becomes worth a penny. For Kate, the situation becomes even bleaker as the $100,000 in her money market account will now only buy what $1,000 used to. Kate has lost 99% of her net worth to inflation. Instead of a comfortable nest egg for retirement, she is impoverished, as are the many millions of others who were not prepared for hyperinflation.
If gold (or silver) serves as “real money”, and maintains its purchasing power even as paper money collapses, then to offset a dollar becoming worth 1/100th of what it used to, gold must climb to a dollar value that is 100X greater than what it was. So gold must go to $100,000 an ounce in order to maintain the same purchasing power as $1,000 an ounce gold today. Once again, we’re assuming that gold acts as a perfect inflation hedge.
Jack’s 100 ounces of gold are now worth a cool $10 million! Jack decides to sell his gold, lock-in his profits, and then start enjoying his new status as one of the ultra-wealthy.
As illustrated below, Jack sells his gold for a whopping $9.9 million profit. The government looks at his profit, and demands its $4,950,000 share. This still leaves Jack a millionaire multiple times over, as he has $5,050,000 in after-tax proceeds. Until we adjust for that technicality of a dollar only being worth a penny. And we find that instead of entering the ranks of the ultra-wealthy, Jack’s net worth on an after-tax and after-inflation basis has fallen by almost 50%, from $100,000 to $50,500.
Jack has made one of the most brilliant market timing moves of all time. But the end result is that he loses almost half of his starting net worth in purchasing power terms. What’s going on?
The Better You Do, The Worse You Do
Something seems seriously, seriously wrong here. Jack bets his net worth that inflation will skyrocket, and he buys an inflation hedge in the form of gold. His prediction comes true, a high rate of inflation does occur, and his gold investment does perform as a perfect inflation hedge. Yet the ending bottom-line is that Jack loses a big chunk of the value of his starting net worth. And the better that the gold performs and the more spectacular his returns — the bigger the chunk of his real net worth that Jack loses.
This relationship is summarized in the chart below. When Jack earns a 100% profit — he loses 25% of his net worth. When Jack earns a 400% profit — he loses 40% of his net worth. When Jack earns a 9900% profit — he loses 50% of his net worth.
A Pervasive & Difficult Problem
Inflation taxes are a basic fact of life which investors pay every year when there is inflation. These taxes are entirely real and are deeply painful when we look at the world in terms of what really matters – which is not the dollar amount of our savings, but what our savings will buy for us.
Real as they are, however, inflation taxes are not a line item on our tax returns. There’s no box that we check that says go to form “30236 IT” to calculate our inflation taxes. There is no check we write that’s specifically made out to inflation taxes. There’s never any discussion in the newspapers or magazines about how much money the average investor pays every year in inflation taxes.
So if almost nobody sees inflation taxes or talks about them – do they exist at all? This may be a good time for a pop quiz of sorts. If you are skeptical, the examples of Jack and Kate were kept very simple for a reason. Go back through the basic illustrations, and try to disprove them. Now, you can change how the price of gold moves relative to the destruction of the dollar, and you can change the tax rate – but there’s no room for anything else.
Do you agree that the numbers work? This “quiz” is self-graded, but your “score” could be essential for your future. Because if our future is one of high inflation, then whether and how you deal with inflation taxes may be one of the biggest determinants of your personal standard of living for decades to come.
Inflation taxes are irrefutable. Whenever you look at investment results on an after-tax and after-inflation basis in an environment of inflation, then inflation taxes make their ugly appearance.
However, while our illustration of Jack and Kate was not all that complicated to follow, the numbers involved are just sophisticated enough where they are rarely acknowledged in conventional personal finance. That combination of just a slight bit of sophistication, with never explicitly appearing on a tax return, means that likely in excess of 99% of the general population is blissfully unaware of inflation taxes.
Let me suggest that a big whopping tax that 99% of voters are blind to represents major opportunity for the government. An opportunity that has been fully taken advantage of by governments, even if the average senator, representative or member of parliament has no better understanding than the general public. Indeed, as I cover in my Turning Inflation Into Wealth mini-course, when we take inflation taxes into account, then the real tax rate on investments in the US has historically been about 256% higher than the statutory rates.
History is bad enough, but as we illustrated with Jack and Kate, the higher the rate of inflation – the worse inflation taxes get. Staying ahead of inflation is hard enough. But even trying to tread water, to stay even with inflation, becomes extremely difficult when you have the lead weight of inflation taxes around your neck, pulling you down. The higher the rate of inflation, the heavier the weight of inflation taxes and the more difficult they are to overcome.
This is true for such traditional inflation hedges as gold and silver. It’s also true for real estate. As it is true for stocks. Indeed, almost any traditional inflation hedge has difficulty in reaching the break-even point on an after-inflation and after-tax basis when we take into account the pervasive problem of hidden inflation taxes.
Reversing Inflation Taxes & Creating Wealth
There are two very sad aspects to what we covered in this article. Unlike most of their peers, millions of responsible, knowledgeable people are seeing through the soothing, complacent illusions created by the government and Wall Street. They understand the grave threat to the value of their money and their investments. They are moving to the real tangible protection of gold and other precious metals. Unfortunately, in the process, they are setting themselves up for victim status as illustrated in this article.
Yes, the “Jacks” of the world are likely to do far, far better than the “Kates”, but despite the dizzying numbers involved with how high gold can go with a truly high rate of inflation — when we look to what our investments will buy for us after we’ve paid our taxes, our status is still that of a victim.
The other sad aspect is that this simply doesn’t have to be. There are two things that gold does spectacularly well during times of financial and monetary crisis. Using these properties of gold, with a monetary crisis of historic proportions, a gold investor can come to the crisis not just with their net worth intact but possibly even having built wealth on a multigenerational scale.
But let me suggest that achieving this result on an uninformed basis, without fully understanding the issues discussed in today’s article, will be a matter of rather unlikely good fortune.
There is a better path. Study. Learn. Invest in your intellectual capital. As covered in my “Gold Out Of The Box” materials, let gold do what gold does best. Let gold provide safety and security for you. Unleash the wealth creating abilities of gold during peak inflation to multiply your real wealth. But don’t rely on gold as an inflation hedge and don’t ignore inflation taxes.
To have a chance of beating inflation taxes, we not only have to realize they exist, but we need to thoroughly understand our opponent. Our opponent is an enormously powerful government that is deliberately blind to the effects of inflation. Government fiscal policy destroys the value of our money. Government tax policy is officially blind to inflation. So a crushing hidden tax is created that keeps us from maintaining the purchasing power of our savings, with our attempts to survive the deadly effects of inflation merely acting to increase government tax revenues.
The key to prospering in a world of inflation taxes is to understand that regardless of its strength, a blind opponent is ultimately a weak opponent. Through careful study and by focusing very closely on the intersection between taxes, net worth and inflation, we can discover how to turn inflation into gains in real wealth, to which the government is entirely blind. We can learn to reverse inflation taxes, so that instead of paying real taxes on imaginary gains, we are paying imaginary taxes on real gains. Entirely legally, with every cent of taxes due paid in full – because remember, inflation taxes don’t appear on your tax return, and neither does their reversal.
Statistics: Posted by yoda — Sat Apr 21, 2012 11:14 am
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