The Cruellest Tax of them All.

Who is John Galt? – Ayn Rand from Atlas Shrugged

Humanity has shown many times that we can be extremely cruel and equally capable at rationalising it away. Taxation comes in many forms and is often not apparent. A well disguised tax is a boon for governments. The cruellest tax of all is a one hundred percent tax on income, disguised and capable of being rationalised as “good”.

Imagine for a moment a peasant farmer who has to hand over a hundred percent of his crop to a feudal lord. It is easy to see the injustice of such a tax. Yet we have a hundred percent tax in our midst and there is no moral outrage. It is the zero interest rate policy. Fortunately that other destroyer of savings, Quantitative Easing, is off the table for the time being.

We rationalise it away as a benign economic policy aimed at restoring economic prosperity. No questions asked. All “policy” happens by government decree. Do not buy into the slight of hand that the central bank is not part of the machinery of government. So the Central Bank can “follow” a zero interest rate policy but the reality of this tax is lost on the population.

Let’s put it up for scrutiny. Would a saver willingly agree to an economic environment of zero interest rates? Certainly not. Would a debtor prefer a zero interest rate? Absolutely. The saver and the debtor would negotiate a “price” for the use of money saved under normal willing economic participant conditions. That price for use of funds is interest.

The Central Bank enters the negotiation between saver and borrower and by counterfeiting money is able to destroy the negotiating base of the saver. Counterfeiting money through policies of unlimited liquidity provision is “price control” over interest rates instituted to force interest rates to zero. The interest income of the saver is completely taxed away.

I want to concentrate on the tax though the plight of the saver haunts me when I interview desperate pensioners who are forced into risk assets in the hope of making up for a loss of interest income. Often they lose capital in this game of risk taking with savings, into a downward spiral of despair. Back to the tax.

Savings will migrate to term assets for meagre interest income but that income has more to do with a term premium than with interest, the cost for use of funds. No-one has any moral standing to defend a policy that dispossesses the interest of the saver however, the indiscriminate redistribution of this “interest” tax is even worse.

The normal standards for a tax are that it must be fair and it must be evenly distributed. The “for the public good” argument is that tax may be levied disproportionately usually with reference to some wealth measure. In simple terms, the rich must pay more and the poor must pay less. A zero interest rate policy tax fails dismally when it is tested against this framework. There is no discrimination. All savers are taxed their entire interest rate. Some savers, usually the wealthier and more sophisticated savers can institute counter tax measures and are able to avoid or escape the zero interest rate tax to some extent. Most can’t and they fund the redistribution.

Looking at the redistribution of the saver’s interest we find the same indiscriminate principles being applied. Is it being distributed by an elected body, fairly and equitably in the interest of society? No. Who are the recipients of the interest that has been stripped from the savers? Obviously the borrowers and it takes place with no reference to the wealth, income or other discerning standards which would normally apply. By which standards do society decide that Homeowner X who bought a property priced beyond his means and who borrowed in excess, must be subsidised by Pensioner Y who had saved to survive the income drought of old age. Why must BIG BANK A have access to zero or near zero cost of funds to carry all those loss making loans while Saver B can no longer afford his child’s tuition?

So the zero interest rate tax strips the interest income from savers and hands it to government, morally justified as stimulating the economy through deficit funding. It is of no use to run up huge deficits if it involves paying a high interest rate, is the justification. Strip the interest and hand it indiscriminately to over-extended borrowers many of which had used the borrowings to speculate on asset inflations. Strip the interest and hand it to the banks to “repair” their balance sheets and to “carry” the bad debts. Strip the interest and hand it to the developers who overinvested in property, capacity or trading. Strip the saver of interest to fund the carry of compounding unliquidated losses.

How totally one sided. Rip off the savers and give to the borrowers. Not even the socialist dictate of Karl Marx which proclaims that everybody should contribute according to ability and receive according to need, can contain the injustice of a zero interest rate policy tax. Surely nobody can have a zero need and a one hundred percent obligation to contribute. Neither can anyone claim one hundred percent contribution from savers against a zero contribution from borrowers (the bank margin excluded).

So, next time when the Fed or the Bank of Japan or the Bank of England proclaims its devotion to a zero interest rate policy, stop and ponder for a moment the injustice to the saver. Think on the co-operative spirit of society and ask why these Central Banks consider it fair, moral and just to strip savers of their income in their quest for self preservation. When you hear the phrase, “interest rates will remain at zero for longer” question the imposition of hardship on the saver for longer. Contemplate the weight of the burden on a small and responsible portion of society and the economic consequences of such self serving behaviour by Central Bankers with the support of Central Government.

In your heart, if you have a heart, you will know that robbing the saver is not moral. You will realise that the indiscriminate redistribution of income rights from the responsible and the cautious to over burdened borrowers, speculators, government and risk seeking banks serve not the short or long term interests of economic society. Most of all do not rationalise this mean policy and indiscriminately cruel tax into a benign and caring action by Central Banks.

Look no further than the escalation in Total Public Debt and compare it to the Federal Interest Outlays to see but a portion of the sacrifice extracted from savers. See how the debt expanded exponentially but the cost of funding the debt dropped dramatically. Interest tax need not be calculated or declared because the tax has already been calculated, declared and transferred to government through the application of the zero interest rate policy of the Fed.







Sarel Oberholster
BCom (Cum Laude), CAIB (SA)
3 November 2009


© Sarel Oberholster



Please email me at ccpt@iafrica.com with any comments. More links and essays can be found on my blog at http://sareloberholster.blogspot.com/ .

Ground Zero

I’ve had many mentors during my career who shared with me their wisdom. One friend told me, Sarel there are two business rules that you must comprehend and apply. The five finger rule and the two finger rule. Showing his right hand and counting from the thumb he said: “The five finger rule is, What’s-In-It-For-Me?” The two finger rule he said is, “Buy low, Sell high.” Silly rules easily made off as platitudes yet they sneak up upon you when you analyze your investment and economic environment.

So we ask of the stock exchange; is it time to buy or time to sell? Buy low and sell high. Perhaps we look at residential property and ask if it is time to buy or sell. Buy low and sell high. What about commercial and industrial property? Buy low and sell high. How about government bonds? Buy low and sell high.

These questions are asked within a relative frame of reference but when we ask the bond question it is when we hit ground zero. The “risk free” short term interest rate is set at zero. Zero is as low as it gets, it simply cannot go lower. Zero interest rates plus a risk premium for term funding and one has the bond rate. Bonds are an inverse investment, thus a zero short interest rate is the highest price base possible for bonds. Bonds are as expensive as they can get. That is ground zero for bonds and it originates from a zero interest rate policy

The zero interest rate policy is at the epicentre of the economic distortion. It sends shock waves via investment channels to distort the investment landscape into a twisted and contorted vision of what aught not be. No market can exist without buyers and sellers yet a zero interest rate policy gives zero interest to the saver. The seller of savings is offered nothing, zero and is driven out of the market to be replaced by the central bank providing liquidity. It is an ultimate distortion, one that cannot be corrected unless the central bank withdraws from the position of the saver. That can only be accomplished by increasing interest rates and the economic consequences that follows such structural re-adjustment. It is a ground zero trap.

Having driven the saver out of interest bearing investments is but the start of the process. Where will the saver turn? The three pillars of investment, interest bearing securities, property and shares. Bonds will suffer huge capital losses if interest rates were to move away from zero. So investors must choose between recovery or permanent zero short interest rates. Residential property is a bubble in deflation. Commercial property is a bubble in deflation. Any professional investor in property will know that property is valued on a yield basis and that yield is tied to interest rates. Property has the same inherent pricing structure as bonds; its value is at a maximum when interest rates are at its lowest. Again lower than zero it cannot be.

The first two pillars of investment look decidedly shaky. The saver moves along and plunges into shares but in the search for yield start behaving just as mortgage bankers did taking on the sub prime debt, the no documents - no questions asked investment decisions. Investment funds are channelled into emerging markets on the flimsy argument that these economies can do the heavy lifting to get the global economy on the road to recovery. Exactly how that is supposed to take place is shrouded in mystery.

So we stand back and observe how the structural aberration of zero interest rates forces investment funds into classic stock exchange inflations and see the absence of harmony with the real economy. The participants in this asset inflation are well aware of it but hoping for a rescue from a recovery which by definition cannot co-exist with zero interest rates.

Yet even the stock exchanges are unable to contain the push of zero interest rates. Investment funds spill over into commodities and further distort emerging market investment. Exchange rates between weak economies and strong economies express as strong currencies for minions and weak currencies for giants. We note leading indicators measuring the stock exchange exuberance and the results of relentless “green shoots”, “better than expected” and “stimulations” propaganda to mislead investors further into risky assets. Emerging markets pile on debt and stock exchange investments in “strong currencies” which their populations can never hope to repay. Debt, which is uncovered for exchange rate risk since the currencies are appreciating. Debt, when it is called will drop their currencies faster than the mercury in a tropical storm. These emerging markets will default as they must just as weak unsuitable debtors had to default on their mortgage loans. The only difference is the bubble in residential property and the bubble in emerging market currencies. “House prices never fall” is a much stronger hope to cling to as opposed to “emerging currencies will keep rising”. Pushing giant economies’ stimulation liquidity into emerging markets is no panacea for the global economic woes, nor will it restore any of the structural deficiencies of abused monetary and fiscal policies. A weak currency policy of giant economies is the script for sovereign defaults. Special Drawing Rights from the IMF cannot prevent sovereign defaults. It will only deepen the debt trap when the illusion of bubble currencies is exposed.

Here is where we need to apply the five finger rule? What’s in it for the emerging markets (or what was in it for the sub prime borrower)? What’s in it for the investor in emerged markets who looks beyond the yield pick-up (or what was in it for the mortgage and investment bankers who dabbled in sub prime debt and its securities and did not consider the liquidity trap of rising residential property prices)? What’s in it for investors to participate in stock exchange inflations, (or what was in it for those who fell over the cliff)?

The ultimate “what’s in it for me?” question is the one governments will soon be asking about stimulations. What is government looking to get out of stimulations? Government will look at its own pocket and will ask the question, “do we get more tax as a result of our stimulations?” and the answer will be patently clear. Ground zero for fiscal policy will be the realisation that stimulations are not a miracle economic cure and as with zero interest rates, a fiscal choice will be made for permanent structural distortion or a new beginning. Japan chose the former on monetary and fiscal policy. Will all leading economies follow the example of Japan into a twenty year economic wilderness?


Sarel Oberholster
BCom (Cum Laude), CAIB (SA)
25 October 2009


© Sarel Oberholster



Please email me at ccpt@iafrica.com with any comments. More links and essays can be found on my blog at http://sareloberholster.blogspot.com/ .

For the Brave - US Government Spending 1933 - 2019

(Click on Chart for an enlarged view.)

The Taxman’s at the Door

Tax is about to hit you like a bare fisted punch in the eye. You will be stripped of all your income, assets and savings as government drowns in deficits and debt. Is this the way it will turn out? Not likely. Certainly, government is drowning in deficits and debt but the taxation will arrive wrapped in the silky touch of the best propaganda machinery ever devised by masterful spin doctors. Your unprotected wealth, income and savings will more likely be dragged naked over a coral reef to die a slow death by a million tiny cuts. Then, when you look upon the dry corpse of your once liquid wealth consider this; all stimulations must be paid for in tax!

Here is the need. Would you dare to extrapolate this chart into the future?





How much taxation will it take to turn this chart down?

The tax will arrive in direct taxes for those who cannot revolt. To the others it will arrive in the form of indirect taxes disguised as anything but tax.

The official Corporate and Individual tax data to the end of 2007 look like this.





A bursting tax bubble has thrashed 50% off the previous $400billion corporate income tax take. Who talks their book when they say we have a recovery under way (see also charts further down)? Don’t you just love a bubble economy and the 1, 2, 3, 4 tax spikes? This is the business of maximizing tax income for government. Now visualize in your mind the spike that will be required to replace the direct and indirect tax collections from the 2003-2007 bubble episode.





FED data ends on 01/01/2008 and Personal Income Tax Receipts were still peaking. Growing unemployment is going to play havoc with this number.





Again the 1, 2, 3, 4 tax spikes. For a more up to date macro assessment complete with projections into a murky future we turn to data from the White House Office of Management and Budget.

The question may be asked; how often do we see significant declines in tax receipts? Rarely.





The events of 1929 are clearly relevant given that it was the only other previous incidence in more than a hundred years, apart from the year post WW2 which saw a significant drop in tax income. The data from the White House covers this period in detail.

The 1929 crash and its aftermath share another very important characteristic with the 2007 crash and its aftermath, a significant debt bubble. So how does the fiscal experiences of the depression compare with the modern experience of a debt bubble?





The tax collected by government saw a dramatic decline of 52.6% in the aftermath of the 1929 crash, while government spending was certainly in stimulation mode. Notably, taxation accelerated in spectacular fashion by 251% from $1,9bil in 1932 to $6.4bil in 1938. Growth during this period remained anaemic. In fact, the GDP growth fell dramatically from 1930 to 1933 and even by 1940 had not yet regained the GDP level of 1930 in spite of government stimulations in the 1930’s greater than anything implemented fiscally since 2007. Monetary policy was the dominant choice since 2007 but I have written often on monetary policy, here the focus is on fiscal policy. Observe that a weak economy is no protection against increased taxation.





The modern debt bubble has been under construction from 1980 until it popped in 2007. The chart hereunder picks up the story in 1990.





So much for counter cyclical fiscal behavior when tax receipts fell short of government spending in each of the boom years of 2003 to 2007. Tax collections though down, still held up in 2008 but took a 17.8% tumble into 2009. Again we note the discrepancy between tax collection and all the talk of recovery together with the exceptional performance of stock exchanges. The 2009 estimates have been presented on the 25th of August 2009 and should be close to the expected actual number. Expectations of a rise in tax collections in 2010 may be premature. The experience in 1929 where tax receipts not only dropped by more than 50% but also did not recover to the 1930 level until six years later in 1936 may indicate potential for a less favorable outcome than the current expectation and estimates.

The subset of Income Tax data yields further interesting data.

The official estimates of Income Tax collections are optimistic, particularly regarding individual taxes which are expected to exceed the 2007/08 levels by 2012. No tax recipes are expected to fall below 2009 levels and income tax collections will start rising as early as 2010 according to current estimates. I expect the tendency of downward revisions in actual tax receipts so prevalent in the Mid-Session Review of the Budget released in August 2009, to be with us for at least thru 2010.





Be sure to note the dramatic shift towards relying on personal income taxes in the modern USA budget. What will be the origin of the tax growth when the best case scenario is a “jobless” recovery and unemployment has yet to level out? Also, for a better perspective on a trillion dollar stimulation consider carefully how it equates to the total per annum Income Tax collected from individuals as averaged between 2005 and 2009. It is of particular interest to see that estimates of Corporate Income Taxes are for a fast recovery to 2007 levels and then to remain static until 2019. I find this projection a combination of opportunism and pessimism, even contrived when one observe the relentless growth projected for Individual Income Taxes against the static projection for Corporate Income Taxes. When the politicians say “Read my lips - no increased taxes”. Don’t. Rather read the charts.

Now for a look at Income Taxes during the period 1934 to 1938.





The burden was shared equally between Individual and Corporate Income Taxes during this period of economic history. The real story remains the dramatic increase in tax collected in the shadow of fiscal deficits and stimulations. Taxes in both categories increased more than 3 fold over this period. It is no coincidence that the Emergency Banking Relief Act of 1933 was passed in March 1933 confiscating Gold holdings to boost the coffers of the state. The need was great and gold confiscation was a tax against “hoarding”, popular with all non gold owning voters.

Stimulation remorse will be of no help. What’s done is done. The tax bill is in the post. TAX is what pays back government debt, a bit of inflation just hides the method and hyperinflation pays nobody. Hyperinflation simply destroys the economy and the currency. Hyperinflation means a lot of pain but no net real gain for anybody, including government. Thus do not look upon hyperinflation as an escape route from the inevitable reality of taxation unless you are prepared to pay the ultimate economic price.

The USA has its international debt in US$’s, while most other countries’ international debt is denominated in a currency other than its own. Any depreciation of the US$ against other currencies will depreciate the international debt of the USA but at a huge cost to imported inflation. It is taxation from behind that most precious and coveted international comparative advantage, the reserve and trade currency of the world. Having the reserve currency of the world allows one the use of money creation to sneak taxation across international borders, yet it is but one of many advantages. Only the most desperate politician would cash in this chip for a short term stealth tax gain. When they do, they may prompt the Chinese and all other funding nations to ask the question; “whose tax base is it anyway?”

Stimulations from central government in whatever form they may take are “fly-now-pay-later” schemes. Japan tried the stimulation-and-recovery trick recently and it failed. In 2009 everybody is pinning their hopes on a global stimulation-and-recovery trick to work. Children marvel at magic tricks but they do not actually believe in them. Intelligent adults seem to have bet their entire economic futures and their children’s economic fortunes on the trick of stimulation and recovery. A spontaneous economic recovery may rescue the global economy. In the ensuing boom Government can collect the required tax shortfalls without a taxpayer backlash. That is the wistful thinking. Cause and effect says it is more likely that the excessive abuse of debt may force a realignment of economic structural distortions. No recovery but, as with the housing bubble and like a bad hangover, the government debt will remain after the stimulation bubbly has been consumed.

The bullish thesis is entirely reliant upon the “stimulation-and-recovery” trick. The fear that shows the white of their eyes at any talk about withdrawing “stimulation” is sufficient to expose the anchor of the bullish thesis. The bears fear “stimulation” equally but not for it’s so called potential to heal the economy, rather for its potential to cause bear rallies. Thus the bulls love stimulations for it allows speculative trading with the support and blessing of government while slaughtering the bears. It may be a tragic drama or an exiting adrenalin rush depending on your favourite candidate but in the bigger picture it is the cost of the game and who will foot the bill that counts.

Government will kick the tax can down the road until it runs out of credit like every reckless borrower eventually must. The alternative is debt revulsion for public debt but that is a responsible outcome where the opportunism of cashing in on stimulations is more likely to draw the crowds. Again, Japan has set the example running up public debt four fold since 1990 and reaped only a 20 year deflationary slump in return.





Consider the harm to the Japanese taxpaying generation who will have to pay for that gratuitous spending frenzy.

Look upon the projected US Government Spending from 2010 to 2019 (hereunder) and the very first chart in this essay of US Total Public Debt, then contemplate who will pay, when the taxman comes knocking…





Sarel Oberholster
BCom (Cum Laude), CAIB (SA)
28 September 2009


© Sarel Oberholster



Please email me at ccpt@iafrica.com with any comments. More links and essays can be found on my blog at http://sareloberholster.blogspot.com/ .

Dr Copper speaks on the economic recovery

It is said that copper (Cu) has a PhD in economics. The logic is that copper is found in almost every human economic endeavour and it is representative in all economies around the globe. The simplistic approach is that all the pertinent information about copper will be reflected in its price. Bare bones, look at the price action of copper and it will tell you what is happening in the economy.

Well, let’s interview Dr Copper and find its views on the state of the global economy.

First the basics, where are we?




Source: Kitco.com


The five year price action says “V” shape recovery. That is when one does not place too much emphasis on the bubble-like behaviour between 2004 and 2009. The five year volume data brings some uneasiness to the basic price action observation. Stock levels are still high and they are now also rising in a “V” shape. Where is the devil’s ton, that one ton of extra production which tips the price into a downward plunge?

One year price action is, of late more muted. The rising stock levels are seemingly in harmony with a lateral movement in the US$ price action since July 2009.

Looking only at copper in US$ terms does not represent a global picture. How does Dr Copper express itself in the major economies and some regional economies? It would also be useful to have a global benchmark which will be representative of currencies and commodities. Gold is the natural choice.


GOLD



Copper is expressed in ounces of gold in the same way as the copper price can be expressed in any currency. The price action of copper expressed in gold shows a peak and decline as opposed to the lateral price movement in US$.

Price action is what we are interested in and having established a gold benchmark we can now observe the relative currency performance against the benchmark.


US$




Short term flat and in step with benchmark but copper is becoming more expensive in US$ than in gold of late.


Euro (EU)




Short term flat and the Euro price trend for copper relative to the benchmark is about the same.


Japanese Yen




Short term trending down in Yen but copper relative to the benchmark is becoming more expensive in Yen.


UK Pound Sterling




Short term trending down and copper is becoming more expensive relative to gold in terms of Sterling.


Chinese Yuan




A short term rising copper price in Yuan and only very recently becoming more expensive relative to the benchmark.


Brazilian Real




A short term falling copper price in Reals and more expensive relative to the benchmark.


Indian Rupee




The Indian Rupee copper price has hugged the gold copper price like a lovesick teenager for most of this period. The short trend for the copper price in Rupees is flat and to trend more expensive relative to the benchmark.


Australian $




The short term copper price trend in Aus$’s is down. Price action against the benchmark is in lockstep.


South African Rand (ZAR)




Similar to the Aus$. Short trend copper rand is down.


Polish Zloty




The copper price in Zloty’s is trending flat and is becoming more expensive relative to the benchmark.

Dr Copper is somewhat stingy with its price action information on the economy and the current trends are anything but robust. The copper price was up strong in some currencies, not so strong in others. Now the copper price is trending flat to down in most cases. The results can be summarised in a table.





Chinese stockpiling is probably behind the price trend in the Yuan price of copper. The rest is giving a weak down signal at this stage. Only the two gold producers and the EU managed to hold their own against the gold price of copper.

The tentative results can be supplemented by looking at the relative price change in the various currencies since the beginning of the year. How did these currencies perform relative to copper?





The relative performances can be expanded to also measure the standing of the currencies against the gold price of copper. The Euro no longer performs when assessed in absolute terms and the Real is on top with absolute performance. Now if Dr Copper would just tell us whether we should consider the Brazilian economy strong or weak? Ditto on the Indian economy.





Extracting information from Dr Copper by looking at the price action is a tedious process. The “V” shaped recovery as presented in US$ price of copper has more to do with a weaker US$ than with a recovery in the global economy when one compare the performance of copper against gold and particularly commodity producing country currencies. Stockpiling and diversification from currency risk takes another bite from the uptrend in the copper price, neither of which is indicative of an economic recovery. The short term copper price trend gives a weak downward signal in spite of the continued need for store-of-value diversification.

Dr Copper says that we should be weary of proclaiming a “V” shaped recovery and in fact should be careful with any claims to a recovery until we see some more solid evidence. The warning is a bit more pronounced when Dr Copper and gold speak in unison on currencies and the devil’s ton is lurking in rising stockpiles.


Sarel Oberholster
BCom (Cum Laude), CAIB (SA)
23 September 2009


© Sarel Oberholster

(Click on any of the charts for a larger version.)

Please email me at ccpt@iafrica.com with any comments. More links and essays can be found on my blog at http://sareloberholster.blogspot.com/ .