Half Empty or Half Full?

Optimist or Pessimist ?

“For myself I am an optimist - it does not seem to be much use being anything else. The pessimist sees difficulty in every opportunity. The optimist sees the opportunity in every difficulty."

Winston Churchill.

Most of the time, I share Churchill's sentiments, but tempered with a lot of apprehension about the huge amounts of money the government and the Federal Reserve have created out of thin air.

Do you recall a book called "Bankruptcy 1995" written by Harry Figgie and Gerald Swanson in 1992? I found it to be highly persuasive and wrote an article about different ways to cope with hyper-inflation. After it was published, Mark Skousen (an economics PhD, a friend and former co-worker) wrote to me and made the point that the 1995 hyper-inflation pinnacle predicted by Figgie and Swanson was pre-mature. He pointed out that the government has enormous powers and tools to "stretch the rubber band." Of course that was about 16 years ago and we have experienced a huge increase in money creation (inflation) since then with a lot more that will be coming in the foreseeable future. I read Mark's newsletter (Forecasts and Strategies) regularly and he is not predicting imminent doom and gloom but he is cautioning about monetary expansion which leads to inflation.

Instead of having to choose between being a pure optimist or a pure pessimist, a better choice is to plan for the best possible future but hedge your bets with some asset protection and risk management strategies. Having some assets offshore in a foreign LLC or a foreign trust would be worth considering along with some diversification out of the U.S. dollar plus investments in hard assets that are likely to keep pace with inflation. And having a portable business that can function from anywhere in the world would be another valuable hedge against severe inflation in the U.S.

Vern

Trickle Down or Trickle Up?

Keynes and his followers -- which includes nearly everyone on the left of the political spectrum -- claim that supply-side economics is a fallacy. They derisively refer to supply-side economics as "trickle down".

The logical implication is that there must be some sort of "trickle up"system of generating economic activity and prosperity.

But that raises the proverbial "chicken or egg" paradox. What causes income to trickle up? The Liberal's answer is that the government stimulates a depressed economy by borrowing or creating money and spending it. The money then filters through the economy creating jobs and prosperity. Pardon me, but isn't that the same process as providing private investment that then filters through the economy creating jobs and prosperity? Except for the source of the money, both methods involve putting money into the top of the spigot and then it uses economic gravity to give people money to spend and to thereby create jobs.

But when the government borrows money, it is paid back by taxpayers in the form of taxes. The actual repayment can be delayed almost forever, but in the meantime, taxes are being used to pay interest to the lenders. If the government creates new money by selling its debt to the Federal Reserve, that results in new money in the system and eventually causes inflation. Inflation causes a loss of purchasing power which has the eventual result of confiscating part of the value of any assets. Either way, if the government stimulates economic activity by spending more money, it will have a bad outcome in the future.

So what happens in the supply-side process?

In this theory, there are people who don't spend all of their available income. Like the Chinese, they save as much as possible. Then, in order to secure some income from their savings, they invest their savings in stocks, mutual funds or other investments. Most of that money is used by businesses to buy equipment, land and buildings that are necessary to produce some kind of product or service. That investment results in income for those who help to build the productive assets. Part of the money is also used to hire and train employees to produce the goods or services in the factories.

The money that investors provide to build factories and equipment results in relatively permanent jobs, which leads to an expansion of other businesses that serve the needs of the employees of the factories. And the money that is provided by investors is used by businesses to earn a profit. Businesses that are unable to use the money they get from investors to provide an attractive return to the investors will soon be unable to secure more funds. The businesses that do the best job of earning a profit for the investors will find it easier to secure more funds to expand their business and create more jobs.

Of course, the Liberals argue that the money spent by government also creates jobs. And some of them even claim that the government is "investing" borrowed money (or future inflation) to create jobs. But the government's concept of investing is far removed from the practical approach of the market place. An investment is something that has value as long as it is producing some income or growth in value. Few government projects provide an economic return or can be recovered by selling the alleged investment to someone else. Most government projects are politically motivated to divert money to the supporters of the politicians and to voter blocks that help the politicians stay in office. And when those projects fail to produce the results that were promised by the politicians, they inevitably are expanded and given more money. In a business, a project that doesn't work is closed up.

The free market is a hard task master, but it produces long term results.

Government stimulus is like another drink to an alcoholic or a fix for a junkie. It fees good for a short time but has no enduring benefit.

Vern Jacobs

http://www.vernonjacobs.com

http://www.offshorepress.com

Regulatory Chaos

Many, many years ago, it was standard practice for the legislature to hold hearings and invite comments on proposed legislation for many months or even years before putting a bill into the legislative hopper. The IRS used to draft proposed regulations and they would hold hearings for years before adopting the regulations. Major changes in the law often took up to ten years of hearings.

Today, the government rushes to pass complex new laws written by their staff and rarely read by any of the legislators. The president is pushing hard to pass his massive 1,000+ page health care proposal that no one has had time to read. Behind the scenes he is also pushing a massive new tax scheme called "Cap and Trade" to allegedly curtail pollution. To add to the nearly comic confusion, the President and some legislative supporters are trying to make fundamental changes in our very complex international tax system without serious consideration of the economic consequences.

Meanwhile, the IRS issues regulations dealing with complex financial matters and then responds to complaints after the fact. Early this year, the IRS issued what they apparently thought was a clear and simple expansion of the instructions to the Foreign Bank Account Reporting Form along with an expansion of the size of the form itself. Questions began to arise within a few months and increased up to the filing date of June 30th. Due to many complaints, the IRS extended the penalty free filing date to September 23rd for those who have reported all foreign source income, but the questions continued to roll in. The IRS was rushing to issue further clarification up to the filing date for the form.

And as of Dec. 26, 2009 the Congress has postponed extension of a variety of expiring tax provisions -- as well as failing to act before the estate tax rate changes to zero in 2010. While I'm personally in favor of total repeal of the federal estate tax, it would be generous to call that wishful thinking in the present political and economic environment. It can't be repealed, but it will cause a great deal of needless problems because of allowing the rate to fall to zero for even a few days in 2010.

And it seems that the IRS is only one of dozens of agencies that are subject to the ineptitude of the Congress.

Vern

The High Cost of Free Health Care

December 22, 2009

With a mere 5 votes out of 435, the House managed to pass their version of a health care bill. The bill (HR 3962) includes the infamous public option which will inevitably drive competing private insurers out of the market if it is included in a final compromise bill. The provision to prohibit the denial of coverage for pre-existing conditions will add to the cost of health care insurance which will lead to higher premiums or will put push many (if not most) health care companies out of the market. In addition, employers with more than a $500,000 annual payroll will have to pay an 8% tax on gross payroll if they do not provide health care to their employees. (At an assumed average payroll of $25,000 per employee, that represents a company with only 20 employees.)

On December 21st, the Senate voted 60 to 39 for cloture to stop further Republican efforts at a filibuster. Getting a few hold-out Democrats to vote for cloture was an example of old fashioned back-room Chicago politics at its worst. CNN said,

"Democrats call it compromise. Republicans call it bribery. But both sides agree that special deals are why the Senate is on track to pass a health care bill by Christmas. It wasn't clear whether Senate Majority Leader Harry Reid had the support needed to move ahead with his chamber's health care bill until Sen. Ben Nelson, the last Democratic holdout, had a change of heart this weekend. He agreed to support the bill in return for compromise language on federal funding for abortion and more money for his home state of Nebraska. As a part of the deal, the federal government will pay 100 percent of Nebraska's tab indefinitely for expanding Medicaid for low-income Americans."

Senate Majority Leader Reid even went so far as to say

".. those who missed out on the perks can blame themselves. I don't know if there is a senator that doesn't have something in this bill that was important to them. And if they don't have something in it important to them, then -- [it] doesn't speak well of them,"

With 60 solid votes in the Senate, final passage in that body is assured. The next step is for a joint committee to convene to work out a compromise between the very different elements of the House bill and the Senate bill. With Democratic control of the committee, it's likely the final bill be closer to the House version and will include the most costly elements of both.

It's a certainty there will be an overwhelming variety of provisions that will raise taxes or an assortment of fees, force insurance companies to raise premiums and cut back on coverage provided by Medicare. As I heard the President confidently state that this bill would reduce the deficit, I thought that this President is either woefully ignorant of basic economics or he is the best liar in recent history.

There is no way in the world that this bill can reduce health care costs, insurance premiums and the Federal deficit. And I'm appalled at the blatant self-serving position of many Senators who voted to move the Senate bill onward toward certain passage. I hate to be a pessimist, but this looks like the beginning of the end of the best health care system in the world. Even worse, it will greatly limit the funds that drug companies are willing to invest in new research because of political restrictions on what the insurance companies will be able to charge for new drugs that cost billions to discover and develop. But the worst outcome of this legislation is not the cost; it's the unavoidable consequence of having to ration health care and of making critical health care decisions by bureaucrats rather than by health care professionals.

Of course, this is just my not so humble opinion.

Vern Jacobs

www.vernonjacobs.com