Riding The Economic Cycles

Riding The
                        Economic CyclesThroughout the history of free market economies, there have been boom and bust periods.  To the chagrin of business owners, individuals and governments alike, economies ebb and flow from growth to retraction and then back again.  In some extremes, we also have had periods of above average growth and as well as periods of more pronounced adjustment, or what can be called recessions and even depressions.  But, is this really a bad thing?  Meaning, is it not just a normal and natural process of growth and re-balance we find in nature also?

The key we think is to know that the good times do not last forever but neither do the negative times as well.  Learning how to survive and plan for both takes the angst out of being caught unprepared.  Of course artificial manipulation by central banks can greatly distort this natural process, often resulting in cures that are worse than the disease.  But don't take our word for it.  Former Bank of England Governor Mervyn King has publicly said: More monetary stimulus will not help the world economy return to strong growth. We have had the biggest monetary stimulus that the world must have ever seen, and we still have not solved the problem of weak demand. There are quite serious disequilibrium both between and within economies that, for good economic reasons, are depressing demand. Simply lowering rates even further or adding more monetary stimulus is unlikely to solve that problem (Editor's Note: Why do all these guys suddenly tell the truth AFTER they leave public office?).

Mr. William White, former chief economist to the Bank for International Settlements in Switzerland and current chairman of the OECD's Review Committee said the following (January 2015): We're seeing true currency wars and everybody is doing it, and I have no idea where this is going to end. Sovereign bond yields haven't been so low since the Black Plague: how much more bang can you get for your buck? QE is not going to help at all.  For those people that point to Japan's recent kamikaze QE initiatives, Mr. White says: The Japanese are now doing it as well but nobody can complain because the US started it.  There is a significant risk that this is going to end badly because the Bank of Japan is funding 40 percent of all government spending. This could end in high inflation, perhaps even hyperinflation.  Those who argue that the US and the UK are growing faster than Europe because they carried out QE early are confusing correlation with causality. The Anglo-Saxon pioneers have yet to pay the price. It ain't over until the fat lady sings. There are serious side-effects building up and we don't know what will happen when they try to reverse what they have done. They have created so much debt that they may have turned a good deflation into a bad deflation after all (Editor's Note: What he is trying to say is, if they left it alone and allowed deflation resulting from the natural market correction mechanism to run it's course, which by the way is an expected and normal result of an economy coming off a credit or debt bubble, then things would be quite different in terms of where we are now.  Unfortunately they have distorted the normal correction process via QE, money printing and even more debt issuance that what we now have is something potentially far worse).

Claiming economic victory in the US and UK due to QE programs is premature and is in reality a myth.  While some new jobs may have been created and whileEconomic Stimulus reported unemployment may be down (according to government figures), the truth is that much of this is attributed to lower wage jobs, whereas the former unemployed may now have work, it involves a lower income type of employment.  This in part contributes to the phenomena that government income tax receipts are NOT really recovering even though they are claiming economic victory.  In the US of course, while stated unemployment is reported to be down, enrollment in Social Security disability is up by 12 percent over the last 8 years, so a reduction in the number of unemployed reported by the government in the US (12 percent unemployment down to the more recently reported 6 percent) is offset by the increase in persons on the social security disability rolls.  In other words, where did the 6 percent reduction in US unemployment come from?  The answer is it was shifted over in part to Social Security disability, which is the new long term unemployment insurance. Mr. Jim Clifton, Chairman and CEO of Gallup, writes in a February 3, 2015 editorial that the US government reported 5.6 unemployment figure is a Big Lie. You can read his comments via the link below:


Seventy percent of new social security disability participants are aged 50 or above (too young to collect retirement benefits, but maybe too old to take on the physically demanding minimum wage jobs that might be out there).  And it has been tabulated that 5 percent of the US population, or roughly 11 Million people are on the social security disability payroll, which is reportedly about the same number of people employed in the manufacturing sector in the entire country.  What has made all this possible are the changes in 1989 that now include mental illness, depression, anxiety and back pain as qualifiers.  In fact, in a few US states, roughly half of all recent applications have been for so-called mental disorders, such as depression.  Now, to be very clear, we are not trying to be heartless and criticize someone that may have signed up.  After all, it is not easy for a 50 year old factory or warehouse supervisor to get a new job with the same pay he might have had before.  Not only that, while such a person was working, they certainly paid taxes into these programs their entire previous employed lives, so insurance is only valuable if the proverbial insurance company (in this case the government) maybe pays off when you really need it.  However, we see this as a very permanent trend.  There is a study that found ten years after starting on disability benefits, less than 4% of recipients had returned to work, so we would say those new enrollments on the social security disability program will stay there until they reach retirement age, and then maybe flip over to the so-called old age insurance part of social security.  But, the point is, the reported US Government figures and the journalists that act as shills for the government are not exactly peddling the truth when it comes to reporting what is really going on with the economy (and one cannot make prudent business or personal economic decisions when the information is a fairy tale).

We touch upon these various but related topics because there has been quite a bit of conversation in the media and among so-called learned economic academics regarding unbalances in the economy plus wealth distribution and a specific call for even more government (read artificial) intervention.  Apart from the prospects of central bank policy involving more so-called stimulus (QE, electronic money printing, bond purchases) and continued (and artificial) interest rates of zero percent, we also have the esteemed politicians harping about increasing various forms of taxation.  Specifically the so-called rich are the target, but what is the definition of rich?  Someone who earns the equivalent of US$50,000? US$100,000? US$1 Million?  If anyone thinks a household earning US$100,000 is rich they are not living in the real world.  Try to pay a mortgage and send a child to college (without burdening the child with student loans for the rest of his or her life) on that kind of income (or more correctly what remains after taxes) – it is not going to happen.

According to the Institute on Taxation and Economic Policy, a report and collection of data from April 2014 concludes the following:  The richest one percent of Americans pay 23.7 percent of total taxes and receive 21.6 percent of total income.  The poorest one-fifth of Americans pay 2.1 percent of total taxes and receive 3.3 percent of total income.  Each income group will pay a total share of taxes that quite is similar to each group’s total share of income.  Contrary to popular belief, when all taxes are considered, the rich do not pay a disproportionately high share of taxes, but they are not under taxed either as is so often claimed.  However, all this does not stop the rhetoric regarding unfair wealth disparity, a segment of the population supposedly not paying their fair share, and so on. 

A January 28, 2015 article from CNN titled: IRS to tax cheats: Stop hiding your money offshore, claims that: The IRS has been cracking down on tax cheats trying to hide money in offshore accounts.  And they highlight the 2009 voluntary amnesty disclosure program as having produced 50,000 people that have reported their offshore accounts, and have supposedly paid US$7 Billion Dollars in back taxes and penalties. And the IRS has re-established this program again in 2012 which supposedly is still in effect.  But interestingly enough, the article also claims that: One of the reasons Americans have one of the highest tax compliance rates in the world is because of this kind of third-party reporting.  Let us repeat that again but worded another way.  The only effective compliance is gained by a non government entity reporting (your banker, your broker, your accountant, and so on).  And so, the pressure is placed on such individuals and institutions to rat you out, to put it bluntly. 


Ironically enough, a number of so-called economic tax breaks given to US corporations is estimated to cost the US government US$45 Billion Dollars in lost tax revenue over the next 10 years.  So, the Internal Revenue Service claims victory in convincing 50,000 individual citizens to pony up US$7 Billion voluntarily while the legislators turn around and give out US$45 Billion in tax breaks to US juridical entities (corporations).  Two noted tax loopholes open to US corporations, that are NOT open to individual US citizens are the CFC Look-Through Rule, which allows corporations to shift or re-domicile income to make it look like (and benefit from) it came from a low or no tax jurisdiction.  Re-invoicing is one term used to describe this practice and it is perfectly legal. The real question is: why is it perfectly legal for a corporation but not for you as an individual citizen?  The law or tax regulations should apply equally to all, or none at all.  The current United States President made a proposal in his very recent state of the union speech to eliminate such tax benefits, but it yet to be seen how this plays out.

The second prominent tax loop hole is the Active Financing Exception.  This regulation, loop hole (or whatever you want to call it) basically allows for passive income (patent royalties, interest, dividends, etc.) to appear as if it were also generated abroad and thus non-taxable until it is brought back to the US (which is never going to happen as long as it has the chance to remain non-taxable abroad).  Again, individual US citizens with non US based bank accounts, brokerage accounts and other investment or passive income generating vehicles are required to report and be taxed on such gains or income and yet corporations are given a free pass.

Nathan Proctor, a director of the Fair Share organization, opines: I don't understand why Congress would want to reinstate loopholes that reward companies for hiding profits offshore and cost us billions annually as part of the tax extenders package.  And let us not forget the illustrious Obama Care tax, which will penalize individuals 1 percent of their entire household income if you do not have any kind of so-called qualified health care coverage.  As an example, a working couple with a combined income of US$100,000 will have to pay a US$1,000 penalty on top of any other income tax owed simply because they do not have a health care policy the US government likes. 

What Can You Still Do To Mitigate US Income Taxes?

Well for starters, try and get a job outside of the US.  US citizens living and working outside of the US (with salaried income) can still benefit from the the Overseas Income Exclusion allowing them to exempt up to US$99,200 (for 2014) for US Federal Income Tax purposes (however you still need to pay the FICA or Social Security tax payment portion).

For some additional ideas, Mr. Todd Ganos offers some interesting information for US citizens about various forms of juridical entities known as Trusts.  One particular article is referenced here:


And in the United States of Hypocrisy, there is always Puerto Rico.  Puerto Rico you might ask?  Yes, Puerto Rico.  While the US has spent considerable time and effort chasing and chastising tax havens around the world in general, it seems what applies to the rest of the world does not apply on US soil (or for US territories as it were).  To explain further, we have the Export Services Act, which allows service business and most notably investment funds, hedge funds and the like to benefit from a flat 4 percent corporate income tax in Puerto Rico (Puerto Rican companies and individuals do NOT pay US Federal Government Income Tax) and dividends paid out from such companies are 100% tax exempt to individual recipients (this is not an error, you read correctly: 4 PERCENT and 100 PERCENT TAX FREE dividends).  This is in stark contrast to President Obama's recent proposal (from the 2015 state of the union speech) to up the income tax on dividends from 20 to 28 percent for all the main landers, so deduce from that what you may.

In addition we have the Individual Investors Act which grants COMPLETE tax exemption on interest, capital gains and dividends for individuals providing the person lives in Puerto Rico for a minimum of 183 days per year.  However, Puerto Rican Government finances are at best Third world with over US$70 Billion worth of junk bond quality bonds outstanding, a debt to GDP ratio over 100 percent, a 14 percent unemployment rate and US$40 Billion in unfunded pension liabilities. And almost 40 percent of the island's residents are receiving food stamps or some other welfare benefit, costing the US mainland taxpayers US$2 Billion (as of 2012 figures).  Overall, US mainland taxpayers send an estimated US$20 Billion Dollars worth of aid related funds to Puerto Rico, earning it the nick name of Welfare Island or America's Greece.  Theft is rampant and epidemic, there are more than 1,000 murders per year (on a island with less than 4 million people) and Puerto Rico has the highest electricity rates in the United States.  It is reported that 20 percent of operating costs for a company will be in the form of the electric bill (if they don't get you on the tax bill, the electric bill will be, pardon the pun, shocking).

The license plate of Puerto Rico claims it is the charming island (but one of the dictionary definitions of that word is bewitched, as in hexed, so choose the definition from Mr. Webster that you prefer best).  With all that said, you can save on US Federal Income Taxes if you move yourself or your company to that charming island, just remember to use the tax savings to put pick proof locks on your doors.  Oh, and what is the difference between a Tax Haven engaging in Unfair Competition (read low or no taxes), and a jurisdiction enacting favorable fiscal laws or policies to attract solvent individuals and corporations to come and reside in order to bolster the local economy?  The answer dear friends is that one is located outside of the US, and the other one is not.  It's all semantics after all. 


Another trend that came to attention recently comes from Mr. Robert Johnson, a former hedge fund manager at the Soros Fund Management group, offering comments at the recent World Economic Forum Meeting held in Davos, Switzerland.  Mr. Johnson goes on to say that: I know hedge fund managers all over the world who are buying airstrips and farms in places like New Zealand because they think they need a getaway. We would ask the question why?  This annual meeting of 2,500 plus of the world's best and brightest (and wealthiest) people in Davos is not exactly a David Icke seminar. Rather, this is a collection of the world's political leaders, captains of industry and otherwise said a group of people that have their fingers on the pulse of world trade, commerce, currencies, politics and central banking.  A meeting of the economic and political elite, to explain it more simply.  And so why do these folks think things are so bad, or will become so bad that they need to do the wealthy equivalent of prepping?

Regardless of the answer, we do think such comments are an interesting insight into what world leaders see and think about what many are themselves directly responsible for when we consider all the initiatives taken in recent years to save the day, economically speaking (how do THEY think it is going?).  Of course the good news is that you do not need to run a hedge fund or be related to a political icon to obtain some kind of safe haven escape plan.  Remember not to place all your faith in one bank or financial institution, one country, one currency or any one asset class.  And that includes possibly obtaining another citizenship and passport (just in case being a citizen of the former falls out of favor for one reason or another).


Is It Inflation or Deflation ?

Inflation or Deflation?In terms of the current economic scenario, we are told to beware of DEFLATION in the US and Europe and INFLATION in the emerging or developing markets.  Indeed the latest victim of deflation appears to be Germany (land of hard working descendants of the Teutons and home to some of the most fiscally conservative people in Europe).  And we have to wonder: if fiscally conservative Germany is experiencing deflation, then what does that forebode for the southern sisters (Spain, Italy, Greece)?  In terms of the inflation comment, many developing market nations have been complaining previously that all of this QE business in the US and Europe has basically been causing or exporting inflation to these other smaller emerging markets.  Increases in food costs of course have pretty much effected everyone world wide over the past few years so certainly we can see cost of living issues for many consumers regardless of where they reside.  And with the recent drop on petroleum, it will be interesting to see if that has any impact on CPI figures going forward.  However, generally speaking, many clients are concerned about where and how to invest with all this mayhem going on.  Do you invest defensively for deflation?  Do you invest defensively for inflation? What's the economic play-book in this kind of environment?

With regards to deflation, we have stated awhile back that is was our belief (and it still is) that central banks (and government policy in general) in the developed work will engage in money printing (electronically at least) and any other inflationary tactics that they can.  Why? Simply because they are drowning in debt and deflation is the bogey man for debtors (and conversely is the friend of anyone with solid balance sheets and conservative economic practices). Throughout history currency debasement or devaluation (inflation) has been the politician's favorite choice as a means to address excessive debt and we have no reason to think things are any different today.  Of course many talking heads from the world's central banks engaging in this kind of activity state they can stop it any time and are confident they will know how to tweak policy for a happy ending (these are the same people that said there was no real estate bubble either, and or it was difficult to spot an asset bubble regardless).  And instead of targeting ZERO inflation, they now claim that 2 percent or 3 percent inflation is satisfactory. It all sounds nice in theory, but inflationary economic policies are like trying to herd a bunch of cats after they have been just released into the woods.  You never know where they will go, never mind trying to catch them all again.

Mr. James Quinn wrote an recent article (January 16, 2015) looking at inflation, deflation, central bank policy and more acutely at housing in the US.  He particularly makes a comment about Wells Fargo Bank, which he points to as the largest mortgage lender in the US, whereby he says: In the midst of a supposed housing recovery, with mortgage rates at historic lows, the largest mortgage originator in the world, saw their mortgage originations FALL by 12% over last year. They are down 65% from two years ago. JP Morgan and Citigroup also saw their mortgage businesses contracting. These banks have been firing thousands of people in their mortgage divisions.


Dominican Republic Real Estate As One Hedge

Speaking of housing and real estate, many of our clients have continued to have an interest in buying real estate in the Dominican Republic, and in many cases using that a conduit for investor related residency (and resulting citizenship as well).  Dominican Republic Farmland and rural properties also are of interest as a non-reportable asset or investment, plus as an inflation hedge as well.  In terms of what your money can buy in Santo Domingo: US$185,000 will get you a brand new 2 bedroom condo in a building with 2 off street reserved parking spaces, a swimming pool for building tenants, a gym, marble floors throughout the apartment and few other amenities.  Another offer of US$225,000 for a brand new condo includes a 2,000 square foot 3 bedroom (each with own bathroom) unit that also comes with swimming pool, gym, children's play area and a meeting room with BBQ area for events.  For something more economical another builder is offering a 1,000 square foot 2 bedroom condo for US$110,000 in a middle class area of Santo Domingo (new building, new construction).  If a single family dwelling is more what you are looking for, a builder in Santo Domingo has a new gated residential project of 2 story semi attached homes from 3,000 to 4,600 square feet. Three bedrooms, home office, marble floors, jacuzzi, central vacuum, backyard patio, and backup generator for the project are some of the amenities and prices start at US$390,000. Truth be told you can find a brand new condo in what can be considered the suburbs of Santo Domingo starting at US$50,000 and you can go up to perhaps US$500,000 or more for a very large high end penthouse (and everything in between).

Getting back to our defensive investing theme, it really all depends upon whom you wish to believe and as a result where you might want to safeguard your savings.  If you believe that the world economy (and the US, EU specifically) is heading for a deflationary environment, then you want to make sure you have no debt, keep plenty of cash or cash equivalents, and are poised to take advantage of falling asset prices.  On the other hand, if inflation is what you are concerned about (and we would tend to suggest the emerging or developing markets are more likely to continue experiencing some degree of economic expansion, albeit perhaps a lower rates than seen over the recent 10 years) then you need to be in inflation hedged assets or investments.  Gold of course comes to mind, as does other hard assets such as real estate and even commodities.  Regardless of the direction economies or markets take over the next decade, we would tend to suggest beware of higher income taxes and other kinds of taxes.  They have built up one heck of a debt bubble and if they do not inflate it away, they certainly are going to be picking a whole lot of pockets to try and pay it off (if they can).