Capitalism Works

In an effort to get the emotionalism out of the analysis, let us begin with the  seldom if ever analysed or even remembered Kennedy tax cuts and then follow through with other similar tax cut measures. It will show how cuts in capital gains taxes expand both the economy and of equal importance, Government tax revenues.
 
Kennedy declared that ?it is a paradox that tax rates are too high and tax revenues too low?. Simply put, high taxes were depressing the economy. Acting on this belief ? what so many today sneeringly refer to as supply-side economics ? Kennedy cut taxes in 1963 and private sector investment exploded. In the four years preceding the Kennedy Tax cuts, only 27.8 per cent of what is termed investment went to business and 38.5 per cent to real estate. During the four years following the cuts, 58.6 per cent went into business and a mere 11.2 per cent went into real estate. But who gave Kennedy this economic advice? Apart from Ludwig Erhardt, (West Germany?s Minister of Finance at that time), there was the Keynesian Economist, Walter Heller who, heretically (went against all his academic colleagues) in believing that tax cuts (because of the Laws of Supply and Demand) would increase tax receipts.  The upsurge of tax revenues flowing from economic expansion would finance higher levels of local, State, and Federal spending than we could possibly have had without the tax cut?s stimulus.
 
The economic response to the Kennedy tax cuts demonstrated that you cannot have a dynamic economy if venture capital is penalized, entrepreneurial mobility severely restricted, and the rewards of successfully satisfying consumers? needs are heavily taxed.
 
In a contrary example: In 1969, President Nixon raised the capital gains tax from 28 per cent to 49 per cent (sound familiar?) Result: Revenue from the tax collection dropped sharply because realized gains from the sale of stock and capital assets fell by 34 per cent, and capital stock issues of new companies fell from about 500 in 1969 to precisely four in 1975.  High-tech companies in Silicon Valley were hit particularly hard. Yet the Treasury and all of his economic advisers assured President Nixon that the tax increase would raise $1.1 billion in the first year and then $3.2 billion a year until 1975. The results are obvious proof that taxes do affect behaviour. If you think about it, capital gains taxes are a great way to soak the poor.
 
In a third example: In 1978, Congress for once did the sensible thing and once again slashed capital gains taxes.  This resulted in the supply of private venture capital exploding. By the start of 1979, a massive commitment to venture capital funds had taken place, rising from a pathetic $39 million in 1977 to a staggering $570 million at the end of 1978. Tax collections on long-term capital gains, despite the dire predictions of Keynesian, big-spending economists, who are all critics of tax cuts, leapt from $8.5 billion in 1978 to $10.6 billion in 1979, $16.5 billion in 1983 and $23.7 billion in 1985.
 
By 1981, risk venture capital outlays had soared to $1.4 billion and the total amount of venture capital had risen to $5.8 billion. In 1981, the maximum tax rate on long-term capital gains was cut to 20 per cent. This resulted in the venture capital pools surging to $11.5 billion. Astonishingly enough ? to conventional economists that is ? venture capital outlays rose by $1.8 billion in the midst of the 1982 Recession. This was about 400 per cent more than had been invested during the 1970s slump. In 1983, these outlays rose to nearly $3 billion. Compare this situation to the period from 1969 to the 1970s which saw venture capital outlays collapse by about 90 per cent. All because of Nixon?s ill-considered capital gains tax increases. But then Nixon ? unlike so many Liberal politicians and journalists ? never professed to know anything about economics.

In 1982, the US General Accounting Office sampled 72 companies that had been launched with venture capital since the 1978 capital gains tax cut. The results were startling. Starting with $209 million dollars in funds, these companies had paid $350 million in federal taxes, generated $900 million in export income and directly created 135,000 jobs

The actual LOGIC (Economics) behind these results is founded in simple Supply and Demand Economic theory: that if you want more of something then reduce the cost of producing it. In this case, it is not really tax revenues that we want to increase but investment. Investment is fuelled by savings and not government political spending. (Solyendra being a perfect example.) Capital gains taxes strike right at the heart of savings and investment which in turn keep living standards lower than they would otherwise be. From this it becomes plain to see that capital gains taxes are also transaction taxes (without transactions there are no Taxes). Where they are levied on the sale of assets, e.g., shares, they have the effect of reducing the number of transactions because this is an easy way of avoiding paying the tax. Reducing Investments effectiveness
 
A look back in History to 19th century England simply reinforces this analysis.
 
Two very important facts must be considered: a) production happens through time and b) occurs in stages. Now it is important to stress these two facts because the majority of economists adhere to the treatment of capital as being a permanent and self-maintaining fund (Really how does it do that?). They also assume that production and consumption occur simultaneously instead of occurring over time, building upon and interacting with each other. (A product must be produced before it can be consumed)

Let us assume that the government abolishes capital gains taxes. The first effect will be to increase the price margins. The differences between the new price margins and the old ones are capital gains. Now capital gains are profits. When these emerge, it is an indication that factors of production are undervalued in relation to the value of their products. This means that it is now profitable for capitalists to employ more and more factors of production until the capital gains have been competed away, resulting in a   longer and wider capital structure. Obviously the new capital structure is far more productive than the old one. Gross savings ? which by definition includes spending on intermediate goods ? has also increased. So long as this business spending is maintained the capital structure will lengthen, not shorten.
 
In a free market, the amount of gross savings depends on decisions made by Individuals, rich and poor and from all walks of life. There is nothing permanent or automatic about the capital structure or entrepreneurial decision-making. (Friedrich von Hayek Prices and Production, Augustus M. Kelley, 1967 and The Pure Theory of Capital.)  The lengthening and widening of the capital structure is what happened in nineteenth century Britain.
 
For example, general prices peaked in 1872 and then began a long decline, falling from 150 to about 70, a drop of some 53 per cent. Whichever way one looks at this, it was a remarkable achievement. It was a period that saw a steady increase in both money wages and real wages even as the population increased significantly. Of particular interest was government spending which in 1841 was 11 per cent of GDP but only 9 per cent in 1890. However, the halving of prices doubles purchasing power, so in real terms government spending as well as the purchasing power of the people rose significantly during that same period.
 
This brings us to the dangerous fallacy that a stable price level indicates the absence of inflation. For the price level to remain stable, it is argued that monetary expansion must equal the growth in output. In plain English, monetary policy must be manipulated in a way that offsets the beneficial effects of increased productivity. (a hidden tax) robbing the people while increasing the purchasing power of the Government:  Exactly what is happening today

Therefore, as the cut in capital gains taxes stimulates investment and production; monetary policy increases the money value of the increased output. As expenditure increases so does the increase in tax revenues. This is an argument against monetary manipulation and not against cuts in capital gains taxes. Furthermore, the British experience clearly demonstrates that even in the absence of an ?accommodating? monetary policy, the government would still be able to raise its spending in real terms which would compensate for any misperceived reduction in revenue due to the fallacious argument against cutting capital gains taxes.
 
The lengthening and widening of the capital structure is what happened in nineteenth century Britain. General prices peaked in 1872 and then began a long decline, falling from 150 to about 70, a drop of some 53 per cent. Whichever way one looks at it, this was a remarkable achievement. It was a period that saw a steady increase in both money wages and more importantly, real wages even as the population increased significantly. Of particular interest is government spending which in 1841 was 11 per cent of GDP, but only 9 per cent in 1890. However, a halving of prices doubles purchasing power, so in real terms government spending rose significantly during that period.
 
Note: The complexity of the production structure, coupled with the manipulation of the money supply, is far too great for anyone to comprehend. Even in the case of a single product, there could be hundreds if not thousands of stages of production as the following quote from Hayek explains:
 
?What is no less important is that, in the course of the lengthening of the process, the stream of operations leading up to a given product will be split up into many branches and sub-branches. And it may be that, long before the first move is made to produce the actual material from which the product is to be made, work is being taken in hand to provide some auxiliary material or tools which will be needed later to convert the raw material into the final product. At each stage of the process from the raw material to the finished product, the main stream will be joined by tributaries which in some cases may already have run through a much longer course than the main stream itself. But all these activities, many of which may be carried on at the same time at different places, have to be regarded as part of the same process, and have to be taken into account when we talk about its length. The series of operations which are required in order to provide the fuel or lubricant, and the tools or machines which are needed for turning the raw material into the finished products; are just as much part of the process of production of the good as the operations performed on the raw material(s) itself. (The Pure Theory of Capital, The University of Chicago Press, 1975, pp. 174-175)

CAPITALISM IS SYNONOMUS WITH FREEDOM

FREEDOM WORKS: It is what turned a small, island nation into the world?s largest Empire that spanned the globe. It was the desire for freedom that allowed a two-bit farming group of independent states with no standing army, navy or central government to take on this world power with underpaid and often unpaid volunteer soldiers and win their freedom, create a Constitution that guaranteed their people their individual freedom.  In the span of a little over 100 years, they became the world?s first and only Super Power. Not by their superior armies, but by their industrial might developed through their freedom and capitalism that could never have happened without individual freedom and individual responsibility.

LONG LIVE THE USA AND THE FREEDOM UPON WHICH IT WAS BUILT.
INFLATION AND THE MONEY SUPPLY

I have always been amazed at how most everything is looked at as either black or white by most people, especially analysts. Either the economy stinks or it is wonderful. Either economic data portends a MARKET CRASH or it heralds the greatest rally the markets have ever seen. The problem is that neither the world nor markets exist in a world of absolutes. To make it even more complicated, the multitudes of variables are always changing, but the most complicated variable of all is the weightings that apply to each one and they are rarely the same even during what seems to be similar times. Not only do they operate in shades of grey they never, ever go in straight lines. I bring this up because the current earnings season is portending a rather scary forecast, raising doubts, at least for me, that the progress made in stock prices is being decoupled from the underlying profits generated by companies. Yet the stock markets, having already surpassed the 2012 highs, are within spitting distance of surpassing the 2007 all time highs, yet the economy is nowhere near its previous stature.

What nobody seems to be taking into account is that the units (dollars) that we use to measure earnings in the markets and everything else are rapidly shrinking in value. The best example that I can give you is that the REAL WEIGHTED (against Gold) DJII is somewhere like 8000 as opposed to today?s recent high of 13,500.

What is even more troublesome is that in the face of overwhelming government stimulus and an all out effort to push the markets UP into the election, the professional manipulators can only maneuver opening 100 to 150 point rallies and closing only up 5 or 10 points. Yet the markets mediocre performance does not seem to be dampening Wall Street?s enthusiasm because, in typical black-and-white fashion, the return of risk appetite is overwhelming. Any fleeting thought that the market might be getting ahead of itself is immediately dispelled. What is lost in this type of analysis is that this 100% rise over the last 2 years has occurred on record low volume and that troubles me greatly. The trillions of dollars of sideline monies in the face of record optimism are not willing, thus far, to come back to the markets and nor has the public. Why? The truth of the matter may be that the improving economy is not really improving at all and the individuals can feel it. They know that the markets are being juiced by a combination of QE?s and manipulated Government statistics that are completely misrepresenting the true picture. The General Markets, although up every week, tend to give investors the impression that the immediate past will extend far into the future.  But, as anyone with even a modicum of experience can attest, this is not usually the case and we are just NOT BUYING IT.

Estimates for the last quarter of 2012 are so optimistic that we wonder, with at best a projected 1.5% to 2% GDP growth rate, where can all those forecasted earnings possibly come from? Especially given the lowest worker participation rate since 1983, and the high and rising inflation rate - how can the economy produce those projected real earnings and GDP numbers?


THE GROWTH IN THE MONEY SUPPLY

Perhaps a far better explanation for the markets rise is (a) the year-over-year (YOY) rate of growth in the US Money Supply (MS), which was reported to be  about 14% and (b) since December 2011 was the 36th consecutive month in which the YOY rate of MS growth was 10% or more, and (c) if the YOY rate of MS growth remained above 10% for two more months, then it would be the longest period of double-digit money-supply growth in US history. So how can we be in 'danger' of experiencing a serious bout of deflation, given that the US is in the midst of a record-breaking period of monetary inflation? Based on recent preliminary data, the YOY rate of growth in US MS has accelerated to 15.4% over the past month. (Reminds me of 1972 when people bought equities to protect themselves from Inflation.) This leaves no doubt that a new US monetary inflation record will soon be set, which would be a better explanation for the rising stock markets than the nonexistent, booming optimism. After all, we should have known that, since it is exactly what Bernanke has been hinting at (without actually saying so) ? so much for the FED?s promise of a new OPENNESS AND CLARITY. If they are so open, why does everyone argue as to what Bernanke is really saying?
 
The question is: If there has been so much monetary inflation over the past few years, why hasn't there been much more "price inflation"? The answer is obvious: The Government has been jiggling the numbers and outright lying to us for years. The reality is that most prices have been driven by monetary inflation, especially gold, silver, oil and the stock market and commodity prices are now much higher than they would otherwise be. For example: Monetary inflation explains why the S&P 500 Index, despite being 12 years into a valuation-compressing secular Bear Market, is only about 2% below its 2000 all time high in nominal dollar terms. It also explains why copper is priced at around US $3.5/pound and oil is priced at over $100/barrel, despite the economic problems in Europe, China, the US and Japan. It also explains why the soybean market, which for decades had a price floor at US $5-$6 and a price ceiling at US $10-$11, now appears to have a price floor at US $10-$11 (the old ceiling has now become the new floor). The fallacious idea that prices haven't risen by much is based on government manipulated price indices that purport to measure the economy-wide movement in prices. These indices clearly understate the extent to which prices have risen; meaning that the actual amount of "price inflation" reported by the US government is grossly understated.   Did I hear someone say BUY GOLD?

THE TRUTH IS FOUND SOMEWHERE BETWEEN THE LINES
That being said, the response to such a large expansion of the money supply is not a surprise to me, because I am always searching between the lines for the truth. However, one of the dangerous characteristics of monetary inflation is that it is never possible to know, in advance, exactly how it will distort the price system. What we do know is that a large increase in the money supply ALWAYS leads to large price increases somewhere in the economy. The best we can do is to make an educated guess as to which items/investments will be the main beneficiaries of monetary inflation.

The bottom line is that monetary inflation in the US is doing what it always does. It is boosting prices in ways that can't be predicted with complete accuracy by anyone, let alone by Central Bankers and Government Economists employing hopelessly flawed Keynesian theories. Although I accurately predicted the rising commodity prices, especially gold and silver, I have been sadly lacking when it comes to the stock markets. Thank goodness for my policy of always using 10% trailing stops. So in actual practice, we still made some money since I accurately picked most of the short term tops and bottoms, letting our trailing stops lock in some profits while getting us out of harm?s way.

A PEAK INTO THE FUTURE OF EUROPE

CONSEQUENCES:

According to Credit Suisse: ?The probability of The Largest Disorderly Default Loss in History Has Increased Dramatically?. The best overviews of the never-ending Greek soap opera and now Spain (every soap opera eventually ends), although when it comes, the denouement is usually a whimper. In the case of Greece, it will be anything but. Yet listening to the daily cacophony from Europe's leaders and our media, who are clueless as to what is really going on, one may be left with the impression that there is a simple solution to the problem and Greece may be "saved... within hours." It can't. In fact, as of today, "I am left with a sense that the probability of delivering the largest default loss in history within 6 months has increased dramatically.? BUT THEY WILL keep attempting to KICK THE CAN DOWN THE ROAD AT LEAST a few MORE TIMES.

As a reminder, Credit Suisse (CS) was the one bank smart enough to choose to completely ignore day to day news flows out of Greece and soon to be Spain (as it is literally just noise with absolutely no clear signal). Wish we could say the same for our Government, FED, analysts and the media. As such, CS' "View remains that, in any case, the chance of a disorderly outcome sometime in the near future is high, so to that extent the immediate events are not really central to their or our point of view." Quite fascinating indeed, because they show to what extent an un-raveling economic and financial system will go to, to pretend that the number one unfixable problem in Europe is the lack of liquidity and good assets available to be sold, reposed, pledged or otherwise monetized.  The real problem is a bankrupt Socialist system that can no longer borrow enough money to keep the Socialist Party going. NOBODY IS WILLING TO PAY THE PRICE OR ACCEPT ANY CUTBACKS.

As I have observed previously, at this point it doesn't matter for Greece- even if the country gets the second bailout, which will be used almost exclusively to recycle cash into the failing banking system. Europe will have a first lien on nearly 150% of its GDP. At that point, the country is both a de facto and de jure colony of the Troika. The longer the crash is delayed, the fewer assets will remain in Greek possession, and the poorer the population will be in for the inevitable fresh start, within or outside the Euro.

The real issue remains the ECB?s exposure to the BOG. Protecting that (i.e., ensuring that Greece does not systematically default via introducing a new currency) becomes the bottom line, as the latest flash explored. Since my objection to leaving EMU is that its corollary is systematic default, bank nationalization and the like, once the latter problems are a given (a situation towards which we seem to be heading rapidly in Greece), then the cost of the incremental step of introducing a new currency becomes less. The economy would subsequently euro-ize at potentially a lower cost level. The effect of the delay would have been to transfer the cost from Greek citizens (who by now have already moved substantial sums of money and other movable assets out of the country, providing in fact a source of subsequent financing that makes the equation even more attractive) to the ECB. The core has a very serious problem and the probability of a major ?Crash? is rising. I remain very cautious about the long-term sustainability of the debt with or without a restructuring, but even if by some miracle a final solution is agreed to, that will not be the end. It is just the beginning. WHO is next? Italy, Portugal, Spain or Ireland? And what about the rest of Eastern Europe or even France? Do you think that America and the rest of the world are immune? How much confidence will the people still have in Fiat Currency and then what?  BUT the biggest problem of all and one which nobody is even talking about are the 1000?s of trillions of dollars of outstanding DERIVITIVES & CREDIT DEFAULT SWAPS (CDS) that would come due, that no bank has fully accounted for on their books.

THIS IS THE BEST REASON THAT I CAN FIND FOR THE ECB TO FINALLY AGREE TO KICK THE GREECE PROBLEM DOWN THE ROAD ONCE AGAIN.

BACK HOME TO THE USA

THE UNEMPLOYMENT RATE

The entire 2012 presidential election could well hinge on one number: The unemployment rate. My prediction, made sometime in June - July was that the official unemployment rate will dip below 8.0%. That theme has already been launched with the media touting that the employment rate now is the "lowest in years. What Obama and the media won't tell you is that the unemployment numbers have two built-in, huge, fudge factors that are hiding the real unemployment situation.

Firstly, the numbers are "seasonally adjusted," which is why the actual number of employed persons could decrease from month to month and still show a drop in the unemployment rate. Apparently, if you are so discouraged by the NON-Recession that we are in and you quit looking for a job, you are no longer counted. And you effectively cause the unemployment rate (%) to drop. Go figure. 

From January 2005 to January 2009 (during Bush's last term), the "participation rate" changed very little (65.8% to 65.7%). In just three years under Obama, the labor force participation rate has reportedly dropped to 63.7%. This two percentage point drop brings the participation rate to the lowest in nearly three decades and makes all the difference.   If the participation rate had stayed the same, even using the "adjusted" employment numbers, the unemployment rate would have been 11%. If the labor force participation rate dropped 1% to 64.7%, the adjusted unemployment rate would be 9.7%. If we use the non-seasonally adjusted numbers and a static participation rate over the past three years, the unemployment rate looks even worse. Obama can't get re-elected at 11% unemployment or 9.6% unemployment.  He needs that number to be under 8%. So they count a smaller and smaller percentage of the population as actually being in the workforce, in an all out effort to get RE-ELECTED.


GOLD

Warren Buffett has once again re-affirmed his opinion about gold?s ?significant shortcomings.? He said that gold is ?neither of much use nor procreative.? He also suggested that gold was in a bubble and compared it to the internet stock and housing bubbles. ?While the majority of the world?s investors and the public were chasing Real Estate, today less than 2% own any gold.? His thoughts regarding gold are a rehash of similar negative views on gold repeated in recent years. Once again, he shows he does not understand gold and real diversification. He does not or chooses not to understand gold as a safe haven asset in a portfolio or more likely he?s acting as just a ?shill? for the administration. FYI Buffett is considered to be a Capitalist, which he definitely is NOT. Being a Good Investor does not automatically make one a Capitalist. A CRONY CAPITALIST yes, which is an oxymoron. A Crony Capitalist is in reality a Socialist (Fascist), which is the furthest thing away from being a Capitalist since the word Capitalist  is a synonym for FREEDOM and would have nothing to do with a Central Planning Government. The less informed continue to have a blinkered, anti-gold bias. They continue to focus solely on gold?s nominal price and assert that it is in a bubble. It?s not even close to being in a bubble. It is directly related to the FALLING US Dollar.  Although it will end up being in a bubble, but not before 2017 and over $5,000+ /oz. and especially since most gold holdings are NOT on margin. Bubbles are always precluded by record margin buying such as 0% down for real estate.

HOW CAN GOLD BE IN A BUBBLE WHEN LESS THAN 2% of the world?s investible funds are invested in GOLD and none of which is held on Margin?

The uninformed refuse to see gold as a form of financial insurance in a diversified portfolio. This is changing slowly with a very gradual growing appreciation of gold?s importance as a safe haven asset in a world of massive paper and digital Fiat money creation where each country is trying to devalue its currency in order to improve its exports and reduce the carrying costs of its outstanding debt. They are all in a RACE to the bottom. Continued monetary creation seems to be the only game for as far as the eye can see. Even Kramer is now bullish on gold. But notice how few questions he gets on gold, silver or their securities.

GOLD  OUTPERFORMS THE STOCK MARKET
Precious Metals Mining Stocks
Last week, gold and silver broke out decisively suggesting the consolidation pattern holding back the metals is over and a new, HIGHER breakout pattern has started with gold and silver likely headed for new all-time highs. The best way to play this market is through the use of ETF?S GDX and GDXJ.
 
THE BEST AND MOST UNDERVALUED COMPANIES are the ROYALTY COMPANIES: ROYAL GOLD, FRANCO NEVADA, GOLD CORP, SILVER WHEATON

 For those of you who want to swing for the fences, I will try to put together a list of Juniors and Exploration Companies that I think are showing good potential in time for the next letter.
 
ETFs are just paper: But there are two ETFs that are not just paper. In fact, owning units of these ETFs, PHYS (Pyse) SPROT Physical Gold Trust  And ( PSLV) SPROT Physical Silver Trust gives you the right to actually  take delivery of your gold and silver if you own over $100,000.  And although they trade on the NYSE and TSE,  they are Canadian Corporations based in Canada and all their assets are held in solid Canadian Banks in  Canada and are audited regularly, out of reach of Obama?s and the IRS?s  grasp.