I think we might be witnessing the last vestiges of the Keynesian economic model dissipating before our very eyes. The supposed economic recovery that has been touted for the last several months is faltering in all-too-rapid fashion, and even the government's cheerleaders are sobering up to the notion that there might never have been a recovery to begin with. The last few weeks have seen one disappointing economic report after another, and Friday’s job report drove the point home with uncomfortable emphasis. It’s a momentous occasion, so it’s worth saying again: I think we’re witnessing the beginning of the end for the Keynesian economic theory. John Maynard Keynes, an esteemed economist in the first half of the 20th century, maintained that government involvement in the economy was a healthy thing, and that money supply expansion during economic downturns was a viable option for reversing such downtrends. Austrian School theorists have always maintained that Keynes had it all wrong -- money supply expansion was dangerous in terms of its propensity for causing inflation, and government involvement would invariably lead to market distortions and myriad unintended consequences for the whole of the economy. For decades now, there hasn't been much in the way of hard and fast evidence with which to prosecute the Keynesian model. However, the 2008 financial crisis, and the response to it since then, has placed Keynesian theory front and center, where it may now be subjected to the most rigorous scrutiny to date. You see, the Keynesian response to the crisis -- the swift and unprecedented expansion of the money supply, on a scale never before attempted -- has seemingly produced little effect on our overall economic health. Trillions of new dollars pumped into circulation ( quantitative easing, or QE) have provided only the smallest of bounces to the economy, contrary to the belief that we'd be placed on a firmer path to recovery after QE1 (early 2009) and QE2 (late 2010). Of course, expect defenders of this approach to simply claim that the efforts weren’t on a large enough scale. “Had we just circulated a few trillion more dollars into the economy, everything would be fine now.” This is the only remaining defense for the QE/Keynesian proponents. To them I’d ask, how big is big enough? Instead of $3 trillion, should we have printed 30 trillion? Or maybe 300 trillion? Why stop there? If printing money is the road to prosperity, why did we go so small in the first place? Print a few quadrillion dollars, and we’ll all be rich. In other words, a little common sense goes a long way when debating with a Keynesian. But I’m digressing... The real point here is the recovery is ephemeral, and we need to recognize this fact and begin adjusting to that reality. I expect a cocktail of gradually-worsening economic data to continue surfacing, and will be looking for the subsequent effect on the stock market. In a nutshell, the declining manufacturing numbers, worsening employment situation, anemic housing market, high gas prices, decreasing consumer confidence and consumption metrics, and steadily rising inflation will create a significant drag on the economy. I anticipate the Federal Reserve will also do their part to help lay the foundation for another financial crisis, as they toy with the idea of QE3 and leave interest rates at rock bottom levels for who knows how long. As always, check your portfolios. The market is down 5% in just the last few weeks, so whether it’s the beginning of a bear market or only a hiccup, either way it’s good practice to review your holdings.
Yes, you read that correctly. And no, I’m not delusional. No matter how many times you’re told we have a capitalist system in the US, it doesn’t make it true. There are a lot of reasons why we don't have a true capitalist system in the US, but rather a hybrid of capitalism and other economic systems. I'll get to a few of those later, but I wanted to first focus on the singular piece of evidence that demonstrated that we do not operate under a true capitalist system:
The banks and other investment institutions at the center of the 2008 financial crisis were not allowed to fail.
That's it. That's really all you need to know to understand that we do not have a capitalist system. Everything else you read, see, and listen to will try to convince you otherwise. You'll hear our country referred to as capitalist in the news and print media. Politicians will trumpet the fact over and over in speeches, campaigns, and edicts. Michael Moore will make an entire documentary trashing this economic system. Let's face it -- say something enough times and people will start to believe it.
But it doesn't change the fact that we don't have a true capitalist system. (I figure if I say it enough in this post I might be able to at least temporarily neutralize the opposing message.)
The premise for saving the banks in 2008 was simply this -- you can't prove a negative. Government officials claimed the system could not be allowed to fail because "things will be so much worse if they do fail than if we bail them out." But you can't actually prove that things would be worse, and so by striking that fear of financial Armageddon into all of us, the system was propped up and taxpayer money used to bail out the entities that took all the risks in the first place.
Capitalism for the profits.
Socialism for the losses.
You see, if we had capitalism, then both the gains and the losses would have been capitalized by those institutions that generated them. Would this have had a ripple effect elsewhere on the global economy? Probably. To what extent? We don't know and we never will. We only know that the losses incurred were socialized. You and I paid for their mistakes, plain and simple.
But that’s not the only evidence we don’t have true capitalism here (it’s just the most recent and compelling one). Consider a few other examples:
1) Social Security. Money is taken from one group (workers) and redistributed to another group (primarily retirees). Any form of redistribution of wealth is not part of the capitalist ideal. If you're a worker, you pay into this redistribution to the tune of a 6.2% tax on your paycheck. The program is now headed for insolvency and threatens to contribute to the bankruptcy of our nation.
2) Medicare. Money is taken from one group (workers) and redistributed to another group (individuals over age 65). If you're a worker, you pay into this redistribution to the tune of a 1.45% tax on your paycheck. This program is costing approximately $900 billion annually (almost a tenth of our GDP), is headed for insolvency by 2020, and the enormously burdensome cost of it threatens to bankrupt our nation.
3) Auto company bailout. In the wake of the 2008 financial crisis, the government took taxpayer money and targeted a particular industry for a financial bailout. The bailout was once again pinned on the notion that you cannot prove the negative; thus, the argument was made that the auto industry's collapse would perpetuate disaster upon certain industries that support the auto industry, not to mention the car companies. Such assistance directly from the government into a commercial enterprise for the sake of altering the economic condition of that enterprise does not exist under a capitalist system.
It’s important for us to understand the true nature of the economic model that exists in our country, and I believe that model could be defined as a mix of capitalism and socialism. This blend of systems has existed for many decades and it has contributed to the current conditions we are enduring today. In many respects, we’ve ended up with the worst of each of these systems. But the mounting crisis we face today with our stagnating economy and growing debt calls for a change, and I believe that now is the right time to embrace a true capitalist system. I once read that capitalism is one of the worst economic systems around…but better than all the rest. And so, while imperfect, it is the system with the best track record for generating growth and prosperity, two things we are in desperate need of today.
I’ve mentioned Peter Schiff, President of Euro Pacific Capital, a few times on this site. Schiff called the bursting of the housing bubble, and ran unsuccessfully for the Republican ticket in the Connecticut Senate race. I plan on writing more about Schiff and my excellent experience with his investment firm, but in the meantime, I recommend you check in on his site once in a while to read his periodic column. It’s usually posted weekly on Fridays, but lately has only appeared every 2-3 weeks. Schiff is definitely a busy guy, not only running his firm but giving speeches, appearing on TV, (previously) campaigning for Senate, etc.Check out his latest column here. It discusses quantitative easing, dollar weakness and deflation, all of which are relevant to some of my more recent posts.
So today I read an article on Yahoo Finance titled “Almost Rich? You Could Pay Less Tax Next Year.” This caught my attention because I’ve become extremely sensitive to any occasion where the words “rich” and “wealthy” are used when referring to income levels in the US. I’ll explain more about that momentarily.
The article was basically saying the following: for those individuals earning an amount slightly over the current 33% tax bracket threshold, a tax decrease is potentially on the horizon as their bracket adjusts downward to 28%. This would occur because, if the current administration gets its way, the 28% bracket will apply to more individuals, and would end up absorbing the lower range of the current 33% bracket. This change would affect those making between approximately $172,000 and $195,000. How much would they save by dropping down the 5 percentage points? About $1300 a year, or a little over $100 a month.
All that said, this is not the key issue here. If you go back to the beginning of this article, and re-read the title, you’ll notice that the people making the cited amount of money are referred to as “almost rich.” Has anyone told them that? Of the reasonably small amount of people I know who make that amount of money, they sit in traffic, work long hours (longer than me at least), worry about paying bills, and get about 10-15 days off a year. Is that our new definition of wealthy, or even near-wealthy?
You see the problem here is, as the American dream of pursuing opportunity and happiness and making a better life continues to grow more and more difficult, instead of removing the impediments to it, we’ve simply changed the definition of it. Burdensome tax policy, inflation, and conversion from a production-based economy to a consumption- and service-based economy have all contributed to shrinking wages and a steadily declining standard of living in our country. It is very difficult, if you’re an elected official nowadays, to change much in the way of tax policy and inflation. Let’s face it – you’re facing a $13 trillion debt, $50 or so trillion more coming down the pike, and a new healthcare bill to pay for…so you really don’t have much room to reduce the tax levels on the citizenry. If anything, you probably are starting to think about increasing them…but I digress.
Getting back to the point, which is the easier way to approach this dilemma if you’re the government? Since you can’t do much in the way of lowering the barriers to entry for a comfortable financial existence (like taxes), then you simply lower the definition. So today, if you’re single and you make $200,000 a year or more, you are now called “rich.” I used to think rich people owned businesses, had high net worth, and didn’t work much if they didn’t care to. But now, it turns out you can be rich while working 80 hour weeks and taking 5 days off a year.
The insidious byproduct of this characterization is the redefining of what it means to have “made it” in this country, allowing more taxes to be collected and even stigmatizing the people who have worked hard to reach higher income levels. In fact, it’s more likely that a person who makes $200,000 a year works harder (and always has) than the individual who makes $20 million simply by being born into it, stumbling into it, or coming up with a single idea that took one hour to conceptualize and earns them a windfall. This is not to say that people who have good ideas and make millions aren’t essential to our economy or don’t deserve their money – we’re only focusing on who works harder for the moment. So while not all $200,000 earners are constantly at the grindstone, chances are high that they are, and that they’ve had to be for quite some time to work up to that income level. In the end, they are penalized for reaching it by paying disproportionate taxes.
I say disproportionate because of the following. Take my $200,000 earner and my $20 million earner from the previous paragraph. According to our society, they’re both rich. They both should pay lots of taxes. The difference is, the $20M earner has an enormously higher capacity for doing all the things necessary to create more wealth through investments and speculation, protect that wealth by hiring lawyers and accountants to navigate the tax code, and to simply dedicate more time to leisure if he or she so chooses, at which time he or she can dream up new ways to make more millions. On the other hand, our $200,000 earner is fighting rush hour, missing soccer practice with the kids, and planning that 3 day weekend “vacation” to the beach this summer. The difference in their tax brackets? Right now it’s 2%. Doesn’t add up. Let’s run through some simplified and relative numbers and see what each of these workers’ tax situations look like:
$200,000 earner – pays 33% federal income tax, meaning $66,000 would notionally be paid in federal tax (I say notionally because we’re not including deductions or adjusted gross income calculations); thus, total income left over after tax is about $133,000
$20M earner – pays 35% federal income tax, meaning $7M would be paid in federal tax; thus, total income left over after tax is about $13M
So who gets hit harder by their tax burden? Clearly, everyone reading this article would rather be in the $20M earners’ shoes. Of course, this seems obvious at first blush…except why does the $200,000 earner get lumped in with the $20M earner when we hear about who’s rich in this country and who isn’t? The bottom line here is the following: we’re told income taxes are progressive (affect higher earners more than lower earners), but in actuality, they are regressive (affecting lower earners more than higher earners, even though their tax bracket percentage is lower). Would you rather pay 10% tax while earning $20,000, or 35% on $20M? Returning to our earlier example, does anyone feel sorry for the $20M earner, having only $13M left over after tax? Could you find a way to make more money (and get richer) with $13M? What about the $200,000 earner? Not a bad salary, but could this person really be categorized as rich?
I won’t be surprised to soon see “rich” defined as $175,000 or more, maybe by the next Presidential election if the economy remains bad. Or maybe $150,000? Perhaps by the time the unfunded liability crisis hits later this decade, and lots more taxes need to be collected, “rich” will be anyone making $75,000 a year or more. Where does it end? Once the definition becomes an arbitrary number, it’s free to be moved as low as the powers that be need it to be moved.
In a future post, I plan to provide a review of one of the best books I’ve ever read, “The Road to Serfdom,” by Friedrich Hayek. Hayek, a Nobel prize winner, is considered the father of the Austrian School of Economics. Austrian economists hold strong beliefs in free markets, with one reason for this being the incentives that capitalism fosters in workers. When you know that your hard work is going to be fully realized in terms of economic or monetary gain, you are more likely to work hard, seek advancement or promotion, and possibly exercise entrepreneurship as an alternative to employment. However, when we dampen citizens’ work ethic by removing these incentives and overtaxing them, we harm the economy as a whole and rob individuals of their right to pursue opportunity and the American dream. (And no, the American dream does not equate to owning a house; rather, it is the unbridled ability to reap the full rewards of hard work.)
So what’s the moral of the story? Don’t work too hard – you just might end up being rich and hating it.
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