Excellent article by Charles Hugh Smith

Charles Hugh Smith explains the current mess in terms of class warfare and entrenched self-interest. In a nutshell:

• The wealthiest top 1% have influenced the tax system so that their investment income is barely touched, especially when there are loopholes and shelters they can use. They and their wealth can stay in the US.
• The bottom 60% depend partly or wholly on what they receive in benefits from the system. They have to stay in the US.
• This puts the burden on the middle-to-upper income-earners. But if the burden gets too heavy, the top half of those earners may choose to flee the country. If so, the system breaks down.

The fear may be overstated.

US citizens have to pay US tax on their earnings anywhere in the world, but if they renounce citzizenship and have over $2 million in net assets (including income-producing assets such as pensions), there is still a one-off ransom tax to pay before they leave.

If they have less than $2 million, they may not have enough to live the idler's dream abroad.

The result is that fewer than 750 Americans chose the escape route in the last year.

But Smith's article is very useful for seeing how the parts of the machine work, and why it resists reconstruction.

What inflation? "Them" won't let it happen

Inflation in food and soon, it is reported, in clothing, is owing to factors such as bad harvests, rising energy costs and government export restrictions.

But if you agree with the monetarists that inflation is caused by the expansion of money and credit, then until people and governments have paid-down (or defaulted) enough debt to feel confident about spending again, we are in a deflationary environment and whoever holds money is going to do well.

That said, there is a subset of monetarists who think that somehow, governments will force-feed money into the system to create inflation, or hyperinflation.

While this is technically possible, people like Mike Shedlock counter that the ruling elite will not allow this to happen, since it would destroy their wealth.

It's a rigged game, not Russian roulette. So barring some catastrophic default, we've got to sweat it out through a new Depression era.

Save money.

"Commercial real estate lags residential and residential real estate has not yet bottomed, and indeed may not bottom for years." - Mike Shedlock

"The most important indicator is “credit growth” or lack thereof. Everything else follows... There is no credit growth, and therefore, according to my long-standing theory, there can be no sustainable economic growth unless and until miraculously credit starts growing. However, given current policies in Washington, that seems unlikely at this time." - Bert Dohmen (htp: Karl Denninger)

DISCLAIMER: Nothing here should be taken as personal advice, financial or otherwise. No liability is accepted for third-party content, whether incorporated in or linked to this blog.

Future issues

White collar work in the West is threatened by lightspeed worldwide communication with countries where wage rates are dramatically lower; and by increasingly powerful computers and programs.

When all but manual and menial work simply and permanently isn't there anymore for very large numbers of people, the moral connexion between work and income is weakened. The issue then will be distribution of wealth: who gets given what, and with what justification?

The embers of socialism are still hot.

Aeolian harp

Stunt preachers

You could almost believe that Pastor Terry Jones and Imam Feisal Abdul Rauf are in cahoots over the controversial Park51/Cordoba House project.

The former is an ex-hotel manager whose sister church cut ties after allegations of his financial impropriety, and who preaches to a congregation of maybe 50 people. His I'll-burn-the-Koran stunt has made a nobody into a somebody.

The latter has allegedly "dedicated his life to building bridges between Muslims and the West and is a leader in the effort to build religious pluralism and integrate Islam into modern society", but his company Cordoba Initiative has a stake in the Park51 project and the recent publicity, athough temporarily polarizing opinion, may ultimately turn out to have been financially useful. Donald Trump reckons so - and he's looking to buy in without getting squeezed for too much extra cash.

It's enough to make a cat laugh.

Goldmans Sachs "fine"

Goldman Sachs is going to pay £20 million to the FSA, says the news. That's not a fine, it's a tip.

Should retirees look to the stockmarket for income?

Adapted from my advice to a client this weekend:

Price inflation is not uniform or universal. Food and fuel have risen in cost recently, but State Pension benefits are linked to a cost of living index and should therefore approximately keep pace with increases in the price of basic needs.

In other areas (e.g. cars, cruises) prices have remained stable or even fallen. During what I suspect will turn out to be a long, Japan-style recession, it may be that the price of luxury goods and services will not inflate greatly, except perhaps for the luxuries of the very wealthiest.

Other than cash, what other ways could you invest?

First, one could look at deposits that link to inflation indices. Unfortunately, NS&I recently withdrew their index-linked savings certificates, the first time they have done so in 35 years. National Counties Building Society has an RPI-linked cash ISA (available until 30 September) but this is for a fixed amount (£5,100), runs for a fixed 5 year term and does not permit earlier withdrawals, so it may not fit in with your requirements.

If the government issues new index-linked gilts, these provide income and capital growth in line with RPI. The initial income may be low, however. For further details, please see the website of the Debt Management Office or a stockbroker. Generally, I would not now strongly recommend government bonds on the second-hand market, because the demand for them has become so high in these troubled times that the yield (ratio of income to traded price) is very low. If public finances unravel and interest rates rise, the effect on the capital value of bonds would be very depressing. As it is, the UK is struggling to maintain its official AAA rating and the implied credit rating on the credit default insurance market is actually rather lower already.**

Residential property appears still to be overpriced in historical terms. I think the only reason prices haven’t fallen much further is that interest rates are very low, which allows homeowners to maintain their mortgage payments on large loans. As the budget cuts begin to take effect, I think we will also see a depression in commercial real estate.

The stock market is also in a bubble, I believe. The ratio of price to earnings is still very high and the earnings may not truly reflect the forward position*. Companies are reportedly maintaining some degree of profitability by running down stocks, closing sites and laying off staff, but there is only so far they can go down this road. Many leading companies derive a significant part of their earnings overseas, but world trade is so interconnected these days that a slowdown in Western consumption will also impact on Eastern production.

The general picture appears to be deflationary, and although governments would like to stimulate further inflation in the way they have done over the past 30 years, there are respected economic and investment commentators who say we are now saturated with debt and unless we see outright defaults by sovereign nations (which could still happen), we will have to go through a long and painful process of retrenchment and paying-off debt.

Others look beyond deflation and think that it will ultimately force governments to find some way to increase the monetary base and devalue their currency. It may be significant that both Russia and China have made substantial purchases of gold in the last few months, and China has announced its intention of increasing her holding from c. 1,000 tonnes to six or ten times that amount in the next decade. But here we are in the realms of financial speculation, and the inflation speculators are already buying into agricultural commodities, precious metals, oil etc.

However, extreme or unconventional government strategies to deal with deflation don’t seem imminent and so I think that over the next couple of years, cash savings are likely to be a good way to build up funds for your envisaged discretionary expenditure***. Should there appear to be a major policy change, then we may have to look at investments that could protect against high inflation.

* Albert Edwards at SocGen expects a major reversal, the FT reports today.

** Though CMA DataVision have raised the UK from aa to aa+ in their Q2 report.

*** "There are no longer any “defensive” securities on the planet. The old asset allocation models and the diversification models don’t and won’t work any more and they haven’t for over a decade. I can’t believe that prominent asset managers are still using this approach." - Steven Bauer

DISCLAIMER: Nothing here should be taken as personal advice, financial or otherwise. No liability is accepted for third-party content, whether incorporated in or linked to this blog.