The Daily Reckoning November 27th

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The World is Not Flat

The boxes were packed. The pictures of Mises, Hayek and Rothbard had come off the wall they’d adorned since 1997 in Suite 203 in the Cannon House Office Building. A maintenance crew stood outside, garbage cans at the ready, perhaps a little too eager to swoop in and finish the job of making way for the next occupant.

Rep. Ron Paul was moving out. We had the privilege of meeting with him on Wednesday, Nov. 14, moments after delivering his final speech on the floor of the House — the one in which he declared the Constitution had failed in the Founders’ stated objectives.

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The speech is now a matter of public record… as are transcripts of the testimony from every hearing the good doctor presided over as chairman of the House Subcommittee on Domestic Monetary Policy and Technology during his final term.

Our friend Nathan Lewis, author of Gold: The Once and Future Money, testified at one of them last August. He suggests Dr. Paul carefully crafted those hearings with an eye toward leaving something behind for the next generation. “The ideas will be on the public record, even if they’re never implemented in our lifetimes.”

In addition, Lewis believes the ideas do have a contemporary audience — overseas. “People in emerging markets pay attention long before Americans do.”

Case in point: the flat-rate income tax pushed by Steve Forbes during his 1996 presidential campaign. It’s now the law of the land in dozens of countries.

We should preface what follows: We are not advocating a flat tax. We are saying that if politicians really wanted a way to pull back from the “fiscal cliff”… and put the government’s finances back on a semi-sound footing… they would stop arguing over trivia and implement a flat tax next week. You might want to keep that in mind as you witness the circus in Washington leading up to year-end.

The first comprehensive proposal for a US flat tax came in the 1985 book The Flat Tax, by economists Robert Ernest Hall and Alvin Rabushka.

“Today, the flat tax idea is perhaps even more politically remote, in the United States, than it was in 1985,” Mr. Lewis says. “However, the rest of the world caught on to the idea. Today there are at least 40 governments with flat tax-type systems, most of which made the switch in just the last decade.”

A sizeable number of these countries used to lie behind the Iron Curtain. Messrs. Hall and Rabushka served as consultants to many of those governments as they implemented a flat tax.

Countries that Utilize a Flat Tax

Is the flat tax a panacea? Hardly. Central bankers can still muck up the works; thus, many of these countries were swept up in the Panic of 2008.

But “we could take 2007 as a representative pre-crisis year,” Mr. Lewis suggests. “How did the flat tax countries do then?

“For 13 countries for which information was available from the IMF, the average GDP growth rate was 10.0%, ranging from 6.2% (Slovakia) to 23.1% (Ukraine).”

Lewis further studied 10 countries from which International Monetary Fund data are available, examining the flat tax’s impact on overall revenues. Revenues rose an average of 17.7%… and that’s after throwing out Estonia’s outlier increase of 81%. Only the Czech Republic saw revenue fall — by a minuscule 0.5%, as crisis encircled the globe in 2008.

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How about revenue as a percentage of GDP — a favorite measure of policy wonks? That looks good too. On average, the ratio was virtually unchanged in those 10 countries — down 0.1%.

“Most of the seemingly impossible promises of the flat-taxers — higher growth, stable revenue/GDP ratio, rising government revenue — are, in fact, common and repeatable,” Mr. Lewis concludes.

Meanwhile, back in Washington, the politicians argue about how to prevent — prevent — automatic tax increases and spending cuts totaling $607 billion, which would barely cut the deficit in half.

As the holidays approach, we encourage you to spend it with your family and not stay glued to the TV for the minute-by-minute negotiating nonsense.

Regards,

Addison Wiggin
for The Daily Reckoning

The World is Not Flat appeared in the Daily Reckoning. Subscribe to The Daily Reckoning by visiting signup for an Agora Financial newsletter.

An “Escalating Face-Off”

It’s come to this: China might end up rescuing Americans from a secret treaty that threatens Internet freedom and national sovereignty.

Four months ago, we tipped you off to the Trans-Pacific Partnership (TPP) — one of those “free trade agreements” with hundreds of pages of devilish details. The United States is negotiating with a motley assortment of countries — New Zealand, Australia, Malaysia, Vietnam, Singapore, Brunei, Chile and Peru. Canada and Mexico joined up in June.

The negotiations are strictly hush-hush… but a draft proposal by the U.S. negotiators leaked earlier this year. Among the gems included…

• $150,000 fines and jail time for copyright infringement – which would be easy to violate
• Foreign multinational corporations exempted from U.S. laws
• Capital controls to keep your wealth trapped inside the U.S.

A new round of TPP negotiations begins next Monday in Auckland, New Zealand.

As it turns out, China is forming its own trade bloc… and New Zealand, a founding TPP member even before the U.S. got involved, is showing interest.

This bloc is called the Regional Comprehensive Economic Partnership (RCEP). “You never know how these things are going to play out,” said New Zealand Prime Minister John Key, “so it is always possible that TPP falters and then RECP becomes the significant trade agreement.”

To add insult to injury, Mr. Key said this on the sidelines of a summit last week in Cambodia, where President Obama was on hand. Australian Prime Minister Julia Gillard also declared herself open to the RCEP.

The countries negotiating the RCEP are China, India, South Korea, Japan, Australia and New Zealand. To be sure, there’s no guarantee the talks will work out — a longtime dispute between China and Japan over the Senkaku Islands is heating up again.

Still, the battle lines between the U.S. and China are now drawn. Almost no one in the United States is talking about it. The Washington Analysis and Assessment Service is one of the few exceptions: “This is another example of the emerging trend in U.S.-China relations where the two countries position themselves — whether consciously or by coincidence — as competitors, rather than as partners.”

In New Zealand, the talk is more bold: “[Prime Minister] Key needs a reality check,” says TPP critic and Auckland University law professor Jane Kelsey, “if he really believes New Zealand can remain best friends with both sides in the escalating face-off between the U.S. and China over the ‘most significant free trade and investment deal ever.’”

Cheers,
Dave Gonigam

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The preceding article was excerpted from Agora Finacial’s 5 Min. Forecast. To read the entire episode, please feel free to do so here.

An “Escalating Face-Off” appeared in the Daily Reckoning. Subscribe to The Daily Reckoning by visiting signup for an Agora Financial newsletter.

Protectionism is a Rip-Off

Winter is upon us, and that means digging out of our closets a whole variety of different kinds of shoes. There are insulated hiking boots, trail shoes, specialized hunting boots, waterproof shoes, and more.

Ah, the wonderful varieties provided for us by the marketplace!

Thank goodness government never did to shoes what it has done to education and health care. If it had, prices would be going up, instead of down, and we’d probably have only a handful of models for all seasons.

Only government-approved shoe stores would exist. And there would probably be no such things as specialty outdoor shoes, which now account for 30% of the retail sales of outdoor equipment in general (which itself is a $646 billion industry).

Yet an interesting thing happened just following the election. The Obama administration, without warning, announced that it opposes prolonging a suspension of tariff walls on the materials that go into making these specialty products. To put it plainly, there is going to be a new tax on imports on your shoes. And it begins on Jan. 1, 2013.

(If you want to know more about the legal mechanism being overridden here, look up “miscellaneous tariff bill”; it is a slight window of freedom in an otherwise closed system.)

This puts many importers and foreign producers in a terrible bind. They’ve already made their business plans and purchases based on the assumption that the lower tariff rates will apply. Industry experts are predicting price hikes of an immediate 38% on outdoor shoes. It will hurt sellers, manufacturers, and especially consumers.

Why would the Obama administration do this? I have no inside knowledge. But if this action fits most such actions, it comes down to a political payoff for some industrial competitor somewhere. It has nothing to do with saving jobs. It is saving some friends of the government at the expense of everyone else. Another possibility is that this action helps give more work and power to the U.S. Customs agency and its public-sector union.

Maybe you have noticed: There is no national controversy about this. It is left to institutions like the Outdoor Industry Association to plead with their members to write, call, petition, beg, or do whatever is necessary to save themselves from the tax. After all, that’s what a tariff is. This tax hurts the many and benefits the few.

In effect, business is back to begging to do business. Does it work? Sometimes it does, provided the affected industries grease the right palms. Often, it doesn’t work. So people will show up at their favorite store in mid-January and be appalled at the suddenly soaring prices of outdoor shoes. Will they curse the Obama administration? Nope. Most people are completely unaware of just how protectionist U.S. trade policy truly is and how it affects millions of products. Instead, they will blame the retailer for gouging or the manufacturer for being greedy. The private sector will again be blamed for the actions of government.

I’m particularly intrigued by these kinds of actions because they suggest the real way that government undertakes its dirty work. Mostly, it is out of public view. It consists of petty bureaucrats working with various industry groups to rig the system in favor of whoever has the political power and muscle to pull it off. The public debates and the elections have very little at all to do with it. In fact, there is no debate about most of what government does.

It’s not so much that it takes place in secret. Most all information is publicly available. The problem is that no one but the most affected have the incentive to watch what is happening in any particular sector on a day-by-day basis. That’s why, if you really want to know what government is doing to business, you have to ask an industry expert. Only they get the communique. Only they have a strong incentive to act.

People think of protectionist policy as a benefit to domestic businesses. This is not true. This is a clear case in which most of the harm of the protectionist policy is done to American business. The reason is that economic production takes place over many stages of production, and these are ever more spread throughout the world. A tax on imports ends up affecting domestic manufacturers and sellers, imposing artificially high costs of doing business.

To be sure, there are remaining forms of protectionism that are a clear sop to American industry. To my astonishment, The New York Times ran an Op-Ed about one just the other day. Maybe you have noticed this, but foreign airlines are not allowed to serve domestic routes in the U.S. They can land in U.S. airports, but they have to head out with passengers destined for foreign countries.

As a result, U.S. air carriers do not face the level of competition they would otherwise. I noticed this only recently when I took a flight on Turkish Airlines. The plane was beautiful, the chairs comfortable, the service fantastic, and everything worked. I was amazed because this is a government-owned airline. Generally, it was vastly better than what we American consumers have come to expect from American companies.

Well, Turkish airlines serves a highly competitive market throughout Europe and the rest of the world. The U.S. is actually unusual in this respect. Only American companies are allowed to serve American domestic routes. The result is a lessening of price competition and reduced service. This serves to powerful interest groups: the air carriers themselves and the labor unions that work for them.

If you think about it, this is an egregious regulation, one that would never exist in a situation of free enterprise and free trade. And the hypocrisy is overwhelming. In the land of the free, the home of all things bright and beautiful, we have draconian laws that keep foreign suppliers out, like some kind of mercantilist medieval fiefdom. What possible harm could come from letting British Airways take me from Atlanta to Chicago?

The cause of free trade has always been about the common man. It is about the right of average people to trade with whomever they want. Protectionism, in contrast, is another way for powerful people to extract money from our pockets and reward their political friends with legal factors. In other words, it’s a rip-off.

You and I might be reminded of this in the dead of winter 2013, when that pair of hiking boots we had our eyes on suddenly soars in price and, instead of buying, we decide to stay home in our slippers and contemplate the fate of liberty in our time.

Jeffrey Tucker

Original article posted on Laissez-Faire Today 

Protectionism is a Rip-Off appeared in the Daily Reckoning. Subscribe to The Daily Reckoning by visiting signup for an Agora Financial newsletter.

3 Events Worth Watching

Indian Gold Demand Picks Up

The love for gold has been reignited in India, according to the World Gold Council (WGC) in its Gold Demand Trends for the third quarter of 2012. India regained its title as the strongest performing market, overtaking the greater China area, as the country experienced a bounceback in demand due to improved sentiment during the festival season.

Compared to the third quarter of last year, Indian gold jewelry demand grew by 7 percent while gold bar and coin demand rose 12 percent. Total consumer demand was 223 tons, compared to 205 tons this time last year. The second largest market was Greater China, which consumed 185 tons in the third quarter of 2012. This was less than the 201 tons consumed in the third quarter of last year.

Together these markets in the east made up 55 percent of the world’s jewelry and investment demand, according to the WGC.

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Although India experienced a setback earlier this year when gold shops boycotted a proposed tax on the yellow metal, imports recovered by July “as inventory levels were bolstered (aided by a well-timed dip in the local price) and the market adjusted to the customs duty,” says the WGC.

The third quarter has historically been a strong seasonal time for the Love Trade to come alive in the east. Monsoon rains and the festival season in the fall are generally associated with the buying and giving of gold. Still, for the year, don’t expect the Love Trade in India to be as strong as it was in 2011, as gold demand remains subdued with the ongoing weakness of the rupee.

FHA in Need of Taxpayer Bailout Keeping Fear Trade Alive

Last week, the Federal Housing Administration reported that it has exhausted its reserves, possibly requiring a bailout from U.S. taxpayers for the first time ever in its nearly 80-year history.

The agency prides itself on being “the only government agency that operates entirely from its self-generated income and costs the taxpayers nothing.” Meanwhile, delinquent loans have been steadily climbing for the last few years. According to data from the FHA, the Wall Street Journal reported that the number of single-family loans insured by the FHA that are 90 days or more past due climbed to roughly 739,000 in September. “That represents about 9.6 percent of its $1.08 trillion in mortgages guaranteed,” says the WSJ.

Now its capital reserves have dropped to a negative $16.3 billion. This is considerably below the required 2 percent capital cushion. Based on its $1.1 trillion portfolio, it should be reserving about $22 billion.

To keep the FHA solvent and meet its requirement, approximately $38 billion of cash would need to be injected.

The FHA has played an important role in keeping the housing market healthy, as it provides insurance on mortgage loans for single- and multi-family homes. Many of the loans backed by the FHA are held by borrowers who make a small down payment, which can be as little as 3.5 percent of the purchase price. Without the government’s guarantee, most private lenders wouldn’t have originated these loans.

It appears that another government bailout is on the horizon. The housing market is key to the U.S. recovery, which incentivizes the government to print more money and debase the currency, just as the Federal Reserve is driven to seek maximum employment. These continuing actions should stoke gold’s Fear Trade all through the winter.

Gold is a “must have” investment today, according to Investment Strategist Keith Fitz-Gerald of Money Map Press. During a recent webcast, Keith explained how gold helps hedge value. The yellow metal has been “proven to have a roughly 10-to-1 relationship with interest rates. And that means it’s an indirect correlation or a corollary to bond portfolios,” he says.

“If interest rates start rising, that’s where your gold is really going to pay off,” Keith says.

Keep in mind that although there are many powerful reasons to accumulate gold, make sure you invest prudently. We recommend having a 5 to 10 percent weighting of gold and gold stocks in your portfolio. How should you invest the other portion?

Keith suggests structuring portfolios using the 50-40-10 pyramid model shown here. At the bottom of the pyramid are the “Base Builders,” where 50 percent of the portfolio is invested in defensive positions that tend to hold their value in nearly all market conditions.

One base builder that Keith recommends is U.S. Global’s Near-Term Tax Free Fund (NEARX), which invests in municipal bonds that have a relatively short maturity.

Above the Base Builders are the “Glocal Income & Growth” investments, which should make up 40 percent of a portfolio. These are globally recognized brands with strong balance sheets, experienced management, high levels of cash flow and above-average dividends.

The remaining 10 percent is invested in what Keith calls “Rocket Riders,” which are riskier assets. Special situations, IPOs and options fall into this category, allowing the investor to “swing for the fences.”

China’s Pyramid of Power

The global economic picture came into focus a little more last week with the announcement of China’s new leadership. We now know the seven men who will lead the world’s most populous country and second largest economy over the next several years.

But don’t expect sweeping changes, as the new pyramid of power will likely follow the path of its predecessors. Yet the leaders will likely feel pressure to “continue making significant reforms to China’s economic structure and expanding the personal freedom of its people,” says China Macro Strategist Andy Rothman of CLSA. Likely pushed to the top of the agenda is the rule of law, as it is a key evolutionary step for China and can benefit both the rich and the poor. CLSA believes it is fundamental to the country’s economic growth as well as its social stability.

We will need to wait until after the Party’s economic work committee meeting in December to hear about China’s economic strategy for 2013, however, more details will be revealed after the new government formally takes office in March. Regardless, it would be helpful to eager investors to communicate stronger reform messages sooner rather than later.

“We’re In for a Barbeque Economy”

Despite the clarity that we have following the outcome of the U.S. elections and the selection of China’s new leaders, we’ll likely continue facing uncertainty during this long, slow recovery, says Keith. It helps to think of the economic recovery like a good barbeque. It doesn’t come from being cooked fast; rather, it requires patience and time. So even if progress is slow in this “barbeque economy,” growth will continue, he says.

Make sure your portfolio is well prepared.

Frank Holmes

Original article posted on Daily Resource Hunter 

3 Events Worth Watching appeared in the Daily Reckoning. Subscribe to The Daily Reckoning by visiting signup for an Agora Financial newsletter.

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avatarThe Daily Reckoning - The Daily Reckoning posted Tuesday, November 27th, 2012.

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