March 3, 2014

If You Build It, They Won’t Come: Opinion

Posted in business, Capital, cost of living, Economic Growth, Economy, Federal Reserve, generation, government, income gap, industrial economy, Inflation, investment advisor, investment banking, investments, job market, labor force, Labor Market, large business, medicare/medicaid, National Federation of Independent Business's, revenue, Robert Barone, small business, social media, social security, taxes, Unemployment, wages, Wall Street at 8:31 PM by Robert Barone

It is not the strongest of the species that survives, nor the most intelligent, but the one most responsive to change.– Charles Darwin

I am often asked: “When do you think the economy will return to normal?”

My response: If by “normal” you mean what we had from the 1980s to 2008 — the “if you build it, they will come” economy — the answer is, not anytime in the foreseeable future.

The economic environment has permanently changed, and businesses that don’t adapt to the new environment will become extinct like dinosaurs. Think about Kodak and Polaroid. They were big, strong and probably smart, but they didn’t adapt.

Slower Growth

In the new business environment, economic growth will be much harder to achieve, the income gap will continue to grow and bigger and more intrusive governments at all levels will demand more revenue.

In mid-February, the Congressional Budget Office concluded that potential economic growth for at least the next 10 years will be much lower than what we have experienced for the last few decades. They attribute this to the health system known as Obamacare as well as disincentives to work.

A Growing Income Gap

The growing income gap is well documented. What’s not well documented are the causes.

There are two major ones starting with government policy. Federal Reserve money printing, for example, benefits the most affluent and Wall Street’s financial institutions. Government policy to under-report inflation (which began in earnest in 1994) reduces budget deficits by limiting payouts to Social Security and Medicare recipients and saves interest costs on the debt. But it has kept wage rates from keeping pace with inflation.

If inflation has been understated by just three percentage points per year since 1994, then wage earners, who have only received “cost of living” adjustments, have lost 55% of their purchasing power. No wonder both spouses have to work (some with two jobs) and still have a hard time making ends meet.

But, there is another factor at play here. In the Industrial Revolution, innovation benefited all workers. It wasn’t hard for workers with little formal education to learn how to operate machine tools, and they could master skills needed in the new industrial economy.

But, that is not true today. In fact, the National Federation of Independent Business’s surveys have for some time now shown an increasing trend that businesses cannot find the skills they need. As a result, jobs go unfilled. The jobs that are available require skills only learned through and intensive educational process, such as majoring in engineering or computer science at a university.

These are the folks who are getting the high paying jobs. Those with few or no skills must take much lower-paying service type or minimum wage jobs. In the latest unemployment survey, the unemployment rate among college graduates was 3.3%, for those with high school degrees it was 7.3%, and for those with less than a high school diploma, it was 11.1%. Thus, it appears that the nature of the new technology revolution is also contributing to the income gap.

Other Endemic Factors

For the past five years, multinational corporations have been hoarding cash. Capital expenditures are at their lowest growth levels in six decades. Perhaps these large businesses have recognized that growth will be slow and that revenue growth will be a function of acquisitions.

Finally, new laws, regulation and taxation strangle small businesses — the recognized driver of economic growth for the past 60 years. The stranglehold that regulators have on community banks that restricted lending to small businesses is just one example.

Unfortunately, instead of recognizing that government policies have both slowed the economy and widened the income gap, politicians are likely to use these as wedge issues. So it appears that more regulations and increased taxation on small businesses and higher income earners is certain.

The Survival Mentality

In such a tough, low growth environment, businesses must be more innovative. For instance, 80 million Millennials (those between 15 and 35 years old) will soon have more spending power than any other generation in history. The common characteristic of this generation is they make spending decisions only after consulting social media (friends, Web sites, comments from strangers).

Businesses have to recognize this and play in that space. This generation also has different attitudes toward such things as cars. They are more interested in convenience and access than ownership. In addition, the recognition that the more highly educated are likely to have the disposable income may dictate marketing strategy.

In conclusion, don’t expect a return of the “if you build it, they will come” economy. Without an approach that is fundamentally different from what has been the norm for the past 30 years, many businesses will become extinct.

Robert Barone (Ph.D., economics, Georgetown University) is a principal of Universal Value Advisors, Reno, a registered investment adviser. Barone is a former director of the Federal Home Loan Bank of San Francisco and is currently a director of Allied Mineral Products, Columbus, Ohio, AAA Northern California, Nevada, Utah Auto Club, and the associated AAA Insurance Co., where he chairs the investment committee. Contact Robert Barone or the professionals at UVA (Joshua Barone and Andrea Knapp) are available to discuss client investment needs.
Call them at 775-284-7778.
Statistics and other information have been compiled from various sources. Universal Value Advisors believes the facts and information to be accurate and credible but makes no guarantee to the complete accuracy of this information.

September 23, 2013

Enjoy the party, but beware of the hangover 09.22.2013

Posted in taxes, Uncategorized, Wall Street tagged , at 7:07 PM by Robert Barone

Despite what was widely viewed as a weak employment report in early September, the U.S. economy appears to be on solid footing. Both ISM manufacturing and nonmanufacturing indexes for August were strong, with the nonmanufacturing index setting a record high. Initial unemployment claims have been in a steady and steep downtrend since 2010. Job openings in the private sector are higher than at any time since 2008, and employers complain they cannot find qualified candidates. So, while we aren’t quite in a boom, put any thoughts of recession on the back burner. But, make no mistake, inflation lies ahead.

Political gridlock

The No. 1 reason for this inflation forecast is the inability of governments at all levels, but especially the federal government, to rein in spending. At least once each year, we are treated to a confrontation between left and right over budgeting, spending and the deficit. But, nothing is ever resolved — the can is just kicked further down the road. The table above uses Congressional Budget Office baseline forecasts, which are quite optimistic. The table displays the baked-in growth in federal spending as a percentage of total economic output (gross domestic product).

09.22.2013 ART

Sources: Heritage Foundation; Jeffrey Gundlach/Doubleline Funds; U.S. Debt Clock website; Congressional Budget Office

2020 is only six years away, and 2030 but 16. From 1959-2008, the average revenue of the federal government as a percentage of GDP was 18.1 percent. For 2013, year to date, it is 16.9 percent. To balance the budget in the next six years, current tax rates must rise 43 percent. To balance it by 2030, those tax rates have to rise 59 percent. And these data points come from optimistic CBO forecasts. In an economy that the Fed considers so sluggish so as to not start its “taper” process, it is unlikely that taxes can be raised to these levels. Furthermore, the middle class, which pays most of the taxes, is rapidly shrinking due to the stealth inflation that has sapped their purchasing power. And, of course, the political chasm and resulting gridlock between the left and right has made addressing the automatic growth in federal spending essentially impossible.

The big story of the week was the fact that the Fed decided to keep the pedal to the metal (the “no taper” announcement) and the rapid growth in its balance sheet, which, essentially, is the creation of money that the banking system can lend several times over, continues unabated at $85 billion per month. Wall Street, the main receptor of the Fed’s largesse, sent the equity averages to all-time highs. But the Fed’s credibility took a hit, especially since the chairman telegraphed the “taper” way back in May. The very next day (Thursday), both jobless claims and existing home sales showed a much stronger underlying economy than expected. The markets now are questioning the Fed’s ability to even read the underlying trends.

Since the financial crisis, the Fed’s balance sheet has grown about $3 trillion, from about $800 billion to more than $3.6 trillion. During that same time period, U.S. Treasury debt outstanding has grown from $10 trillion to $17 trillion. In effect, the Fed has “monetized” 43 percent of the new debt over this period. Given the growth in automatic federal spending, it appears that monetizing the debt will be a major function of the Fed.

Conclusions:

• The economy is stronger than the Fed thinks and the unemployment report intimated.

• This is the first Fed in modern history to advocate higher rates of inflation (2.5 percent). Don’t be fooled; do you think that when the official CPI reaches 2.5 percent, it will automatically stop there because that is the Fed’s target?

• The rapid growth in automatic federal spending over the next few years will require the Fed to continue its large-scale asset purchases, just to support the Treasury’s need to issue debt and to keep interest rates down. Otherwise, the cost of interest alone will overwhelm the federal budget. The alternative, much higher taxation, is not politically viable.

• Ultimately, the dollar will weaken as the world recognizes that dollar debasement is occurring. Note that on the day of the Fed “no taper” announcement, gold rose by $55 an ounce. Market players aren’t stupid.

• Meanwhile, enjoy the continuation of the Wall Street party. But, beware of the inflation hangover.

Robert Barone (Ph.D., economics, Georgetown University) is a principal of Universal Value Advisors, Reno, a registered investment adviser. Barone is a former director of the Federal Home Loan Bank of San Francisco and is currently a director of Allied Mineral Products, Columbus, Ohio, AAA Northern California, Nevada, Utah Auto Club, and the associated AAA Insurance Co., where he chairs the investment committee. Barone or the professionals at UVA (Joshua Barone, Andrea Knapp, Matt Marcewicz and Marvin Grulli) are available to discuss client investment needs.

Call them at 775-284-7778.

Statistics and other information have been compiled from various sources. Universal Value Advisors believes the facts and information to be accurate and credible but makes no guarantee to the complete accuracy of this information.

September 4, 2013

Hidden Inflation Slows Growth, Holds Down Wages

Posted in Inflation, Robert Barone, taxes, Uncategorized tagged , at 7:52 PM by Robert Barone

On Thursday, August 29th, fast-food chain workers conducted strikes in nearly 60 cities asking that chains like McDonalds (MCD), Burger King (BKW), Wendy’s (WEN) and Yum Brands (YUM) (which holds KFC and Taco Bell) boost their minimum hourly pay to $15/hour.

Meanwhile, the saga between Walmart (WMT) and the D.C. City Council continues with Mayor Gray having 10 days from August 30th to sign or veto legislation which requires Walmart (WMT) to pay a minimum wage of $12.50/hour while other employers are only required to pay the D.C. minimum wage of $8.25/hour.

The Income Gap

In 1980, wage earnings as a percent of Gross Domestic Income (GDI, the sister concept to GDP) were 49%. In the last GDI report, they were closer to 42%. Meanwhile, corporate profits are up 50% from about 8% of GDI in 1980 to about 12% today. There is no doubt that the income gap between the rich and the middle class is growing.

The Slide in GDP Growth

The accompanying table shows the Compounded Annual Growth Rate (CAGR) of Real GDP (as “officially” measured) from the bottom of each of the last four recessions to the following peak.

09.04.2013

Source: Department of Commerce

It is notable that the CAGR of Real GDP in today’s recovery (2.23%) is about half the pace in the recovery from the recession of the early ‘80s. Note that in each subsequent cycle since 1982, GDP’s CAGR has slid more than 50 basis points.

The “Official” CPI

In the mid-90s it was determined that demographics would become an issue regarding the cost of social programs like Social Security and Medicare. So, the CPI formulation was changed so as to slow down the “official” rate of inflation, which, in turn, slowed the cost of the social programs.

But there was also an unintended consequence, one not recognized by any politician or the main stream media today. Because the “official” CPI is widely accepted as “the” measure of inflation, and because “cost of living” raises for most of middle America are based on it, its manipulation over time has lowered the real incomes of wage earners (the middle class) with the resulting negative impact on the CAGR of Real GDP, because if the prices of goods and services are actually rising faster than incomes, then aggregate demand is negatively impacted.

I first published the accompanying graph on August 12th at TheStreet.com (“CPI Manipulation Has Exacerbated the Income Gap”). The graph shows the growth rates in the official CPI, Average Hourly Earnings, Corporate Profits, and the Shadowstats (John Williams) computation of inflation. As you can see from the graph, wages have only kept pace with “official” CPI, but corporate profits have grown more in line with the Shadowstats inflation rate (SGS Alternative CPI, 1980-based), interrupted only by an occasional recession. There are several private sector measurements of true inflation including that published by John Williams. In each private sector survey, the cost of living is shown to be rising significantly faster that the “official” CPI.

09.04.20130 - 2

Sources: Bloomberg, Federal Reserve Bank of St. Louis, & Shadowstats.com

Conclusion

If the “official” CPI had accurately reported inflation over the past 20 years, it is likely that wage rates today would be significantly higher, that wage earnings would command a larger percentage of GDI, that aggregate demand would be more robust because a larger share of income would be in the hands of those with higher marginal propensities to consume, and that GDP would be growing faster.

For those in Washington D.C. waiting for Mayor Gray to make a political decision about wages for Walmart (WMT) employees, and for those disgruntled fast-food workers who conducted strikes in 60 cities in late August, be careful who you blame. The federal government has the power to remedy the wage situation and the income gap simply by being forthright about the real rate of inflation.

Robert Barone (Ph.D., economics, Georgetown University) is a principal of Universal Value Advisors, Reno, a registered investment adviser. Barone is a former director of the Federal Home Loan Bank of San Francisco and is currently a director of Allied Mineral Products, Columbus, Ohio, AAA Northern California, Nevada, Utah Auto Club, and the associated AAA Insurance Co., where he chairs the investment committee. Barone or the professionals at UVA (Joshua Barone, Andrea Knapp, Matt Marcewicz and Marvin Grulli) are available to discuss client investment needs.

Call them at 775-284-7778.

Statistics and other information have been compiled from various sources. Universal Value Advisors believes the facts and information to be accurate and credible but makes no guarantee to the complete accuracy of this information.

February 12, 2013

‘Margin Tax’ a potential disaster for Nevada

Posted in Nevada Legislature, taxes, Uncategorized tagged , , at 6:29 PM by Robert Barone

On Jan. 31, the Nevada Supreme Court reversed a lower court decision and reinstated the “margins tax” petition sponsored by the state’s teachers’ union. As a result, the proposed tax likely is to be on the 2014 general election ballot.

The Texas experience

Texas adopted a margins tax in 2006 with its effective implementation in 2008. There were five goals of the Texas experiment: fairness, broad based, modern, understandable and competitive. None has been achieved. The tax falls disproportionately on different types of businesses, with businesses with high labor costs, like law firms, paying little, while those with low labor, like money managers, paying significantly more as a percentage of their revenue. The tax turned out to be extremely complex with high enforcement issues and complex tax forms to fill out. Finally, the tax discourages businesses from relocating to the state.

The 2011 Nevada Legislature

In the 2011 Nevada legislative session, a “margins tax” was proposed to take the place of the current “modified business tax,” a tax currently on payrolls. Because of the failure of this tax in Texas, the effort had so little traction that it never even was brought up for a committee vote.

In Texas, the tax rate is 1 percent on “taxable margins” with some select industries paying only 0.5 percent (they had better lobbyists). The first $1 million of revenue is exempted. In the 2011 Nevada legislative session, the proposed rate was 0.8 percent, with the first $1 million of revenue exempted. And, remember, it was supposed to replace the “modified business (payroll) tax.” But, as it likely will appear on the ballot, the tax rate suddenly has shot up to 2 percent and, unlike the original proposal, the “modified business tax” remains. The proposed Nevada tax, like the one in Texas, defines three options from which businesses can choose:

• Total revenue minus cost of goods sold (in Texas, there is a huge controversy as to what “cost of goods sold” includes); or

• 70 percent of total revenue.

Dangers to Nevada’s economy

It is important that voters understand this tax before they go to the polls. It is often the case that voters will vote for a tax that they don’t think will impact their own pocketbooks. And, the advertising for this tax is sure to position it as one needed for K-12 education. Unfortunately, there is no guarantee there will be more K-12 funding if the tax is passed as the Legislature will be able to reduce existing funding if it so chooses, spending that money elsewhere.

The “it won’t impact me” perception, however, is inaccurate, as the passage of the tax could significantly and negatively impact economic growth prospects for the state, something that impacts every citizen’s wages and benefits and job prospects. The passage of such a tax likely is to destroy any hope that Nevada can become a haven for high tech, other high margin or nationally recognized companies.

Braeburn Capital is a Reno-based subsidiary of Apple. It was created in 2006 to manage Apple’s considerable stash of cash (currently about $65 billion) to avoid California taxes. I have no direct knowledge of the size of the assets that Braeburn manages, but let’s just assume that it is $10 billion of Apple’s considerable stash. A 6 percent annual return would mean $600 million in revenue, which, using the 70 percent of revenue election and a 2 percent tax rate, translates into $8.4 million in taxes. Since it fled California due to taxes, there is a very real risk it also will flee Nevada.

Warehousing companies like Amazon.com and Barnes and Noble, already here, likely will look elsewhere. Microsoft has its licensing division in Reno. Intuit has a similar division, as does Oracle. And, think about the money managers and hedge funds on the Nevada side of Lake Tahoe. Licensing, money management and hedge funds are businesses with small staffs and no cost of goods sold component. With 70 percent of the revenue subject to a 2 percent tax, management likely is to take notice.

Conclusion

The “margins tax” has been an abject failure in Texas. The same tax proposed for Nevada is more than twice as high, and more than double what was proposed in the 2011 Legislature. It is likely to drive out high-margin businesses. The tax burden will fall upon the middle class via lower pay and benefits and reduced job opportunities. Worse, for the next two years, because the tax is on the ballot, businesses that might have considered Nevada as a situs now will be looking elsewhere.

No doubt the tax regime in the state needs an overhaul. The margins tax will just make the current tax system worse. How about a broad-based consumption tax? That would satisfy all of the five broad and desirable goals that Texas originally sought. The Legislature should think about that.

Robert Barone (Ph.D., economics, Georgetown University) is a principal of Universal Value Advisors, Reno, a registered investment adviser. Barone is a former director of the Federal Home Loan Bank of San Francisco and is currently a director of Allied Mineral Products, Columbus, Ohio, AAA Northern California, Nevada, Utah Auto Club, and the associated AAA Insurance Co., where he chairs the investment committee. Barone or the professionals at UVA (Joshua Barone, Andrea Knapp, Matt Marcewicz and Marvin Grulli) are available to discuss client investment needs. Call them at 775-284-7778.

Statistics and other information have been compiled from various sources. Universal Value Advisors believes the facts and information to be accurate and credible but makes no guarantee to the complete accuracy of this information.

December 31, 2012

Barone: 2013: Forecasts for the unsettled road ahead

Posted in Economy, Markets, taxes, Uncategorized tagged , , , at 7:59 PM by Robert Barone

Forecast 1: Slow economic growth in 2013’s first half; second half could be better.

Whether we go over the “fiscal cliff” or not, the first part of 2013 will be quite slow with the possibility that even the “official” numbers could show up as negative. At this writing, it does not appear that the Washington politicians will reach any sort of meaningful deal by year’s end. But, even if they do:

• Economic confidence already has plummeted.

• There are significant 2013 tax increases in Obamacare and a return to normalcy in the employee portion of the Social Security tax; furthermore, the end of extended unemployment benefits is a significant hit to consumer income.

• The job market remains weak; much of it due to a skills mismatch, which is a very long-term structural issue.

• Consumers’ real incomes continue to fall.

The second half of the year might be a different story. If some fiscal certainty is delivered in January, U.S. business investment spending, currently at a six-decade low, easily could pick up and spur the economy above the 1 to 2 percent growth rates we have seen in recent years.

Forecast 2: Nevada’s housing market will continue to struggle.

The housing market in Nevada appears to have been a bright spot for 2012. Realtors indicate that the rise in the median price is due to a shortage of supply, not an increase in demand. Nevada’s AB284, effective in October 2011, all but halted foreclosures. There remains a dearth of first-time and move-up homebuyers. I suspect this scenario will change in 2013 as the Legislature, prodded by the powerful banking lobby, deals with the technical issues in AB284 that now make it difficult and dangerous for mortgage holders to foreclose. That means more supply in 2013’s second half, and, perhaps, a plateau in home prices.

Forecast 3: Europe will sink further in 2013.

The markets are thrilled that Europe is uniting to save its insolvent banking system. While the immediate crisis has been averted through the injection of liquidity, the insolvency issues remain. The chosen path for Europe is to inflate its way out.

In 2013, the European Union will continue to be ensnared in a significant recession (depression in Greece, Spain and Portugal). France, considered to be part of the strong northern European core, also will enter recession in 2013. Even the mighty Germans will be hard-pressed to show more than a flatline.

Forecast: We have not yet seen the last of the European Union implosion. It has just been placed on the back burner with the European Central Bank’s adoption of Bernanke-style money printing policies.

Forecast 4: The Chinese miracle will continue in 2013.

China avoided a “hard landing” in 2012. The reason: A one-party political system doesn’t end up in policy gridlock. There is hot debate as to the sustainability of the current Chinese turnaround, but one thing is for sure: Economic policies, be they right or wrong, are carried out quickly and the economic impacts are felt with minimal time lags.

Forecast 5: The currency race to the bottom will intensify in 2013.

All of the world’s major central banks (the Fed, Bank of Japan, ECB and Bank of England) are printing money at breakneck speed.

The Fed is printing at least $85 billion per month, which, at least temporarily, allows the Washington politicians to shirk their fiscal responsibilities. After all, even if foreign demand for U.S. treasuries (i.e., Japan and China) dries up, the Fed will purchase any new debt due to the tax and spending imbalance.

The same scenario is true in Japan where the newly elected Prime Minister Shinzo Abe has successfully attacked the independence of the Bank of Japan, which now appears willing to print enough to cover the fiscal deficits on which Abe campaigned. Ditto for the U.K.

All of this money printing is really a form of mercantilism, i.e., policies aimed at producing a positive trade balance, resulting in higher factory output and employment levels at home. China is the world’s role model in this regard.

I call this the “race to the bottom,” because when every country does this, as is the current situation, not only is it a zero-sum game (i.e., no one wins), but there are significant unintended consequences. We see this throughout the world with zero interest rate policies penalizing seniors and savers.

Forecast 6: Precious metal, art and gem nominal prices will rise in 2013.

After 10 years of strong gains, the prices of precious metals recently have seen downward pressure due, in part, to profit taking ahead of inevitable capital gains tax increases in the U.S. in 2013. There also is a rumor of significant liquidations in a large hedge fund (Paulson), which has heavy gold investments.

Nevertheless, the underlying demand for precious metals, art, gems and other hard assets is strong, especially in the face of the “race to the bottom.” My forecast is for the nominal prices of these assets to continue their upward trajectory as every country in the industrialized world has chosen inflation over fiscal austerity.

Robert Barone (Ph.D., economics, Georgetown University) is a principal of Universal Value Advisors, Reno, a registered investment adviser. Barone is a former director of the Federal Home Loan Bank of San Francisco and is currently a director of Allied Mineral Products, Columbus, Ohio, AAA Northern California, Nevada, Utah Auto Club, and the associated AAA Insurance Co., where he chairs the investment committee. Barone or the professionals at UVA (Joshua Barone, Andrea Knapp, Matt Marcewicz and Marvin Grulli) are available to discuss client investment needs. Call them at 775-284-7778.

Statistics and other information have been compiled from various sources. Universal Value Advisors believes the facts and information to be accurate and credible but makes no guarantee to the complete accuracy of this information.

December 3, 2012

Barone: Spending: the nation’s real fiscal cliff issue

Posted in Economy, government, recession, taxes, Uncategorized tagged , , , , at 11:51 PM by Robert Barone

The business media is fixated on the “fiscal cliff” issue, not because its avoidance will spur economic growth, but because failure to avert it likely would mean another severe contraction in an already underperforming economy.

The most likely short-run outcome is for Congress and President Barack Obama to reach a “compromise,” which “kicks the can down the road” and gives these institutions additional time to resolve the issues. “Kicking the can” is a skill that has been mastered by politicians throughout the world, especially over the past five years.

The most significant and serious issue of the fiscal cliff, one that has been discussed but poorly analyzed, is the “spending” issue. Most Americans who pay some attention to the federal budget issues believe that the deficits have been $1.1 trillion to $1.5 trillion in the Obama era, and about half of that level when George W. Bush was president. The reality is that the federal budget deficit is grossly understated. It is calculated on a “cash” basis, meaning that only current cash-in and cash-out is counted. Future promises are completely ignored in calculating this deficit.

Think about this: Every single day for the next decade or so, 10,000 Americans will become eligible for Medicare and Social Security. These programs have no real assets of their own and must be financed out of current tax revenue. Today, 86 perrcent of all federal revenue collected already is committed as “transfer” payments (Social Security, Medicare/Medicaid, income security and federal pensions) (USDebtClock.org). Just think of how much federal revenue will have to rise just to take care of these newly eligible benefit recipients. If interest on the debt (at historically low interest rates) is added, 97 percent of federal revenues are already accounted for. That leaves precious little for all of the rest of the federal functions, including defense, education, environment, homeland security, immigration, agriculture, foreign policy, etc.

Every publicly traded company in America is required to report their financials on a Generally Accepted Accounting Principles (GAAP) basis. GAAP reporting includes, via a present value process, taking into account the cost of future promised payments. The underfunding of public pensions has become a big issue in America today.

But, even a pension that is 40 percent underfunded still has 60 percent of the assets that it needs. The promises made for all of the social programs of the federal government have 0 percent of the assets needed to meet the required payments. All must come from current tax collections and borrowing. You can see how the problem is exploding, given the current demographics of the population and those rapidly becoming eligible for such transfer payments.

Once each year, by statute, and to little fanfare, the U.S. Treasury reports (Dec. 15) what GAAP accounting would be for the federal budget. In 2004, under Bush, the headline federal cash-based deficit was $412 billion, but, because of changes to Medicare that year (prescription drugs), the GAAP-based deficit exploded to $11 trillion. For the first three years of the Obama era, the GAAP-based deficit exceeded $5 trillion each year.

The Treasury recently has postponed release of the 2012 fiscal year (ended Sept. 30) GAAP deficit until Jan. 17 so as not to inflame the fiscal cliff negotiations. I’ve seen an estimate from John Williams, a noted economist (shadowstats.com), that puts the 2012 GAAP deficit at $7 trillion, or about 44 percent of the entire output (GDP) of the country. Worse, while the official U.S. debt is approaching $15.2 trillion, the actual amount of promises already made for Social Security, Medicare and prescription drugs is more than $121.6 trillion, according to USDebtClock.org (and about $88 trillion using official U.S. Treasury estimates, according to Williams). Using the USDebtClock.org data, which appears to be more comprehensive, that amounts to $386,000 in unfunded promises for every U.S. citizen and $1,059,000 for each U.S. taxpayer.

Just to put this in perspective, the estimated value of all U.S. business, corporate and household assets is only $87.4 trillion. Now, do you see the magnitude of the spending issue?

No amount of spending cuts outside the social and entitlement programs and no amount of tax increases can bring the real GAAP budget deficits into balance. This fiscal cliff appears to be the last real opportunity to address the deteriorating spending issue.

Unfortunately, unless the social programs are addressed, the overspending issue isn’t going to be touched.

No doubt, a successful fiscal cliff can-kicking will encourage equity investors and most likely propel stocks upward, at least for the short term. But, if the social program and entitlement issues are not addressed, then all of us should worry about the future value of the dollar and future interest rates. The current situation in Greece will be just a microcosm of what could happen here.

Given the recent track record of Congress and the president on spending issues, you should begin to prepare your portfolio now.

Robert Barone (Ph.D., economics, Georgetown University) is a principal of Universal Value Advisors, Reno, a registered investment adviser. Barone is a former director of the Federal Home Loan Bank of San Francisco and is currently a director of Allied Mineral Products, Columbus, Ohio, AAA Northern California, Nevada, Utah Auto Club, and the associated AAA Insurance Co., where he chairs the investment committee. Barone or the professionals at UVA (Joshua Barone, Andrea Knapp, Matt Marcewicz and Marvin Grulli) are available to discuss client investment needs. Call them at 775-284-7778.

Statistics and other information have been compiled from various sources. Universal Value Advisors believes the facts and information to be accurate and credible but makes no guarantee to the complete accuracy of this information.

July 9, 2012

Economic issues, good and bad

Posted in Banking, Big Banks, debt, Economic Growth, Economy, Europe, Federal Reserve, Finance, government, greece, Housing Market, International Swaps and Derivatives, investment advisor, investment banking, investments, Italy, recession, sovereign debt, Spain, taxes, Unemployment tagged , , , , , , , , , , , , , , , , , , , , , , , , , at 3:17 PM by Robert Barone

This is a mid-year overview of the economic and policy issues in the U.S. and worldwide, both positive and negative. I have divided the issues into economic and policy issues. With enough political will, policy issues can be addressed in the short run, while economic issues are longer-term in nature and are clearly influenced by policy.

Positives

• Cheap energy (economics and policy): There is growing recognition that cheap energy is key to economic growth; the next boom will be based on cheap energy.
 
• Manufacturing (economics): After years of decline, American manufacturing is in a renaissance, led by the auto industry.

• Corporate health (economics): Large corporations are extremely healthy with large cash hoards and many have low cost and low levels of debt.

• Politics (policy): Americans are tired of special interests’ ability to pay for political favors.

 
Negatives
 
• Recession in Europe (economics): This has implications for world growth because Europe’s troubled banks are the engines of international lending; Europe’s economy rivals that of the U.S. in size.

• European Monetary Union (policy): A Greek exit from the euro is still probable after recent election and is likely to spread contagion to Portugal, Spain and even Italy. There is also danger here to America’s financial system.

• Brazil, Russia, India, China or the BRIC, Growth Rate (economics): China appears to be in danger of a hard landing, as is Brazil. India is already there. This has serious implications for commodity producers like Canada and Australia.

• Fiscal cliff and policy uncertainties (policy): A significant shock will occur to the U.S. economy if tax policy (Bush tax cut expiration and reinstatement of the 2 percent payroll tax) isn’t changed by Jan. 1, 2013.

• Entitlements (policy): Mediterranean Europe is being crushed under the burden of entitlements; the U.S. is not far behind. This is the most serious of the fiscal issues but the hardest for the political system to deal with.

• Housing (economic & policy): In the U.S., housing appears to have found a bottom, but because of falling prices and underwater homeowners, a significant recovery is still years away. Housing is a huge issue in Europe, especially Spain, and it will emerge as an issue in Australia and Canada if China has a hard landing.

• Energy costs (economics & policy): The current high cost of energy is killing worldwide growth (see “Positives” above).

• U.S. taxmageddon (policy): The U.S. tax system discourages savings and investment (needed for growth), encourages debt and favors specific groups.

• Too Big To Fail (TBTF) (policy): The U.S. financial system is dominated by TBTF institutions that use implicit government backing to take unwarranted risk; TBTF has now been institutionalized by the Dodd-Frank legislation; small institutions that lend to small businesses are overregulated and are disappearing.

• Debt overhang (economics): The federal government, some states and localities and many consumers have too much debt; the de-leveraging that must occur stunts economic growth.

• Inflation (economics & policy): Real inflation is much higher than officially reported. If a true inflation index were used, it is likely that the data would show that the recession still hasn’t ended.

It is clear from the points above and from the latest data reports that worldwide, most major economies are slowing. It is unusual to have them all slowing at the same time and thus, the odds of a worldwide recession are quite high.

In the context of such an event or events, the U.S. will likely fare better than most. But that doesn’t mean good times, just better than its peers. There is also greater potential of destabilizing events (oil and Iran, contagion from Europe, Middle East unrest), which may have negative economic impacts worldwide. Thus, in the short-term it appears that the U.S. economy will continue its lackluster performance with a significant probability of an official recession and vulnerable to shock type events. (Both the fixed income and the equity markets seem to be signaling this.)

 
 
The extension of Operation Twist by the Federal Reserve on June 20 (the Fed will swap $267 billion of short-term Treasury notes for long-term ones through Dec. 31 which holds long-term rates down) was expected, and continues the low interest rate policy that has been in place for the past four years. That means interest rates will continue to remain low for several more years no matter who is elected in November. Robust economic growth will only return when policies regarding the issues outlined in the table are addressed.

Looking back at my blogs over the years, I have always been early in identifying trends. The positive trends are compelling despite the fact that the country must deal with huge short-term issues that will, no doubt, cause economic dislocation.

The only question is when the positives will become dominant economic forces, and that is clearly dependent on when enabling policies are adopted. 1) In the political arena, there is a growing restlessness by America’s taxpayers over Too Big To Fail and political practices where money and lobbyists influence policy and law (e.g., the Taxmageddon code). 2) The large cap corporate sector is healthier now than at any time in modern history. Resources for economic growth and expansion are readily available. Only a catalyst is needed. 3) America is on the “comeback” trail in manufacturing. Over the last decade, Asia’s wages have caught up.

Cultural differences and expensive shipping costs are making it more profitable and more manageable to manufacture at home. 4) Finally, and most important of all, unlike the last 40 years, because of new technology, the U.S. has now identified an abundance of cheaply retrievable energy resources within its own borders. As a result, just a few policy changes could unleash a new era of robust economic growth in the U.S. Let’s hope those changes occur sooner rather than later!

 
Robert Barone (Ph.D., Economics, Georgetown University) is a Principal of Universal Value
Advisors (UVA), Reno, NV, a Registered Investment Advisor. Dr. Barone is a former Director of the Federal Home Loan Bank of San Francisco, and is currently a Director of Allied Mineral Products, Columbus, Ohio, AAA Northern California, Nevada, Utah Auto Club, and the associated AAA Insurance Company where he chairs the Investment Committee.
 
Information cited has been compiled from various sources which UVA believes to be accurate and credible but makes no guarantee as to its accuracy. A more detailed description of the company, its management and practices is contained in its “Firm Brochure” (Form ADV, Part 2A) which may be obtained by contacting UVA at: 9222 Prototype Dr., Reno, NV 89521. Ph: (775) 284-7778.

April 9, 2012

Financial armageddon: Should you worry?

Posted in Armageddon, Banking, crises, debt, Economic Growth, Economy, Finance, government, Housing Market, investment advisor, investment banking, investments, IRS, medicare/medicaid, Nevada, payroll tax reductions, recession, social security, taxes tagged , , , , , , , , , , , , , , , , , at 8:37 PM by Robert Barone

You’ve probably seen them in your email, or even on TV — I’m talking about the “approaching financial armageddon” forecasts. People must be responding to them, because they keep on appearing in my email — several per week, and others I know get them too. Should you be concerned?To answer this, we examine data from the six largest categories of Federal expenditures in 2000, 2012, projections for 2016, and their associated compounded annual growth rates (CAGR). Much of this data comes from USdebtclock.org. Caution, the website is not for the faint of heart.Six expense categories (Medicare/Medicaid, social security, income security, federal pensions, interest on debt and defense) account for nearly $3.1 trillion of spending in 2012, represent more than 86 percent of total federal spending and account for 137 percent of taxes collected. These six spending categories are critical when trying to understand the nature and extent of the structural deficit.Growth rates in CAGR show Medicare/Medicaid spending growing to $1,050 billion per year in 2016. The demographics of the U.S. population don’t show us getting younger and baby boomers are just beginning retirement. Social Security will also advance much more quickly than its 5.4 percent growth rate of the past 12 years. All in all, the projection of expenses I’ve shown in the table for 2016 ($3,692 versus $2,265 in 2012) appear quite optimistic. But, let’s go with it.Americans, in general, will tell you they oppose bigger government, at least in the abstract. But in poll after poll, when asked where Congress should make significant cost cuts, almost no specific program eliminations are favored by a majority of Americans. Given this predilection among Americans and assuming that these six categories again account for 86 percent of Federal spending in 2016, then, total Federal spending will be approximately $4.3 trillion.

Some analysts fret about the “fiscal cliff” on Jan. 1, 2013 when the Bush tax cuts are scheduled to expire along with the 2 percent payroll tax reduction for individual social security contributions.

Those analysts put the impact of these at a 3 to 4 percent GDP reduction. When the Bush tax cuts expire, the Federal government theoretically could collect about $300 billion more in taxes if economic activity were otherwise unchanged (a heroic assumption). In addition, the reinstatement of the 2 percent social security tax on individuals will add about $160 billion to tax revenues (again, assuming no decline). The breakout with this story is an estimate of what the deficit would be and its relationship to 2016 GDP. It assumes the Bush tax cuts have been eliminated, the payroll taxes are reinstated, and economic activity is not negatively impacted, so it is likely to understate the deficit. The tax revenue growth rates (left hand column) begin in 2013, after the “fiscal cliff.”

As you can see from the table, reinstatement of the Bush tax cuts and the payroll tax reductions alone do little to solve the issue, as the deficit remains at $1.54 trillion if no further tax increases occur.

 

OUR ‘FISCAL CLIFF’

If Tax CAGR is: Deficit/GDP will be: Deficit will be ($trills):
0% 9.1% $1.54
5% 6.6% $1.12
7% 5.5% $0.93
8% 4.9% $0.83
10% 3.7% $0.63
16% 0.0% $0.00
 
Such a tax regime will clearly keep the economy in a no growth or recessionary mode. If America resists the tax increases, then deficits will balloon, interest rates will rise as the world spurns the dollar, the Fed will continue to print money and purchase the debt that can’t be placed externally, a nasty inflation will likely set in (it has already begun — look at food and energy prices), and we will find ourselves in a Greek type tragedy. The only way out is to significantly cut the growth of Medicare/Medicaid, Social Security, Income Security and Federal Pensions. Which Congress and president will do that?So, should you be concerned about an approaching financial armageddon? Yes.
  

Robert Barone and Joshua Barone are Principals and Investment Advisor Representatives of Universal Value Advisors, LLC, Reno, NV, an SEC Registered Investment Advisor.

Statistics and other information have been compiled from various sources. Universal Value Advisors believes the facts and information to be accurate and credible but makes no guarantee to the complete accuracy of this information.

Universal Value Advisors, LLC is a registered investment adviser with the Securities and Exchange Commission of the United States. A more detailed description of the company, its management and practices are contained in its “Firm Brochure”, (Form ADV, Part 2A). A copy of this Brochure may be received by contacting the company at: 9222 Prototype Drive, Reno, NV 89521, Phone (775) 284-7778.

Robert Barone (Ph.D., Economics, Georgetown University) is a Principal of Universal Value Advisors (UVA), Reno, NV, an SEC Registered Investment Advisor. Dr. Barone is a former Director of the Federal Home Loan Bank of San Francisco, and is currently a Director of Allied Mineral Products, Columbus, Ohio, AAA Northern California, Nevada, Utah
Auto Club, and the associated AAA Insurance Company where he chairs the Investment Committee.

 Information cited has been compiled from various sources which UVA believes to be accurate and credible but makes no guarantee as to its accuracy. A more detailed description of the company, its management and practices is contained in its “Firm Brochure” (Form ADV, Part 2A) which may be obtained by contacting UVA at: 9222 Prototype Dr., Reno, NV 89521. Ph: (775) 284-7778.

 

February 22, 2012

Dr. Robert Barone Interview with Face the State on KTVN News Ch2

Posted in Banking, Big Banks, Business Friendly, Economy, Education, Finance, Foreclosure, Gaming, government, Housing Market, investment advisor, Las Vegas, Nevada, taxes, Unemployment tagged , , , , , , , , , , , , , , , , , , , , , , , , , , at 4:15 PM by Robert Barone

If you missed the televised interview with Robert Barone on February 16th, 2012 with Face the State on Ch.2 News, you can watch the video by clicking the link below.

Dr. Robert Barone Interview with Face the State on KTVN Ch. 2 News

February 16, 2012

Debunking the Warren Buffett Tax Deception

Posted in Economy, Finance, government, investment advisor, investment banking, investments, IRS, local banks, taxes tagged , , , , , , , , , , , , , , , , , , , , , at 10:10 PM by Robert Barone

It is an election year, so the media makes a big deal out of Warren Buffett’s assertion that the tax system unfairly taxes his supposedly “working class” secretary at 33% (we’ve also seen 34% and 35.8%), while he only pays 13.7% (we’ve also seen 17.4%) on the millions that he makes.

The political implication is that he, and others like him, such as GOP hopeful Mitt Romney, somehow aren’t paying their “fair share” of taxes.

But instead of doing even superficial analysis, the media carries the story at face value. That is naive. Even a slight amount of digging will turn this story upside down.

Let’s start with Buffett’s secretary, Debbie Bosanek. In order to pay a marginal tax rate of 33% (or 34% or 35.8%), she would have to be in Occupy Wall Street’s 1%, not the 99%. Using the 2011 tax tables for individuals, if she were single making a $250,000 adjusted gross income (that’s after deductions!), she would be in the 33% marginal tax bracket and would have a 27% effective tax rate. To get to the 35% marginal tax bracket, her adjusted gross income would have to be more than $379,000. Isn’t a $250,000 income the magic line that [President Barack] Obama has drawn that demarcates those who he is targeting as “rich” and should be paying more taxes? So, let’s not be deluded into thinking that his woman somehow represents America’s working class.

But the bigger deception is Buffett’s claim that he pays a much lower tax rate than he supposedly should. A quick review of business taxation in the US today will show that Buffett pays in excess of 30% of his income in taxes.

Most small-business owners choose the Subchapter-S or LLC format for their businesses. Any profit from their business flows directly to their personal taxes (form 1040). Assume two similar businesses, one owned by X and the other by Y. Both businesses make $450,000 in pretax income. Owner X has chosen the LLC format. Owner X’s company pays no taxes to the IRS, but sends Owner X a K-1 requiring X to declare $450,000 on his form 1040. His marginal tax bracket is 35%.

Owner Y has chosen the C-Corp format. Y’s company also had a pretax income of $450,000, which is taxed at the corporate 35% tax rate. Y has chosen to declare a $50,000 dividend to himself which shows up on his 1040 and is taxed at 15%. Looking only at his 1040, you would think that Y doesn’t pay much in taxes. In fact, Y pays more taxes than X because the dividend is double taxed – that is why most small businesses choose the LLC or Sub-S format.

Now let’s talk about Buffett. He is famous for buying large stakes or even controlling interests in large C-Corps. He is the equivalent to Owner Y.   So, the taxes that Buffett pays go well beyond what is shown on his 1040. Like Owner Y, the 13.7% rate on Buffett’s 1040 shows only the taxes he pays on the dividends and therefore is only part of the story. I looked up Buffett’s 13F SEC filing dated January 30, 2011. That filing shows nine major holdings.

Using the share price of each holding and the number of shares shown on the 13F, I estimated the value of each of those holdings. Then, using the C-Corp’s reported effective tax rate, the pretax income per share, and the dividends per share (taxed at 15%), I calculated Buffett’s effective tax rate on each holding. Finally, using the market value of each holding to form a weighted average, I then calculated that Buffett’s effective tax rate on these nine holdings was more than 32%.

Buffett Holdings from September 30, 2011 13F
Click to enlarge

This should debunk the myth that America’s investor class does not pay its “fair share” and that we should put a minimum of 30% on their 1040 filings.

Finally, some advice for Romney. Should you become the GOP candidate, I would advise that you do an analysis on your income similar to what I did for Buffett in the table above. If you are the GOP candidate, you can take the issue of paying your “fair share” of taxes off of the table.

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