Inequality - Does It Really Matter?

"I hope my ship comes in before the dock rots." - Anonymous

The great American heritage is one based on opportunity.  Come to America the land of the free and you can achieve anything your heart desires.  As an immigrant to the United States more than 20 years ago I bought into that dream.  Over the years I have had my share of success and failure but I persevered through thick and thin on a hairline budget in order to break through to the other side.  It has not been easy and even now I have not completely achieved all of my goals and ambitions but then nothing in life worth obtaining is easy, or should be. 

Having arrived in the late 1980's with nothing but a backpack on my back and a few hundred dollars in my pocket it did appear that life was easy and that if you took a chance you could win, however year after year it seemed to be getting more difficult and these past few years have been worse than anything I have experienced.  Now economic problems aside there are numerous studies that have shown that the inequality or the divide between the haves and the have nots has grown to an unimaginable level and that the playing field has been shaped so that the haves can keep theirs while the have nots continue to spiral south.  Is this inequality all it is hyped to be and should we care?

Having come from one of the most economically skewed countries in the world, the South African apartheid economy, I have witnessed first hand inequality.  I have also witnessed that it is unsustainable and that if it is not addressed sooner rather than later that it all ends poorly for the haves.  That is not to say that the United States is anywhere near what South Africa was under apartheid but I use it simply as an example of what can occur.  For other examples look at Russia or other communist societies to see just how skewed wealth can be and how fragile those leadership regiments are.  People will only put up with inequality as long as there is the hope of prosperity (China) but once it becomes clear that there are two sets of rules there is no way to stop the avalanche of change.  Furthermore it makes no economic sense to enforce a level of rigidity to keep the masses down as studies have shown that economies grow far quicker when they are balanced than when they are divided.

During my 20 plus years here numerous changes have shaped America so that it now is the most divided of the world's prosperous democratic countries.  Not what you would expect from the land of the free.  This does not happen over night but happens as laws are crafted to institutionalise the advantages.  There are numerous examples and I will go through a few of them:

1. Tax inequality - high taxes on income tax but low taxes on capital gains.  As the majority of citizens do not own their own businesses or stocks it serves to reduce the burden on the tax to the higher income classes.  The counter argument is that this is a stimulant to investing but if you do not have access to the dollars needed to start then you cannot play.  Take a look at the majority of tax receipts and you will clearly see who pays tax and who does not, in fact 80% of the tax receipts come from payroll and individual taxes while only 9% come from corporations.  Note that I am not suggesting that this should be switched but you can see that getting ahead is not going to come from earning your way out of poverty.
2. Bankruptcy laws - you cannot declare bankruptcy on a student loan but you can walk from a poor investment.  In order to get ahead many get schooled and many of those schools do not provide gainful employment to their students however the student now cannot get rid of that loan while the bankers can walk away Scot free from their poor investments.  Worse still is that small businesses are left to fail while certain too big to fail institutions are propped up with tax payer money and we saw whose money that was!
3. Business regulation - the same laws apply to large businesses as to small businesses.  This burden has kept many people from starting a business.  The costs of complying with all the red tape are overwhelming and the thought of all the expenses associated with hiring a new employee are just too burdensome.  I have met with hundreds of small entrepreneurs and many are considering throwing in the towel as the costs to run a businesses suck the life out of them and in the end they earn less than what they could working for someone else.  This is not a platform that fosters growth or innovation.
4. Health care reform - increasing the payments on health care hurt the small business and the middle class far more than big business and the wealthy.  This is another burden on small business and while I believe that the law was crafted out of concern for those who cannot afford health insurance it has added another layer of expense onto an already over burdened small business owner.
5. Capital mobility - capital is mobile while labor is not.  Once you have accumulated your millions you can leave the mess behind you.  Take your money and run so to speak and there are plenty who have done just that.  Labor however cannot move.  They do not have the resources and are therefore stuck to bear the burden which is why inequality is unsustainable.
6. Printing money - the present methodology of extracting the United States out of its doldrums by printing money directly benefits the haves.  Money printing is not a targeted solution.  Creating money out of thin air does not create jobs it creates inequality as most of that money ends up in the hands of the bankers, speculators and large businesses which once again skews the playing field.  This is why the inequality has grown so fast since 2000 when Greenspan started on this printing racket.  As a simple example look no further than the stock market which continues to plow higher benefiting the rich and large business at the expense of small business as they do not have access to capital.

I am sure there are plenty more examples and I am sure that a lot of you will have a counter argument but it is clear to me that unless the playing field is made level things are not going to improve very quickly in the United States.  Making it easier and less burdensome to start a business encourages entrepreneurs to take the chance.  Some will work and some will not but it will plant the seeds to growth.  From this growth comes hiring and this alleviates the unemployment problem.  Paying people to sit at home for 99 weeks does not and wastes tax payer money.  Give people the opportunity to grow and they will, take that away from them and at some point in the future they will retaliate.

To me this is a relatively easy fix but the question is do we have the leadership to get it done?  It is not long now to see who will take us forward for the next four years and I pray that whomever it is has the vision to get this done but then again I doubt it!

Is Housing Bottoming?

"Up on housing project hill, it is either fortune or fame.  You must pick one or the other but neither one of them are to be what they claim." - Bob Dylan

Trying to pick a bottom in any market is a futile task and one that has destroyed many a trader.  So it is with housing however as I have repeatedly mentioned throughout my blog posts, a recovery in housing will mark a proper recovery in the economy.  So if that is the case I spend a fair amount of time trying to work out whether we are turning the corner in housing.

The most recent Case Shiller Index of United States housing showed a moderate improvement in the price of housing through the nation of 1.3 percent in April (the data takes some time to reach the market).  In recent articles I have read it appears that Arizona has experienced a sudden resurgence in housing prices and contractors have been caught off guard as the number of requests to build or renovate housing has exceeded their expectations.  In fact there is actually a shortage of skilled labor in Arizona and wages in the construction industry are rising.  Now Arizona is a unique case in that it implemented some very stringent immigration controls (that have subsequently been reversed by the White House) but it has done a lot to scare off a number of illegal skilled workers and this could be showing up in the low level of skilled labor in that state but the news is encouraging.

Taking a look at our local market in San Diego I have spent a lot of time speaking to developers and investors and there appears that investors are finding it hard to find good deals and developers are starting to look at new opportunities to build.  This is all good news and may signal that the low interest rate environment is starting to take hold but remember that the market is coming from a very low level.  However, any improvement is encouraging.  In addition with any recovery it comes in fits and starts and this may once again be a false start.  Furthermore you need a solid employment environment to fuel the fire as investors will only buy until rents are once again too low to support mortgage payments.  Therefore to continue to add fuel to the recovery you need homeowners to step into the fray.

That said if the receovery can continue it will start to feed into the unemployment numbers and may slowly start the road to recovery.  Certainly we have a very long road to treck and I am not about to blow the corcks off the champagne as there are many global problems that could derail this modest recovery but at least for once I have something good to report!  Finally it is clear that to continue to support this recovery interest rates must be kept low for at least the next few years, but I have no doubt that the Federal Reserve will continue to force these lower.

What is the Bond Market Telling Us?

"Insanity: doing the same thing over and over again and expecting different results." - Albert Einstein

Around the globe the money printing continues.  Reserve banks in Europe, Britain, Japan, the United States and other countries are printing money in the trillions of dollars.  Ever since Alan Greenspan decided that the best way to save the economy was to print money the mantra of the Federal Reserve bank (and now all central banks it seems) is to hit the print button any time something goes awry.  As the quote above says, doing the same thing over and over (and in the case of printing money over and over and over and over) again expecting different results is shear lunacy but I am afraid that is what is happening.  It did not work in the run-up to 2000 as it created a stock market bubble that burst, it did not work in the run-up to 2007 as the real estate bubble burst and now it is being tried again.  Each time the quantities of money required to kick start the economy are larger and each time the effect is more muted and the problem at the end of the rainbow even more catastrophic.

After trillions have now been printed there is no true form of a recovery - it even appears likely that the world will slip into a recession in the very near future.  A study of the world's bond markets tells us a story and not one that most people believe.  I know plenty of people that believe that the bond market is the next bubble to burst.  There is no way (they say) that bond yields can be kept this low forever and it is just a matter of time before they rise quickly.  As you know by now, if a bond yield rises the price of the bond falls, so the bond bulls in effect lose if this happens.  The main thesis to the argument is that with all the money that is being printed around the world inflation will take hold and once it does, in order to fight inflation, interest rates will rise.  While this may be a reasonable analysis in normal economic conditions, I believe that it is inherently flawed for a number of reasons.

First there is the fear factor.  With all the problems that are going on around the world there is no quick fix.  Most of these problems are structural rather than cosmetic and in order to repair them a complete change to the management of the Euro zone needs to be implemented.  Furthermore a balanced budget in the United States is required and a manageable resolution to the impending problems of underfunded social security and medicare need to be performed.  Without these massive structural changes being implemented (all of which are political suicide for the leader base) there is little hope that the economy will resume its normal growth.  With this uncertainty comes fear and people seek a safe haven to protect their assets and this is driving demand for safety and keeping the interest rates down.

Second there is no desire on the part of the reserve banks of the world to let interest rates move higher.  If you take a simple example of the US budget deficit you can quickly see why.  At present the United States is running a budget deficit of around $1.5 trillion a year.  With the 10 year note at 1.5% the cost of the current portion of the loan balance (excluding social security and medicare holes) costs the United States roughly $300 billion a year to service.  Of a $1.5 trillion deficit this equals 20% of the deficit.  If interest rates rose to say 5% (as some bears say they should), the interest burden would move to roughly $1 trillion.  This would increase the total budget deficit to $2.2 trillion a year and that is completely unmanageable.  This is why when you see interest rates in Italy and Spain rise to above 6% the markets fear a sovereign default.  The reserve banks need to keep interest rates down and they are doing this by buying their own debt!

Third, you have to have inflation to push interest rates higher.  At present with all the excess capacity of high unemployment and at factories around the world, the overall cost of a basket of goods and services is not rising very fast.  Certainly there are parts of the basket that are - food and for a while oil, but even oil prices are down over 25% in the past 6 months and if the global economy contracts next year these will drop even more.  All of this is keeping a relatively tight lid on inflation for now.  Furthermore you need money to move to generate inflation.  This is referred to as the velocity of money.  At present this is stagnant mainly due to the problems that the banks face.  At present the banks are not open to lending like they were a few years ago so regardless of how much money the reserve banks print the money is not moving but is being used to bolster bank reserves.  Should this money start to move, velocity would pick up and at that point you would have inflation.  With all of the global problems and worries it appears that this will not happen any time soon.

Fourth is the crowding out effect.  As sovereign debt makes up more and more of the global debt market it becomes a major factor pinning back growth.  Already we see the impact in the United States where GDP growth is at an anemic rate of 1.9% and trending lower.  It is my contention that this drag will be felt for years to come and will result in a long slow economic recovery interspersed with regular recessions.  Under the weight of this overburdening debt the drag will prolong the problems and will result in anemic growth and low interest rates for years to come.

Based on these points there is a high probability that interest rates will remain low for the foreseeable future which is why bond investors continue to buy bonds even at these incredible low rates.  It is also why the reserve bankers continue to print money as it is cheap and they believe will eventually produce a different result!

The Retirees Connundrum

"The trouble with retirement is that you never get a day off." - Abe Lemons

The blog is a few days later than normal this week as I took some time off to recharge the batteries.  During this time I was able to enjoy a wonderful time with my son and I must say that looking through his eyes (he is 10) anything is possible.  On the flip side I spoke a while back to my brother who is 13 years older than me and I asked him whether with age life became less stressful and I have to say that I was not pleased with the answer.

Through my years of investing money I have never had as good an understanding about retirement and the stresses that institution brings than I do now.  Thousands of Americans are retiring on social security and not much else.  Furthermore those that are retiring on more are finding that 8 percent returns on their money is virtually impossible to achieve without taking on enormous amounts of risk which they can ill afford.  This is causing an enormous amount of stress as suddenly what looked like a good sized nest egg is suddenly meager.

When you retire your money and investments have to support you for the rest of your existence.  Now most of us that make it to retirement age will live a good long life.  While that sounds good it can be miserable if you cannot support yourself and most cannot, particularly when you factor in that the rates of return on "safe" money are pitiful and essentially non-existent.

As an example take an individual who has $1 million saved.  This is a lot even by modern standards.  Suppose that everything is paid off (no house payment, no car payment, no credit card debt) and that they want to enjoy their retirement so they budget $10,000 a month to spend.  This includes travel, eating out, playing golf, seeing friends and family and buying the odd luxury outside of food and gasoline.  If they retire at 60 and live to 90 what rate of return will they need to support this lifestyle (assuming no inflation and that they both die on the same day and have no medical expenses that are in excess of their insurance)?  Leaving nothing behind for their heirs (they spend the last dime on the last day) would require that they earn 11.63% compound annual rate of return on their $1 million portfolio.  In today's current environment that is next to impossible without taking on serious levels of risk.

So what are their alternatives?  Well first off they can retire later or they can cut back their monthly spend or both but either way they need to ratchet down the required rate of return on their investment portfolio substantially.  Given today's low interest rate environment it is imperative that people base their retirement income on rates of return around the 4 percent mark.  While this may seem ludicrously low, show me someone that is actually beating this while maintaining a safe investment portfolio.  Furthermore if the investor achieves a higher rate of return then they will have excess cash to spend on a better lifestyle or to prepare for the large medical expenditure that normally occurs in the last five years of life.

The hope is that this level of return is sufficient to beat inflation as should that rear its ugly head then the hurt is even worse, but for this blog I will not delve into that issue.  For now I will assume that inflation produces the opportunity to earn more on their savings offsetting increases in prices (a pretty wild assumption).

Retirees need to make critical decisions and they require careful thought and planning as otherwise our couple mentioned above will surely run out of money well before they die and that is a real cause for stress!  Back to our example.  If they earn 4 percent on their portfolio what can they actually spend per month?  $4,775 a month is all and remember this does not set aside anything in reserve.  Living exclusively off the interest would reduce that amount to $3,333 a month and believe me even with everything paid for that will be hard to do in southern California which is why you are seeing so many retirees moving to cheaper parts of the globe.

For those condsidering retirement soon please have a financial overview with a trusted professional and make sure that you retire on a realistic budget so that you enjoy yourselves and do not spend your nights awake worrying.  For those of us still working, I am afraid that it will probably be a while before we can even consider retirement as I for one plan to have a ball and that is going to cost me a lot of money!