Monday, January 5, 2009

TAX AND SPEND OR BORROW AND SPEND?/ Managing the Future Now/African Grey Parrot for President of U.S. or Just Citigroup?

I have heard about a million or so times the phrase tax and spend used to describe Democrats. Prior to the success of the Reagan presidency, that may have been an appropriate description. Reagan started us down a new path, where the two parties now share the same tag phrase: borrow and spend. When I was in my twenties and started to make serious money, I was living in Silver Springs, Maryland. Maryland and Montgomery county then had a flat state and local income of 7.5% I worked constantly, and a normal work load was probably over 70 hours a week. This was before Reagan. Generally speaking I was working for myself until around mid year. After June 30th, for the remainder of the year, I was working solely for the benefit of the federal and state governments. At the federal level, earned income had a maximum tax rate of 50%, and that was actually an improvement over the marginal tax rates. The Democrats were responsible for this tax structure that actually served to penalize hard work and virtually any income generating activity. Part of the Democrats' gravy train for money back then was to control the House Ways and Means Committee where tax breaks largely unfathomable to an average American were written into an incredibly complex tax code for those with money to buy them (and who remembers Wilbur Mills & the tidal basin incident).

At some later date, I will discuss what I view as the conservative and liberal positions on tax issues. For now, I would just say that both parties are more in the mode of borrow and spend rather than tax and spend. The difference now is that the Democrats do actually want to cut taxes for the middle class, finally recognizing after a few decades the success of such an appeal in winning elections. They may at times be a little dim but not entirely tone death. I suspect that a significant middle class tax cut will be a high priority when the Democrats soon gain firmer control over governmental policies with the Beanpole and a more significant majority in the Senate to unclog the barrier of the cloture rule. While the following comment will cause some consternation among a certain Tribe, the Republicans, on the other hand, mostly talk about delivering tax cuts to the middle class now. The entire thrust of their tax policies is to increase the gap between the very rich and everyone else, by convincing their tribe members that the Democrats want to raise their taxes and then spend it on poor black people. When you examine what they are actually proposing, most of the tax cuts go to the very wealthy, who fund their campaigns, with a few sops thrown to anyone making less than $250,000.

A lot of this analysis can be found at the non-partisan Tax Center web site when the proposals of the two tribes on taxes were compared as to their impact on Americans at different income levels. TPC Tax Topics | 2008 Presidential Candidates' Tax Proposals The Republicans could not win an election by saying that most of their tax cuts would go to the super rich whereas the Democrats, having at last learned the lesson taught by Reagan, were offering to give more to the vast majority of taxpayers. Yes, I doubt that Rove would approve of a campaign spiel that says vote for me and I will increase the wealth gap by reducing the taxes on the wealthy. But one fact struck me when I read the report prepared by the Tax Policy Center. If all proposals made by both parties were enacted, the budget deficit would swell. So, to be fair about it, a more apt description of the policies of both tribes would be to cut taxes, borrow more money, and spend like crazy with the Democrats more willing to fund some of their spending proposals by taxing the rich.

All of these comments do have something to do with investing and that is always my main topic. I can not change what is about to happen. I have no control as the saying goes over events beyond my control. I can only control how I react to what I believe to be the likely course of history over the next several years. There are a few premises that I am now using to fine tune my investing strategy. First, the budget deficits will soar over the next four years to levels that were previously unimaginable. I would only be slightly surprised to find out in four years that the debt of the U.S. had doubled from current levels. My current estimate is an increase of 60 to 70%. This will eventually cause a fall in the value of the dollar, a rise in interest rates which in itself will contribute greatly to the deficit, and a return of meaningful inflation, sufficient to cause the Federal Reserve to tighten credit. Second, the massive fiscal and monetary stimulus, including the soon to be enacted middle class stock cuts Yahoo! Finance, will likely result in an economic recovery sooner than the current pessimistic forecasts of the dire economists who of course did not predict the severity of the current downturn. These forecasts may change as times goes by, as new evidence accumulates which requires a modification, but this is the forecast forming the foundation of my investing decisions at the moment.

One thing that is totally beyond my comprehension is the yields of U.S. treasury notes and bonds.

I mentioned in a prior post Alex the Parrot, an African grey, who recently passed away after a long life and whose eulogy in a British rag started by saying he was smarter than most U.S. presidents. I am not sure about that. Do not misinterpret me on this point. I am not saying Alex would have been a better President than W. It did cause me to think, however, whether Alex should have replaced Stan at Merrill Lynch or Chuck at Citi while he was still alive of course. I started to think about that point more after reading another article in the NYT's Sunday Magazine about a Grey called Sadie who was an assistance animal for a man with psychological Whenever the man started to go crazy, the Parrot would recognize what was happening to her charge and say something like "calm down" as the Parrot would successfully talk the man down out of a psychotic episode. It was relatively easy to train the parrot to perform this function. So, when I read that, and being familiar with Alex and his proven mental dexterity, it occurred to me that all of the investment banks and large financial institutions needed an Alex or a Sadie to head up their operations. A credible case could be made that those institutions would have been far better off with the Parrot leading the way. It would have also been a lot less expensive than paying hundreds of millions to people to blow up the firms that paid them. When the brains at Merrill started to load up on the toxic CDO mortgage trash or the whiz bangs kids at AIG thought that they had invented the printing press, the Parrot could chime in and say something like "Calm down, do you know what you are doing. Stop". And that is my solution to the entire mess. Scrap the VaR models of risk and just do whatever the Parrot thinks is best. It would make at least more sense, and certainly a whole lot cheaper, to just go with the Parrot.

One last observation is in order about birds. I was watching over the weekend a mom and dad bluebird take turns going in and out of a bluebird box. The mom then perched outside the hole, peered into the box, and acted like she was feeding some chicks. I thought for a second that this had to be a confused young couple since it was early January. Surely, they were not building a nest. I went down and looked inside the box and nothing was in it. Those birds were just checking it out for later, and both had to be satisfied that it would be a good home. They were just planning ahead.

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