Greece – the Road Not Taken
Greece is now being forced to go hat in hand to the European Union and the IMF for a massive bailout. The market wants to see real cash, not empty promises or implied guarantees. The Europeans should have called former Treasury Secretary Hank Paulson. Paulson found out that announcing a back up for Fannie and Freddie wasn’t enough. The government had to put its money where its mouth was.
The Greek crisis will be the first of many among the Western countries (including Japan) in the coming ten years. All the Western countries have bloated public sectors, aging populations and unfunded entitlement programs. This combination will generate a tsunami of government debt that, added to the huge budget shortfalls generated by the recent Great Recession, will ultimately bring about a giant “no mas” from the capital markets. Taxes will go up which will only slow economic growth and spawn an army of tax refugees and an exodus of capital towards favored locations around the world. With slow economic growth and rising interest rates, the higher taxes won’t be enough to pay the debt. Who is going to bail out the US, the UK or Japan? The unhappy ending will be a “default” – either an outright default where debt is denominated in foreign currencies or default by inflation and central bank buying government debt in countries like the US where debt is denominated in the borrower’s currency.
From time to time one reads comments from prominent economists urging Asian countries to broaden their social safety nets and thus lower their high personal savings rates. Asians in many countries including China are alleged to save so much because they have inadequate government sponsored retirement programs for their old age. One wonders whether these prominent economists are doing stand-up comedy. The Western countries are all going slowly broke precisely because of their entitlement programs. Why should Asia imitate this?
I have argued in the last few Dismal Optimists that Europe would have been better advised to let Greece default. In the end, Greece will be viewed as having defaulted anyway. Eight US states and one US territory defaulted in 1841-42 without the collapse of the American monetary union. Europe and the euro will be worse off for this bailout. At least with East Germany the Germans were in direct control. For the Germans, East Germany was a basket case but it was their basket case. The German Chancellor Angela Merkel says all the right things but in the end she seems to give in. Greece will become a perennial bailout recipient and default recidivist. (Actually according to Reinhart and Rogoff in ThisTime It’s Different, Greece has been defaulting with some regularity since 1800). IMF imposed conditions to raise taxes will be harmful to Greek economic growth. Cutbacks in bloated Greek government expenditures will be insufficient and made with great reluctance. The euro will survive but the Europeans will look back at this with regret as a road not taken. And the markets will go on to worry about Portugal and the other weaker countries using the euro.
Go East Young Man (And Woman)
In the global knowledge economy, capital and skilled people go where they are welcome. Two places they are welcome are Singapore and Hong Kong. Readers might find a comparison of tax rates in these two entities and the US quite interesting. Admittedly such comparisons are imperfect since there are always special circumstances. Hong Kong for example has its defense and foreign affairs functions provided by China. And Hong Kong derives substantial income from the sale of land which drives up property prices at the high end. Both Hong Kong and Singapore are small. But they are both thriving financial, tourist, transportation and managerial centers. They are not tax havens located in some out of the way island. Rather they are successful entrepots for which low taxes are just one of several major drivers of their prosperity.
The table below is taxes faced by citizens. The US taxes are estimates for the year 2011 assuming enactment of all Obama tax increases, the expiration of the Bush tax cuts and a reimposition of a substantial estate tax. They do not allow for the reduction in allowable deductions which are also scheduled. Note the table below does not include the surcharge imposed by the US health-care “reform”. In 2013 health-care reform will add an additional 3.8% Medicare tax to all dividends, interest, capital gains, annuities, royalties and rental income for joint taxpayers with adjusted gross incomes of $250,000 and single taxpayers with incomes of $200,000. For the typical upper income taxpayer who derives at least a portion of income from those sources, that would put his or her Federal marginal tax rate well over 50%.
Taxes are never simple anywhere. But without question they are incredibly complex in the United States and relatively simple in Hong Kong and Singapore. Complex tax codes are a negative.
All taxes below when appropriate are the marginal tax rates for each of these entities’ citizens in the highest income category. The numbers speak for themselves. The US comes off as a high tax locale. Though not presented here in part because they involve a greater level of complication, the corporate rates would present a similar picture:
United States Hong Kong Singapore
Incl Medicare 42% 16% 20%
State and Local Inc Txs 6-10% in hi tax states None None
Taxes on Interest Top ord inc tax rate None Generally none
Taxes on Capital Gains 20% long term None None
Taxes on Dividends Top ordinary income rate None Generally none
Taxes on Inc Earnd Abrd Yes –Worldwide None – Territorial None -Territorial
Estate Taxes Likely to be substantial None None
Sales Taxes, VAT Substantial in hi tax states None 7%
Level of Complexity Extremely High Low Low to Moderate
Buy and Hold – Will It Make a Comeback?
The 2000 high tech bust and the 2008 global financial crisis have given a bad name to the buy and hold investing approach so well articulated by Jeremy Siegel in his book Stocks for the Long Run. Perhaps it’s time to reread Siegel’s book. Usually when an investment strategy becomes popular it ceases to work. Conversely, discredited strategies sometimes Lazarus-like rise from the graveyard.
Buy and hold – with some revisions – may come back in style at least for US investors. US capital gains and dividend taxes take a huge leap in 2011 and beyond. By 2013 successful in-and-out traders along with affluent coupon clipping retirees will be working for Uncle Sam. It may make sense to buy and hold assets in areas of the world where capital is welcome and just put up with the cycles. I will offer some opinions on that in the next Dismal Optimist. But I will offer a clue. I think investors should favor places where leaders say things such as “to be rich is glorious” rather than “I want to spread the wealth around.”
Meanwhile, a cottage industry will develop on the best ways to avoid the new US taxes. Just what Ronald Reagan tried to get rid of.
Are Things Hopeless for the US?
Will the US automatically face a debt/foreign exchange crisis sometime in the next ten – or maybe the next two – years? The short answer is no, it is not too late, but the odds are growing more unfavorable. A major victory for pro-capitalist, pro-market groups in the midterm elections must happen. The mid-term elections could be a turning point in the markets’ expectations regarding inflation and government debt in the future. The elections must show that there will be an appreciation in Washington that a declining ratio of workers to entitlement recipients coupled with ever expanding entitlements is a recipe for fiscal catastrophe. Finally there must be a realization that filling budget gaps with higher taxes is a recipe for slow or no economic growth.