Thursday, November 15, 2007


Europe is "rolling over". Old money is learning new tricks.

The Euro is estimated to be over priced by 25%. Can an efficient market be over priced by 25%? Certainly! The smell of fear often leads to irrational behavior.

There are basically two types of money, "safe money" and "aggressive money". The problem the world markets have been dealing with is that "safe money" no longer seems to be "safe". "Safe money" is no longer a "sure thing". Yesterday, the "sub prime slime" showed up in a GE money market fund. GE is offering the holders of this "safe money" account 96 cents on the dollar. "Safe money" is typically left lying around in money market accounts even while the owner knows he could be earning much higher returns. High returns are not the point of safe money. Those who leave money in these accounts are concerned about the return of their money not the return on it. If you are rich enough, accepting the losses due to taxes and inflation on substantial sums is not seen as a big deal, losing principle month after month and year after year grows into a disaster.

Wealthy folk who have had safe money accounts in Europe and America have seen their American money fall in relative value by 35% or more. Those who had equal amounts in Europe and America made as much in Europe as they lost in America but losing is still no fun. Aggressive investors saw similar results but they moved quickly to correct the problem. Indeed, the most aggressive investors jumped to China to rack up substantial gains last year. One of the differences in safe money and aggressive money is that safe money is relatively slow. Another name for aggressive money is "hot money", because it moves quickly.

After five years of seeing the value of American safe money fall in value relative to safe money in Europe the flow of safe money from America and to Europe has gradually increased. The sub prime mess served as a catalyst to change a steady flow to a flood. It does not matter that some European banks took big losses on sub prime paper. The fear of loss caused money to" flow to where it has been being treated best". The dollar has fallen as a result of fear of additional loss in value. The selling of dollars reached the panic phase but has at least leveled off for now. The fundamentals do not matter to those who smell the stench of fear. After David slew Goliath, the Philistines sheathed their swords and ran away from farmers using garden tools and sling shots as weapons. Fear has rolled through several US real estate markets. Some resort properties have sold for less than half price because some people want out no matter what.


One group which has picked up on the "cheapness" of US assets has been the Canadians. Those who winter or vacationed on the southern coasts have noted the powerful combination of falling real estate prices and the rising Looney. Many are taking advantage of this double whammy. The flow back this way is just a trickle so far but the pace will quicken. The buying power of other currencies has also shown up in the export - import numbers. US manufactured goods exports increased by 16.1% over the past year!

In just a few days, weeks or months, I expect the flow of funds flood to fully reverse. The aggressive money will lead the way but once the Euro Central Bank follows the US lead with lower interest rates, the flood will include the return of tons of safe money. The bottom line is that the relative values of currencies is such a complex issue that the funds flows are reduced to momentum plays for the great majority of participants. The further a currency falls, the more eager the participants to sell. No one wants to get in front of a moving freight train. There is a train about to leave the station and you should make sure you are aboard.


Warren Buffet deserves respect for his investment acumen. He has made billions by investing wisely. Yesterday, he testified before congress in favor of raising estate taxes. What a crying shame? The effect of high estate taxes is a reduction in the net revenue to the US treasury. High estate taxes cause distortions and inefficiencies. High estate taxes are harmful to all Americans. Class warfare may be politically smart but it is not sound economics and it is not fair economics.

Part of the joke is that Warrens 70 Billion Dollar Estate will pay little in taxes. Estate tax laws are always written such that lawyers and accountants can drive big estates through the massive loop holes. It is the moderately wealthy, often a farmer or small business owner, who gets zapped by estate taxes. Many a small business is sold to people like Warren when the families must sell to settle estates.

One of the ways estates taxes are avoided is by holding assets until death in order to receive a stepped up basis. The great grandson of a farmer may inherit land that has appreciate over a few generations from $10,000 to $10,000,000. Under the rules promoted by Buffet, the increase in the value is never taxed as a gain because the grandson receives the property at its current value. The US government receives no revenue on the increase in value. On the other hand, a few lawyers, accountants and insurance salesmen take a whack out of the proceeds and a charity or two might get a nice slice. The farm is likely to be sold not to pay the government but to pay all the other fees involved.

Billions, if not trillions of dollars are locked up in assets for decades in order to avoid confiscatory taxes of around 45%. The revenues to the government would rise dramatically if all gains were taxed at reasonable rates. A 15% tax on accumulated gains would raise huge amounts of money for the government while encouraging owners to find the highest and best use for those assets.

Taxes on the "little guy" could be lowered if the government were to collect from the rich instead of forcing the rich to make high priced lawyers all the more wealthy. The automatic response to the above sentence by the average citizen is along the lines of "it will be a cold day in hell before the little guy sees a tax break". It has been show that people are willing to ignore or even refute facts that are counter to their established beliefs. The fact is that tax rates on the "little guy" have been brought down dramatically as a result of lower taxes on the rich. Before the cuts made by John Kennedy, marginal tax rates on the wealthy were 90%. Before the cuts made by Ronald Reagan, marginal rates on the wealthy were 70%. Back in the days of Kennedy, the income tax game was similar to the current estate tax game, the marginal rate was high but no one paid the marginal rate.

Instead of looking up and getting into the exact numbers which would show the dramatic decline in tax rates for the average citizen, let me offer the fact that the top earners today pay a higher percentage of the taxes than ever before. For example, thirty nine percent of all income taxes paid are paid by 1% of the tax payers. Indeed, the bottom 50% of wage earners pay very little in income taxes. While it is true that the social security tax has increased over the years, it is the rich who are paying a higher percentage of their income in taxes. The high rates with built in loop holes have been replaced with moderate but collectible rates. The moderate wage earner pays more in social security taxes than he does in income taxes. On average, we will get his social security taxes back and then some.


The congress faces a quilt of absolutely crazy laws. If no action is taken, the estate tax exemption goes to about $4 million in 2009. For the year of 2010, the estate tax has been repealed. In the year 2011, the law is reinstated with a 1


The list of stock market buy signals continues to lengthen. When ever the spread between the rate on corporate bonds is high relative to treasury bonds, a big move in the stock market is pending. That is the situation today. Socks can go lower first but a short term decline, if it happens, will not negate the success of the buy signal. Good buy signals are for net moves of 20% or more over 6 to 12 months.


The signs of lower interest rates are also plentiful. For example the slowing German economy is a result of the fall in the dollar. Germany prospers as a strong exporter. The currency swing means that Germany needs lower interest rates. Bernanke said yesterday that he is watching head line inflation. Once the pending decline in food and oil begins, Bernanke will have no reason not to lower rates.


Millions of Iraqi refugees are moving back home. Peace is breaking out. The Mehdi Army has laid down its arms and is working hard to become a political force. The good folk at STRATFOR reported yesterday that there has been a significant thaw in US-Iran relations. PEACE IS AT HAND!


My family is staying at home for Thanksgiving. This will make two Thanksgivings at home in 19 years. Various family members have given various reasons for staying at home but I must wonder if gasoline prices were an underlying factor. If so, we are clearly in the same boat with many Americans. It is estimated that airline travel will be up 4% over the holidays but gasoline demand will be down about .6%. A point that I cannot make enough is that people are substituting email, phone calls, web postings and instant messages for gasoline. The savings are huge, inflation is dead!



ron said...

I need to begin a bond portfolio with about $200,000 of IRA money. Considering some ETF fixed income, bond mutual funds and individual corporate. I don't need to take the cash yet. Maybe I'd be better in a equity-income fund like Oakmark OAKBX which is about 60/40 stocks and bonds. Any advise or comments how I should approach this?

Jack Miller said...


I would like to know more about your situation before making specific comments. As a general rule, many people are investing too heavily in bonds. Bonds are currently priced at levels seen only for a brief time in 2003 and before 1963. Putting too much into high priced bonds could be a huge mistake. Over the next 5 years or more, the dividend returns on many a blue chip stock will dramatically exceed the current bond coupon and bond values will fall should interest rates return to "normal". My email address is Send me a poke if you would like to discuss your situation in more detail.