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Trapped Between Debt and Taxes

by William (Bill) Buckler / The Privateer


It has taken just about two decades to accomplish it, but today - right now - Americans have been caught in an economic trap. The "jaws" of the trap are taxes on one side and the necessity of servicing debts on the other. It is the latter that did not have to have happened. Fundamentally, it HAS happened for political reasons. The American political Establishment has always had in front of themselves a fundamental choice. They could have made laws that kept taxes low and allowed real monetary savings to be accumulated and then funnelled into real, productive, private investments. Or they could have kept taxes high to expand the size of the State, and then "compensated" for the tax burden by making borrowing very easy indeed.

The U.S. political Establishment chose the second course.

Artificially low interest rates inescapably lead to increased borrowing. But borrowing is the other side of debt, so debts have climbed higher.

Debt And Taxes:

According to the Tax Foundation in Washington, Americans are paying the highest amount of Federal taxes in 50 years. Based upon the per capita income in the U.S.A., the Federal income tax is now taking 23.4% and an additional 10.4% goes towards State income taxes. This total now stands at 33.8% of what Americans earn. American consumers currently have to use 14.1% of their after-tax incomes to service their installment and mortgage debts. When home mortgage equity loans and vehicle leases are added, debts take an enormous 34.1% of the average American income.

Taxes take 33.8% and debt maintenance takes 34.1% of total incomes.

Adding The Burdens Together:

Taking Federal and State incomes taxes of 33.8% and the average total debt maintenance burden of 34.1% makes a total of 67.9% of all income. Please note that this tax calculation does not include sales taxes, property taxes, fees, fines etc., etc.. But what this basic calculation does show is that about one-third of income is ripped away by the State and that about another one-third is ripped away to service outstanding debts. That leaves only the remaining one-third for everyday living expenses and savings, if any. The new "serfdom" is composed in equal parts of tax payments and debt servicing payments.

If Americans had not been enticed into going into debt over the past decade, most of them would now stand with some cushion to weather an economic downturn. But they don't. So, Americans are stopping their borrowing and spending - hence the suddenness with which the U.S. economy is slowing down.

A Very Political U.S. Economy:

Several generations of politicians, from both U.S. parties, can claim the "credit" for having brought the U.S. to the precipice of a gigantic debt collapse. It began, literally, in 1913 with the establishment of the U.S. Federal Reserve and the Constitutional Amendment (#16) which introduced the Federal income tax. The arrival of the first gave the American political Establishment the means with which to fund the U.S. Treasury without taking it out of the hides of Americans through taxes - instead they could just borrow it. The second gave the Establishment the means to actually take what the Treasury needed out of the hides of Americans. The Establishment, in the end, chose both methods.

When a real chance came to contract the State (to drastically diminish the size and scale of both the civilian bureaucracies and the military) in 1991 when the U.S.S.R. disappeared, the chance was missed.

We Won - Let's Party:

Instead, during the eight years of the Clinton Presidency, both the civilian and military parts of the US Establishment were kept at their full size. As compensation, the American public was offered the easiest borrowing requirements possible - the Fed Funds rate fell from 8.25% in 1990 to 3.0% in 1992. The Fed Funds rate has never gone above 6.50% since and presently stands at 5.50%.

Borrow the American public most certainly did. They borrowed so much that the Federal budget deficit began to shrink as a higher proportion of government spending was funded by more tax revenues - especially capital gains tax revenues in the latter half of the '90s. The public abandoned savings for borrowing. One result of this was that U.S. stock markets surged to previously undreamed of highs. The Dow had never closed above 3000 until July 1991. It hit nearly 12,000 in January 2000. Americans borrowed to spend on a consumption wave that has forced the U.S. economy into enormous current account deficits. America became the world's most externally indebted nation with a total external debt of $US 2.2 TRILLION. In 2000 alone, that debt climbed by $US 439 Billion. It is still climbing.

The Real Problem For The U.S. Establishment:

Having induced millions of individual Americans and their families to contract huge debts, and then having watched them do it, the U.S. political Establishment has marched itself into a corner. They can help Americans to service their debts by lowering interest rates. They have already started that and more and MORE rate cuts are anticipated. They can also do what Mr Bush set as his core policy in the Presidential election. They can lower taxes. President Bush has placed a budget proposal before Congress that entails a tax cut of $US 1.6 TRILLION over 10 years.

No Jam Today:

The political "kicker" comes in the fact that these tax cuts are to be phased in over TEN YEARS. The problem is that even if these tax cuts are enacted by Congress and backdated to Jan. 1, 2001, the tax cut over the first year will amount to a paltry $US 21 Billion. Allowing a scant $US 21 Billion to remain in the pockets of Americans who have earned it, in a budget that proposes federal spending of $US 1.9 TRILLION, is not a tax cut worth mentioning. Allowing an additional $US 21 Billion to remain in the private hands of those who have earned it is not a "stimulus" to a $US 9.3 TRILLION economy.

Having Their Cake And Eating Your's Too:

This is a political Establishment which wants to do two incompatible things at the same time. It wants to keep the current size of the State as it is. There are no proposals to do away with any department of State. The Clinton defense budget - including an extra $US 19 Billion for the Pentagon - has gone to Congress unchanged. There have been no cuts in the budget allocation to any Department. During the 10-year life of the "tax cuts", no such cuts are planned or proposed. What, or WHO, are they counting on?

They Are Counting On YOU:

What the U.S. political Establishment is counting on is the individual productive American citizen.

They are counting on Americans to hang on, to service their debts, to pay their taxes, and then to live and work in the hope that over the next 10 years, taxes will go lower. On top of that, they are hoping that the American economy will continue to grow over the next 10 years so that the tax burden of the State will be lower in relative terms. They are hoping that the economy will continue to grow so that the current corporate and private debt burden continues to be serviced, and perhaps even some principal repaid.

The Critical Economic Point:

It is the above that brings the U.S. political Establishment to the critical point in economic terms. This critical point is a simple question: What makes economies "grow"? Adam Smith gave the answer back in 1776 when he published An Enquiry Into The Wealth of Nations. His basic answer has been refined ever since. To find out what makes economies "grow" is an easy task. The best answer can be found in Human Action by Ludwig von Mises, published more than 50 years ago. The answer is already HERE.

The "problem" is that the answer requires a policy of SOUND money, i.e. a Gold coin monetary base. It also requires the full, total and utter abolishment of Central Banks, followed by bringing commercial banks back under standard commercial law so that their present politically privileged standing is ended. It requires laws which make private property sacrosanct. It requires that private business be precisely that - PRIVATE. It requires free contract between consenting adults. And internally and internationally, what is required to make an economy "grow" is completely free trade.

To safeguard all of this requires that governments shrink to a very small remnant of their present size and that governments work on a balanced budget - every year. What is required to make an economy grow is FREE ENTERPRISE, a "system" in which adult men and women live free from the State and any and all of its multitudes of agencies.

Why is that a "problem"? Because under Free Enterprise, there is NOTHING for a political Establishment to do. In fact, there is no "need" for a political Establishment at all.

Only a century ago, there was a political theory which encompassed all of the above. It was known as LIBERALISM. The economic dimension of this theory, which was parallel to the political one, was known as CAPITALISM. And the study of both these dimensions was well established and (sadly) taken for granted. This was the study of POLITICAL ECONOMY.

Looking At What They DO:

As both the Republican Party and the phalanx of American "right wing" think tanks and talk-back radio hosts never tire of informing us, President Bush is a "Conservative". A "Conservative" is a species of politician whose fate throughout the past century has been to "conserve" each and every expansion of the taxing, spending, inflating, and credit- expanding State that the other side of the political aisle, the modern "Liberals" have accomplished.

The exemplar of a Conservative politician is Margaret Thatcher. When Mrs Thatcher departed from U.K. politics, the budget was larger in terms of total expenditures and as a proportion of GDP than the budget she inherited when she took office in 1979. Yes, America's Ronald Reagan accomplished the same feat, but he at least managed to bring about the fall of the Soviet Union by increasing U.S. defense spending to the point where the Communists couldn't match it. Mrs Thatcher had no such requirement.

George W. Bush has all the requirements to become America's Margaret Thatcher.

Maintaining The State:

If the entire structure and array of the current U.S. Federal Government has to be maintained at anywhere near its present size, taxes cannot be lowered by much. To then "grow" the U.S. economy, even if the State does not "grow" but merely maintains its present size, will take something more, in fact something unknown to economics. With taxes chewing up 33.8% of American incomes and with debt servicing chewing up another 34.1%, where are the savings to come from? Savings are absolutely required in order to make the new and additional investments that actually cause an economy to advance.

The fundamental fact is that these savings are nowhere to be found. Americans have NO savings at present. Nor are they likely to have any in future for as long as Americans see 67.9% of their incomes pulverised between the millstones of debt and taxes.

Sustaining The U.S. Economy:

U.S. industrial production is down by 18% since June last year. Unsold inventories in the U.S. are piling up. The world is feeling the effect. Exports from Asia to the U.S.A. are now falling fast. If the Bush (mini) tax cut has any effect at all, it will probably be that most Americans will use it to pay down some of their outstanding debts. If they do that, they will not be "consuming". Instead, the U.S. banking and financial system will see some of the principal of the debt on their books paid down. If the U.S. banks see this, then it will have a contractionary effect upon the total stock of deposits, issued as loans. Such a contracting stock of bank deposits is a real DEFLATION. Just as an inflation is an increase in the total stock of money (and nothing else), a deflation is a decrease in that total stock of money. A contraction of total bank deposits is the same as a contraction in the total stock of U.S. Dollars.

If, over the year ahead, the bank deposit component of the total stock of money inside the U.S. contracts, something else has to give elsewhere in the economy. What gives first is PRICES.

Initially, it may only be a few prices in a few sectors. But all the businesses in those sectors will discover that in order to sell their goods and services, they will have to meet the lower prices being asked. But there is a much more dangerous thing than a fall in prices, and that is a fall in the "valuation" of the assets against which the banks have lent money.

These "valuations" could be on shares, or on land or buildings, or on houses, or even on commodities and other raw materials. But ANY fall in valuation cuts right in underneath whatever financing had been attached to the product in question. In financial terms, any fall in valuation is the equivalent of a fall in COLLATERAL.

If troubles arise in servicing loans, then it is the borrower who is most affected. But if the value of the collateral falls to a point which is lower than loan leaning against it, then it is the LENDER who is most affected. If these lenders have deep financial reserves, they can stand a collateral decline for a while. But if these lenders are themselves geared 10 to 1, then it only takes the disappearance of 10% of their total collateral to cause them to go totally (technically) bankrupt.

This is the danger which Japan has faced for a decade. It is also the danger which is now creeping up on the U.S. financial system. If and when collateral values fall far enough, the danger is always that of debt default. And in the modern financial system, debt default is the exact equivalent of DEFLATION.

The Last Stop - The Fed:

When U.S. lending institutions are on the verge of failure because the collateral behind their loans has crashed, then only the Fed can stand forward and "buy" these loans - by printing Federal Reserve Notes.

The State Of The U.S. Stock Markets:

The current exemplar has to be the Nasdaq 100. At present, the Nasdaq 100 (the top 100 stocks in the Nasdaq) is setting all time historical records in respect of price/earnings ratios (P/E ratios). As of mid February, the Nasdaq 100 is trading at a P/E ratio of 811! Until the beginning of 2001, this ratio had never been above 165! That means that in less than the two months of 2001, the combined share prices of the top 100 stocks on the Nasdaq are all trading at a ratio of 811 times their combined annual earnings.

In simple terms, buyers of Nasdaq 100 stocks are paying $US 811 for $1 in annual earnings. This is, not to put too fine a point on it, completely absurd.

At the end of December 2000, the Nasdaq 100 stood with a P/E ratio of 127. At the peak of the Nasdaq in March 2000, the Nasdaq 100 P/E ratio was 165. Please note this carefully. At its present level, the Nasdaq is down more than 50% from its March 2000 peak. Yet the P/E ratio of the Nasdaq 100 has blown out from 165 to 811, or 391.5%. How could this be, with prices down more than 50%? Easy, over the same period, EARNINGS are down over 90%!

If Nasdaq 100 write-offs become much larger as the first and second quarters of 2001 continue, then many if not most of these companies could easily find themselves with net LOSSES. In that situation, there will be no P/E ratio, because there will be no earnings. The last time a U.S. stock market average showed net losses was the Dow in 1933, right at the bottom of the Great Depression.

Across The Street To Wall Street:

The Nasdaq is an extreme example, but a similar thing is taking place over on Wall Street where the Dow and the S&P 500 live. There too, earnings are coming in that look very fragile indeed. But as yet, neither the Dow nor the S&P have slumped like the Nasdaq. The principle on Wall Street is that Mr Greenspan will save us all. But falling earnings are a growing feature, even on Wall Street. Slowly and inexorably, the underpinnings are crumbling.

The Political Maginot Line:

The most important "number" in the financial world today is 10,000. 10,000 is the bottom of a trading range in which the Dow has been trapped since March 1999. In the U.S., and everywhere else in the world, the most important market index is the Dow. The Dow is the index that all stock markets react to over and above any other. When the Dow goes up, the rest of the world knows that the U.S. economy is OK and that they can plan to funnel even more imports into the U.S.A..

When the Dow goes DOWN, the opposite is the case. And because the 10,000 level on the Dow has held for so long - almost two years - it is VITAL. Any move on the Dow that goes below and STAYS below 10,000 would confirm to Americans and everyone else that the U.S. IS sliding into recession.

Alan Greenspan and the entire U.S. political Establishment know this. The fear is that if the Dow falls below 10,000, it would be the start of market, currency, financial and economic events of an unstoppable nature, the end of which would see the U.S. financial system in a collapse under the weight of huge debts.

Looking Ahead:

The Privateer expects any and all means, overt and covert, to be put into use by the U.S. authorities over the weeks ahead. The goals will be, in order of importance:

To support the Dow above 10,000,

to re-liquify the U.S. financial system, and

to support the U.S. Dollar.

And as an essential prerequisite to all of this, the Gold price must be held down. The U.S. political Establishment has its back to the wall.

by William (Bill) Buckler
February 18, 2001

Commentary from the first five pages of The Privateer market letter--

The Privateer
GLOBAL REPORT: Trapped Between Debt and Taxes

2001 Volume - Mid February Issue - Number 418
Published on February 18, 2001

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Copyright © 2001 by William buckler/The Privateer. All Rights Reserved.

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