Is Earth Round or Flat? The Global Hunt for Taxes by IceCap Asset Management
What goes around, comes around
The Global Hunt for Taxes
Back in his day, Christopher Columbus was known as a swashbuckling adventurer willing to risk his life and limb for a boat ride. His thirst for adventure discovered many things, including the fact that the earth is round, and not flat.
Then in 2005, American journalist Robert Friedman declared the opposite in that the world isn’t actually round, but flat as a pancake. His best selling book explored how technology was changing the way people, businesses and countries do business.
David Einhorn Buys Three New Stocks: These Are The Names And Theses (Q3 Letter)
David Einhorn's Greenlight Capital funds returned 5.9% in the third quarter of 2020, compared to a gain of 8.9% for the S&P 500 in the same period. This year has been particularly challenging for value investors. Growth stocks have surged as value has struggled. For Greenlight, one of Wall Street's most established value-focused investment funds, Read More
Yet today, a mere 9 years later, legions of financial analysts, economists, elected and unelected officials are declaring the world is neither flat nor round, but a bunch of individually, wrapped islands completely separate, independent and unaffected by anything outside of their respective borders
Call us old fashion, but we lie squarely on the side of Christopher Columbus. Yes, the world is indeed round and what goes around, comes around so to speak. Financially speaking, it’s our view that it is impossible today for any major country to function independently from anyone else. Economically, if most countries are doing well then it is highly likely any laggards will be dragged along for the ride too.
Of course, the opposite is also true. If the majority of the big economic countries are not doing well, then it is highly likely the rest will follow them down the garden path.
Today, most major countries are struggling. In Europe for example, recent GDP data shows the old world growing at +0.8%. Hardly the acceleration needed to declare victory over the debt crisis. Italy in particular, is really struggling with what now looks like another return to recession, while everyone’s favourite socialist country – France, also disappointed with no growth to speak of at all.
Meanwhile, emerging market countries – the darlings of the pre-2008 crisis continue to grow, but at half the rate of what they regularly achieved previously during their boom years.
There is some good news. The United Kingdom has now officially returned to the same level it was prior to the 2008 crisis. And then there is America – the self proclaimed economic engine of the world.
At first glance, America seems to be firing on all cylinders. Over the last 4 years, the country has averaged +2.4% growth. Measured another way, the American economy increased from $13.8 Trillion to $15.6 Trillion, for a total 4 year gain of $1.8 Trillion.
At second glance, during the exact same time frame the US Federal Reserve printed money totalling $3.3 trillion. While viewing the data in Chart 1 on the next page, we ask you to really think about what you are seeing. Essentially, using a money printing machine to produce $3.3 Trillion only helped to grow the US economy by $1.8 trillion.
Be bold, but not bad
Obviously, the Americans didn’t quite get the bang for their buck they were expecting, and this is the point we make – despite trillions in Dollars, Pounds, Yen and Euros of economic stimulus, world economic growth remains a rather big disappointment.
As there are always consequences, the major consequence of massive money printing followed by low economic growth is the one few investment analysts, economists, and big bank investment committees speak about. Now, whether the reason for this silence is a business decision, lack of product to express the view, or even plain ignorance, the fact remains the connection isn’t being made. And worse still, it isn’t being communicated to the majority of investors around the world.
Maybe this lack of communication can be blamed on Christopher Columbus, or Robert Friedman. More likely however, the real target of blame is the current culture imbedded in the financial industry that central bankers do know what they are doing and eventually they will deliver the world from its current economic funk.
In fact, the current state of economic, monetary and fiscal policies has become so severely warped and twisted that for the first time ever, we have economics and business graduates that have spent their entire academic career in a period with 0% interest rates, money printing and subsidized lending.
Think about this for a moment, our future leaders have established their entire economic and monetary belief system during the most bizarre economic moment in the history of the world. To them – this is normal. In many ways, it’s very much the same as the film “The Truman Show” where unknown to him, Jim Carey lives his entire life within a manmade bubble, only to eventually discover his entire belief system was manufactured by the director and producers of the show.
In our opinion, it’s rather quite obvious that the world’s policy makers absolutely know that the economic and financial world isn’t quite up to par. In some ways they should be congratulated and maybe even admired for stoically making many very bold decisions. In other ways, they should read their report card and admit their failures.
Just because you sit in the corner office and make bold decisions, doesn’t mean you are right. The corporate world is famous for firing under performing workers. Those that make bad business decisions rarely find themselves with the opportunity to continue making even more bad business decisions. It’s mind boggling that the world’s central bankers are not treated the same way.
In our mind, it’s become rather obvious that current stimulus plans are not working. Rather than scrap the madness and start over, our world political and economic leaders insist on a rather bizarre analysis that what they are doing is actually correct. But the reason for its ineffectiveness is that they haven’t done enough of it. In other words, yes the central banks and governments of the world have certainly dug themselves into a pretty deep hole. Yet, instead of trying to climb out or shout for help, they ask for more shovels – dig deeper! Chart 2 on the next page shows the amount of money printing that has been initiated since 2008. Considering that the previous 100 years produced no money printing by the world’s major countries, the current amount is rather shocking to say the least.
And this brings us to the consequences of all of this digging by our central banks. Despite massive amounts of stimulus, global growth remains stagnant. The reason for the lacklustre rebound is due to businesses and individuals slowly withdrawing their money from the economy.
Many people have commented that all the world really needs is a little more confidence. Once people and companies become more comfortable they’ll start to spend again. This view is 100% correct – but what’s missing from this analysis is the reason confidence is declining. The reason for the decline is due to the very policy actions of our governments and central banks to help restore confidence. Their actions are actually causing people to have less confidence – talk about irony.
When it comes to money, no magic formula or pixie dust can be applied to make it behave differently than it should. Individuals and companies both live in a world where you can only spend what you make. If you spend more than what you make, you need to borrow to make up the difference. Eventually, you will have reached your borrowing limit and then you have to start repaying your debt, or if you cannot repay – you default on your loans, and whoever lent you the money takes a loss. Simple enough.
Governments also use money and rarely spend less than what it collects in taxes. The difference of course is referred to as a deficit, and the only way money math works is to borrow money to equal the difference.
Yet, this seemingly perpetual access to debt has proven to be an open ticket for most governments to evolve into spendthrift characters of the worst kind. Months, years and decades of deficits and borrowing have literally pushed the natural laws of money and mathematics to the limit. With many countries having reached this limit, the inclination is to keep the money party going – which of course is the reason for 0% interest rates, money printing, bank bailouts and robbing savings from the poor to pay the rich.
While most media outlets only focus on the growth story of our world, we find it interesting that very few ever discuss the debt story. There are many reasons for this. For starters, you can see growth but you cannot see debt. When you see a nice car parked in front of a nice house, full of a nice family who takes nice vacations, most people say “wow, it must be nice to be rich.” Since you cannot see the debt used to become so nice, perhaps you should be saying “wow, they must have a lot of debt.”
A real doozy
As most countries continue to spend more money than they collect in taxes, the amount of debt continues to grow. And, this brings us to the global hunt for taxes. Because our economies are growing slower than our debt levels, the only other way for governments to improve their financial lot is to either reduce spending or to increase taxes.
The old story of how we can always grow out of our debt problem, is just that – a story. For proof, simply look at the last 5 years. With the growth option clearly not working, governments are slowly turning to taxes as the way to close the debt gap.
Charts to the above historical tax rates in the US and Europe. It will surprise many that during the 1950s, the top marginal tax rate was over 90% – talk about a disincentive to work. Meanwhile in Europe, personal tax rates have already begun to creep higher. And if that isn’t creepy enough, understand that tax rates will begin to creep even higher.
Other easy tax grabs will include real estate and then the real doozy, that will really wake everyone – wealth taxes. In their “Taxing Times Oct 2013” paper, the IMF stated that taxing properties is an easy way to raise money because no one can hide a cottage or condo in an offshore bank account. They also recommend taxing personal real estate as opposed to commercial. The point being – if you own a home, be prepared for either higher tax rates, or higher reassessed values on your property. The bottom line is the same – more money out of your wallet, and less money for the economy.
Britain will likely leave the EU
Moving along, the next new tax to hit the world is a global wealth tax. Europe will be first up to hand over more money with this new tax and we have a feeling the after effects will be unexpected. We’ve shown Chart 3 on the next page in previous publications, but it’s importance deserves a second showing.
We’ve now had 4 separate occasions where the idea for a wealth tax has been floated and there has been no push back whatsoever – not from shocked politicians, flabbergasted business owners, nor dismayed average Joe’s. The same IMF paper went into great detail on how much tax revenue can be raised, who to tax, at what rates and exactly how to do it. This is important to know and understand. If you reside in the European Union you should be prepared for this tax. And if you are not convinced, see Chart 4 and read for yourself.
Of course, when the tax is announced we fully expect several non-Eurozone countries to protest and actually leave the European Union. We would be absolutely shocked if Britain stuck around for this tax. The recent, sharp swing towards the anti-EU party, UKIP, all but guarantees neither the Conservatives, nor Liberals will support the wealth tax – doing so would be political suicide.
For everyone else in the world, you need to understand that as taxes begin to increase in Europe and elsewhere, economic growth will slow – there is simply no other outcome. More aggregate taxes means there is less aggregate spending. Less aggregate spending means less growth.
The tax will be announced over a holiday weekend, the extra day of planning should help quite a bit in soothing over any unreasonable people. We believe it will occur within the next 18 months. And if you are wondering exactly when this European Wealth Tax occurs, simply follow our European Roulette Wheel for a clue.
This is why the earth is indeed round – it isn’t flat, nor is it a collection of separate, independent, and autonomous countries unaffected by the other. Policies to address the European debt crisis will certainly affect every country on the planet, and its resolution will create chaos, confusion, losses and enormous opportunities for those who are positioned correctly.
Lending money to yourself
Making new friends
Recently we were chatting with a well educated, experienced and trained economist and he stated that sovereign debt levels are actually not as bad as what we write about. He said, if you cancel the debt that was purchased via quantitative easing, then the remaining debt levels are actually manageable.
For those not stuck in the snoozy world of classical economics, this effectively means yes, you can create wealth out of thin air. It is also the same as believing in Santa Claus, the Easter Bunny, and England winning the World Cup. In hindsight, it probably isn’t fair to Santa nor the Easter Bunny to be associated with the failure of English football, but it also isn’t fair, or truthful to claim that wealth can be created by the snap of a central banker’s fingers.
As you know by now, for the last 6 years the world’s most important central banks have been printing money. And, when they print this money they use it to buy bonds from their respective government. America’s central bank – the Federal Reserve has printed over $3 trillion alone, while Europe, Britain and Japan have cranked out another $3.6 Trillion combined.
Claiming this exercise can create wealth is a little hard to understand and certainly shouldn’t become the accepted train of thought. Yet, it may be too late.
This exercise of printing money to buy your own bonds is the same as lending yourself money and then deciding that you do not have to pay yourself back and then believing that you are suddenly wealthier than before. It plain simple language – this doesn’t work. If you are not convinced, we encourage you to lend yourself $10,000, and then buy something with this $10,000. Next, tell yourself that you do not have to repay the $10,000 loan. What happens next, becomes a bit wobbly but all we can do is suggest you attempt this exercise and let us know how it works out.
In the real world, the only way to create real wealth is through good old fashion hard work, wages and savings. All of this talk about quantitative easing, zero interest rate policies and forward guidance is an attempt to stimulate the real economy which will in turn create real wealth. Yet instead we are seeing the following:
- low wage growth
- low economic growth
- low interest paid on savings
Of course, with stock markets presently hitting all-time highs, few people care about fake or temporary wealth creation – after all, those are just fancy words for fancy people. As long as people’s investment portfolios are increasing they are happy. As investment managers, we are invested in the stock market. Yet, unlike many investment managers, we are not blindly invested in the stock market. This unbridled love for the accelerating economic recovery and wealth creation effect quite frankly makes us shake our head from time to time.
Give peace a chance
Now, for those who do actually care about their real wealth and preserving this wealth, and for those who actually want to understand the glue that keeps everything together we suggest a better understanding of real versus fake wealth creation is required.
Let us know what you find.
Riots in Canada
Absent a hockey stick, Canadians in general are pretty calm, conservative and reserved people. So, what happened on June 20, 2014 felt a little awkward for everyone.
The day started out like any other until new Bank of Canada Governor Stephen Poloz announced that not only would he leave overnight interest rates at 1%, but he warned about the risk of lower inflation. While everyone expected interest rates to remain the same, the shot across the inflation bow sent economists scrambling for their thesaurus to conjure some very un-Canadian critiques.
First up was Bank of Montreal Chief Economist, Doug Porter who quivered “the low-inflation ship has sailed in Canada, and I think the Bank of Canada pretty much has to change their rhetoric as of the next meeting.“ BAM!
Then with reference to inflation vs interest rates, HSBC Canada Chief Economist David Watt politely noted “it creates a fairly complicated communications strategy for the Bank of Canada.’’ WHAM!
And finally not to be outdone, Bank of Montreal’s Head of Global Foreign Exchange Strategy Greg Anderson, really took the gloves off adding “…CPI, stripped of energy and food, and it’s surging higher. It is untenable, they’re going to have to change their forecasts massively.” SLAM!
For those who are not that familiar with Canada’s central bank and its Bay Street groupies, this recent exchange does not happen very often. In fact, not only is confronting and critiquing the Governor of the Bank of Canada somewhat un-Canadian, it really goes to show how heated this entire inflation-deflation debate can be.
Now, despite what Bay Street may think, the Canadian economy is very much interconnected to the rest of the world. While we may see a short-term, supply-push inflation shock, it is our view the world remains trapped in a deflationary spiral. Mr. Poloz was absolutely correct in warning about the risk of downward prices. While the consensus expect the next move in Canadian rates to be up, don’t be surprised to see the opposite occur. We expect the global economy to continue its sluggish slowdown into next year creating the perfect monetary environment for Mr. Poloz to cut rates, and very likely receive another tongue-lashing.
Welcome aboard Ariz
Our Strategy We’ve made no changes since our last publication. Our research continues to tell us that longer-term the stock market and the US Dollar really have the potential to surge higher. The reason for the optimistic outlook is based upon a sharp deterioration of the global debt crisis elsewhere around the world. As the crisis escalates, investors should expect private capital to leave affected areas and seek safety in the USA.
However, presently we do not see significant signs of stress in government bond markets or foreign exchange. This tells us our longer-term view is not about to happen today. Meanwhile, stock markets continue to climb higher and although many headline stories are calling for a sharp correction we believe a mild correction will be the most likely outcome. When the correction occurs, and it will, we will use the opportunity to add further to our positions in the stock market.
As you know, we firmly believe the world is being engulfed with deflation. However, the real short-term risk is an unexpected supply shock to the commodity complex which will create uncomfortable moments for both stock and bond investors. Unrest in the middle east continues to build and the entire Sunni-Shiite relationship has the potential to cause oil prices to surge higher.
At this point we’d like to introduce you to the newest member of our team. Ariz David, CFA has joined IceCap as a Global Strategist and we are absolutely thrilled to have him on board.
As always, we’d be pleased to speak with anyone about our investment views. We also encourage our readers to share our global market outlook with those who they think may find it of interest.
Please feel to contact:
John Corney at johncorney@IceCapAssetManagement.com
Ariz David at arizdavid@IceCapAssetManagement.com or
Keith Dicker at keithdicker@IceCapAssetManagement.com.
Thank you for sharing your time with us.