The 'Risk Out' Scenario

I don't want to wait for our lives to be over
I want to know right now what it will be
I don't want to wait for our lives to be over
Will it be yes or will it be...sorry?
--Paula Cole

Interesting proposition by Peter Atwater that the ultimate indicator that a secular bottom has arrived may not be one where individuals have moved out of more risky financial assets and into less risky assets. Instead, perhaps it will be a 'risk out' situation, where market participants flee securitized financial assets altogether.

There is, of course, a decent argument to be made that the probability is non-zero of a systemic meltdown that chases participants away. With systemic leverage thru the roof and issues of re-hypothecation raised by last year's blow-up of MF Global, it isn't that difficult to envision a scenario where the financial system ceases to function. Cascading bank failures, sovereign debt defaults, and other contagious events could bring the system to its knees.

Indeed, a good case for owning physical gold or other 'hard assets' is that they are tangible and outside the 'paper' financial system.

I'm going to keep Peter's proposal in mind. Perhaps the time to 'buy the list' is not when people are selling the list, but when both buyers and sellers have gone home en masse.

position in SPX

Fed Leverage Update

Nothing's so loud
As hearing when we lie
The truth is not kind
And you said neither am I
--Toad the Wet Sprocket

By my math, Federal Reserve balance sheet currently sports leverage of 54:1. That's higher than Fannie, Freddie, Bear, Lehman prior to the 2008 credit implosion.

Indicator of how risk has been socialized, meaning that risk has been transferred from private to public balance sheets.

position in SPX

Portugal Debt Hammered Again

I keep looking for something I can't get
Broken hearts lie all around me
And I don't see an easy way
To get out of this
--Cutting Crew

Portugal credit spreads are widening significantly this am. Ten yr CDS now pricing in over 70% chance of default.

For better or worse, I kicked much of my long exposure (mostly precious metals) last Friday and entered today's session about 10% net short via equity index ETFs.

position in silver, SPX

Double Taxation of Dividends

If you drive your car, I'll tax the street
If you try to sit, I'll tax your seat
If you get too cold, I'll tax the heat
If you take a walk, I'll tax your feet
--The Beatles

The Left is once again fixating on dividend income and its tax characteristics. Since 2003, ordinary dividends have been taxed at 15% for individuals in that marginal tax bracket or higher. Although set to expire in 2010, the 15% dividend tax rate was extended thru 2012 by legislation signed into law by the Obama administration.

Liberals detest the 15% dividend tax rate because wealthy individuals who receive dividend income often realize an effective tax rate significantly lower than the current 35% top bracket. This is the gist of Warren Buffett's absurd argument that his secretary pays less tax than he does. Although the reality is that wealthy people pay the lion's share of all taxes in the US, with nearly 50% of all people paying next to no income tax, those on the Left want...more.

In a back-and-forth Facebook thread on this issue that I was observing the other day, someone noted that, while the tax rate on dividends is 15%, dividends are double taxed--once at the corporate level and then a second time when shareholders receive dividend checks. If corporations pay a 35% rate, then total taxes paid on dividend income amount to a 50% rate.

A second contributor, obviously sympathetic to the notion that dividends are undertaxed, subsequently offered two arguments in attempt to refute the double taxation observation. One argument was along the lines of: 'all income is taxed multiple times, so double taxation of dividends is nothing special.' He suggested that a store owner, for instance, could not avoid paying taxes on dollars received from patrons even though the patrons had presumably already paid income taxes on dollars used to purchase goods or services in the store.

This argument is in error.

Income is defined as an individual's rightful share of output gained thru productive effort. Prior to the inception of money, income was measured in terms of tangible production. If I chopped wood for a living, then my income was a fraction of the cordage produced by me that I could rightfully claim as my own.

Although income is commonly measured in units of currency today, it still reflects production claimed as personal property. Since passage of the Sixteenth Amendment in 1913, government can legally tax a fraction of that production claimed as individual income.

The error of the second contributor's claim lies in viewing the transaction between store owner and patron as a one sided transfer of resources. If a patron purchases a box of ceral for $4, the patron plainly does not 'give' after tax income to the store owner. Instead, the patron exchanges his/her income for a quantity of product/services rendered by the store owner.

In addition to the cereal, the patron might pay for the convenience of the store's location, or for the selection that the store offers. Indeed, such service attributes is how retail establishments commonly add value.

The important point is that the store owner has generated new production, The proprietor has provided goods and services that were previously unavailable to the market. The $4 represents the price of the store owner's output in terms of the resources that the patron was willing to trade to get that output. After accounting for costs of business, the store owner hopes to generate a positive income--i.e., his own fraction of output to be claimed as personal property that, under our current system, will be subject to income tax.

As such, this situation describes already taxed resources owned by someone being traded for newly produced resources owned by someone else that have yet to be taxed. There is no double taxation here.

The second argument offered by the second contributor was that taxes on dividends do not constitute double taxation at all. Companies pay taxes, then individuals pay taxes when companies send them dividends. Two different owners, two different taxes.

This is argument is also misguided, as the owners are the same in both instances.

Shareholders are the owners of corporations. When dividends are declared, shareholders receive the payouts. Those payouts typically come from earnings realized from the company's activities. Corporate income is subject to tax when reported. Because shareholders have a rightful claim on corporate earnings streams, any corporate income tax paid is effectively taxing shareholders, because there is now less income available for subsequent distribution to the owners.

To further grasp the impact of corporate taxes on shareholders, suppose that the corporate tax rate was 100% . In this case, corporate shares would be worthless since no cash generating capacity would be available to owners.

Higher taxes reduce income available to shareholders.

Should the company declare a dividend subsequent to paying corporate taxes, then those earnings declared as dividends are once again subject to tax. Currently this is the 15% levied on dividend income.

Dividends are indeed double taxed, because shareholders have ownership claims on earnings taxed at corporate rates as well as dividend payouts taxed at individual rates.

Unfortunately, history suggests that reason is unlikely to sway the minds of liberals in pursuit of a cause. The cause in this case is a redistribution of resources among people using government force, a cause that is at odds with nature.

Taxation of dividends is but one of a litany of rationalizations recited by the Left seeking to legitimize the taking of life, liberty, and property at gunpoint.

Fairness by Force

In violent times
You shouldn't have to sell your soul
In black and white
They really, really ought to know
--Tears for Fears

In another round of 'what if,' the Judge asks, "What if the government persuaded a majority to think that somehow its theft of your property was in pursuit of 'fairness.'"?

Those who value freedom increasingly recognize that when politically motivated people discuss the notion of 'fairness,' then it is time to guard one's wallet.

It takes no genius to reason that a government which forcefully takes from some and gives to others in the name of 'fairness' is the epitome of discretionary rule. Who defines fairness? The king? The majority?

Unless all agree on what 'fairness' means and how it should be enacted, in which case of course government force would not be necessary, then some person(s) will be the subject of aggression.

Fairness by authoritarian rule. Fairness by force.

Capitalism We Have Not

Too many shadows, whispering voices
Faces on posters, too many choices
If, when, why, what?
How much have you got?
--Pet Shop Boys

Nice rejoinder to escalating claims that our current economic system is 'capitalism.' The author also observes that, contrary to popular belief, capitalism is not based on 'rugged individualism' in dog-eat-dog fashion. Instead, capitalism is grounded in voluntary social cooperation.

What we have now is a system increasingly driven by political force.

Debt Ceiling Quietly Increases

These changing years
They add to your confusion
Oh and you need to hear
The time that told the truth
--Level 42

And just like that, the debt ceiling goes up by $1.2 trillion. The new upper bound is now $16.4 trillion. Rick Santelli is correct. Not much noise from the media this time around.

Coping with Variation in the Human Condition

All for freedom and of pleasure
Nothing ever lasts forever
Everybody wants to rule the world
--Tears for Fears

A fundamental axiom of nature is variation. In terms of the human condition, variation is expressed in the differing capabilities and interests among people. It is also expressed in the differing situations in which people are born--some environments being more favorable than others.

Why this occurs is unknown and perhaps unknowable. If you believe in God, then the answer rests in the mystery of the Creator. If you don't believe in God, then the answer rests in the mystery of secular humanity.

Two primary belief systems have evolved in modern times for coping with variation in the human condition. One belief system accepts this variation as part of life. People employ their resource endowments, whatever their nature, to advance their interests. Capacity and resource position can be enhanced thru self-development or thru voluntary exchange with others. Individuals are free to pursue their interests, which of course may include charity and outreach, as long as these pusuits do not forcefully intrude on the pursuits of others.

A second belief system views variation in the human condition as unacceptable. It is unjust that some have been endowed with less resources than others, and it is unfair for those with less to have to work harder to achieve what gifted people might accomplish with less effort. The equitable solution is to even up resources among people--to level the playing field in terms of resources and opportunities. Doing so requires forceful intrusion on the pursuits of others to obtain the resources deemed necessary to even things up.

It should be clear that the first belief system is grounded in the concept of personal liberty. People have a right to pursue their dreams unencumbered by forceful intervention by others. Each person's resource endowment, large or small, is but a starting point for growth based on free choice. This system is also grounded in the principle of non-violence. Individuals engage in peaceful, voluntary exchange with others when it is deemed mutually beneficial. Force is employed only to protect each person's life, liberty, and property from expropriation by others.

The second belief system is grounded in the concept of collective submission. Individual pursuit of happiness is subservient to the interests of others. Those endowed with less are viewed as unlikely to succeed unless they are provided resources. Voluntary dependence is a consequence. Because the resources given to the poor must be taken from the rich, a dominant principle of this belief system is violence--made legitimate thru government agency. Force is required to reduce variation inherent to the human condition. To keep people from pursuing their own interests, authoritarianism must rule.

It should be readily apparent which belief system is in harmony with nature.

But if the second belief system is so unnatural, then why does it predominate society? Perhaps it is because the drivers of freedom and peace conflict with another axiom the pervades human behavior: the urge to satisfy needs using the least amount of effort possible.

The spectre of getting something for nothing has been driving forceful conquest since the beginning of time.

Low Fed Rates till 2014 Sparks Gold

Here comes the rain again
Raining in my head like a tragedy
Tearing me apart like a new emotion
--Eurhythmics

In today's FOMC announcement, the Fed signaled that they will be keeping rates ultra low thru most of 2014. Wow, that even raised my eyebrow...

This news put some giddy-up into gold, which vaulted about $50 this afternoon on the FOMC news.

I used this leap to sell my GLD position. It's up about 10% from its lows, price is now filling the gap, and stochastics are getting twisty in the overbought zone.

Am also concerned about the re-hypothecation issues surrounding these metal ETFs on the back of the MF Global situation last fall.

Selling this position puts me just about 0% net long (long metal and ag commodities against short equity index). Feels about right given the current field position of various asset classes.

position in commodities, SPX

Technology and Voluntary Workforce Attrition

Welcome back my friends
To the show that never ends
We're so glad you could attend
Come inside, come inside
--Emerson, Lake & Palmer

The title of this missive suggests another piece on technology crowding out labor in the workplace. Instead, the author is more focused on the effect of emerging information technologies such as social networking on propensity to work.

The author posits that the decline in labor force participation is due to people, particularly young people, having more of their needs satisfied by info technology. This in turn is proposed to reduce peoples' need to work to obtain resources, and to reduce the need for products that would otherwise be necessary if people were commuting to, and doing more, work.

While there is some novelty to this argument, the empirical data that he provides do not support it. Jobless and participation rates have been falling for periods longer than Facebook and Twitter have been around, with primary inflection points on/around tech bubble poppage--the beginning of early deflationary action.

Moreover, the proposition that technology makes leisure more attractive compared to work might make more sense if standard of living were high with few obligations to care for. Currently, however, general standard of living is stagnating and debt load is high.

This means that, absent a windfall of innovation that permits efficient payback of debt, people will need to work more in the future in order to approach today's standard of living while paying back what they owe.

While they might lighten the workload a bit, info technologies like social networking seem unlikely to drive large amounts of voluntary attrition from work.