The Fiscal Cliff, In Three And A Half Graphics

[copyright1997reloaded]

I too have a bunch of losses left over. So if it goes to 20% it has increased the value of those old losses..right?..

Bob

Right. The strategy would be to delay LTL until higher rates, and take LTG now. However, very few of my positions are long term losses.

 

[explanade]

US can't be compared to Greece.

 

[obgyn65]

Why not ? Both are sovereign nations with heavy debts.

US can't be compared to Greece.

 

[Fermion]

Why not ? Both are sovereign nations with heavy debts.

But only one of them has control over its money.,

 

[copyright1997reloaded]

But only one of them has control over its money.,

Yes, that is a major difference between US and Greece or the Weimar Republic (Weimar Republic - Wikipedia, the free encyclopedia). However, this only works as long as other countries accept US currency in return for the goods and services they are exporting to us. Given that the biggest holder of US treasury debt is us in the forms of the Social Security Trust Fund, Medicare Trust Fund, and now over 1.6 Trillion in Federal Reserve instant money (aka "quantitative easing"), I wouldn't be to sure that we will be able to expand our money supply without consequences for ever.

The "good news" is that we aren't alone in the rush to the bottom. It seems to be a desire of many of the western nations. (For example, Japan just announced additional QE of their own.)

All of this is an attempt to stem the implosion that occurs when debt doesn't get repaid...the question everyone needs to ask themselves is will they be able to reverse the qe when the velocity of money starts going the other way, i.e. when consumer demand starts pushing prices higher.

 

[explanade]

US also has a productive economy, Greece doesn't.

US isn't full of freeloaders like Greece, except those who don't want the marginal tax rates to return to their previous levels.

Etc.

Whenever there is trouble, everyone will rush into the dollar. For all the dilution of value in the dollar, is US Treasury having to pay high interest rates?

If US Treasury instruments had to pay rates comparable to what the PIIGS were paying for their bonds, there will probably be a lot of other problems than high debt. Something will seriously be wrong in the global economy.

 

[Fermion]

I would feel a lot more uneasy if the USA didn't have such vast reserves of coal, natural gas, shale oil, timber, copper, etc. If we really started to get into serious trouble with respect to the world's opinion of our currency, we could tap into those resources in a way almost unimaginable today. We really are sitting on top of a gold mine, so to speak.

 

[MasterBlaster]

I don't know about the rest of you, but one aspect of the expiring (end of 2012) rates that has my attention is the long term capital gains rate. Under the current rate structure, it is 15%. As of January 1, 2013, it is scheduled to rise to 20%.

As a result, I have some serious thinking to do on certain securities that I have a low cost basis on, that I've either had for a long period of time and a bunch of stuff I bought in the early 2009 time frame. That is, do I:

1. Sell after the election if Obama wins, assuming re-election means the rates will be rising.
2. Sell now, assuming everyone and their brother will be doing 1.
3. Wait it out.

I normally try not to use taxes as input into my buy/hold/sell analysis of securities I own, but the differences in taxes between the 15% and 20% is significant.

Present law also has the following tax for high earners. If your income is over $200k single (or $250k married) then there will be the additional (Obamacare) tax on investment income of 3.8%.

So your rate could go as high as 23.8%

Also, dividends lose their special status and will be taxed at your ordinary income rate. That could be as high as 43.4% versus the current 15% max.

 

[Midpack]

I would feel a lot more uneasy if the USA didn't have such vast reserves of coal, natural gas, shale oil, timber, copper, etc. If we really started to get into serious trouble with respect to the world's opinion of our currency, we could tap into those resources in a way almost unimaginable today. We really are sitting on top of a gold mine, so to speak.

No doubt about the advantage we have for at least several decades ahead if not more WRT utility/power, most nations are at a disadvantage in terms of "natural resources." However, replacing crude oil (transportation mostly) would take some time and/or considerable disruption and expense, but at least it's technically doable.

 

[Fermion]

No doubt about the advantage we have for at least several decades ahead if not more WRT utility/power, most nations are at a disadvantage in terms of "natural resources." However, replacing crude oil (transportation mostly) would take some time and/or considerable disruption and expense, but at least it's technically doable.

I was thinking of the Fischer–Tropsch process, which is used by South Africa and was used in Germany in WWII. If you toss out environmental concerns (which would not be a factor in a full scale currency crisis), I think it becomes profitable at something like $60 a barrel oil?

 

[MasterBlaster]

I would feel a lot more uneasy if the USA didn't have such vast reserves of coal, natural gas, shale oil, timber, copper, etc. If we really started to get into serious trouble with respect to the world's opinion of our currency, we could tap into those resources in a way almost unimaginable today. We really are sitting on top of a gold mine, so to speak.

Yeah, we'll need some way to pay back all that debt. Of course they'll have to strip-mine literally all of Wyoming and Montana but hey It's worth it.

 

[Fermion]

Yeah, we'll need some way to pay back all that debt. Of course they'll have to strip-mine literally all of Wyoming and Montana but hey It's worth it.

Never said it would be pretty, just that it is there as a last resort type of option that other countries may not have. If we lose our world currency status and our ability to import oil is cut off, it may be one of our few options.

 

[bo_knows]

Lots of worry here in the DC area about the defense cuts. Don't have much hope our dysfunctional Congress will work this out. Glad we sold our other house.

Yup. I'm a little young for these forums and still w*rking... in the Defense Contracting industry.

There are all sorts of worries about the sequestration and how it effects current contracts and even contracts that were just awarded. Everyone is clenching their proverbial butts right now.

 

[packrat44]

I don't disagree, but it also demonstrates the stupidity of "temporary" tax cuts or tax hikes. Just make it permanent into law, and if the economic situation and/or political will changes in the future, change it again.

But in reality I am a strong supporter of VERY stable tax policy. The exact level of taxation or the exact number in each of the brackets is, within reason, less important to me than the certainty a very stable tax policy, not one likely to change with every change in political power in Washington, would provide for businesses, labor, consumers and investors.

+1.

This is a major beef I have with the present system. It has similarities to playing a game where your oponent can and does change the rules as the game progresses.

 

[packrat44]

I don't know about the rest of you, but one aspect of the expiring (end of 2012) rates that has my attention is the long term capital gains rate. Under the current rate structure, it is 15%. As of January 1, 2013, it is scheduled to rise to 20%.

As a result, I have some serious thinking to do on certain securities that I have a low cost basis on, that I've either had for a long period of time and a bunch of stuff I bought in the early 2009 time frame. That is, do I:

1. Sell after the election if Obama wins, assuming re-election means the rates will be rising.
2. Sell now, assuming everyone and their brother will be doing 1.
3. Wait it out.

I normally try not to use taxes as input into my buy/hold/sell analysis of securities I own, but the differences in taxes between the 15% and 20% is significant.

I chose #2. This is sure to guarantee the Capital Gains tax cuts will be extended and equities will rise. Always do the opposite of what I do and you will prosper in the market.

 

[MasterBlaster]

This is a major beef I have with the present system. It has similarities to playing a game where your oponent can and does change the rules as the game progresses.

We would all like a stable affordable tax system.

yet looking at our present fiscal system and looking at how the boomers will swamp entitlements. It just seems as if higher rates are inevitable for all but the poorest. Oh it's still to be determined who gets taxed and the details of such. But it's coming. You can count on it.

Those that think we can take it all from those few rich people aren't looking at the numbers. No this will affect pretty much everyone.

So plan for it. Things will change. It's inevitable.

 

[packrat44]

We would all like a stable affordable tax system.

yet looking at our present fiscal system and looking at how the boomers will swamp entitlements. It just seems as if higher rates are inevitable for all but the poorest. Oh it's still to be determined who gets taxed and the details of such. But it's coming. You can count on it.

Those that think we can take it all from those few rich people aren't looking at the numbers. No this will affect pretty much everyone.

So plan for it. Things will change. It's inevitable.

That is the way I viewed retirees 40/50 years ago when I was young.

 

[copyright1997reloaded]

US isn't full of freeloaders like Greece, except those who don't want the marginal tax rates to return to their previous levels.

...

Whenever there is trouble, everyone will rush into the dollar. For all the dilution of value in the dollar, is US Treasury having to pay high interest rates?

I was very careful not to interject political dialog in my statements regarding QE. So, do you think I'm a "freeloader" because I discuss tax strategy regarding capital gains rates?

Regarding Treasury interest rates: I believe it is a a combination of a few factors:
1. Return of capital is more important than Return on capital. This is in support of your statement regarding "rush into the dollar" but also encompasses more. If you have investment capital, but are afraid to put it into plants, people, equipment, etc, where do you park it? Best place is in short term US paper, with the emphasis on short term.
2. Who are the buyers of US Government debt in recent auctions? Well, according to this article, 61% of the net new US Government debt auctioned in 2011 was purchased by......the Federal Reserve. Here's a quote:

But in recent years foreigners and the U.S. private sector have grown less willing to fund the U.S. government. As the nearby chart shows, foreign purchases of U.S. Treasury debt plunged to 1.9% of GDP in 2011 from nearly 6% of GDP in 2009. Similarly, the U.S. private sector—namely banks, mutual funds, corporations and individuals—have reduced their purchases of U.S. government debt to a scant 0.9% of GDP in 2011 from a peak of more than 6% in 2009.
The Fed is in effect subsidizing U.S. government spending and borrowing via expansion of its balance sheet and massive purchases of Treasury bonds. This keeps Treasury interest rates abnormally low, camouflaging the true size of the budget deficit. Similarly, the Fed is providing preferential credit to the U.S. government and covering a rapidly widening gap between Treasury's need to borrow and a more limited willingness among market participants to supply Treasury with credit.

Whether or not you think this is a good decision (by the Fed), you must admit that it cannot go on forever.

I would rather not have a political discussion on this, or even one with implied name calling or to discuss who are "freeloaders".

You are free to believe whatever you want. I make my investment decisions based on what I think is happening, or will happen in the future. While I could have it exactly backwards, I've managed to steer a pretty decent course over the years, my net worth is double what it was in 2004, almost 3x what is was 1/1/2000, and I've been FIREd since early 2009. In addition, after reaching a peak net worth in May 2008, I was able to re-coup all losses and reach a new high net worth by the end of 2009...without having a work income stream.

One other thing....I own plenty of US Government paper....however it is inflation adjusted, pretty much all purchased when the real rate portion was much higher.

 

[copyright1997reloaded]

Present law also has the following tax for high earners. If your income is over $200k single (or $250k married) then there will be the additional (Obamacare) tax on investment income of 3.8%.

So your rate could go as high as 23.8%

Also, dividends lose their special status and will be taxed at your ordinary income rate. That could be as high as 43.4% versus the current 15% max.

Thanks for mentioning this! When I had looked at this back a few years, I was still working. Now that I am FIREd, my income is much lower...but need to do some what ifs with tax software to make sure I don't get myself into this situation.

 

[StuartR]

I was very careful not to interject political dialog in my statements regarding QE. So, do you think I'm a "freeloader" because I discuss tax strategy regarding capital gains rates?

Regarding Treasury interest rates: I believe it is a a combination of a few factors:
1. Return of capital is more important than Return on capital. This is in support of your statement regarding "rush into the dollar" but also encompasses more. If you have investment capital, but are afraid to put it into plants, people, equipment, etc, where do you park it? Best place is in short term US paper, with the emphasis on short term.
2. Who are the buyers of US Government debt in recent auctions? Well, according to this article, 61% of the net new US Government debt auctioned in 2011 was purchased by......the Federal Reserve. Here's a quote:


Whether or not you think this is a good decision (by the Fed), you must admit that it cannot go on forever.

I would rather not have a political discussion on this, or even one with implied name calling or to discuss who are "freeloaders".

You are free to believe whatever you want. I make my investment decisions based on what I think is happening, or will happen in the future. While I could have it exactly backwards, I've managed to steer a pretty decent course over the years, my net worth is double what it was in 2004, almost 3x what is was 1/1/2000, and I've been FIREd since early 2009. In addition, after reaching a peak net worth in May 2008, I was able to re-coup all losses and reach a new high net worth by the end of 2009...without having a work income stream.

One other thing....I own plenty of US Government paper....however it is inflation adjusted, pretty much all purchased when the real rate portion was much higher.

You are exactly right, the Fed Reserve has picked up the slack because China and the rest of the world have become risk adverse to the US government spending, debt and the US Dollar. The Fed Reserve is no longer the buyer of last resort, they are the primary buyer, with inflation producing digits conjured out of thin air.

You want to know what direction we head from here? For the second time in two weeks, Philadelphia Fed President Charles Plosser is warning about the time bomb that is excess reserves.

HOT: Fed Prez Spills the Beans on the Excess Reserve Inflation Time Bomb

Before the CFA Society of Philadelphia/The Bond Club of Philadelphia, Plosser said today (my bold):

"I have been a student of monetary theory and policy for over 30 years. One constant is that central banks tend to find it easier to lower interest rates than to raise them. Moreover, identifying turning points is difficult even in the best of times, so timing the change in the direction of policy is always a challenge. But this time, exit will be even more complicated and risky. With such a large balance sheet, our transition from very accommodative policies to less accommodative policies will involve using tools we have not used before, such as the interest rate on reserves, term deposits, and asset sales. Once the recovery takes off, long rates will begin to rise and banks will begin lending the large volume of excess reserves sitting in their accounts at the Fed. This loan growth can be quite rapid, as was true after the banking crisis in the 1930s, and there is some risk that the Fed will need to withdraw accommodation very aggressively in order to contain inflation. At this point, it is impossible to know whether such asset sales will be disruptive to the market. A rapid tightening of monetary policy may also entail political risks for the Fed. We would likely be selling the longer maturity assets in our portfolio at a loss, meaning that we may be unable to make any remittances to the U.S. Treasury for some years. Yet, if we don’t tighten quickly enough, we could find ourselves far behind the curve in restraining inflation.

While these risks are very hard to quantify, it is clear that the larger the Fed’s portfolio becomes, the higher the risk and the potential costs when it comes time to exit. And based on my economic outlook, that time may come well before mid-2015. In my view, to keep the funds rate at zero that long would risk destabilizing inflation expectations and lead to an unwanted increase in inflation."

This is very candid talk from a Fed insider, Plosser clearly sees the potential for massive price inflation if those excess reserves hit the system, even more striking is that Plosser knows that the Fed will likely be very slow in hiking interest rates, thus fueling the inflation.

When the price inflation hits, don't say you haven't been warned, Plosser is revealing very clearly how it will hit.

Prepare your portfolio accordingly.

 

[bo_knows]

Prepare your portfolio accordingly.

Assuming you're fully on-board for such a scenario, what exact IS preparing accordingly?

 

[marko]

US can't be compared to Greece.

Right! Greece has better weather, better food and knows how to enjoy both regardless of the economy and/or politics.

"fiscal cliff, schmishcal cliff! pass the ouzo!"

Friends just got back from a month in Greece. Verdict: nobody over there worries too much about the whole thing...party on the beach!

Seriously, I think our fearless leaders will resolve this before year end.

 

[Midpack]

Simpson-Bowles (Bowles-Simpson), still the best place to start IMO http://www.fiscalcommission.gov/sit...files/documents/TheMomentofTruth12_1_2010.pdf. Every American taxpayer should read it and be prepared to sacrifice responsibly, but few ever will. I quit holding my breath quite a while back. I hope we find the collective will to act before we reach Greece's predicament...

US can't be compared to Greece.

But only one of them has control over its money.

US also has a productive economy, Greece doesn't.

US isn't full of freeloaders like Greece, except those who don't want the marginal tax rates to return to their previous levels.

Etc.

So you believe we can't become comparable to Greece if we don't act to bring our fiscal house more in balance at some point? The ability to print your own currency only works to a point. There are about 40 examples where that's failed among the many listed here.

 

[explanade]

Well the own currency is one factor.

I think the fact that we have a much more productive economy whereas Greece only has what, tourism, is a much bigger factor.

Greece got into its fiscal crisis because they were spending money that their economy didn't justify.

We're in debt mostly because of political and policy decisions and the refusal to agree on how to address the problem.

 

[samclem]

Assuming you're fully on-board for such a scenario, what exact IS preparing accordingly?

Part of the problem is that most folks can't afford to be "fully on board" with this scenario. To stake the whole portfolio on this potential scenario would be very risky.
But, I think the scenario Plosser outlines is a significant possibility. I've done a little by significantly reducing my bonds and bond maturities (on the assumption that higher inflation will drive interest rates higher as well). I think stocks, overall, will do relatively well in keeping pace with moderately higher inflation. Since Plosser's view doesn't seem to be widely held, I'd think that hedging against it should be fairly cheap, but that's about where I run out of ideas. I guess I could buy gold/gold options, but that introduces another point of of uncertainty (e.g. will higher inflation result in significantly increased demand for gold this time?). It'd be more straightforward just to "bet" on the inflation index.
So, what's the cheapest way to buy some insurance against a 2-5% increase in the CPI?