Browsing the blog archives for April, 2013.

Capital Flight & the US


Andrew Wilkow and I had an interesting discussion on his show Thursday about the global flight of capital. I want to address this on the blog and explain why it’s relevant to all of us.

It’s very simple. People flee persecution, and so does money. It finds its way to places where it is less likely to be confiscated. Money doesn’t like political and social risk, and it likes its privacy.

Historically, Switzerland has scored well on all three fronts in terms of foreign capital—taxation, risk, and privacy. Recently, however, the US and other European governments have threatened to sue Swiss banks for allegedly helping wealthy clients avoid taxation in their host countries. To avoid legal battles, these banks have agreed to share their financial information with the host governments…so much for privacy. Moreover, Switzerland is slated to raise taxes on foreigners in 2016. This is where Singapore comes in.

While Singapore has serious issues with certain personal liberty, it’s an attractive place for commerce and foreign capital. Singapore’s highest income tax rate is 20%. Its highest corporate rate is 17%. There are no tax on capital gains and no death taxes.

Many refer to Singapore as the “Switzerland of Asia.” Indeed, banks in Singapore are enjoying an influx of capital not only from individuals in Asian countries in like China, Indonesia and Malaysia, but also from those in the West. The Swiss still hold about a third of the funds controlled by wealth management firms, but that percentage is declining. Singapore’s share of the wealth management pie is still far behind Switzerland, but the nation is on track to become the new Switzerland for the entire world in the next decade.

There is a lesson here. Creating a less friendly environment for capital will cost the Swiss dearly. Even with higher tax rates, government receipts will likely decline over the long term as money seeks greener pastures. Singapore and other capital-friendly nations will reap the benefits. All things equal, capital always finds the best returns.

On a global level, Marxists campaign for global taxes and other regulations because they would restrict the ability of nations like Singapore to develop more attractive policies. You can only avoid a global tax if you leave the globe. From an American perspective, what we are witnessing in capital flight is further evidence that higher taxes and regulations not only stymie business activity but also fail to raise the revenue politicians seek in the first place. As long as individuals and firms are relatively free to make their own decisions, they will conduct their affairs in the most competitive nations. The U.S. could become the new Switzerland with the right policies, but we have a long way to go.


Stocks, Gold & the Economy


I’ve received several emails lately that cite the stock market’s recent surge as evidence of the long awaited economic rebound. Is this a valid argument? Not necessarily…Here’s why.

Stock prices are based on a number of factors that are indirectly related to the economy. In theory, a stock’s value should reflect the expected short- and long-term earnings of a firm, but many investors buy stocks simply because they believe their value will rise more than other investments. Put another way, I might not like GM as a long-term investment but I might purchase the stock if I believe others will do so, which would drive up the value of my investment in the short run.

Others might invest in the stock market if they don’t like the available alternatives. After increases in gold and silver prices for the last several year, many investors have pulled back for the time being. The Fed also manipulates the stock market, and has recently sold naked shorts of gold to both drive the price down and profit from the decline. With the Fed keeping interest rates (artificially) close to zero, fixed term investments offer returns below the expected rate of inflation, prompting even conservative investors to buy more equities.

My point here is that the stock market is driven by many factors and should be considered one indicator of an economy’s health. In my view, the U.S. economy is in a holding pattern, and many companies are beginning to adjust to the new normal of increased regulation, government influence, and Obamacare. This, combined with economic weakness in many other countries, has primed the stock market as well. Many firms appear to be sidestepping increased hiring costs by getting by with fewer employees, which is why the U.S. workforce is shrinking.

A modest rebound is not out of the question, but my long-term outlook for the economy remains grim. Trillion-dollar deficits are expected for some time and many in Washington are still calling for more taxes and government spending. Entitlements are out of control and any serious reform is unlikely to pass while Obama is in office. Even with some gains in the stock market, another financial crisis is inevitable if we don’t change course. The only question is when.


A Global Currency Devaluation


The Bank of Japan followed the US Federal Reserve and other central banks, unveiling its own package of easy-money policies on Thursday. By doubling its holdings of government bonds and the amount of yen circulating in the economy, the Bank of Japan is essentially printing money to create inflation and drive down the value of the yen relative to other global currencies. The value of the yen has already declined substantially since November 2012 in anticipation of such a move. A US dollar buys 97 yen today compared to about 80 5 months ago, resulting in a yen-to-dollar depreciation of over 20%.

The Keynesian thinking is that a weak currency boosts an economy by making exports cheaper and raising the price of imports, thereby encouraging citizens to buy goods produced domestically. A central bank’s easy-money intervention accomplishes this goal, thereby devaluing the currency and creating inflation. These facts are not disputed. As noted in a recent Fed letter, “Surprise unconventional policy easing has pushed down the value of the dollar roughly as much as similar surprise downward moves in the federal funds rate did before the crisis” (see

The arguments of Paul Krugman and other Keynesians notwithstanding, a devalued currency doesn’t help a nation in the long run. The inflation it causes is an indirect tax on wealth and devaluation expectations scare potential investors. But what happens if all developed nations seek to devalue their own currencies? The result would be a currency war. This is a serious possibility, as Japan is simply joining a lost list of nations–including the US–that have already gone down this road.

The answer is not very complicated. If every nation devalues its own currency, then no nation will obtain any short run relative trade advantage because the devaluations cancel each other out. Such a combination of independent central bank actions would have the same effect as a coordinated global currency devaluation. Some economists and politicians might actually like to see this, as it would decrease the value of government debt at the expense of inflation and current cash holdings, including those at corporations and in retirement accounts. Any currency devaluation steals from those who hold wealth by reducing the purchasing power of their cash holdings.

Japan’s move will encourage other central banks to follow suit, and an impending global currency devaluation would have a devastating effect on the US economy. Interest rates would rise because investors will demand higher returns on government debt. At current debt levels, a 3% hike in the interest rate would increase our annual interest payments by about $500 billion. Faced with rising inflation, the Fed would be forced to raise interest rates, which have been kept at artificially low levels to prime the economy and prop up the housing market. While the full effects of these currency devaluations will not be felt immediately, they–like most Keynesian policies–will kill us in the long run.