12 Gold = Inflation Sponge
Inflation doomsayers pointed to the huge jumps in commodity prices as proof that we were entering the ‘end times.’ The great impending economic implosion was weeks away, they warned. The price of gold quadrupled and rising. The explanation was that ‘investors’ were ‘running for the hills’ by cashing out of the paper money’s failing system and converting it to the only true currency - gold. Raghu-nomics recognized that there was another dynamic at play. It has a different narrative. It was not so much ‘investors,’ but banks. Banks were now sitting on hundreds of billions received from the banking bailout. They were more lazy then scared to loan so they bought gold.
Banks took the bailout money and put it into gold. Ideally, they would have loaned this money to small businesses. Banks did not do this. The next best place was gold. Gold is somewhat inflation neutral. The reason for this is that gold has a dwindling role in the modern world. An ever growing number of its manufacturing functions are being replaced by new materials. The impact of rising gold prices therefore plays a smaller role upon consumption. This would not be true for a gold standard currency that actively uses gold for trades and accounting. Gold today is primarily relegated to capital ‘hoarders.’ It’s becoming more of a holding pen for excess capital rather then a market driver of consumption or a reduction thereof.
Lost Traction w/ Larger Market
Gold buffs are still few and far between on a per capita basis. People just don’t have the same sense of urgency for gold, even when faced with slowing economic times like we’ve seen of these last few years. Billions of people have access to gold markets for the first time. And yet, only millions actually buy gold as a hedge against this latest crisis. Gold is losing some of its lure as a percentage of the population with access to it. This means its inflationary impact is reduced along with it.
Gold has a place with traditions - Indian marriages or Chinese medicine, but these are luxury items rather then a financial staple. Gold’s shrinking role makes it an ideal inflation holding tank. In a sense, gold can help offset inflation when used to absorb excess capital. Better gold then other commodities. Commodities like iron, food or energy impact the cost of consumption far more directly then gold. Banks invested in these other commodities as well, but gold absorbed a great deal of their excess cash. This reduced the capital poured into commodity consumables like food and iron. Flooding these commodities with cash would have created far more inflation for the average consumer then we see of gold.
Gold Cost vs. Inflation
Gold’s pricing spikes don’t have the same impact to consumption or the larger economy as it once did. Gold is now competing against technology and the global access of new market investments against domestic risks. This has changed gold’s relevancy and relegates it to a smaller role – at least for now. It’s a new economy with new rules. This shift is not accounted for by doomsayers. The proof is easy to find. Look what happens when they make predictions based upon the high price of gold. They are always off target. The ‘end of the world’ date is revised more then biblical doomsayers. Raghu-nomics has found more accurate measures then gold. They are summed up in our ‘10 Steps to Great Manufacturing Jobs.’
Apathy vs. Panic
There is another side to this gold rush. It did not represent a typical inflationary spike nor even a market panic. In other words, we did not have a genuine fall in the supply of gold because of market demand – per say. There was not some sudden manufacturing need for it. These price spikes were primarily from lazy bankers. They were not hording gold because of a market panic so much as they were just too lazy to lend their huge stash of cash to small businesses. Gold was fast, safe and easy. It was more a case of an apathetic view of the economy rather then terror of it. Of course, this can change if the economy truly ‘tanked,’ but much of today’s gold demand is a carry-over from bankers hording it versus a private sector run on gold. Should banks dump their gold, the price of gold would drop. These banking purchases distorted prices far beyond the markets natural value for it. Interesting to note that this gold rush was primarily confined to US banks versus a global run on gold. US banks were sitting on billions from the banking bailout. Gold ended up absorbing much of this excess capital over other commodities. That is a good thing.
Raghu-nomics offers a simple solution to this hoarding: Taxes. We call the program: Deflation Tax. Republicans insist that taxes slow the economy. Raghu-nomics agrees and so we suggest using taxes much as the fed uses interest rates to slow an over heating market. Taxes offer a special feature that fed rates cannot. Taxes allow us to target specific market bubbles without affecting other market sectors. In contrast, fed interest rate hikes slow the entire economy. We have a good example in banks and gold. Raising taxes on both of them would have led banks to consider higher risk investments while dumping their gold shares. This would have generated more loans and lower gold prices. The Inflation Tax would have corrected these market bubbles – very quickly.
Higher Taxes = More Investment
Higher risk investments make more sense when a business is faced with a higher tax rate of say 40%. The 15% tax rate that banks and investors now pay leaves them investing far more conservatively. That would change once they knew gov’t was going to take 40% of their profits. They would only be able to find the savings through investment tax write offs.
Russia – Low Reinvestment
You find this with countries with lower tax rates. They also have lower rates of re-investment. They tend to have more conservative investors. Russia for example has a tax rate of just 13%. What incentive do Russians have for making higher risk investments? Raising those taxes to say 40% would leave investors looking for other places to ‘invest’ their money rather than losing it to higher taxes. The rush for the door to move their capital out of the country would be offset against the tease of rising opportunities of an economy booming once more. What do you think the US economy would look like if the $4 trillion in bailout money was used for small biz investments rather then commodity purchases? The economy would be in full swing once more. Investors would be jumping back in to take advantage of all the new opportunities – even if the tax rate was 40%.
Clinton Secret: Tax Rates
We gather that the Clinton years stimulated greater investment via his higher tax rates. We suspect that the wealthy did not actually pay more in taxes, but rather, they simply invested more of their income to avoid paying the higher taxes. Hence, the market boom of the 80’s. This left us with such market expansion as the tech bubble. Though the tech bubble finally did pop, it left behind the infrastructure for our tech boom of the last 15 years. It was built upon a host of risky investments that would not have been made without those higher tax rates. In turn, it created a generation of technology which would have not happened without out this mass cash infusion. Tax rates that are too high will also kill investment incentive. 35% to 45% seems to be a magic number for targeting over inflated market bubbles and stimulating more pro-active investments. These higher tax rates are also great for soaking up excess liquidity. They have the same effect as higher interest rates by the feds.
We call this the ‘reinvestment stimulus cycle?’ It’s covered in our article:
‘Do Mortgage Interest Tax Breaks Expand Pool of Capital Investors.’
Tax Breaks for Taxes Paid
These ‘Higher Tax Rates’ MUST be matched with ‘Generous Tax Breaks.’ For example, banks would get tax credits against profits of the small business they loaned to. Let’s say the bank made a loan of $1 million to a small business. Let’s also say the business then made $150,000 profit the next year. That biz would pay $60,000 in taxes. The bank could receive $10,000 in tax breaks for making this loan to that business. The bank would get this tax break on top of the interest earned. This is covered in more detail in our FATE Tax program:
The Fair Tax Exchange: Big Tax-cuts for Great Wages.
More Tax Credit then Profits
The FATE Tax would likely offer ‘lower’ taxes then biz presently pays at today’s 15% tax rate. The Inflation Tax is no longer based upon how much profit the bank makes. The banks tax rate is now determined upon the profit the business makes and pays in taxes. Let’s say the biz pays more taxes then the banks total profits. This would allow the bank a surplus in tax credits above its total income. You would then have people buying banking stocks for the tax breaks. Banks that loan money to business will have this other layer of value – dividends plus tax breaks.
FATE Off-Sets Risk
The bank maybe allowed this tax-credit for the first 2 to 4 years after each loan. This will create the incentive to find new customers and loan more money. The banks would also be encouraging business to pay more in taxes as well. It would also guarantee the gov’t added tax revenue against the tax-deductions. This combination of higher tax rates along side larger tax credits would offset the risk of making small biz loans while allowing banks to pay less in taxes then they do at today’s lower tax rates. The FATE Tax is a performance based tax-write off against revenues created.
Performance Based Tax Credits
The Inflation Tax is likely more generous then today’s 15% tax rate. It will also prove to be more efficient (and fair) as a tax policy. It’s directly tied to performance rather then a sum of the banks total profits. Banks whose loans generate greater tax revenue, have more tax credits. Those investing in commodities will instead pay 45% on those commodity profits. We don’t need banks investing in commodities. We need them loaning to small businesses. Those who loan can cash in on generous tax breaks. Those banks that don’t, pay the higher tax rate of 45%. This is the most efficient way to break this bottleneck banks have on capital. This will get banks loaning again while finally dumping their gold holdings. This is tax policy that can stimulate market investment rather than having gov’t intervene with cash stimulus programs.
Both the FATE Tax and Inflation Tax are intended to be temporary. It’s geared to pop market bubbles, suck out excess capital or stir market investments. In the case of banking, this would last for say 1 to 3 years. It would run however long it takes to meet small business capital needs and flush out excess liquidity sloshing around our banking system. Tax rates would again revert to their old scale of 15% once capital has found market parity. This represents a huge shift in tax policy. The FATE and Inflation Tax programs are no longer geared to fill gov’ts financial needs. These taxes function more like the Federal Reserve. The feds apply interest rates to offset inflation or stimulate markets.
Tax On Gold
The Inflation Tax could also be applied to gold when it becomes ‘over-inflated.’ It would be applied on all gold investments above say $250,000. It could run 3% to 10% of total holdings, per year. This would offset the value and security of gold. This would remain in place until the price of gold fell by 30% to 60%.
Speculation vs. Consumption
Market bubbles led by speculation are much easier to ‘pop’ then consumption based pricing hikes. Taxes on speculation can pop bubbles relatively fast and painlessly. Consumption based pricing hikes requires a change of consumption habits. This has a slower turn around time and a tax premium is likely to cause greater public disruption. Therefore, the Inflation Tax is primarily geared to pop speculation led market bubbles rather then consumption led pricing hikes. The stockpiles of gold sitting in bank vaults would be an example of a speculation bubble.
For more info on the Inflation Tax:
Deflation Tax Part I: Economic Smart Bomb Against Inflation
Deflation Tax Part II: The Taxes to Risk Ratio