Outside Economics

Hardly anyone likes taxes, but some are more offensive than others. Here are three that are pretty big offenders. I don’t think folks mind paying some taxes, but it’s when it takes nearly five months of work to hit tax freedom day that it becomes a greater burden. Not to mention the waste that is found in government, so these three taxes can and ought to be fixed.

Alternative Minimum Tax - AMT

Once upon a time, Congress dreamed up the alternative minimum tax (AMT), which is an add-on to the “regular” federal income tax. The stated reason for the AMT was essentially to make sure that the rich who benefit from multiple federal income-tax breaks still have to pay at least something to the Treasury. Oddly enough, the rules for this tax were poorly crafted, thereby allowing for creative math to come into play, of course, erring on the side of the IRS.

One can consider the AMT as a separate tax system. The AMT will affect certain types of income that are tax-free under the regular tax system, while not allowing some regular tax deductions. Also, the maximum AMT rate is “only” 28%, versus 39.6% under the regular tax system.

The most likely AMT victims are upper-middle-income individuals who pay relatively high state and local income and property taxes and have spouses and kids. The truly rich ($750,000+) are rarely affected, and this is for two reasons.

First: Their marginal regular federal income rate is 39.6%, while the maximum AMT rate is 28%. So the regular tax bill for a person with really high income will usually exceed the AMT bill. On the other hand, folks in the upper-middle-income zone may have enough regular tax deductions that they pay an average regular tax rate lower than the AMT rate. If so, they will get hit with the AMT.

Second: Many tax breaks for really high-income folks are already cut back under regular tax rules before they even get to the AMT calculation. For instance, the passive activity loss rules restrict tax benefits from traditional tax-shelter investments like rental real estate and limited partnerships. And if your income exceeds certain limits, you’ll run into phase-out rules that chip away or eliminate your personal and dependent exemption deductions, your biggest itemized deductions, and your tax credits. So you may have little or nothing left to lose under the AMT rules. In contrast, folks in the upper-middle-income zone often have lots to lose, such as significant deductions that are allowed for regular tax but disallowed under the AMT rules. As a result, they wind up owing the AMT.

You are allowed a relatively generous AMT exemption, which would be the equivalent to a deduction when calculating your AMT bill. But unfortunately, the exemption is phased out at higher income levels. If your AMT bill exceeds your regular tax bill, then of course you will owe the higher AMT amount.

Varying factors make it difficult to figure out who will be affected by the AMT and who won’t. But here are some general guidelines:

• Your income is high enough ($250,000 or more) that a good part or all of your AMT exemption is phased out.
• You have relatively hefty deductions for state and local income and property taxes under the regular tax rules (say, $20,000 or more). These deductions are not allowed under the AMT rules.
• You have a spouse and several kids, which translates into four or more personal and dependent exemption deductions under regular tax rules. These deductions are not allowed under the AMT rules.
• You exercised an in-the-money incentive stock option (ISO). The so-called bargain element (the difference between the market value of the shares on the exercise date and the ISO exercise price) does not count as income under the regular tax rules, but it counts as income under the AMT rules.
  • You have a significant deduction for home equity mortgage interest. Under the regular tax rules, you can deduct interest on up to $100,000 of home-equity loans. But under the AMT rules you can only deduct interest on loan balances of up to $100,000 that are used to acquire or improve a first or second residence.
  • You have write-offs for miscellaneous itemized deduction items (such as investment expenses and fees for tax advice and preparation) under regular tax rules. These deductions are disallowed under the AMT rules.

Social Security or FICA Tax

The second tax that has some serious flaws is the Social Security tax. It can be just as expensive as the federal income tax for many folks, especially self-employed individuals.

If you are an employee, your wages will be reduced by the 12.4% Social Security tax up to the annual wage ceiling. Half the Social Security tax bill (6.2%) is withheld from your paychecks. The other half (also 6.2%) is paid by your employer.

Unless you closely examine your pay stubs, you may be completely unaware of how much the Social Security tax is actually costing you. Potentially, a lot! The Social Security tax wage ceiling for 2014 is $117,000, and it will be even higher next year. If your wages meet or exceed the $117,000 ceiling for this year, the 2014 Social Security tax hit will be a whopping $14,508 (12.4% x $117,000).

If you are self-employed as a sole proprietor, partner, or limited liability corporation (LLC) member, you know the full cost of the Social Security tax all too well. That’s because you must pay the entire 12.4% rate out of your own pocket, via the self-employment tax.

But there is a disconnect between the Social Security tax and the benefits. While the Social Security tax ceiling increased by 2.9% from 2013 to 2014 (from $113,700 to $117,000), Social Security benefits only increased by 1.5%. This scenario has occurred routinely in the past few years, and they aren't stopping now! According to Social Security Administration projections, the Social Security tax ceiling in 2022 will be $165,600, which equates to a $20,534 Social Security tax bill (12.4% x $165,600). That is a hefty tax, especially considering it is in addition to regular income tax as well as all the other taxes!

Social Security Benefits Tax

And this leads us to the third unfair tax. When you start receiving Social Security benefits, you may be surprised to discover that between 50% and 85% of your payments get hit with federal income tax (the taxable percentage goes up with your income). Incredible, right?

As I just explained, you already paid Social Security tax years ago in the form of withholding from your wages or the self-employment tax. Plus, you already paid federal income tax on those Social Security taxes years ago, because they were included as part of your taxable salary or self-employment income. Now you are paying tax on the benefits too. That amounts to double taxation, or maybe even triple taxation depending on how you look at it. While retirees with very low income, less than $32,000 per year, won’t get taxed on their Social Security benefits, everybody else will take a hit.

Tell us what you think about these taxes are they a burden on your family? How would you solve the problem of these taxes?

Is there any doubt that we are living in a bubble economy? At this moment in the United States we are simultaneously experiencing a stock market bubble, a government debt bubble, a corporate bond bubble, a bubble in San Francisco real estate, a farmland bubble, a derivatives bubble and a student loan debt bubble.

Another very troubling bubble that is brewing is the massive bubble of consumer credit in the United States. According to the Wall Street Journal, consumer credit in the United States increased at a 7.4 percent annual rate in May. That might be okay if our paychecks were increasing at a 7.4% annual rate, but that is not the case at all. Instead, median household income in America has gone down for five years in a row.

This pattern of bubbles is not isolated to the United States alone. In fact, the total amount of government debt around the world has risen by about 40% just since the last recession. It is never sustainable when asset prices and debt levels increase much faster than the overall level of economic growth. At some point a massive correction will happen. History has shown us that all financial bubbles eventually burst.

You know that things are serious when even the New York Times starts pointing out financial bubbles everywhere. Their definition of a bubble is “when the price of everything blasts upwards, obliterating the previous ceilings of historical benchmarks, it's a pretty good indication that you're in a bubble.”

The bubbles in the financial markets have become so glaring that even the central bankers are starting to warn us about them. For example, just consider what the Bank for International Settlements is saying:

“There is a common element in all this. In no small measure, the causes of the post- crisis malaise are those of the crisis itself – they lie in a collective failure to get to grips with the financial cycle. Addressing this failure calls for adjustments to policy frameworks – fiscal, monetary and prudential – to ensure a more symmetrical response across booms and busts. And it calls for moving away from debt as the main engine of growth. Otherwise, the risk is that instability will entrench itself in the global economy and room for policy maneuver will run out.”

This is quite a harbinger coming from the BIS. As for the “room for policy measures running out,” according to Jim Rickards, author of Currency Wars and The Death of Money, the Fed has two options at this point, they can continue to taper off the mass printing of money, which he says will lead to another recession within this depression. Or if they don't continue to taper, perhaps have a pause in printing and they increase their asset purchases, then that will signal to the market that the Fed must keep on printing and it will trigger hyper-inflation. This will cause the dollar to collapse and gold prices to increase.

According to the minutes from the Fed's June 17-18 meeting, the Federal Reserve is leaning towards ending the economic stimulus in October. Fed policymakers have been tapering their government bond purchases in $10 billion increments at each meeting since December, cutting them to $35 billion a month from $85 billion. At that pace, the Fed would be buying $15 billion in Treasury bonds and mortgage-backed securities by its October meeting.

Yet while Fed officials are planning on halting the bond buying, closing out the program will have another side-effect. The bond purchases have held down long-term interest rates for several years, spurring purchases of homes and factory equipment. The Fed has been planning on increasing the interest rates sometime in 2015, after all, they can't stay suppressed forever.

With all the bubbles that are out there, what will happen once the interest rates increase?

Is this sustainable?

Of course not.

None of these financial bubbles are.

So, what to do?

Now is a good time to be considering other options such as precious metals. Precious metals have always been an important part of a well-rounded portfolio. But with all the economic uncertainty out there, many people are beginning to insist on having some sort of precious metal not just in their portfolio, but in their hands. There are even a few states who have recently voted to accept gold and silver as legal tender. There is a reason why these precious metals have been the currency standard since Biblical times. In short, they don't lose their value.

There are many naysayers out there arguing that buying gold and silver is a foolish investment. Perhaps as an investment, they are right. But as a type of insurance against the consequences of the monetary manipulations and bubbles that are within our economy, maybe having some gold or silver in your hands becomes wisdom. How much to have dependes on your personal situation, 

We really don't know what the economy will look like in the next few years. We can look at history to see what typically happens when this type of mix of bubbles and monetary manipulation come in to play. We would be foolish to think that the results that happened then could never happen to us. Common sense tells us to be prepared. What does being prepared look like for you? I believe it is far easier to be prepared than to try and predict the future.

Last week I discussed some of the factors that go into the decision about when to take Social Security. The discussion was primarily based on working the numbers and coming to the basic conclusion that it is an entirely individual choice based on one's financial situation. This week I want to add to this discussion some of the qualitative aspects of life that should not be neglected when making such a decision.

To give an example of what I have in mind for this discussion, consider some of these questions: Will I be better able to do some of the things I have always wanted to do if I take Social Security earlier rather than later? If I wait on taking Social Security will I have the stamina, interest and motivation to do the things I want to do now, later in life?

Last week I showed that the payout is often larger by waiting a few years to take Social Security, however, will waiting enhance the quality of your life? Would you be wiser to take it at a younger age and use the lesser amount to fund some of the life experiences (travel, toys, etc.) that you may not have the stamina or interest to pursue later in life?

The US Travel Association reports that the average age of leisure travelers is 47.5 years old. Mature travelers comprise 36 percent of leisure travel volume (18% are 65+, 18% are 55-64). Nearly two in ten (19%) are 45-55, 17% are 35-44, 20% are 25-34 and 8% are 18-24 years old. I give this statistic because many people dream of traveling once they retire. The majority of travelers- 36%- are over age 55. Will you have the money and the stamina to fulfill your travel dreams? Would the decision to take Social Security earlier help you reach that goal?

The American Psychological Association reports that a number of physical changes occur as adults reach age 65. The most common are listed below.

• Hearing impairment among older adults is often moderate or mild, yet it is widespread; 48 percent of men and 37 percent of women over age 75 experience hearing difficulties.
• Visual changes among aging adults include problems with reading speed, seeing in dim light, reading small print, and locating objects.
• The amount of time it takes to respond to features in the environment once they are detected is typically slower among older adults.
• The proportion of older adults needing assistance with everyday activities increases with age. Nine percent of those between ages 65 and 69 need personal assistance, while up to 50 percent of older Americans over 85 need assistance with everyday activities.
• The top five causes of death among older adults are heart disease, cancer, cerebrovascular disease (relating to the blood vessels that supply the brain), pneumonia and flu, and chronic obstructive pulmonary disease. In spite of a decline in physical health, two-thirds of older adults who are not living in institutions (such as nursing homes) report their health to be good, very good, or excellent compared with others their age. What's important to remember about people over age 65 is that while many begin to experience some physical limitations, they learn to live with them and lead happy and productive lives.

These statistics can help us factor in the very real changes in health that we experience as we age. Not that everyone will experience some or all of these health challenges, but to simply acknowledge that the older we get, the more physical limitations we can expect. What do you want to do with your life before physical limitations set in that would thwart your dreams?

The point is that there is a qualitative dimension to this choice that is often overlooked or ambiguously lumped in the statement of 'individual choice'. People often forget to take into consideration the aging process with its diminished energy and somewhat constricted abilities, and therefore run the risk of not achieving their dreams and dying with a pot full of money. Abraham Maslow once commented that you can pay too much for money.

In researching for this article, I wondered, how are seniors spending their money? Below is a chart showing the top five areas that seniors are spending their money. It may surprise you to see education listed. This is typically due to either contributions to a grandchild’s college fund or else paying off college loans that were co-signed by the seniors.

Now see how those expenditures change as seniors age past 75.

Seniors spending reflects their hobbies. For 65 to 74 year-olds, for instance, notice that two of the top five fastest-growing expenditure categories are miscellaneous entertainment, which includes exercise equipment, photography equipment, campers, boats and other motorized recreational vehicles, and electronics; and pets and hobbies, which not only includes expenses for pets and pet supplies, but also toys, games, tricycles and playground equipment.

The Baby Boomers are far more active than their parents were. They have traveled more places, participated in more sports, and likely climbed more mountains. All resulting in an active lifestyle, that will be interesting to watch as they continue to age; how and when will they start to slow down?

According to the Bureau of Labor Statistics, the number of seniors age 75 and older are around 12,147,000 with a mean after-tax income of about $34,245 and a mean expenditure of $34,395.

One more thing that is noteworthy to mention is that 25 years ago, the credit card debt of seniors was negligible, and now it is around $5000 for seniors aged 75 years or older. I hope these statistics give you an idea of how to plan for your senior years. It isn't just about the numbers, but it is very much about the quality of life you want to maintain during those years.

I would like to share the story of a dying 85 year old man imagining how he would've lived his life differently if given the chance. It is found in the book Living, Loving & Learning by Leo Buscaglia, who discovered it in a journal of humanistic psychology.

He says, "If I had my life to live over again, I'd try to make more mistakes next time. I wouldn't try to be so perfect. I would relax more. I'd limber up. I'd be sillier than I've been on this trip. In fact, I know very few things that I would take so seriously, I'd be crazier. I'd be less hygienic. I'd take more chances, I'd take more trips, I'd climb more mountains, I'd swim more rivers, I'd watch more sunsets, I'd go more places I've never been to. I'd eat more ice cream and fewer beans. I'd have more actual troubles and fewer imaginary ones.

You see I was one of those people who lived prophylactically and sensibly and sanely hour after hour and day after day. Oh, I've had my moments, and if I had it to do all over again, I'd have more of those moments. In fact, I'd try to have nothing but beautiful moments- moment by moment by moment.

I've been one of those people who never went anywhere without a thermometer, a hot water bottle, a gargle, a raincoat, and a parachute. If I had to do it all over again, I'd travel lighter next time. If I had to do it all over again, I'd start barefoot earlier in the spring and stay that way later in the fall. I'd ride more merry-go-rounds, I'd watch more sunrises, and I'd play with more children, if I had my life to live over again. But you see, I don't."

The bottom line is that as we age, we may not want to travel as much, go out to the movies as much, or visit great grand-children who may be graduating from Kindergarten (as important as that may be). We may simply choose to stay closer to home and do less, simply because our perceived needs are changing and we discover that we want less. While this may be the case, and it is hard to predict, exactly how we will live at that age, choose to be happy with what you have. Manage your affairs so that when you do take Social Security it works for you and your life style, not just by the numbers. 

There is a great debate growing about when is the best time to start taking Social Security. There are pro's and con's on either side of the debate. But really, it all boils down to a very personal decision based on your specific situation.

The factors of when to take Social Security depend on two considerations: 1) the quantitative information, your work status between age 62 and your full retirement age; your life expectancy; your marital status; and your desire to protect your assets; and 2) the qualitative information, what are your goals during retirement, when do you anticipate slowing down, will you have the stamina or interest to pursue things later in life, say, over age 80, etc. This will be a two part article, first I will discuss the quantitative factors how each of these may affect your personal situation, next week I will discuss, perhaps the more important, qualitative factors.

If you have not yet reached your full retirement age as defined by Social Security (for most people that's about age 66) and you are still working, it will probably not make sense to start receiving your Social Security benefits. Why? Because if you earn over the Social Security earnings limit, your Social Security benefits will be reduced. Once you reach full retirement age your benefits will not be reduced regardless of other income you may earn (although your benefits may be taxed.)

If you live to your standard life expectancy, believe it or not, you will get almost the same amount whether you take Social Security early, or wait until later to take it. To see how this works, it helps to look at an example using real numbers, such as the one below.

Steve is age 61 and he is deciding when to take social security. Here are the numbers from his Social Security statement showing what he will get at which age:

• Age 62: $1,643 ($19,716 per year)
• Age 66: $2,238 ($26,856 per year)
• Age 70: $3,009 ($36,108 per year)

A 62 year old man has a life expectancy of nineteen years, or age 81. Social Security has a cost of living adjustment which provides an increase in benefit of 2% a year, but for now we’ll factor it without that. Here are the three possibilities:

• Assume Steve starts receiving benefits at 62. He gets $1,643 per month, or $19,716 per year, for 19 years. This is a total of $374,600.
• If he waits until age 66, he gets $2,238 per month, or $26,856 per year, for 15 years. He'll receive a total of $402,870.
• If he waits until age 70, he gets $3,009 per month, or $36,108 per year, for 11 years. He'll receive a total of $397,190.

Clearly, if Steve lives to life expectancy, he maximizes his lifetime income by taking Social Security benefits at age 66. When you factor in the 2% annual increases, Steve would expect the following total amounts:

• $450,320 if he started benefits at age 62
• $502,720 if he started benefits at age 66
• $514,800 if he started benefits at age 70

If Steve lives to age 81, he will maximize his lifetime income by waiting until age 70 to begin taking his Social Security benefits. In Steve's case, his break even age matches the average breakeven point which is 80, meaning if he waits until age 70 to begin benefits, he must live to at least age 80 to receive the same total dollars he would have received if he started taking benefits earlier. If you don't think you'll live past 80, you're better off claiming earlier. If you are married and think one of you will live past 80, it might make sense to delay.

Morningstar's Blanchett wrote a report, "When to claim Social Security" in The Journal of Personal Finance. He said "We find that females, married couples, retirees who expect to invest in relatively conservative portfolios during retirement, and retirees who have longer life expectancies are likely to benefit most from delaying Social Security benefits. On the other hand, retirees who have shorter life expectancies or invest more aggressively and believe they can achieve a relatively high return on their retirement portfolios would likely be better off taking Social Security earlier."

There are a lot of dollars at stake, and of course no one knows their life expectancy with certainty. However certain health and lifestyle factors will affect your own personal life expectancy. Just as an insurance company would do underwriting, I would suggest you do an analysis on your own personal life expectancy, using a life expectancy calculator that will ask you health and lifestyle related questions.

For singles, life expectancy is one of the primary factors to consider. For married couples, you have to consider more than just life expectancy. The way Social Security survivor benefits work, when you are married, upon the death of the first spouse, the surviving spouse can keep the larger of either their own benefit or their spouse's benefit. Because of this, there are ways for couples to coordinate how and when they each take benefits so they can get more as a couple.

I'm a strong believer in leaving an inheritance for my posterity. Using up retirement savings in lieu of potentially one day getting a larger Social Security check just doesn't achieve this goal. It makes more sense to use money that won't be there after I'm gone - i.e. Social Security - than to burn through things like cash savings, retirement account funds, and home equity. Personally, I'd rather try to save these assets, using Social Security (a source of income that I won't be able to pass on to descendants) to pay the bills rather than dipping into personal assets.

There are also a variety of strategies regarding Social Security. One is a switching strategy, which allows one spouse to claim another's benefits. For example, a married man who is 67 and doesn't need the benefits can claim his wife's benefits until he's 70, and let his own benefits continue to grow. When he turns 70, he can switch to his own benefits. Another switching strategy: A divorced woman who is 67 and had been married for at least 10 years can claim her ex-husband's benefits until she reaches 70, then switch to her own.

When to begin taking Social Security benefits is a very personal decision. Knowing the rules will help insure that you don't needlessly waste months of benefits that you could have received. If you have questions about when you should receive Social Security benefits, feel free to contact us for a free consultation. If you know of someone who may be at the threshold of this decision pass along this article to them, you may just save them some grief.

Note: Next week qualitative issues surrounding Social Security.

A Special thanks to Dan Perkins, PhD. who helped with these articles.

The Fed and the politicians as well as many modern economists featured in the main stream media continually hearken back to the Great Depression, as if that is the only time in history our country went through a decline in the economy. There have been other depressions that are noteworthy examples to compare and contrast with the Great Depression. Perhaps there is some instruction we can glean from the depression of 1920-21.

This time period is continually ignored by the powers that be because it proves the absurdity of their policies. The conventional wisdom holds that without government countercyclical policy, whether fiscal or monetary (or both), we cannot expect economic recovery—at least, not without an intolerably long delay. Yet the very opposite policies were followed during the depression of 1920–21, and recovery was in fact quite swift.

That particular depression, although short lived, was as difficult and as steep in it's slump as that of the years of 1929-33. The simple difference is that it ended quickly. Here are some of the stats from that time period: From the spring of 1920 to summer 1921, nominal GDP fell by 23.9%, wholesale prices by 40.8% and the CPI by 8.3%. Unemployment topped out at about 14% from a preceding low of as little as 2%.

The depression also saw an extremely sharp decline in industrial production. From May 1920 to July 1921, automobile production declined by 60% and total industrial production by 30%. At the end of the recession, production quickly rebounded. Industrial production returned to its peak levels by October 1922. The AT&T Index of Industrial Productivity showed a decline of 29.4%, followed by an increase of 60.1% – by this measure, this depression of 1920–21 had the most severe decline and most robust recovery of any between 1899 and the Great Depression.

The climate was terrible for businesses – from 1919 to 1922 the rate of business failures tripled, climbing from 37 failures to 120 failures per every 10,000 businesses. Businesses that avoided bankruptcy saw a 75% decline in profits.

It is instructive, as well, to compare the American response in this period to that of Japan. In 1920, the Japanese government introduced the fundamentals of a planned economy, with the aim of keeping prices artificially high. According to economist Benjamin Anderson, “The great banks, the concentrated industries, and the government got together, destroyed the freedom of the markets, arrested the decline in commodity prices, and held the Japanese price level high above the receding world level for seven years. During these years Japan endured chronic industrial stagnation and at the end, in 1927, she had a banking crisis of such severity that many great branch bank systems went down, as well as many industries. It was a stupid policy. In the effort to avert losses on inventory representing one year’s production, Japan lost seven years.”

The U.S., by contrast, allowed its economy to readjust. “In 1920–21,” writes Anderson, “we took our losses, we readjusted our financial structure, we endured our depression, and in August 1921 we started up again. . . . The rally in business production and employment that started in August 1921 was soundly based on a drastic cleaning up of credit weakness, a drastic reduction in the costs of production, and on the free play of private enterprise. It was not based on governmental policy designed to make business good.”

Instead of “fiscal stimulus,” President Warren Harding cut the government’s budget nearly in half between 1920 and 1922. The rest of Harding’s approach was equally laissez-faire. Tax rates were slashed for all income groups. The national debt was reduced by one-third. The Federal Reserve’s activity, moreover, was hardly noticeable. As one economic historian puts it, “Despite the severity of the contraction, the Fed did not move to use its powers to turn the money supply around and fight the contraction.” By August of 1921, signs of recovery were already visible. The following year, unemployment was back down to 6.7 percent and was only 2.4 percent by 1923.

The federal government did not do what Keynesian economists ever since have urged it to do: run unbalanced budgets and prime the pump through increased expenditures. Rather, there prevailed the old-fashioned view that government should keep spending and taxation low and reduce the public debt.

Those were the economic themes of Warren Harding’s presidency. In his 1920 speech accepting the Republican presidential nomination, Harding declared:

“We will attempt intelligent and courageous deflation, and strike at government borrowing which enlarges the evil, and we will attack high cost of government with every energy and facility which attend Republican capacity. We promise that relief which will attend the halting of waste and extravagance, and the renewal of the practice of public economy, not alone because it will relieve tax burdens but because it will be an example to stimulate thrift and economy in private life.

“Let us call to all the people for thrift and economy, for denial and sacrifice if need be, for a nationwide drive against extravagance and luxury, to a recommittal to simplicity of living, to that prudent and normal plan of life which is the health of the republic. There hasn’t been a recovery from the waste and abnormalities of war since the story of mankind was first written, except through work and saving, through industry and denial, while needless spending and heedless extravagance have marked every decay in the history of nations.”

It is hardly necessary to point out that Harding’s counsel—delivered in the context of a speech to a political convention, no less—is the opposite of what the alleged experts urge upon us today. Inflation, increased government spending, and assaults on private savings combined with calls for consumer profligacy: such is the program for “recovery” in the twenty-first century.

Not surprisingly, many modern economists who have studied the depression of 1920–21 have been unable to explain how the recovery could have been so swift and sweeping even though the federal government and the Federal Reserve refrained from employing any of the macroeconomic tools—public works spending, government deficits, inflationary monetary policy, TARP, bailouts, QE—that conventional wisdom now recommends as the solution to economic slowdowns. The Keynesian economist Robert A. Gordon admitted that “government policy to moderate the depression and speed recovery was minimal. The Federal Reserve authorities were largely passive. . . . Despite the absence of a stimulative government policy, however, recovery was not long delayed.”

While there were many problems with Harding's presidency, his counsel applies to us today just as much as it did back back then. Sound fiscal policies, whether in government or in our homes require us to practice the principle of thrift and sacrifice; to learn to live a more simplified life, with less extravagance, and to live within our means.

What do you think about the solutions the Fed and the politicians are offering us today? Do you see ways we can return to the wisdom of the past? Join in the discussion with your comments.

Recently, I came across a great explanation/story about how bonds worked and I added an element that explained how derivatives worked.  I have never had a drink, I think the story is rather funny simply because I have over the years been to many business parties where the booze flowed rather freely and I could imagine this sort of thing happening.

Bond and Derivative Market

An Easily Understandable Explanation of Bond Markets

Heidi is the proprietor of a bar in Detroit. She realizes that virtually all of her customers are unemployed alcoholics and, as such, can no longer afford to patronize her bar. To solve this problem, she comes up with new marketing plan that allows her customers to drink now, but pay later. She keeps track of the drinks consumed on a ledger (thereby granting the customers loans).

Word gets around about Heidi's "drink now pay later" marketing strategy and, as a result, increasing numbers of customers flood into Heidi's bar. Soon she has the largest sales volume for any bar in Detroit.

By providing her customers' freedom from immediate payment demands, Heidi gets no resistance when, at regular intervals, she substantially increases her prices for whiskey and beer, the most consumed beverages. Consequently, Heidi's gross sales volume increases massively.

A young and dynamic vice-president at the local bank recognizes that these customer debts constitute valuable future assets and increases Heidi's borrowing limit. He sees no reason for any undue concern, since he has the debts of the unemployed alcoholics as collateral.

At the bank's corporate headquarters, expert traders transform these customer loans into DRINKBONDS, ALCOBONDS and PUKEBONDS. These securities are then bundled and traded on international security markets. Naive investors don't really understand that the securities being sold to them as AAA secured bonds are really the debts of unemployed alcoholics. Nevertheless, the bond prices continuously climb, and the securities soon become the hottest-selling items for some of the nation's leading brokerage houses.

Enter the derivatives… a derivative is basically an insurance policy on the bonds that buyers get to help insure that the bonds will one day pay off. These policies are traded too on the securities markets, however they are completely unregulated. Because the policy insures the bond it helps strengthen the bonds’ rating. The unregulated nature of the derivatives allows for the issuing company to extend its self beyond what typical capital requirements of other financial institutions, making these financial instruments extremely risky. (The greater the risk, the greater the reward; natural risk and return economics.)

For example a bank typically has a leverage ratio of 8-10 percent capital so for every $1,000.00 they lend they keep $80-100 or a ratio of 10:1 or 12:1 in what is called tier-one capital. However some of the derivatives were written by institutions whose capital level was extended to as much as 40:1 on up to 100:1; so they were keeping as little as $10.00 for each $1,000.00 they insured. Derivatives are not offered by your typical insurance companies.

Now for the rest of the story…

One day, even though the bond prices are still climbing, a risk manager at the original local bank decides that the time has come to demand payment on the debts incurred by the drinkers at Heidi's bar. He so informs Heidi.

Heidi then demands payment from her alcoholic patrons, but being unemployed alcoholics they cannot pay back their drinking debts. Since, Heidi cannot fulfill her loan obligations she is forced into bankruptcy. The bar closes and the eleven employees lose their jobs.

Overnight, DRINKBONDS, ALCOBONDS and PUKEBONDS drop in price by 90%. The collapsed bond asset value destroys the banks' liquidity and prevents it from issuing new loans, thus freezing credit and economic activity in the community.

The suppliers of Heidi's bar had granted her generous payment extensions and had invested their firms' pension funds in the various BOND securities. They find they are now faced with having to write off her bad debt and with losing over 90% of the presumed value of the bonds. Her whiskey supplier also claims bankruptcy, closing the doors on a family business that had endured for three generations. Her beer supplier is taken over by a competitor, who immediately closes the local plant and lays off 150 workers.

The size of the world derivative market, as of December 2013, is $710.182 Trillion; The world economy is $72-85 Trillion, the US economy is only $17.02 Trillion, it is an extremely big market!

The investors turn to the insurance companies who insured the bonds and demand that they too pay up, however because they did not keep enough capital to cover such large losses they implode and seek a bail out to keep from laying off thousands of employees and to keep the world markets open. After all without insurance on the bonds, no one would buy the bonds in the first place (even government bonds) and thus capital flows would completely stop. Totally crippling not just Heidi’s community of Detroit, but the world as we know it!

Fortunately though, the bank, the brokerage houses, insurance companies and their respective executives are saved and bailed out by a multi-billion dollar cash infusion from the Federal Reserve Bank and the Government.

The funds required for this bailout are obtained by new taxes levied on employed, middle-class, non-alcoholics.

If you want check if your portfolio holds derivatives let us know by clicking here.

Note: I could not find the original author of the story about Heidi's Bar to give proper credit; I added several paragraphs because the original story did not actually talk about derivatives - just bonds.

Tomorrow is the 4^th of July the day we celebrate as the day our great country was founded in 1776, when we declared our independence from England. I thought I would write a few of my feelings about our country. I was raised the youngest of seven children in Los Angeles, California. My parents met during World War II in Utah. My father was a photographer in the Signal Corps and in charge of the photographic departments on several bases west of the Rockies. My mother worked in one of those departments in Ogden.

I was raised with a great love for our country. My parents took this very seriously. As I learned more and more about our country’s history and founding my love grew. Having read many books on our founding fathers, Abraham Lincoln, and other presidents, I do have an appreciation and love of these great people.  When we spend time learning about the good in America we learn to love her.

My brother-in-law use to take me backpacking when I was a teenager in the High Sierras. There is no place like the High Sierras in the world (so I am told by the many people we met on the trail from other countries). The time spent there I learned again to love our country and its amazing beauty. I have traveled to many of the other states in the Union on business, and I am always amazed at what a wonderful country we have. It is truly special. I personally believe that God put all the right elements here so a nation could thrive and spread goodness throughout the world.

We have a constitution like no other country, with our republican form of government; yes we are a REPUBLIC, not a democracy. This constitution was the first in human history to declare that as individuals our rights came from the God who created us, not from a person or a government. These rights limited the government’s control over our lives and allowed us the freedom to develop ourselves as we chose.

We have the world’s strongest best trained military. Now I know many people say we dwell too much on the military or spend too much on the military, etc. I have heard all of that, including we should not be in this country or that country, we should not be the world’s police force – we should just stay home and mind our own business. The reality of being the world’s police force is this, if we are not there to serve, some other super power will be called in to serve. So would we rather have China, Russia, or someone else in those countries? What would be the political frame work they would leave behind? Now I know that not everything is rosy with the military there are a few bad apples that commit crimes, etc. But by and large they are great people who serve and truly bless the lives of the people in those countries. An opportunity to help these struggling countries blesses everyone involved.

I have read several histories about the wars America has been involved in, I have visited several cemeteries where hundreds of thousands of soldiers are laid to rest. I have pondered on their lives being cut short by the conflict they were in, with deep gratitude I give thanks for their sacrifice and  the sacrifice of their families; I believe that the God of this land has a special place for them.

We have an amazing geography wherein we are able to produce food in abundance, like no other place on earth. Very few things won’t grow in America. What a great blessing to produce and eat so many different foods.

We have a country where people from other countries can become an American. Becoming an American is a very special thing and I would hope that all people who come would be contributors to this great country and not work to tear it down. We have so many people who wrongfully beat a negative drum that it is sad to see what they are missing. I would ask them to study deeply its history and learn about the people and hopefully they will discover what an amazing great country that God has blessed us with.

I could go on with many more things about the greatness of America, but time and space are limited. So I will invite you to find at least five of your favorite things about America and share them with your family and friends this weekend. Help others understand why you are grateful to be an American. And always ask God to continue to bless America.

Oh - and one more thing we have a great flag - I love our flag - long may she wave!

Bitcoin is a payment system introduced as open-source software in 2009 by developer Satoshi Nakamoto. It is the first decentralized digital currency. Bitcoins are digital coins that can be sent through the internet.

The payments in the system are recorded in a public ledger using its own unit of account, which is also called bitcoin. Payments work peer-to-peer without going through a bank, a clearinghouse, a central repository or single administrator. This has led the US Treasury to call bitcoin a decentralized virtual currency. Although its status as a currency is disputed, media reports often refer to bitcoin as a cryptocurrency or digital currency.

Bitcoin promotes a number of advantages to it's use. Namely, the lack of a middleman via a bank or clearinghouse means lower fees. Bitcoin can be used throughout the world, in virtually every country. A bitcoin account can never be frozen. There are no prerequisites for using bitcoin and there are no arbitrary limits.

There are several currency exchanges that exist where people can buy bitcoins for dollars, Euros, etc. They can also be earned by what is termed mining. In mining, the bitcoins are created as a reward for the payment processing work associated with bitcoin in which miners verify and record payments into the public ledger. Besides mining, bitcoins can be obtained in exchange for products and services.

Bitcoins are stored in a digital wallet that can be accessed through a computer or mobile device. Sending bitcoins is as easy as sending an email. About 1,000 brick and mortar businesses were willing to accept payment in bitcoins as of November 2013 in addition to more than 35,000 online merchants.

The biggest problem with bitcoin seems to be in it's volatility. The price of bitcoins has gone through various cycles of appreciation and depreciation referred to by some as bubbles and busts. In 2011, the value of one bitcoin rapidly rose from about US$0.30 to US$32 before returning to US$2.

In the latter half of 2012 and during the 2012-2013 Cypriot Financial Crisis, the bitcoin price began to rise, reaching a peak of US$266 on 10 April 2013, before crashing to around US$50. As the people of Greece began to see their financial markets collapse, they sought out alternative ways to preserve their wealth and bitcoin was seen as a viable option.

At the end of 2013, the cost of one bitcoin rose to the all-round peak of US$1135, but fell to the price of US$693 three days later. In 2014 the price fell sharply, and as of April remained depressed at little more than half that of 2013.

Growth of the bitcoin supply is predefined by the bitcoin protocol. Currently there are over twelve million bitcoins in circulation with an approximate creation rate of 25 every ten minutes. The total supply is capped at an arbitrary limit of 21 million, and every four years the creation rate is halved. This means new bitcoins will continue to be released for more than a hundred years.

Bitcoin opens up a whole new platform for innovation. It provides access for everyone to a global market. Businesses have an advantage with using bitcoin as it minimizes transaction fees, there is no cost to start accepting them, it is easy to set up, and they get additional business from the bitcoin economy.

Bitcoin is an interesting currency, worth investigating. There are many pro's and con's to this as it is making it's way into a more prominent role in the financial world. There have been many innovations in many fields for many years. But innovations in the monetary system are long over-due. Perhaps bitcoin is the new competition that will prompt the Federal Reserve System and other central banks to operate sound policies.

In May, consumer prices posted their sharpest increase in 15 months as inflation continued a recent acceleration from unusually low levels. According to the Labor Department, the consumer price index jumped 0.4% after rising 0.3% in April. Economists had expected a 0.2% increase. Over the past 12 months, prices have increased 2.1%. Core inflation, which excludes the volatile food and energy categories, was up 0.3% last month the most since August 2011. And housing starts fell 6.5% in May.

The rise in prices was broad-based, with energy, food, housing, apparel and other costs among those increasing. Energy costs surged, with gasoline prices rising 0.7% and electricity costs increasing 2.3%. Food costs jumped 0.5%, the largest increase since August 2011, as meat, poultry fish and eggs rose 1.4% and fruits and vegetables rose 1.1%. Those categories have been rising for months, in part because of a drought in California, the huge loss of cattle herds from an early blizzard in the upper Midwest last fall, and a virus in the pork population.

Prices for goods other than food and energy also were up. Airline fares jumped 5.8%, the largest increase in 15 years. Apparel prices and housing costs both rose 0.3%. And an index of medical care costs increased 0.3% with prescription drug prices expanding by 0.7%. Last week, the Labor Dept. said that wholesale prices fell in May for the first time in three months.

The recent pick-up in consumer prices is generally considered good news for the economy because annual inflation was well below the Federal Reserve's 2% target last year. Low inflation reflects a weak economy and can lead to deflation, or falling wages and prices, which often foreshadows recession.

The unusually sharp rise in inflation last month could help prompt the Fed to begin to raise interest rates earlier in 2015 than expected or to increase rates more rapidly, especially if significant price increases continue. "The chances that (the Fed) will raise interest rates before the middle of next year are increasing," economist Paul Dales of Capital Economics said in a research note this month.

In planning for increasing interest rates, typically a person would invest in short-term instruments, these will have the lowest interest rates and least chance of principal loss. As they renew, they will renew at a higher rate. It is not a bad thing to look at other investments as well, but the whole portfolio should be structured in a way that it is well balanced, diversified, and has depth and breadth. Mutual funds and ETF’s can give you the depth, while a wide variety of those funds can provide the breadth.

Laddering bonds (bonds are purchased based on their duration over a period of time, for example purchasing each month a bond that expires in three years) is another strategy that when implemented can provide increasing rates – but again looking at short-term durations, typically nothing over three years, with something maturing monthly or quarterly.

Any of these strategic solutions also depends on how fast rates rise. If rates rise fast in a short period of time it can be difficult to manage, while a slow steady increase in rates is more manageable. However remember that rates at 25 basis points, which is a very low rate, increases to 50 basis points, still a very low rate; that is a 100 percent increase in the rate and is a very big move.

The years of low interest rates seem to be coming to an end. As investors, what does this mean for you? If you are close to retiring, this may influence you to re-think some of your investments. Bonds, equities, stock market, alternatives? What is the best route for your money?

Outcome-based wellness programs are more popular than ever. Employers want to reward employees who take personal responsibility for their health. The obvious goal of the outcome-based wellness incentive approach for employers is to reduce medical costs. In addition to this, employers lose money when their employees are sick or injured, and other employees have to make up for their absence. It is in an employers best interest to encourage healthy behavior from their employees.

Recently, requirements for wellness programs were issued as a part of the Affordable Care Act (ACA). The main goal of these wellness regulations is to make sure employers do not use wellness programs as a way to discriminate. The regulations state that there are two types of wellness programs:  Participatory and Health Contingent.

A participatory wellness program functions in a way that the reward (or penalty) is based on participation only – so the average employee does not have to meet a health standard (e.g. blood pressure below a certain level).

A Health Contingent wellness program can be activity only or outcome-based. With the activity only option, there is a requirement to do some activity related to a health standard but the user is not required to meet a specific health standard. An example of this might be to require an employee to do exercise or follow a diet that can help reduce blood cholesterol.

For the outcome-based option, the user must attain or maintain a health standard such as body mass index, cholesterol, blood pressure, etc. or meet an alternative standard to qualify for an exemption.

Here are several elements to consider if a company offers a Health Contingent program: If an outcome-based program is used, one element is that a “reasonably designed program” must be provided to help the employee change their numbers and achieve the reward. These guidelines specify that the employer cannot require the employee to pay for this effort and the requirements must be practical. 

The ACA regulations state that there must be alternative ways to earn the reward or to have the standard waived altogether. A possible statement to help accomplish this might be: “Our goal is to help you be healthy by providing a wellness program that includes rewards! These rewards are available to all employees. If you think you might be unable to complete tasks required to earn a reward in the wellness program, contact us at (insert contact info) and we will work with you to modify the tasks so you can still qualify for the reward.” This statement could be included in your open enrollment materials. This statement in other words negates the “standard” because the programs standards can be modified for anyone who thinks they are special.

The requirements also counsel employers to use a Health Risk Appraisal that is HIPPA and GINA compliant. “Do not base incentives, health enrollment, eligibility, or benefits on genetic or family medical history information.”

Wellness programs that are just getting started should be a “participatory” wellness program for at least the first year. This means that employees should not be required to participate or to meet a health standard in order to qualify for benefits, etc. In other words, rewards should be based on participation in the wellness program and not on health screening data, personal medical history, or addictive behaviors.

The primary notion of an outcome-based incentive strategy is to offer rewards for healthy behaviors and penalties for unhealthy behaviors. But from a scientific perspective, is this approach effective? The Safeway case study is commonly cited to support the outcome-based approach because Safeway had a flat medical cost trend from 2005 to 2009 purportedly by tying employee health insurance premiums to outcome-based wellness incentives. However, Safeway's program began in 2008, making it an unlikely cause of the flat cost-trend between 2005 and 2009. The truth is, the evidence is fairly limited at this point.

Too many outcome-based strategies simply raise standards that must be met by employees to qualify for preferred rates without providing behavioral tools and skills to help employees adopt and maintain healthy behaviors. That is a little like requiring an employee to produce a business report without providing a desk or a computer. When an outcome-based strategy is paired with a well-designed wellness program that creates impact – you have a winning combination!

The key for employers then is to create a healthy culture by providing tools and skills to help employees change. This can be done in part by providing incentives. There are essentially two ways to provide incentives and both have one primary advantage and disadvantage.

Strategy number one is to reduce the employee portion of the premium every month, which is a good thing now but it creates complexity for HR, payroll, and/or benefits. Strategy number two is to reduce employee portion of co-pays and deductibles along the way (good thing later). This strategy comes with the advantage of administrative simplicity that HR, payroll, and benefits managers will love. Other incentive ideas include a discount or rebate of a premium or contribution; a waiver of all or part of a deductible, co-pay, or coinsurance; the absence of a surcharge; or the value of a benefit that would otherwise not be provided.

If the goal is to reduce medical costs, employee must make healthy life choices. The outcome-based wellness strategy is promising because it provides tools and skills to help create a culture of health coupled with incentives that encourage employees to change.

These programs are more complex and maybe difficult to implement due to the over-kill of ACA regulations. With a little paperwork and tracking; this type of a program can be instituted in small businesses as well, which can help the owners too, by providing extra benefits they can qualify for, thus making a fitness membership tax deductible.