Taxing Our Way to Prosperity
It has been a strange week. We start with the proposal to raise U.S. corporate income taxes to 28% (from 21%) and impose a minimum 21% “global” corporate income tax. The proposal is part of the new $2.5 trillion “infrastructure” package. I put infrastructure in quotes because, as they have done with so many other words, the new rulers in Washington have redefined the term. Perhaps New York Democrat Senator Kristin Gillibrand said it best:
Our new rulers also redefined racism and gun ownership this week as an emergency “public health” crisis. I guess the designation is some lame attempt at a constitutional cover for President* Biden to dictate executive orders from on high. But Trump was a dictator, right? Truly, I despise all of these policies and Presidential Executive Order abuse, no matter who does it.
Also, don’t get me wrong. The new rulers see that revenue is an integral part of good accounting practices and that is a good thing. It’s just that the proposed 21% minimum global corporate income tax requires the Biden Administration to conspire with as many foreign governments as possible to stifle global competition for companies, wealthy individuals, and jobs. This would allow countries (like ours) to tax as much as they want without fear that these companies and their wealthy overseers will leave for greener pastures.
This new, global tax kind of reminds me of price-fixing. Hopefully, some foreign countries still appreciate competitive capitalism and won’t accede to the U.S. Wokie demands.
The U.S. proposal envisages canceling exemptions on income for U.S. corporations from countries that do not legislate a minimum tax to discourage shifting their operations and profits overseas.
The proposed increase in the headline rate to 28% from 21% would partially reverse the Trump administration’s cut in tax rates on companies from 35% to 21%. More importantly, the US proposal includes an increase in the minimum tax included in the Trump administration’s tax legislation, from 10.5% to 21% — the benchmark minimum corporate tax rate that Yellen has propounded for other G20 countries.
Of course, there is that old axiom “corporations don’t pay taxes people do.” When corporations are taxed, people pay in the form of higher prices for goods, lower wages for workers, fewer jobs, lower corporate earnings, and dividends, not to mention lower stock valuations. The proposal seems counterproductive in a world attempting to recover from the elites’ Global Panic Pandemic.
You can be sure that a global minimum individual income tax is around the corner too. That would spoil my plan to get the hell out of this country if it keeps embracing Marxism, higher taxes, and oppressive leftist policies. As the book “Atlas Shrugged” by Ayn Rand remains one of my favorites, I want to know where John Galt is headed. I will follow.
Of course, the Wokie goal is to prevent successful corporations and people from checking government power by finding a competitive alternative – whether that be another city, state, or nation.
Just wait, the U.S. red states with no income taxes – like Florida, Texas, and Wyoming – will soon be punished by the ruling class in Washington for their no-tax policies – as will the people who move there. There will be no more shopping for the best governments, with the best tax and business policies and lowest tax rates. This new, autocratic ruling class must standardize mediocrity and inflate government power. Dow 40,000? Probably not.
And Then There is the Inflation Problem/No Problem
In another strange move reminiscent of a communist country last week, the Federal Reserve has decided to stop publishing weekly money supply statistics (M1 and M2) in favor of monthly. Why? It seems the latest round of politicians in Washington are more autocratic (and less tolerant) of contrary opinion than the last group. The “peeps” are asking all these pesky questions about the money supply and inflation. For example, could it be inflationary that M1 has risen from $4 trillion a year ago to $18 trillion? Now we can’t have all these pesky questions from deplorables, can we? Look, increasing the Money Supply does not cause inflation they tell us. Just like increasing the national debt to $30 trillion or 138% of G.D.P. no longer matters either. After all, money is just a “construct.” As with many issues lately, “we the people” need to just shut up and sit down. After all, the global Wokies know what is best for us!
For the moment, only one view is tolerated in Washington, D.C. – that is unless you want to be “canceled.” Fortunately, they can’t cancel me because I use their own foibles and idiocy to pull money out of the markets daily, I don’t need them. Well, I do need them in a way, because I profit from their stupidity. And I don’t think they will stop being imbeciles just to spite me.
Lessons from 1920’s Germany and 1989 Japan
Just for giggles, I thought I might spend a little time examining the hyperinflation-induced collapse of the 1920’s Weimar Republic (Germany) and the asset bubble explosion of 1989 Japan. This is just in case the Wokies are wrong. I mean, what could be the harm in comparing notes?
The collapse of the German Mark led the Great Depression by a few years. As you might recall, the U.S. Stock Market lost 90% of its value in the 1929 crash and did not recover its losses until November 1954.
Japan collapsed in 1989, followed by persistent deflation and resulting in driving their stock market down 90% from the 1989 peak to the 2008 low. Japan has yet to fully recover, some 31 years later.
I wasn’t alive in the 1920s, but I well remember the 1989 Japan peak. At the time, they called it Japan, Inc. Japan was buying up real estate and golf courses in the U.S. Not only did they own Rockefeller Center in New York, I recall them buying Columbia Pictures. The Japanese Imperial Garden was said to be worth more than the State of California. Japan was set to rule the world with its enviable production methods and quality (brought to them by an American). But alas, the bubble burst and Japan has remained in convalescence.
In my opinion, the German and Japanese lessons can be better understood in the context of what is misunderstood by the Wokies and others now – or purposefully obfuscated. But first, let me share my backstory.
The Backstory
The story of how I gained my “armchair economics” degree in banking is long but bear with me as it will all tie together in the end. In 1997, I had co-owned and co-founded a trusted company, brokerage firm, and investment management firm with my former wife. We started the Scottsdale, Arizona-based firms in 1987, just ahead of what turned out to be the infamous Savings and Loan crisis and collapse of Arizona real estate. I even served as a director on the board of a local television station with Charlie Keating – the poster child for the Savings and Loan debacle. I will save that colorful story for another time, but I will reconsider some of the problems he caused in the banking world that eventually came back to haunt us.
Suffice it to say, it was not the best time to start an investment business in Arizona. Nevertheless, through an accident of fate, I was soon introduced to the director of a prominent Midwest state banking association. At the time, interest rates had been falling from their historic highs to the point that money was leaving the small banks for the stock market – via the help of a small but successful and growing brokerage firm called Edward D. Jones. Edward D. Jones and their capable, well-trained, small-town brokers had been raiding the local bank C.D.s as they matured.
Unlike California and Arizona at the time, the Midwest states were economically healthy and remained “unit banking” states and unreceptive to “branch banking.” States like Oklahoma, Texas, Kansas, Mississippi, and Missouri had hundreds of banks – and each was individually owned and operated as a community bank. I recall that Oklahoma alone had 450 separate, individually-owned banks. If an intersection had a bank on every corner, each bank was owned by a different family with their own money at risk. In fact, there were 30,000 banks in the U.S. at that time. We now have barely 5000 left, and the number dwindles every day as the big five (too big to fail) banks dominate the landscape.
I worked with this creative banking association director to create a competitive investment management program that my trust company would ghost and private label for each bank to help them compete with Edward D. Jones and keep their customers. A number of the state associations endorsed the program and formally introduced it to their banks. With the credibility of the associations behind us, the program became very successful and diversified us away from the savings and loan crisis and real estate collapse in Arizona.
I traveled the Midwest incessantly during this time, going bank to bank and getting to know the owners, their families, and the customers. It was one of the most informative and pleasurable experiences of my life. What is relevant about this story for this discussion is that I got to experience a first-hand view of community banking in our country’s Midwest region, a region that solidly anchors this country and our traditional American values and wisdom. The bankers knew their region, their customers and took qualified, discretionary risks in funding small businesses. Nothing was commoditized – centralized executives far removed from the region evaluated loans case by case. I always joked that if you started in the middle of our country, it just got weirder in both directions as you got closer to the coasts and water.
Then, in 1997, I had the opportunity to help start a small business bank in Phoenix. Since we were managing so much money at the time, and we were literally parking millions of our customer funds in other banks and mutual fund money market accounts, the idea of starting a bank and bringing those funds in-house was appealing. We were the controlling shareholders of the bank.
Starting the bank turned out to be disappointing. Thanks to Charlie Keating and his fellow S & L swashbucklers, we had to sign “Lincoln covenants” (named for Mr. Keating’s failed Lincoln Savings). Essentially, the covenants prevented us from doing business or keeping deposits at our own bank – because we could supposedly and potentially abuse our positions as controlling shareholders, just as the S & L swashbucklers had done. That kind of defeated the purpose of starting the new bank in the first instance. Nevertheless, the experience was invaluable.
Insights from the Banking World and Inflation
The point is, I learned how things really work in banking and the money supply, blowing apart several prevailing economic myths persistent to this very day. Let me explain; then, I will tie all of this back to our current challenges.
Business schools and economists still teach a theory that banks are intermediaries. Supposedly, banks take deposits and pay interest, then lend the deposited funds out at a higher interest rate. They are virtually guaranteed a profit if they minimize their loan defaults but are believed to have no impact on the money supply. Yet, nothing could be further from the truth, and bursting this myth is critical to understanding where we are now and the path ahead of us.
Here is how it really worked as I personally experienced it. If you come to my bank for a loan, I don’t tap the depositors’ accounts and write you a check. After all, what would the depositors say when they needed their funds, and the funds were not in their accounts? What would they say if they got their monthly bank statement and the money was gone? It does not work that way, and I don’t understand why this myth continues to be propagated – unless it is useful to the oligarchs.
What actually happened is that your loan became a book entry on my balance sheet. I would book your loan as an asset, maybe offsetting a small amount to add to reserves. We didn’t tap the customer deposits at all. Instead, and this is the wringer, the loan was credited to your account as a new “deposit.” In essence, your loan created money almost out of thin air, thus increasing the money supply.
Even if you deposited all or part of your loan at another bank, the new bank could spin that book entry to more loans and new money supply. In fact, bank credit may very well be the biggest contributor to the money supply that exists – at least before Quantitative Easing. And when credit contracts or loan standards rise, the money supply contracts, as will the economy along with it. That is how it really works in the real world.
That may very well explain why another prevailing myth – that lowering interest rates will boost economic growth – is so dead wrong. We can start with Japan lowering its interest rates following the 1989 peak. No matter how much Japan lowered rates, it made little difference in their 30-years of pain and lost decade of the 1990s.
And how has this theory faired in our own country lately? If lower interest rates boost economic growth, shouldn’t GDP have been 10% annually these past 10 years? We have had falling rates for years, especially since 2008. Yet economic growth in the U.S. – in a word – sucks.
Europe has negative interest rates; how is Europe doing? Not so well from recent, personal experience. I cannot believe that the central bankers are this dumb, so there must be other reasons why they continue to propagate this myth. We can speculate on that another time.
Higher interest rates lead to economic growth, and lower interest rates lead to economic decline, in my own experience. Maybe it is all just a timing thing but think about your own experience. One cannot help but conclude that our fearless leaders have this all backward – or cause and effect are confused.
The only thing I have experienced in my life that led consistently to economic growth – and what I observed first hand at the Midwest community banks and my own bank as lenders – and even what I have experienced owning my own businesses – is the availability of capital and credit – especially for small business.
Everyone agrees that 70% of jobs in this country (and in Europe) are created and maintained by small businesses. If capital is loaned to or invested in small businesses – especially businesses with new ideas, products, and services – not only will you get economic growth, but it generally won’t be accompanied by inflation.
Who better to make those lending decisions than small community banks with their ear to the ground? They know their region and know their customers. With discretion, they will do a much better job placing capital than behemoth, centralized banks. Both Japan and China are modern examples of this proposition’s truth – yet our own country is sliding backward.
Lessons from Japan
Japan’s demise stemmed from two primary problems. Most of their newly minted “money supply” funds went into asset purchases, just as we see now in the U.S. stock and real estate markets. Because there were only 20 banks for the entire country, decisions were centralized and made by executives far removed from the front lines.
The Japanese used their real estate assets as collateral to obtain more loans and buy more assets. The more real estate values rose, the more they borrowed. Sound familiar? It is not unlike the Gamma squeezes going on now in the U.S. stock market. Someone buys a call option. The market maker who sells the option then has to buy the underlying stock to neutralize her delta risk and hopefully keep the premium. As more calls are purchased, more stock is purchased, leading to higher and higher prices. When you roll the tape backward, the same process reverses.
With real estate, as the price falls and the collateral is threatened, distressed real estate sales must follow. The process repeats itself into more loan defaults and more distressed sales. So what did the money creation from all that credit gain Japan in the final analysis? Prolonged pain.
The money did not go into new businesses, ideas, efficiencies, etc. So when the bubble burst, there had been nothing gained in economic growth to fall back on. That is the simplest explanation of what happened and why it has taken so long for Japan to recover. Almost 25% of all Japanese bank loans defaulted. When you consider that most banks are only required to maintain capital equal to 10% of assets – you can see that the entire Japanese banking sector became insolvent.
As China increased its economic commitment to capitalism, they studied the Japanese debacle. As a result, China implemented a community banking model not unlike what I had experienced in the Midwest in the 1980s and 1990s. China’s program has been very successful – and you will see why below.
Lessons from Germany
Germany was somewhat of a unique case. They were printing money to pay revenge reparations to the rest of Europe for World War I. Once again, Germany did not invest their newly minted money productively – it went mostly to pay reparations.
What surprised me in my studies is that for at least 18-months before the German Mark collapsed and the hyperinflation set in, Germany experienced a phenomenal, growing economy with zero unemployment. Everyone was making money in real estate, the German stock markets, etc. Of course, it was built on a house of cards. The speed of the collapse also was stunning. I worry that our country may be in a similar position – as the good times roll.
The Bottom Line
We started this discussion with the Federal Reserve’s decision to stop publishing weekly M1 and M2 money supply statistics at an unprecedented moment with nearly a five-fold increase in the money supply in a very short period of time. Theoritically, such an increase would be inflationary – but the Federal Reserve is now claiming that the money-supply does not affect inflation. No doubt, Milton Friedman is rolling over in his grave.
However, in one sense the Federal Reserve is correct but it will not help their cause at this time. What we have learned in the last century is that the aggregate money supply is less important than how it is being spent. If the money is primarily used for asset purchases, we will have asset inflation (as we now see in real estate and the stock market) and there is not reason to expect that to end any differently than it did in Japan.
If the funds are used for consumption (e.g. all of the untargeted stimulus checks) – that will lead to inflation in goods and services. We are experiencing that now. How far it goes and how bad it gets is difficult to forecast – but it is a terrible, hidden and regressive tax on those who can least afford it.
If the newly minted funds go to small businesses with new ideas, or to modernize and become more efficient, then we will have sustained, non-inflationary economic growth.