Do Industrialized Economies Support Growth?

Fri, 24 Sep 2010 15:20:00 GMT

The book "For Good and Evil: The Impact of Taxes on the Course of Civilization" by Charles Adams is a must read for those interested in learning how taxation has both created and destroyed civilizations. Over the course of history, governments have tried every tax strategy and tax rate imaginable from flat income taxes to taxes based on how many windows a building has. Students of history will find a clear pattern. Low and fair tax rates have fueled the creation of massive expansive empires, and repressive unfair tax rates have destroyed countries to the point at which they are no longer recognizable.

During the Pyramid age, Egyptian peasants paid 20 percent of their crops to the Pharaoh. Historically, medieval serfs and farmers revolted when tax rates exceeded 30 percent. European empires such as France and the Netherlands collected tax rates between 15 and 20 percent during the 1600's and prospered. However when those rates increased, it led to French Revolution in the late 1700's. The Roman Empire began as a free trade state, in which revenue was collected from 1 to 3 percent in property or sales taxes. However, in the last years of its decline, tax rates and inflation were so repressive that many peasants welcomed barbarians.

Although capital is often taxed at capital gains rates, global economic activity is largely defined by income derived from labor. In this spirit, it can be argued that capital will tend to flow into countries with low income tax rates and enough perceived economic and political freedom to conduct business transactions in the pursuit of happiness.

One reason why economies are able to grow is because workers are able to specialize in a particular skill and trade that skill for other services or products. This concept, known as division of labor, enables increased productivity because producers can focus on what will create the most economic value. For example suppose apples and oranges cost the same amount, but farmers are specialized in growing one or the other and can produce twice as much product in their field. The apple farmer can produce two apples and trade one with the orange farmer who produced two oranges so both would end up with more value than they could individually produce. However, if tax rates exceed 30 percent then this division of labor breaks down because the apple farmer wouldn't produce enough apples to pay the tax and trade for an orange. If tax rates exceed 50 percent, then the farmers would have to be 300 percent more productive in their specialization to make it worthwhile.

It is not a coincidence that the three largest economies have effective tax rates higher than 50 percent (including social security and other income taxes), zero economic growth, near zero interest rates, and are past the point of no return in insolvency.

Country	GDP	Currency	% of Currency Exchanged Market	Unfunded Liabilities as Percent of GDP
EU	$16.4 Trillion	Euro	42.45%	434%
US	$14.2 Trillion	Dollar	19.55%	854%
Japan	$5 Trillion	Yen	9.5%	227%
Total	$35.6 Trillion		71.5%	574%

The three largest economies in the world are in structural decline and represent 61 percent of the global economy, measured by GDP estimated at $58 trillion. Their currencies also account for 71.5 percent of the global foreign exchange market. The Swiss Franc, and British pound account for an additional 9.65 percent of the market which leaves only 20% of the remaining foreign currency market from a long list of countries.

Currency "investors" and traders are really just gamblers unless they are only seeking to hedge another business transaction. There is no fundamental basis for 80 percent of the market, and no reason why Jim Sinclair or others will be right that the US Dollar index will fall to 50 or below because all major currencies are priced against each other. However, compared to any tangible asset a severe decline in currencies is inevitable. If hyperinflation does occur, it will likely be in all major fiat currencies and be witnessed in all countries except those with a completely closed economy.

With virtually every major industrialized nation insolvent, using repressive taxation and unsound fiat currencies the implication is clear. No matter how bullish the prospects are for emerging economies – they are not large enough to sustain positive global economic growth nor do they have an alternative currency that could be used to replace foreign exchange at current levels. The reality of peak oil and other resources will cap emerging economy growth as well.

Because these global imbalances are structural, capital will continue to flee industrialized economies in favor of higher returns and lower taxes. The result will be overnight boom towns, and planned cities, but it's arguable whether much of this money will be misallocated. Precious metals could also undergo a historic revaluing as holders of majors currencies seek alternatives. It is unlikely that capital, or people anywhere in the world will be left unaffected by the ongoing and inevitable devaluing of all major currencies.

China Plays Currency Chess

Wed, 30 Jun 2010 23:31:00 GMT

Mainstream media has interpreted the recent announcement by China that it will allow their currency to float more against the dollar to be a positive signal for the global economy and beneficial for the US. This stream of political spin, that came from the White House and Congress, will prove to be as false as talk of a long term recovery last year.

Politicians are claiming that the move, which will lead to a higher Yuan, was made to appease American officials. They also claim that China wouldn't allow their currency to float higher if their leaders were concerned over a double dip recession. For this reason, the announcement was perceived to be a sign that China is bullish on the markets and economy.

Let there be no mistake; China will revalue their currency on their terms when the timing is most beneficial for China. A more likely scenario is that Chinese officials are anticipating the next phase of the recession and realize it is an opportune time to decouple their currency from the dollar. Despite common misinformation, a strong currency supports a strong economy. The dollars relative strength during the last century is a testament to this. The Chinese realize this and do not want to dragged down with the western economies as they drown in debt and currency debacles. China wasn't calling a bottom in the stock market, they were calling a top in the dollar.

Would it have made sense to revalue the Yuan against the dollar a couple of years ago when the dollar index was threatening to break below 70 and everyone was short the dollar? The near financial collapse launched the dollar higher to its current level near 90, and the Chinese Yuan went along the ride by default. Had the Chinese decoupled earlier their currency would have been trashed just as the Australian and Canadian dollars were.

The coming weakness in the global economy has already begun and will in the near term continue to increase demand for the dollar and treasuries. This will be an opportune, and possibly the last great time to exit the dollar. By decoupling when the dollar is near its peak, the Chinese currency will be launched at a moment of strength and might even give them the chance to sell some dollar based assets before the next round of quantitative easing begins.

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Do Industrialized Economies Support Growth?

China Plays Currency Chess