Subject: Nikolai and Hillary
The economic long wave comprises twenty to thirty year swings in prices and interest rates from low levels to high levels and back again to lows. These large and long swings impact social and political outcomes in major ways as well as the economy. From the economic long wave inflationary top of 1974-1980 to the disinflationary low in 1998-2003, interest rates fell from over 14% to under 4% on 20-30 year US Treasury bonds. Crude goods prices fell dramatically, and so did rates of change for GDP, wages, family incomes, and many other economic series. Corporate stocks went up due to declining crude goods costs, decreases in rates of change of wages, rapid employment of new labor-saving technology, and off-shore manufacturing for or by US-based corporations. Had frank deflation occurred, as in the 19th century under the old regime (pre-1933), stocks would have fallen, but under the modern easy credit regime there was only disinflation. Deflation did occur in Africa, Japan, the soviet states, and third and fourth world places in Asia, but not in most developed social democracies.
As in the 1930's after 1932 and 40's in the US, the 1980's and 90's were very favorable for corporations and for people with investment capital. A one million dollar twenty year T bond bought in 1981 would have paid $140,000 per year or $2,800,000 total for 20 years. When you got your million dollars back in 2001 you could have bought another twenty year US Treasury bond, but this time you would only have got $55,000 per year. One could have bought the Dow Jones 30 Index at the beginning of 1981 for $839, and it would have grown to $10,791 by the beginning of 2001, a compounded annual rate of 13.62% without counting the 2-3% of dividends paid at current rates. These were good times for corporations and people with money. In addition to labor costs, many prices of consumer goods, were stable or falling. Also taxes fell and large infra-structure projects were postponed due to lack of demand for new parts, railroads, highways, storage facilities, refineries, mines, and agricultural facilities. Overall demand was falling, at least as measured by rates of change. Job-sparing technology reduced costs further for industry and finance and services. People who lived in financial or technology centers were completely unaware there was an economic problem anywhere. It didn't happen to them anywhere they lived
Labor and others without capital did not fare as well after the 1970's. Labor unions in the US had been king from the end of World War II until 1980. Strikes were frequent and wage increases were liberal by any measure. By the mid 1970's inflation and labor costs had finally eroded the strength of industry and sent bonds and stocks to nearly half their values of the 1960's, even in nominal terms. In real, or inflation-adjusted, terms the loses were 90% or more.The standard 6% US Treasury Bond nearby futures had fallen to 55 from the 100 original issue price. So the 1950's to 1970's were good for labor, as prices started out low and wages rose inexorably. But those times were not so good for capital, especially after the mid 1960's.
This short course in the social and political aspects of the economic long wave makes it possible to anticipate what will happen after next year's election. For one thing, this will be a time when infrastructure needs from power generation to roads, bridges and airports and refineries, mines, and ports, schools and health facilities will need to be addressed in the quest to satisfy crude goods demands, and, ultimately, finished goods, which are in great demand, and social demands. These will create many high paying jobs in the US for the next 15-20 or more years. This process has already begun , and it will speed up. We are already seeing labor growth and demands for increased benefits, mostly in the form of wages.
Employers will increasingly shed their role as provider of health care and pensions, and universal government health care will be phased in, starting with the youngest age groups and spreading to all age groups. Government will also mandate, instead of merely encouraging, that each individual contribute to a tax-deferred retirement plan such as an IRA or 401k plan. This will be the only way around the Social Security impasse expected for about 2020-2025, apart from greatly increased Social Security tax rates on all earned income. The new health care plan will have to be phased in due to the scarcity of personnel and facilities, and it will also require major tax rate increases at all levels on individuals, small businesses, and corporations. Businesses will rejoice over getting out of the benefits business, but will pay a high price in taxes for that freedom. Likewise the middle class will rejoice to have health care provided but will pay for much of it through taxes as well, since they pay 50% of all income taxes. However, middle income working people will see their wages gain faster than taxes and inflation, at least for perhaps the first ten years or so.
Bonds will fall as interest rates rise, but corporate stocks in many sectors will continue to rise for a number of years until wages, inflation and taxes finally make their negative impact on real profits, as in the late 1960's and 1970's. Crude goods and precious metals will continue their bull markets with obligatory intermediate term bear markets. Demand is still quite strong and will remain so until supply catches up and overshoots demand and until interest rates and inflation take their tolls.
There is good and bad in each half cycle of the economic long wave. Political leadership arises to follow the long cycle, thinking they are leading. Labor will do better than capital in this next period, and we can see the early changes already in labor action. The middle class will do better in the US and throughout the world, and commodity producing nations will outperform those without commodities. The US will begin to re-develop its own commodity producing base which is considerable. The long winter of commodity production declines will be over. Mines are already being re-opened in the US and new ones developed, and energy production from US resources will be greatly developed due to higher prices. After the real estate decline currently in progress, commercial and residential real estate will continue to prosper until interest rates get "too high" a decade or more from now.
If you have investment money it will be harder to make it pay, especially after taxes, without a different approach. Interest rates are low and will go much higher, but money market rates (with no capital risk) will not keep up with inflation until much later. Bonds will go down as rates rise. Bond closed-end and mutual fund bond funds may be a better choice than buy-and-hold bonds for a number of reasons, some of which I have discussed recently in the Retirement Income post. Treasury inflation-protected bonds (TIP's) increase their payments in parallel (updated annually) with US CPI inflation but all the payments are taxable when received. So they would be best in tax-deferred funds if you are saving, although if you are living off the income, paying the tax and living off the post-tax residual can work.
Treasury I Bonds are inflation-adjusted like TIP's and can be bought through TreasuryDirect on-line (http://www.treasurydirect.gov/indiv/research/indepth/ibonds/res_ibonds_iratesandterms.htmhttp://www.treasurydirect.gov/indiv/research/indepth/ibonds/res_ibonds_iratesandterms.htm) for any amount of at least $25 at a time up to $30,000 per person per year. They can be bought and held up to as long as thirty years. If they are sold within the first five years, one loses the last three months of interest paid. They must be held at least one year. I Bond federal taxes on accrued interest may be deferred, if desired, until cashing them in, unlike the case with TIP's. I Bonds would be a good vehicle for laddering for (or in) retirement by buying up to $30,000 per year of I Bonds with the ability to cash in that amount plus accrued interest each year after five years. If you have excess after tax income, this could be a better way to reinvest it than bank CD's or treasury bills. I Bond interest is exempt form state and local taxes. I Bonds do not decline in value below their issue price. Their value at redemption is the face value plus the inflation-adjusted interest accrued.
See the recent Retirement Income post at this blog also for information on US municipal bond funds which are exempt from federal income tax and at least some state and local taxes. Currently they are selling at extremely favorable terms compared to federally-taxed bonds of all sorts. When taxes go up in 2009 you will want to have bought good municipal's. I prefer to use
Vanguard's municipal funds which are excellent and make tax reporting and capital gains/loss information carefree compared to having your bank or trust construct a portfolio or doing it yourself. If you are investing over $100,000 in intermediate or long term Vanguard municipal bond funds the annual total cost is only 0.09%! On $100,000 that is $90 per year. Plus they are buying in quantity and quality and get the best prices in the business. There is no way you or your bank or trust could beat these costs. If you invest under $100,000 the cost is 0.17% per year or $170 per year, still far less than what anyone else charges. The current reinvestment yield of the Vanguard A rated municipal fund with a duration of 6.5 years is 4.75%. for someone in the 35% tax bracket (combined Federal, State and local taxes) that is equivalent to 7.31% on a taxable bond or bond fund. Such a rate is currently unobtainable for taxable bonds without taking very high risks. During persistent interest rate rises, bond fund prices will decline but the interest paid will increase. You should consider the principal at least partly as an "annuity-like" entity.
Under the new US federal administration in 2009 it's very likely that capital gains taxes will also be greatly increased from current historic lows. They could even be made equal to income tax rates which, as above, will also increase. If you have highly appreciated assets you will have to consider selling some of them in 2008, even with the specter of some alternative minimum taxation (AMT) and redeploying capital to more favored investments such as TIP's and municipal's, gold and selected stock sectors. Real estate with low or no leverage will do well if well rented. If you can get a low long term fixed rate on a mortgage for residential or commercial property, the rentals and property prices will protect you when interest rates get into relentless rises, but increased maintenance, property taxes, insurance, and capital gains tax gains will impede gains later on. Also it is quite likely that estate taxes will NOT be discontinued after 2010 as originally planned, and that the basis step up feature for appreciated property on death will be abolished which will decrease the value of holding appreciated capital assets for heirs to inherit.
If you have gradually accumulated gold bullion coins or bars over the years, as many people of my generation have done, you will want to keep them intact for inflation protection and for the ability to cash them in at daily published rates any day you wish at any coin dealer in the world. Many people bought them every month after 1974 either in a fixed dollar amount, say $500 per month, on up. You bought as many as your monthly set-aside contribution amount would allow. The higher the then current price, the fewer you bought that month, and the lower the price the more coins you could buy. You could do the same thing for larger dollar amount commitments with gold bars produced and stamped by several reputable gold bar fabricators known throughout the world, although bars may not be as easily cashable at all coin dealers. For those living on fixed income enough coins or bars could be cashed in each month or quarterly to meet increased inflationary costs in your budget. The sale of small numbers of coins is easy to do and individual small sales are not currently reportable by US dealers. If you do not have coins or bars already accumulated you should now start buying some each month as above. If you buy some monthly you will not have to worry about having "bought the top" and can relax when prices go down, knowing you will get more coins or bars.
If you think in terms of investing like you did in the 1980's and 90's you will do very poorly for the next few decades. Inflation and declines in the US dollar have resulted in real dollar losses in the Dow Jones even since 2003, and that is before taxes take their toll. Be sure to think of every corporate stock or investment trust before purchase as to how likely it is to benefit from inflation. Does it produce a crude goods or commodity product? Can it raise its prices more than its costs and increase its earnings? Can it grow so rapidly that costs and prices don't matter? Can it sustain a growing dividend? If not, they are not for these times except perhaps for trading during recessions.