There are a lot of mixed emotions on the latest legislation to extend tax rates and increase spending.  The legislation extends the current income tax rates for 2 more years.  The estate or death tax goes up, but not quite as much as what was scheduled to happen.  The payroll tax on the employee portion of Social Security will be cut from 6.2% to 4.2% for one year.  Meanwhile, the legislation also includes increased spending, particularly an extension of unemployment payments.

The Republicans and Democrats compromised on this.  The Republicans got the tax cuts extended and the Democrats got more spending.  Meanwhile, we all get a bigger national debt.  Ron Paul supported the legislation because he said doing nothing would mean that taxes would rise.  I almost always agree with Ron Paul’s votes, but I disagree with him on this one.  I completely understand his position and I am sympathetic towards it, but I think he should have voted no.

This legislation was a bribe to get the tax rates extended.  Other than the payroll tax being cut, this was not a tax cut.  This was preventing current tax rates from going higher.  If the tax part of this bill had stood alone as its own bill, then it would be appropriate to support it.  But it wasn’t.  This was legislation that contained good and bad.  Ron Paul has typically voted against such legislation.

Extending unemployment is a joke.  If someone can’t get a job after 2 years, they are either severely handicapped or they are just not trying hard enough.  Obviously 99.99% of the people fall into the latter category.  It is understandable.  If you are collecting unemployment checks and you can’t find a job making significantly more, what is the incentive?  There are many people that wouldn’t be looking for a job anyway.  Some people may have wanted to leave the workforce anyway and unemployment payments are just icing on the cake.  Any person that is not severely handicapped can find a minimum wage job within 2 years.  The government is just encouraging unemployment.  Unemployment paid by the government is unconstitutional and unlibertarian to start with.  Having it go for longer than 2 years is just plain ridiculous.

This legislation will just add to the deficit and debt because it doesn’t address spending.  The federal government keeps on spending money like crazy and there seems to be no end in sight.  The end will be when the Fed has to stop buying bonds because of massive inflation.  Then interest rates will go really high and the government will be forced to cut back.  Then we will get a depression.  This is all reasonably predictable.  The hard part is trying to time it.

Robert Murphy has written an article discussing the payroll tax cut and its possible effect on unemployment.  Murphy is a clear writer and clear thinker.  This article today may be a little bit harder to follow than some of his other material, but you can still get a good idea of what he is talking about even if you don’t understand his graphs.

The gist of the article is saying that the payroll tax cuts probably won’t help the unemployment situation and may even hurt it.  Obama and the Republicans compromised on a tax and spending package.  It will retain the current income taxes and, like most things coming out of DC, will increase or retain spending on programs such as unemployment.  The other piece of the legislation is that it will cut the Social Security payroll tax from 6.2% to 4.2% for one year, but just on the employee portion.

In this article, Murphy discusses and confirms comments by Bryan Caplan.  Basically, he says that by reducing the employee portion of the payroll tax and not the employer portion, it could actually cause an increase in unemployment.

This makes some sense.  There are several ways to reduce unemployment (reducing government), but basically wages need to fall or productivity needs to increase.  If we have high inflation in the future, this could help with unemployment in one sense because it could reduce real wages even if people don’t see a number reduction on their paycheck.  In giving a payroll tax cut to the employee, it actually increases their take home pay.  This has actually increased wages, in a sense.  But we need wages to fall if the market is going to clear the unemployment problem.

Aside from this argument, the problem once again is spending.  The Republicans and Democrats compromised.  The Republicans got tax cuts and the Democrats got more spending.  We need lower taxes with lower spending.  This whole thing just adds to the deficit and the debt and brings us closer to the day of reckoning.  We should take advantage of any money that we can get now and convert it into real assets, whether it is gold, silver, housing, food, or toilet paper.  You don’t want to be in dollars when the massive inflation comes.

There are many fallacies that exist in the world of economics.  One of the worst fallacies is the Keynesian myth that spending drives the economy.  Spending does not make someone or a nation rich.  Almost everyone likes to spend.  The problem is having the money to spend in the first place.  In the case of an entire nation, the issue is production.  You can only buy something that is first produced.  If spending was all that mattered, then everyone on earth would be rich.  Don’t you think that people in poor countries around the world would like to buy things as much as Americans do?

To go along with this myth, there is another economic issue in which we need clarity.  Even some libertarians don’t understand this point.  Hoarding money does not hurt the economy any more than spending helps the economy.  Many people think that if people aren’t spending, then they should at least be investing or loaning their money out.

Let’s walk through this carefully.  Let’s say there is a billionaire who decides to take a billion dollars and put it under his mattress.  If this is too extreme of an example, let’s say he puts his money in an offshore bank and for the sake of argument, let’s even say that the bank keeps all of the money in reserve and doesn’t lend it out.  Is this billionaire hurting the economy?  Not only is the answer no, but I would argue that he is helping the economy.

Let’s say you build a shed from scratch.  You cut down a tree in your yard, you saw up the wood, and you hammer it together to make a finished product.  You then sell your shed to your neighbor for $100.  At that point, you take your $100 and you put it under your mattress, you bury it in your yard, or you burn it.  The point is, you don’t spend the money or loan it out or invest it.  You just did the economy a favor.  You just built a shed for free.  It wasn’t free to your neighbor who spent his $100, but it was free to society.  You just deflated the money supply by $100.  Now everyone else that owns U.S. dollars has just benefited by your action.  Their money is now worth more than before because you took $100 out of circulation.  Of course, one hundred dollars is negligible, but the point stands.  Everyone benefited at your expense.  You labored and made a shed and you did it for society for free.  There is one more shed in existence now that didn’t exist before and you still haven’t consumed anything for your labor.

The same thing happens with the billionaire.  Assuming he made his money honestly by selling his labor or goods and services, then the billionaire is doing society a favor by hoarding his money.  It is less money to bid up prices.  It makes things just a little bit cheaper for everyone else.

We so often hear that you should help the economy by going out and spending some money.  It is really the exact opposite.  If you want to help the economy, take your money and hoard it.

The news on real estate continues to be bad, at least for those owning real estate.  Since the government tax credits (subsidies) expired earlier this year, housing sales have struggled.  Now interest rates have gone up in the last few weeks, which makes housing seem even more bearish.

Today, there is an article saying that foreigners are flocking to Florida for real estate bargains.  This should not be surprising.  Prices are way down from where they were 4 years ago, interest rates are still relatively low, and it is even more attractive to foreigners because the dollar is weak.  Some foreigners may be paying one quarter of what they would have paid 4 years ago due to the huge drop in prices and the weaker dollar.

It really astounds me how many articles are out there saying, essentially, that you’d have to be an idiot to buy a house right now.  Unless these people were saying the same thing 3 or more years ago, then they are not worth listening to.  If someone thinks that only an idiot would buy a house right now, then what does that make someone who actually bought a house 4 years ago that is now only worth half of what was paid for it?

If you are considering buying a house, then you should do it for the right reasons.  If you are going to live in it, then it is a consumer good you are purchasing.  You should be able to afford it.  If you are buying a house as an investment, then you should be able to afford it and you should be able to get positive cash flow from it.  If you meet these criteria and you plan to own it for a while, then there is absolutely nothing wrong with buying right now.  You can find some really good deals in some areas and you can still get a relatively low interest rate on your mortgage.

While housing will continue to struggle with the down economy, high unemployment, and a lot of foreclosures, I think it will be ok longer term.  This is not a prediction, but if I had to guess what housing prices will look like in 5 years, I think they will be down in real terms (adjusted for inflation), but I think they will be up in nominal terms.  In other words, housing prices may not keep up with inflation in the next few years, but prices will still be up from where they are now.  Food and gasoline are likely to go up in price by a greater percentage.

As the dollar weakens and price inflation starts showing up more, people will get back into housing for the simple reason that a house is a hard asset.  The Fed can’t print houses like it can money.  If you buy a house now with a 30 year fixed rate mortgage, there is a good chance that your last payment in 30 years will be about the equivalent of a nice dinner.

During the Great Depression, there were runs on banks.  Even though the Fed was printing money, the runs on banks led to, in effect, a contraction of the money supply, due to a reversal in the fractional reserve lending process.  Out of this, came the FDIC, another Roosevelt government program that is still causing massive damage to this day.

It sounds scary to most people today when they consider a world with no FDIC.  After all, how are they supposed to be assured that their money is safe?  First, it should be pointed out that there are no guarantees in life no matter what.  There are a million different ways that you could lose your money, with or without the FDIC.  Second, with no FDIC, consumers would actually pay attention to the solvency of banks.  Now you many think that you don’t have the time or knowledge to research banks, and that would be the case for most people.  But like anything else in our economy, it would be done by the whole market.  You are not a mechanic and yet you manage to buy a car.  You are not a farmer or food inspector and yet you manage to buy safe food.  It would be the same with banking.

The FDIC has created huge moral hazard.  Banks have taken on far more risk than they ever would without this insurance.  In addition, it is the Federal Reserve with its power to create money out of thin air that allows the FDIC to exist.  Without the Fed, the FDIC would not be able to guarantee deposits.  The FDIC would be broke in no time.

This whole system creates a huge problem.  It is one of the reasons for the panic that happened 2 years ago.  It was one of the reasons for the huge bailout.  If there had been no bailout, there would have been bankrupted banks with depositors losing their money.  Then the FDIC would have stepped in and gone broke.  Then the Fed would have bailed out the FDIC.  This chain of events would have been better, because at least the bailouts would have just gone to depositors and would not have propped up failing banks.

In a libertarian world, there would be no Fed and no FDIC.  The best case scenario now is to phase out the FDIC.  Everyone would be surprised by the changed behavior of the banks.  You might have to start paying a fee to have a checking account with a bank.  But at least we wouldn’t have huge bailouts and a constantly depreciating currency.

The FDIC is a tough issue for libertarians.  Should depositors be stiffed?  How do we go about eliminating the FDIC without causing a major crisis?  Do we abolish the Fed first or the FDIC?  Or do we abolish them in tandem?  There are a lot of interesting questions.  One thing for sure though is that there is no place for the Fed and the FDIC in a free market.

There is an article, linked on DrudgeReport today, that says some Social Security advocates fear a cut in the payroll tax.  Obama recently proposed cutting the payroll tax for Social Security from 6.2% to 4.2% for one year.  It can be assumed that this would just be the employee’s share of the tax and not the employer’s.

This is a joke.  Social Security is a Ponzi scheme.  Not only that, but any additional tax collections that should have been saved have been spent.  There is a Social Security trust fund that is filled with IOUs.  The federal government basically owes itself this money.  It really doesn’t make a difference at this point.  The taxes collected for Social Security have been mixed with the general fund for decades.  The Social Security surplus money of the past has been spent.  Now that it is in deficit, it will be the general fund that makes up the difference.  We can’t say whether it is federal income taxes, excise taxes, corporate taxes, or money printing that will fund the shortfall in Social Security.  All of this money is mixed together.

This is what allowed Clinton to declare a surplus in the late 1990s.  This was a lie.  The payout for Social Security was less than what was collected at that time.  This money should have gone to the Social Security trust fund.  Instead, part of the money was spent and the remainder was used to proclaim a surplus.

Now Social Security is in the red as the payouts are greater than the tax collections.  It isn’t an insurance program and it never has been.  It is broke and there is no way the government will be able to keep all of its promises.  There is going to be a default eventually.  The question is whether it will be a default through inflation or outright default.  I think it will be a combination.  Either way, the whole system is in jeopardy.  It will be painful for many, especially those who are highly dependent on the government.  But the laws of economics have caught up with the system. It will go bust and will be cut back severely.  Long-term, this should be a good thing.

From a personal standpoint, support any cut in taxes that you can, even if it is the payroll tax.  The government is going bust anyway.  We might as well get what money we can now.  The environment continues to point to high future inflation.  We should use any tax cut to increase our positions in hard assets that will hold their value with high inflation.  Take what you can get while it is still there.

The current tax rates are still set to expire at the end of the year.  If nothing is done, the rates will rise.  It had looked like Obama and some of the Republicans had a deal, but now the House Democrats are shooting down the plan.

There are a lot of reasons for unemployment being so high.  One big reason is the Austrian Business Cycle Theory.  The prior Fed inflation caused an unsustainable boom that went bust.  Now, resources are trying to realign themselves to more sustainable things.  Other reasons for high unemployment include the minimum wage, other labor laws, and taxes.

There is another factor in the unemployment situation.  In 22 days, the current tax rates will rise if nothing is done.  How are businesses or individuals supposed to plan in this kind of environment?  There is enough uncertainty with the current economy and the unstable dollar (QE2).  That is bad enough.  But we don’t even know what our tax rates will be in 22 days.  This is really truly unbelievable if you think about it and you can blame both major parties in DC.

The Republicans never made the tax cuts permanent.  Instead, they only passed tax cuts through 2010.  Then the Democrats had almost 2 years, along with Obama, and nothing has been done yet.  On top of it all, this deal that was supposed to happen between Obama and some Republicans wasn’t really a good deal for us citizens.  There were a couple of good things like maintaining the current income tax rates and possibly reducing the payroll tax for a year.  But then there were all kinds of welfare included in the bill, including extending unemployment and funding Obamacare.  So yes, the Republicans have already caved on Obamacare.  To top it off, the death tax would come back at a rate of 35% with an exemption on the first $5 million.  So I guess it would only be the really rich people committing suicide on December 31.

DC is so far gone, it really is hopeless.  We just have to make sure that when the house of cards falls down, that we have done a good job of educating people on the benefits of liberty.  Until then, we should hope for reduced taxes.  The government will continue to spend and inflate, regardless of what the tax rates are.  We might as well try to get our benefit now and convert some of our money into hard assets while they are still relatively cheap.  In the meantime, sit back and enjoy the show and let’s see if Congress can get the tax rates figured out in the next 3 weeks.

The bond market has taken a beating in the last couple of days.  Interest rates have gone up quite dramatically over just a 2 day period and mortgage rates are following.  This is ironic, considering the fact that Bernanke’s reasoning for QE2 is to lower interest rates.  Rates have gone up since his announcement of QE2.

I have been saying that for gold to go to the moon, interest rates would have to start rising.  It’s not that high interest rates cause gold to go higher, but there should be some correlation if gold starts to rise dramatically due to price inflation.  It has been a battle between gold and bonds up to this point.  Both did poorly today. Bonds have been telling us that there is little to worry about as far as inflation because rates have been so low.  Gold has been rising, which is possibly telling us something different.

I think for gold to go to $2,000 per ounce or more, interest rates are going to rise.  This is not to say that you should wait to invest in gold until rates rise.  You should be significantly invested in gold or gold related investments now.  But again, for gold to really go sky high at this point, we need to start seeing some price inflation.  You may see a little price inflation at the gas pump and the grocery store, but the bond market has been telling us that it is not a significant threat in the future.  I think the bond market is finally waking up to the reality.

With all of that said, I would not short the bond market at this point.  If you do, you should know that it is a total crap shoot.  Bernanke has barely started QE2, if at all.  QE2 means the Fed will be buying bonds.  Although it means the Fed will be inflating the money supply (despite what Bernanke says) which could ultimately be negative for bonds, for now the Fed will be bidding up bond prices.  It’s not to say that the Fed will be successful in driving down rates in the short term, but I wouldn’t bet against the Fed at this point either.

Yesterday I talked about Ben Bernanke’s interview on 60 Minutes.  It is still a fascinating topic.  Here is one of the most powerful men in the world.  I won’t say that he is the most powerful because he can’t launch a nuclear attack, but he could certainly fund it.  This is a guy that essentially controls the nation’s money supply.

The interviewer asked some decent questions, but the problem is that he had no follow ups.  This makes him almost useless as an interviewer if he is not going to challenge Bernanke on the things he says.  I keep going back to Bernanke’s comment that he is not changing the supply of money in circulation.  How can he make this comment and not elaborate?  How can the interviewer not follow up?  Up until this point, his statement is true.  The monetary base has not risen, even after his QE2 announcement.  I’m not sure when it will start to rise.

But if he goes through with QE2, then the monetary base has to go up.  It will be an increase in the supply of money.  The Fed is technically not printing money, but they are doing the equivalent and creating money out of thin air.  It is done on a computer instead of a printing press.  But the key word in his comment is “circulation”.  He is saying that the increased money supply won’t be in circulation.  If he really means this, then that means that banks will continue to accumulate excess reserves.  But then if they are doing this, then that defeats the whole purpose of him lowering interest rates.

This whole thing has to be price inflationary at some point.  The velocity of money has been low since the fall of 2008.  This has helped keep prices down.  At some point, some of this money will end up in circulation.  Bernanke cannot time when he is going to withdraw the money.  He will get into a situation, something like the 1970’s, with high price inflation and a stagnant economy.  He will eventually have to choose between massive inflation and depression.

The problem, as I’ve pointed out before, is that he will not be able to withdraw all of the new money.  In 2008 and early 2009, the Fed bought assets from the banks in the form of mortgage backed securities.  Some of these are now only worth a fraction of what the Fed paid for them.  Selling them back into the market will only withdraw a portion of the money that was used to buy them in the first place.

Bonds are the same way.  If interest rates go up, the bonds they have bought will be worth less.  They can withdraw some of the new money, but not all of it, if interest rates rise.  I really don’t think Bernanke knows what he is doing now.  He cornered himself in many years ago when he apologized to Milton Friedman on behalf of the Fed for allowing the Great Depression to happen.  Bernanke thinks that it was the Fed’s fault, not because of the initial artificial boom, but because the Fed did not print enough money once it was there.  This is his legacy.  He is trying to make sure that he doesn’t allow another Great Depression on his watch.  In the process, he will just about destroy the U.S. dollar.

Ben Bernanke was on 60 Minutes last night.  If you didn’t get to see it, go ahead and watch it.  This is one of the most powerful men in the world.  Even if you don’t like him and think he is a total liar or a total fool, you should still pay attention to what he is saying.

The interview is quite interesting.  The first thing I noticed is that he sounded nervous.  Maybe I don’t listen to him enough and this is the way he always sounds.  While there were a lot of interesting soundbites, the most interesting one was about inflation.

The interviewer asked him about inflation.  Bernanke said that “the amount of currency in circulation is not changing.  The money supply is not changing in any significant way.”  He said they are lowering interest rates to stimulate the economy.

I don’t understand what he is talking about here.  Is he saying that the banks will increase their excess reserves (as was done 2 years ago)?  That is what one economist thinks (see halfway down the article).  That is really the only explanation for his comment.  If the Fed is buying U.S. bonds, then it is creating money.  The government could sell bonds to individual investors, to companies, or to foreign governments and none of these actions alone would be inflationary.  But if the Fed is buying U.S. government bonds, then the Fed is creating money out of thin air to buy them.  Therefore, for him to say that the amount of currency in circulation is not changing, would have to mean that the additional money gets bottled up at the banks.

Of course, he didn’t say this and the interviewer didn’t follow up with him.  It contradicts his other statements.  If he is engaging in QE2 to lower interest rates and encourage lending, then how is lending taking place if the banks are increasing their excess reserves?  So are the banks going to lend or are the banks going to increase reserves?  Which is it Bernanke?  And what is it you want them to do Bernanke?

The man is either a liar or a fool.  But he is in a position of great power and we must listen to what he says. His actions dictate the future of the economy and they dictate how certain investments will behave.  If he is right that there will be no additional money in circulation, then we should be cautious about stocks and gold.  If he is wrong, then we should expect high price inflation to follow the high monetary inflation and we could see gold skyrocket more than it already has.