[nmap]

Originally Posted by Surf n Turf

Nmap,
Several queries / comments:
By cutting benefits, I assume you are describing “means testing” eligibility. Would this not make the Social Security / Medicare programs pseudo “Welfare Systems”, in that the larger contributors would receive no benefits for their contributions. Additionally, wouldn’t this make “voluntary contributions” to either program less attractive, when one realized they are unlikely to benefit from their contribution?

Means testing is only one option. It is possible to reduce benefits for all future retirees (as was done back in 1983.) The reduction could be accomplished by changing the way benefits are calculated, increasing the retirement age, or making more of the benefits taxable. One could also lower the income trigger that starts taxation of benefits. Yet another way is to change the way inflation statistics are calculated, with official numbers providing a lower figure for inflation than did the previous method of calculation (which has already been done).

Each of these moves us incrementally closer to your scenario. A more rapid transition is incorporated in the Obama plan, since it removes the upper limit on social security taxation of income. It seems unlikely that upper income earners will receive payments proportional to their contributions.

So, yes, those contributions become steadily less attractive. This will surely cause some to seek ways to avoid such taxes, and may encourage some to consider illegal tax evasion. The underground economy, with its emphasis on cash transactions, is likely to become larger.

Originally Posted by Surf n Turf

By raising taxes on these programs, the taxes would be directed to the group described above, who are “means tested” out of the programs. Again, wouldn’t the same arguments be made for raising taxes for programs, that a significant portion of the population would be proscribed from participation?

Sure. That’s the fundamental reality of “spreading the wealth” or income redistribution. Right now, the increase in Social Security taxes is an easy way to raise a great deal of money in a manner hidden from most wage earners. It is interesting to note the proposed increase in capital gains taxes from 15% to 20%. I strongly suspect we will see others, just as you suggest.

Ironically, the victims in all this are middle class people who earn a paycheck through an employer. The truly wealthy will have the means to choose other (often better) options. The poor (however defined) will benefit from the programs. In addition, both the wealthy and the poor can shift away from traditional paychecks to other approaches. In the case of the poor, cash compensation as part of the underground economy might work. The wealthy can use approaches that avoid ordinary taxes. The middle class, however, are trapped.

Originally Posted by Surf n Turf

By debasing the dollar I am not sure if you are suggesting inflation or deflation.

My meaning was (and for that matter, is) inflation. As the supply of dollars increases, inflation follows. Present trends bring that view into question; however, I regard the present governmental deficit spending pattern as a prelude to future inflation. We’ll see how that works out.

Originally Posted by Surf n Turf

There are certainly signs of inflation (to much money chasing to little goods), but with the current overstocked housing market & Automobile market, plus the credit card default increases, are we not setting the stage for deflation (To much goods chasing to little money). Plus, as you point out, the Boomers will sell stocks, bonds, and other assets for subsistence. Isn't that deflationary?

Yes – we are going though a remarkably strong period of deflation. I wonder if the failure of various assets has not destroyed money at a rate even faster than the Treasury and the Fed can generate it. If we enter a global deflationary cycle, matters will become, quite frankly, bad. We live in a debt driven economy, and the liquidation of hundreds of trillions (yes – seriously. Hundreds of trillions is not a typo) of debt would destroy the monetary system.

There is another possibility. The current deflation may be a side-effect of debt and asset liquidation coupled with a flight to safety. I’ve attached a chart of the U.S. dollar index. Notice the rapid appreciation. This begs the question – why?

In a monetary crises, where does one put one’s money? In Switzerland? Maybe. But they have (as I recall) a deposits to GDP ratio of 7. Iceland was at 9. Iceland is not turning out well, with talk of defaults and lost depositor money. Is Switzerland better? That’s hard to say.

Europe seems strong, but we’re already observing some internal stresses among the EU nations. Japan seems strong. But notice that there are few truly safe places to put money, and the U.S. seems like one of the best, leading to people putting their assets into dollars.

In addition, much of the debt being liquidated is denominated in dollars. This means that debtors must buy dollars, putting upward pressure on the dollar. It also means that other assets must be liquidated – and I cannot help wondering if that isn’t part of the reason stocks, oil, gold, and other assets continue down. Hedge funds had 30-to-1 leverage, and they weren’t the only entities that used that dangerous tool. So the present price action may be an artifact of market reaction to unwinding all these positions.

Still, based on the present price action, the case for deflation is strong. If prices continue lower, and if unemployment starts forcing wages lower, then we are likely to experience a deflationary spiral that could last for years – or even a decade. Such a period will be memorable, and is likely to share characteristics of the 1929 depression.

Originally Posted by Surf n Turf

If we are to expect social confrontation and upheaval, I have two queries:
Based on the above, where / how do people plan their finances to maintain purchasing power.
Based on the above, where and how do people live in order in minimize upheaval?

This is no small problem. From the standpoint of maintaining purchasing power, we face two contradictory scenarios. With inflation, cash (here, cash includes bank CDs, treasury securities, and other high-grade debt instruments) are all wasting assets. Tangibles, including gold, land, and even stocks will generally appreciate along with inflation. However, with deflation, tangibles decline, and the value of cash increases. A bank CD is better than gold, land, or stocks. These do not consider social upheaval.

Our problem is finding a way to prepare for both scenarios at the same time – which means, we must allow for an internal contradiction in our expectations. A strategy that works for one scenario is wrong for the opposite situation. One approach that might fit someone with deep concerns about the economy would probably allow for about 80% of assets allocated to insured bank accounts and treasury securities. Perhaps 20% could be placed in physical gold coins. One well-respected newsletter advocates precisely this approach (Dow Theory Newsletters by Richard Russell). Others take a more dire (or, perhaps, apoplectic ) position and suggest that present trends suggest complete monetary failure. Karl Denninger is an example, and you can read some of his thoughts HERE. He has some interesting arguments. These couple well with your concern over fiat currencies.

Social upheaval is an additional factor. This can range from complete breakdown, as in Somalia, to a few riots and increased crime rates. This is an interesting problem in that one must examine our society critically, and come to a conclusion about both the severity of the problem, and the likely reaction of the general population to such problems. My personal view is that matters will not degrade as badly as some suggest, and civil society will continue, although with greater risks for crime.

Personally, I have doubts about my ability to protect a substantial cache of gold coins, so my emphasis is on undeveloped land. On the negative side, it is has far less liquidity than gold and no transportability. On the positive side, it is harder to steal. I like bank CDs and FDIC insured bank money market funds. Some mutual funds, a few stocks, and some commodity ETFs (all down since the first of the year) round out the position. In essence, I assume that deflation will be temporary, that the dollar will not be destroyed, and that inflation will return. In addition, I suppose that upheaval will occur but within limits. Your mileage will probably vary.

By the way – again, purely my opinion – the next problem we will see is the decline of the Cantarell oil field, and hence revenue for PEMEX in Mexico. Combine a general economic slowdown with problems for PEMEX revenues, and one has the potential for 100,000,000 people to face desperate circumstances. Such a situation might create instability in the border regions. I hope to finish up my degree work in just under two years, and I intend to look seriously at locating further away from the border. Once again, your mileage probably varies from mine on this issue.

I have attached two charts. One represents the value of the dollar. Notice the recent sharp appreciation. The second chart is the Baltic Dry Index, and is a measure of the cost of shipping dry goods. As such, it provides some indications on the level of global trade. Further declines in trade could trigger long-term deflation.

Notice the effort in Argentina to seize private pension assets. LINK. T he actions taken by FDR are worthy of reflection.