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Omicron Covid Variant and Your Investments

The Covid-19 virus continues to mutate and occasionally causes new variants to occur. As the virus mutates further and further away from the parent Wuhan strain, there are the risks of more aggressive viruses, strains that are not treatable by current medications and regimes, and variants that are not affected by current vaccines. So far the new Omicron variant appears to spread more easily than previous strains but does not seem to cause more severe disease. It will take a few weeks to find out if current vaccines are effective against the Omicron variant. What does all of this say about the Omicron variant and your investments?

What Is the Omicron Covid-19 Variant?

The World Health Organization provided an update on Omicron on November 28, 2021. They designated Omicron a variant of concern because it has several mutations that may affect its ease of transmission and how sick it will make people who catch it. They are concerned that people who got previous strains of Covid-19 and recovered could more-easily catch the Omicron variant. Regarding transmissibility, severity, and vaccine effectiveness the jury was still out when the issued the update. But, in the last few days the virus has been identified in more than twenty countries and it has become the dominant strain in South Africa where it was first identified. So far in South Africa it does not seem to be making people any sicker than previous variants and folks who have been vaccinated seem to have protection although how good that is will need to be found out.

Omicron Covid Variant and Your Investments

How Will the Omicron Covid Variant Affect the Stock Market?

So, we have another (predictable) Covid-19 variant. Experts have been saying that the pool of unvaccinated people due to vaccine hesitancy and simply the lack of vaccines in many regions of the world have created a situation where repeated variants are likely to arise. Each time this happens there is the risk of renewed damage to the economy and individual investments. How any of this relates to the Omicron Covid variant and your investments will likely depend on what you are invested in. The Motley Fool looks at how Omicron will affect the stock market. The 2020 Covid Crash happened because the economy shut down and because nobody had a real clue about how the pandemic would work out. After the initial plunge we saw a K-shaped recovery with tech stocks booming while travel and hospitality stayed weak or even worsened. Because everyone has now seen this playbook we might expect a similar scenario if Omicron surges due to greater transmissibility and severity as well as not being preventable with vaccines. Because everyone has seen the playbook we would not expect a crash of the market simply based on Omicron being worse that currently expected. But, there are more factors to consider.

Omicron and More for Investors to Worry About

The world and national economies were functioning normally before the Covid Crash. Today we have inflation worries, the risk of a real estate meltdown in China, and supply chain disruptions with computer chip makers making it hard for automakers to meet their production quotas. The Fed is talking about accelerating the processes quantitative easing and, perhaps, raising interest rates sooner and higher than previously expected. The risks of one or more of these factors added to an aggressive new Covid-19 variant are real. Many will chose to take some profits out of the stock market just in case. Then the problem is that still-low interest rates offer the prospect of investing with negative real interest rates for now and the prospect of 1970s stagflation on the other.

Omicron Covid Variant and Your Investments - Permanent Pandemic

Intrinsic Value in the Era of Covid-19

In the USA and other nations herd immunity from high vaccination rates is theoretically possible. But, it would take a huge change in the mindset of a large segment of the population and, more importantly, lawmakers and the courts for this to be achieved. Then the issue is vaccinating enough folks across the world to reduce the load of the virus to a point where new variants are less likely to emerge. It would appear that the pandemic that we all thought would go on for a year or two may well be a permanent human condition. That being the case, how do you assess intrinsic value in the era of Covid-19? The necessary clue is contained in the tech rally from the depths of the Covid-19 Crash. Microsoft, Apple, and Alphabet are not the only possible investments in this case. The world is going to be producing more and more electric vehicles that will need lithium batteries and lots of strategic minerals. Tech and all of its support aspects are in all likelihood where to find intrinsic value as the Covid-19 pandemic becomes a permanent part of the human condition.


Investments in Agricultural Carbon Credits

An article in The New York Times Dealbook about carbon credits as the latest farm product caught our eye. The article lead states that cropland across the globe could potentially sequester up to 570 million metric tons of carbon every year. The Intergovernmental Panel on Climate Change puts the number at 8.6 billion metric tons. The article notes on how farmers could make money from carbon credits when they modify their farming practices. They also touch on the details of getting this to work including how the whole process could be a money-loser for any given farmer. Thus, we decided to look into investments in agricultural carbon credits as a viable way to make money, or not.

The Market for Carbon Credits

As noted in the article in The Times, carbon credits have been around for more than 30 years. The intent is to reward businesses that reduce the emission of greenhouse gases or even sequester carbon by various means. Companies that want to become carbon neutral often purchase credits when they have no way by their own actions to meet their goals. An example is Microsoft which recently bought 200,000 farm-based carbon credits. They are said to have turned down 5 million potential agricultural-based credits as they could not see how the practices involved in generating the credits were going to result in permanent climate benefits. A typical payment for such carbon sequestration credits is $27 ($15 to $30) which is for sequestering enough carbon to offset the emission of a ton of carbon dioxide.

Investments in Agricultural Carbon Credits
Investments in Agricultural Carbon Credits

Are Investments in Agricultural Carbon Credits Profitable?

A fact of life on the American farm is that crop prices go up and down. When corn, soybean, or wheat prices are high it makes economic sense for the farmer to use synthetic fertilizers to boost crop yield. This practice typically means that the farmer will not get any carbon credits but will make more money that the credits were worth in extra revenue. When a farmer does not change farming practices year and year and receives carbon credits every year there is the cost of verifying that the process is successful in sequestering carbon.

Cost of Carbon Sequestration Verification

A farmer who wants to get carbon credits has to first establish the amount of carbon in their soil by having multiple samples taken and analyzed in the laboratory. Programs involved in this process look at farming practices, seed types, and even the weather to estimate how much carbon is captured by modified farming practices. The credits are, in turn, issued by third parties that validate the data.  The cost to the farmer of verifying their initial situation and the results of ongoing operations has been an impediment to getting cash-strapped farmers to enroll. The United State Department of Agriculture reports that shifting to the sustainable practices commonly reduces row crop yields for the first two years after which farmers need to use less fertilizer due to breakdown of old, retained crop roots. Thus, the cost of carbon sequestration verification and reduced crop yields in the first two years are a deterrent to farmers following this path. The economic question for the farmer will be if the carbon credit payments and reduced costs of fertilizers will offset yield losses over the years. As with investing in stocks, an analysis of intrinsic value of the investment is necessary. Sustainable agriculture is good for the soil over the long term but farmers need to survive year by year while running the risk of another trade war with one of their biggest buyers.


Investing in Chip Makers

Supply chain disruptions have slowed the economic comeback from the depths of the still-present Covid crisis. One of those disruptions that affect virtually all products that use electronics is the difficulty in getting computer chips. Car makers can’t make enough cars because they can’t get chips. If you are thinking of investing in chip makers don’t just look at the largest chip producers. This situation has favored older, less well known, chip makers such as Microchip, Marvell Technology, STMicroelectronics, NXP Semiconductors, Onsemi and Infineon. Stocks such as Marvell Technology have gone up four-fold in a year and a half.

Secure Chip Supplies into the Future

As chips became scarce the most attention focused on the giants of the industry such as Taiwan Semiconductor Manufacturing Company and their foundry’s. Because the industry giants could not keep up with demand this favored lesser-known chip makers who don’t always make the most advanced chips but who make the ones that are the backbones of many industries.  The supply disruptions caused by the simmering trade war with China, the Covid crisis shutdowns, and difficulties shipping things from one part of the world to another have highlighted the need for US companies to have sources of chips produced on US soil or at least outside of China. The decades-long rush to outsource everything to the cheapest producers in Asia has come back to haunt US companies. Our belief is that for chip supplies going into the future the less-known US chip manufacturers will remain strong as US buyers hedge their bets against the risks of trade wars and global supply chains.  

Chip Companies to Consider for Investment

If you are thinking of investing in chip makers we suggest that you look at the following along with the giants in the industry.

Microchip
Marvell Technology
STMicroelectronics
NXP Semiconductors
Onsemi
Infineon

Marvell Technology

Marvell Technology sold for $18.67 at the depth of the Covid Crash and sells for $74.58 today. This company has a $61 Billion market cap and a 0.32% dividend yield. Founded in 1995 and headquartered in Santa Clara, CA, it has current annual revenue of $2.9 Billion, 10,000 worldwide patents, and more than 6,000 employees.

Investing in Chip Makers - Marvell Technologies

Microchip

Microchip Technology sold for $29.82 at the depth of the Covid Crash and sells for $82.68 today. It has a $45.88 Billion market cap and has a 1.12% dividend yield. They manufacture embedded security devices, radio frequency devices, analog management devices for thermal, battery, and power uses, microcontrollers, Serial EEPROM devices, and Serial SRAM devices. Its production facilities are in the USA but it has test and assembly facilities in Thailand and the Philippines. Its 2019 revenue was $5.3 Billion.

Investing in Chip Makers - Microchip Technologies

NXP Semiconductors

NXP Semiconductors sold for $73.58 at the depth of the Covid Crash and sells for $221.26 today. It has a market cap of $58.84 Billion and a 1.02% dividend yield. This is a Dutch multinational with $9 Billion yearly revenue that focuses on chips for the automotive industry.

Investing in Chip Makers - NXP Semiconductors

Infineon

Infineon is a German company that traded for €11.47 at the depths of the Covid Crash and sells for €43.17 today. Its dividend yield is 0.63% and its market cap is €56.74 Billion. Infineon Technologies is a spinoff from Siemens in 1999, has 46,665 employees and generates €8.567 Billion in revenue a year. They produce motor control ICs, AC-DC power conversion units, isolated industrial interfaces, intelligent power modules, solid state relays, Gate Driver ICs, LED Driver ICs, linear voltage regulators, smart low-side and high-side switches, IGBT, MOSFET, HEMT, and Diode and Thyristor devices. Their main competitors are those companies listed in this article.

Investing in Chip Makers - InfineonTechnologies

STMicroelectronics

STMicroelectronics sold for $16.42 at the depth of the Covid Crash and sells for $51.67 today. This French and Italian company manufactures electronics and semiconductors. They have a market cap of $46.41 Billion and a dividend yield of 0.51%. They have a large product line of microprocessors and microcontrollers. The company was founded in 1987 and carries a large line of legacy products as well as newer and advanced microprocessors.

Investing in Chip Makers - STMicroelectronics

Onsemi

Onsemi is an American semiconductor producer with a $27.29 Billion market cap. It does not currently pay a dividend. The stock sold for $10.94 at the depths of the Covid Crash and sells for $63.34 today. On Semiconductor has yearly revenue of just under $4 Billion and make a wide range of products including power and signal management, logic, discrete, and custom devices for automotive, communications, computing, consumer, industrial, LED lighting, medical, military/aerospace and power applications. They have facilities in North America, Europe, and the Asia Pacific.

Investing in Chip Makers - Onsemi


All of these “smaller” chip makers are billion dollar companies. In a recent interview on Bloomberg TV the former head of IBM, Samuel Palmisano (2002-2012) was asked about the dilemma US companies have with getting computer chips for their products and keeping their supply chains secure. The interviewer asked if companies like GM and Ford would just as well start their own chip manufacturing operations. His reply was this approach is not feasible as it takes an initial investment in the billions of dollars and increasingly advanced technology to keep up in the field. The better choice would be to support US manufacturers by guaranteeing them a place to sell their products. If this is the route that US companies take, investing in chip makers that we have noted here might not be such a bad idea.

Investing in Chip Makers – Slideshare Version


Are Electric Vehicle Stocks Safe Investments?

There was a time when people would invest in virtually any new company that had dot com at the end of its name. The stock market was supposed to have become different. Then the Dot Com bubble burst, taking 75% of the value of the NASDAQ and $5 Trillion in market value with it. Today the situation with electric vehicle stocks bears some similarities to stocks in the early internet era. Are electric vehicle stocks safe investments when a company like Rivian which has yet to make any electric pickups went public with a market cap of $127 billion which is more than General Motors which generally sells more than 200,000 vehicles a month.

Hoping to Invest in the Next Microsoft

We all wish that we had bought Microsoft the day it went public. That stock today is worth a thousand times its original price with splits and appreciation. One of the places where investors are looking for comparable opportunities is in the list of new electric vehicle manufacturers. The world is finally catching on to the fact that the climate is changing and that in order to avoid the worst consequences the world of transportation is going to switch from gasoline and diesel to electric vehicles. The success of Tesla which has a market value of $1 Trillion attracts investors. Tesla’s market cap is more than the market cap of every other car and truck maker combined. Tesla produces fewer than a million of the 78 million vehicles produced in the world each year. Rather than jump into Tesla which many consider to be overpriced, many investors are looking at other electric vehicle stocks which, hopefully, have room to grow.

How Big Will the Electric Vehicle Market Be?

A fair estimate is that the world will spend $5 Trillion on electric vehicles between now and 2030. Analysts are expecting companies to make a profit of $80,000 per car versus people paying an average of $80,000 per car today. Experts expect Tesla to end up producing half of the electric vehicles in the world. The rest of the electric vehicle makers would then produce the other half. Today Tesla makes 28% of electric vehicles at just under a million a year. GM has set a million electric vehicles a year as a target for 2025 and wants to make all electric cars and trucks by 2035. As more and more companies ramp up production we think it will be difficult for one company to control half of the global market. We also think that a large proportion of the startups are going to fail. So, are electric vehicle stocks safe investments. As a group they will prosper but it is very likely that some of these overvalued companies that have produced few if any vehicles as of yet will not be around five and especially ten years from now.

Are Electric Vehicle Stocks Safe Investments?

What Determines Success in a Crowded Industry?

The companies that provide reliable vehicles at competitive prices will tend to out-compete the others in the electric vehicle sector. Customers return to companies who offer strong customer service, stand behind their products, and fix problems so that their brand does not get a bad name from the very start. While we doubt that Tesla will make half of the electric vehicles in the world, it is telling that Tesla has a 90% satisfaction rating from their buyers and 80% buy a Tesla for their next car. Tesla is priced for further growth. Since we don’t think they will have total control of the market that may be the only “safety factor” issue for investing in Tesla. On the other hand, we see Rivian as a gamble as they will spend years catching up to their current share price. As a niche this one should be profitable. Picking the winners will be the key.

Are Electric Vehicle Stocks Safe Investments? – Slideshare Version

Why Are Insiders Selling Stocks?

From the depths of the Great Recession until the Covid crisis the stock market kept going up despite predictions of a crash. The Covid Crash hit the market and when the Fed intervened the market started back up again. Is the stock market going to head up forever? If that is so, why are insiders selling stocks? What do they know that we don’t? We got to thinking about current insider stock selling after reading a recent article in Market Watch about record selling by insiders.

How Often Does the Market Correct or Crash?

On average the US stock market suffers a 10% or greater correction every two years. It experiences a 20% or greater crash about every seven to eight years (1968-70, 1973-4, 1980-2, 1987, 2000-2, 2007-9, 2020). Crashes typically take longer to recover from. For example, the Dot Com 2000 to 2002 crash took 929 days to recover to pre-crash levels and the 2007 to 2009 Financial Crisis crash took 517 days to get back to pre-crash levels. Most long term investors look at market corrections as opportunities to look for stocks with good intrinsic value and buy at discounted prices. If they can expect their shares to appreciate again after a correction and recovery, why are insiders selling stocks?

What Do Insiders Know About Their Stocks?

Factors that drive the stock market include the amount of cash available for investment. 2021 has seen the highest stock inflows in decades which Market Watch says may have kept the market propped up. Thus strong companies kept going up and average companies did not lose ground. However, the folks who run companies do not need to wait for annual or quarterly reports to know how their companies are doing. And, they often act on that information. The average investors only finds out about this when reports of filings with the SEC emerge.

We’ve had all-time record levels of insider selling, meaning that the top executives, the people that are the most experienced investors in the world, have been pretty much spending all year getting rid of their stakes in some cases and unloading huge amounts of shares they have accumulated for decades.

Examples include Elon Musk, the chairman of Charles Schwab, and the heads of Amazon.com, Meta (Facebook), and Apple. You cannot blame folks who have converted stock options which are part of their compensation for turning those shares into cash for whatever purposes they choose. But, the timing is always suspect and when insiders sell instead of holding onto their appreciating stock one needs to be concerned that they know something that we don’t and that their stocks are due to correct or even crash.

Why Are Insiders Selling Stocks?

Inexperienced Investors and Bear Markets

There are many young investors today who have never seen a prolonged bear market. What they saw of the Covid crash and recovery was not good preparation for a crash of the magnitude and duration of the Financial Crisis, Dot Com Crash, or, for that matter, the 1929 to 1933 crash. Robinhood comes to mind as a platform that makes investing and trading available from a smartphone with a few clicks. Experienced investors will heed warnings of trouble in the market such as insider selling. And, they will be patient enough to pick up bargains when the next correction or crash bottoms out. Our concern is for new investors who have never had to endure a prolonged bear market.

Why Are Insiders Selling Stocks? – Slideshare Version

How to Invest in the Johnson & Johnson Split

Johnson & Johnson is a 135-year-old company whose brand names like Tylenol and Band-Aid can be found in virtually every home in America. It is also a leading big pharmaceutical company with 58 drugs in its pipeline for late stage development in the USA and EU. Johnson and Johnson announced its intention to spin off its well-known consumer products into a separate company with the process to be complete within two years. This got us thinking about how to invest in the Johnson & Johnson split.

Why Is Johnson & Johnson Spinning Off Its Consumer Products Division?

Although Listerine, baby powder, Tylenol, Band-Aid and the rest of Johnson & Johnson’s famous brands are the face of the company for most people, they are part of a legacy business with low profit margins and slow, if any, growth. Analysts expect Johnson & Johnson to realize profits in the billions from the spinoff. That money may be used to pay for acquisitions that will fuel faster growth. Another issue that gets glossed over is that Johnson & Johnson has liabilities associated with products like its famous baby powder which is claimed to have caused several cases of cancer due to the inclusion of talc in the product.

What Kind of Profits Will the New Johnson & Johnson Consumer Products Division Provide?

Currently, the Johnson & Johnson consumer products division generates 17% of total company sales or $14.05 billion but 10% of company income. Income from this business segment grew by 3% in the last year. The company has a market cap of $434.4 billion at a current share price of $165.01 and a P/E ratio of 24.66 and a Shiller CAPE ratio of 29.86. Total 2021 sales are projected to be $88.8 billion excluding vaccine sales. Net company profit is projected to repeat at $54 billion for the fourth year in a row. The new consumer products company will have reliable sales for its well-known product line but with a 3% rate of growth we expect the company to lag in profits and for its share price to stagnate.

How to Invest in the Johnson & Johnson Split - Consumer Products

What Kind of Profits Will the Remaining Johnson & Johnson Units Provide?

The medical device division of Johnson & Johnson and the pharmaceutical division make up 90% of company profits and 86% of company sales. The pharmaceutical division made 50% of company sales and provided 55% of company revenue last year as it grew 8.4% year over year. The medical device segment slowed due to distortions caused by Covid in 2020 and 2021 but over the last few years this division grew at closer to 10% a year than the 3% a year of the consumer products division. It typically generates about 30% of sales and 35% of revenue. Thus, the remaining Johnson & Johnson business segments will grow at more than double the rate of the spun-off consumer products division starting at 85% of sales and 90% of revenue. If you look at the company’s pipeline of drugs nearing FDA and EU approval you can see the promise of the pharmaceutical division far into the future. Looking at the two segments from the viewpoint of intrinsic stock value, there is no question that the medical device and pharmaceutical segment will outperform the spun-off consumer products and will be the far better long term investment.

How to Invest in the Johnson & Johnson Split - Pharmaceuticals

How to Invest in the Johnson & Johnson Split – Slideshare Version

QE Tapering and Your Investments

The Open Market Committee of the US Federal Reserve has announced plans to begin tapering off their Quantitative Easing policy of purchasing Treasuries and mortgage-backed securities. This will begin in November 2021. In November monthly purchases will fall from the previous $120 billion per month to $105 billion and in December it will go down to $90 billion. This decision may result in slow economic growth. Our concern is about QE tapering and your investments. When Fed Chairman Powell announced the plan to taper he also noted that there will be no immediate increase in interest rates at least not in the first half of 2022.

What Is Quantitative Easing?

Quantitative easing is a policy used by central banks to increase the supply of money in the economy. This strategy was used to help get the US economy out of the Financial Crisis and has been employed again during the Covid Crisis. This strategy has been used when interest rates were already low thus taking away the most common central bank tool of lowering interest rates when a recession hits. An offshoot of this policy can be inflation which then requires an increase in interest rates. QE tapering is likely to reduce the risk of runaway inflation and/or stagflation.

Does Quantitative Easing Devalue the Dollar?

Pouring more dollars into the economy, which is what quantitative easing does, can reduce the value of each dollar against other currencies. This tends to help domestic manufacturers whose exports become more competitive. It also raises the cost of imported items in dollars. The US dollar fell against a basket of foreign currencies when QE was used by the Fed from 2009 to 2114 for the financial crisis. The dollar rose in that index by nearly 20% when QE was tapered in 2014.

QE Tapering and Your Investments - Estimated Purchases Going Forward

Tapering of QE and the Stock Market

Investors get spooked when they see big moves coming from the Federal Reserve. The saying is that “you can’t fight the Fed.” Thus Fed chairmen and chairwomen have learned to use “Fed speak.” They start early with suggestions about which way they will be taking monetary policy and when they do so effectively the markets don’t get spooked. That is what happened the time where the stock market had already priced in the long-anticipated tapering. The S&P 500 has hit all-time highs.

QE Tapering and Your Investments - Unemployment

Federal Reserve Mandates

When wondering what the Fed will be doing over the coming months it is wise to keep in mind the three 1977 Congressional mandates under which the Federal Reserve operates. These are to promote effectively the goals of maximum employment, stable prices, and moderate long term interest rates. Employment has improved since the depths of the Covid Recession but still has a way to go. The path that the Fed needs to follow will be one that does not extinguish the move towards fuller employment and at the same time not let inflation get out of hand. Tapering QE too fast may slow the economy and cause more unemployment while going too slowly could drive inflation higher. With their data-driven approach any coming changes are likely to be gradual and broadcast repeatedly and early.

QE Tapering and Your Investments

Long term investing always benefits from the analysis of intrinsic stock value whether applied to individual stocks or to ETFs that track market sectors or even the whole market. Our opinion at this time is that gradually getting Covid under control and putting the infrastructure legislation into action will both be major drivers for the economy and will thus create investment opportunities beyond the tech sector. We do not see actions by the Fed as likely to cause problems with your investments but are keeping an eye on potential economic problems in China and any potential fallout if the Chinese Communist Party seeks to distract from problems at home with foreign adventurism.

QE Tapering and Your Investments – Slideshare Version

Should You Care About the Billionaire Tax?

There is a sense today that the richest among us are not paying their fair share of taxes as a proportion of their wealth. Thus the idea of a billionaire tax that would only apply to about 400 people has come to pass. Since the odds are pretty good, dear reader, that you are not one of the 400, should you care about the billionaire tax? On one hand it seems like a fair way to get these folks to pitch in and help out. On the other hand you have to remember that income tax was invented in the USA to get the very rich to pay up and gradually turned into the main way that the government gets its money from everyone

Federal Income Tax, the 16th Amendment

For the first half of the years of the Republic there was only income tax during the Civil War and that only applied to incomes over $800 a year and included multiple deductions. In the 1860s laborers made $6 a week or $300 a year and skilled tradesmen like carpenters made $8.40 a week or $436 a year. Union army privates made $11 a week or $572 a year. Thus the vast majority of people were not subject to income taxes and it was repealed in 1872. The 16th Amendment to the Constitution came into being in response to a sense of injustice that the most wealthy like the Vanderbilts, Rockefellers, Melons, and a handful of other ultra rich were not paying their fair share based on their total wealth. Thus the 16th Amendment ratified February 3, 1913, initially affected only the wealthiest in American society. Exemptions, deductions and rates were such in 1913 that only 1% of the population paid an income tax and only paid 1% of their net income up to $20,000 a year for most who needed to pay. The system went up stepwise so that anyone making more than $500,000 a year paid 7%. That only lasted until World War I when the highest rates hit nearly 80% in 1918. Rates went down during the Depression and reached a 94% top tax rate in 1944 at the peak of World War II spending.

Means of Taxation

The most prominent means of taxation in the early days of the Republic were excise taxes on tobacco and whisky. The 1791-1794 Whiskey Rebellion in Western Pennsylvania was in response to a tax on whisky. (It was cheaper and more profitable for farmers to make whiskey from their grains and ship to markets like Philadelphia or New York than to ship the grain.) Property taxes and head taxes were common. As a small segment of society grew more wealthy the idea of an income tax arose in the late 19th century and was only sent to states as an amendment because the powers in charge doubted that it would pass but it did! There was, in fact, a tax on wealth for a couple of years in the 19th century but it was repealed by the courts.

Should You Care About the Billionaire Tax - US Marginal Tax Rates
Top US Tax Rates Over Time


Legal Tax Avoidance, Independence, and the Public Good

Learned Hand, a famous judge in his comments on a tax case said this:

Any one may so arrange his affairs that his taxes shall be as low as possible; he is not bound to choose that pattern which will best pay the Treasury; there is not even a patriotic duty to increase one’s taxes.

This would seem to be the advice that the majority of law-abiding citizens follow in paying their taxes. And, it is what the likes of Jeff Bezos follow as well. Recently evidence of how the wealthy avoid income tax has gotten people talking about a billionaire tax. ProPublica got its hands on tax records of many billionaires.

In 2007, Jeff Bezos, then a multibillionaire and now the world’s richest man, did not pay a penny in federal income taxes. He achieved the feat again in 2011. In 2018, Tesla founder Elon Musk, the second-richest person in the world, also paid no federal income taxes.

Michael Bloomberg managed to do the same in recent years. Billionaire investor Carl Icahn did it twice. George Soros paid no federal income tax three years in a row.

None of these wealthy folks broke the law. They simply used the rules in the current tax code to avoid paying taxes. Most Americans would follow the same courses of action if their circumstance were similar. Thus, the argument (as always) is one of “fairness.” Is it right for some to be so wealthy and to pay so “relatively” little?

Taxing Income versus Taxing Wealth

The wealthiest Americans have generally become much wealthier during the Pandemic as the economy has sagged but the tech sector of the market has prospered. People like Bezos don’t bother to pay themselves a salary but rather profit from the appreciation of the value of their stock and other assets. If the government needs (wants) more money from them to pay for more government spending or to avoid taxing everyone else more, they need to change what they tax and how they go about doing it.

Should You Care About the Billionaire Tax - Wealth Tax Example
Wealth Tax Example from Spain

Taxes Tend to Go Up and Spread Out

A lesson to be learned from the US income tax is that it was set up to remedy a social injustice by making the ultra rich pay at least something to help the government run. It was very quickly seized upon as a way to finance involvement in World War I and never went back to the original rates. Thus a tax intended for one segment of very rich people came to be used to tax virtually everyone. As much as one would like to see the ultra rich pay their “fair share” one should be careful about what one wishes for. A wealth tax could be used across a broader segment of society by simply lowering the levels at which it would be employed. As much as the ultra rich should be shouldering a larger share of the tax burden, there is the very real risk that a tax on appreciation of wealth will end up affecting everyone and then the ultra rich will go on to find other ways to optimize their profits, increase their wealth, and minimize how much they pay in taxes.

ROI on Treasury Inflation Protected Securities

As inflation raises its ugly head, investors have started to think back to the stagflation of the 1970s and worry about negative real interest rates. One option for those who want buy to US Treasures is to purchase TIPS or Treasury Inflation Protected Securities. Is the ROI on Treasury Inflation Protected Securities sufficient to stay ahead of inflation and protect you from getting negative real interest rates? And, what happens with TIPS if the economy goes into a spiral of deflation and negative interest rates?

What Are Treasury Inflation Protected Securities?

Also called TIPS, Treasury Inflation Protected Securities are issued by the US Treasury just like T-Bills, T-Notes, and T-Bonds. They can be purchased at Treasury Direct, through a bank, or through a broker. The idea behind this interest-bearing investment vehicle is to protect the buyer in the case of a huge rise in interest rates happening after the person makes their investment. The interest rate paid on a TIPS is adjusted according to the Consumer Price Index. Interest is paid twice a year and added to the principal. TIPS can be purchased in $100 increments for 5, 10, or 30 years. Like other Treasuries and unlike Series I Savings Bonds they can be bought and sold in the secondary market. TIPS can be redeemed after holding them for a minimum of 45 days.

What Is the Current Interest Rate on TIPS?

As of October 29, 2021 the interest rate for a 10 year TIPS was 2.57%. The long term effective rate will go up as the CPI rises and down as it falls. The current “break even” rate to stay up with inflation is 2%. Thus, you will not be getting a 2% yield in terms of purchasing power but your TIPS investment will currently keep up with the purchasing power it had when you purchased the 10 year TIPS. 2% is the current Fed inflation target.

What Happens to TIPS with Deflation?

The point of buying TIPS is to protect against inflation. What happens if the economy tanks and we see negative interest rates, falling prices, and a Japan-like scenario? Here is what the Treasury says about this:

What happens to TIPS if deflation occurs? The principal is adjusted downward, and your interest payments are less than they would be if inflation occurred or if the Consumer Price Index remained the same. You have this safeguard: at maturity, if the adjusted principal is less than the security’s original principal, you are paid the original principal.

In other words, the interest added to principal on your TIPS will be reduced as the CPI drops. But, should the bottom drop out of interest rates and the economy, the worst you can do is get your initial purchase amount back in dollars. Thus, TIPS are actually a protection against severe deflation as well as one against inflation.

ROI on Treasury Inflation Protected Securities

Why Buy Treasury Inflation Protected Securities?

If you want part of your investment portfolio in interest bearing vehicles, US treasuries are your safest bet. The value of TIPS is that you get some protection against runaway inflation like happened in the 1970s. TIPS are not a cure all. An ETF that tracks the S&P 500 is likely to provide a better ROI over time providing that the market does not implode. The latter possibility is why many investors keep a portion of their assets in bonds, CDs, or Treasuries.

ROI on Treasury Inflation Protected Securities – Slideshare Version

What Are the Risks with Stablecoins?

The US Department of the Treasury just issued a report in which they urge lawmakers to set up rules for regulating stablecoins. These cryptocurrencies that are tied to “stable” assets like the US dollar have grown to have a market value of $130 billion, $100 billion more than at the beginning of the year. The companies that offer stable coins, Tether and Circle, fall into a grey area in that they are not tech companies and not banks but are operating like both. What are the risks of stablecoins? The folks at Treasury are concerned about things like fraud, mismanagement and bank runs if these growing assets are not regulated.

What Is a Stablecoin?

The chief argument against cryptocurrencies like bitcoin is that they have no basis for their value outside of what the market will pay. The rationale for stablecoins is that they are pegged to a “reserve asset” such as the US dollar or gold. Tether (USDTUSD) and TrueUSD are both tied to the dollar. They have dollar reserved that are kept by custodians separate from the companies and are audited regularly. There are also stablecoins that are pegged to other cryptocurrencies and ones that derive their value from computer algorithms (Basecoin).

What Are the Risks with Stablecoins?

Why Are Stablecoins Attractive?

Currencies are supposed to be stores of value. Cryptocurrencies like bitcoin function like commodities that double in price over a week or two and then collapse by half. Ten percent variations over a day are common. This feature makes trading bitcoin attractive and the fact that the overall trend is going up makes bitcoin attractive to some investors. But, if you are going to spend your cryptocurrency such as was intended when cryptocurrencies were first envisioned, a stablecoin would seem the better bet as the price does not fluctuate so severely.

What Is the Worry With Stablecoins?

Treasury Secretary Yellen said this about stablecoins:

Stablecoins that are well-designed and subject to appropriate oversight have the potential to support beneficial payments options but the absence of appropriate oversight presents risks to users and the broader system.

Banks need to maintain reserves and are subject to oversight by regulators. Banking issues that came to light after the 1929 and 1968 market collapses showed the need for such oversight. The Treasury does not have a problem with the idea of stablecoins as a means of exchange or store of value. What they want is to bring this asset into the regulatory scheme that protects uses from malfeasance or simply from dumb mistakes as noted in an article in The New York Times Dealbook about stablecoins.

The working group determined that authority to regulate stablecoin issuers would have to come from an act of Congress and that the group could not currently mandate standards for digital payments reliant on stablecoins. That lack of authority, the report said, makes these types of crypto-based transactions more vulnerable to “human errors, management failures or disruptions” that could result in consumers losing money, becoming victims of fraud or being unable to get their money.

A couple of months ago we asked if crypto banks were really pawn shops as they required a deposit of dollars to use their cryptocurrencies for loans, credit cards, or for deposits. Stablecoins are just one more iteration of cryptocurrencies, many of which may be very useful and some of which may be dangerous without proper oversight.

What Are the Risks with Stablecoins? – Slideshare Version


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