Nearly six months ago, I taught a course entitled “Surviving the Crisis.” While not knowing how this crisis will end (either now or back then), I was pretty sure that it could not end given the economic policies put in place. At that time, I stated: “From the standpoint of economics, I don’t think I have ever seen a more harmful set of programs and policies. These started with Bush but have been taken to insane levels by Obama. It defies logic, economics, common sense and history to believe that these programs will help. If implemented and/or continued, they will seriously compromise the nation’s ability to sustain its current standard of living.”

At that point I thought we had reached bottom in terms of economic policy nonsense. Much of what happened, I thought, was the panicked reaction to the financial crisis and the euphoria of a new President. Surely, rational analysis would prevail and policies would change for the better. There was no way to imagine that policies would continue to worsen. At this point, there is no hope for a recovery, despite what one hears in the press. Now I am concerned whether our form of government can be maintained through the next decade. The economic crisis we experienced is likely little more than a pre-Earthquake tremor. The real crisis has not hit yet.

The following letter from Casey’s Daily Dispatch conveys many of the reasons I view the future so pessimistically.

Dear Reader,

Welcome to the weekend edition of Casey’s Daily Dispatch, a compilation of our favorite stories from the week for the time-stressed readers.

Of course, if you want to read all of the Daily Dispatches from the week, you may do so in the archives at CaseyResearch.com.

Retro-Taxes

As I sat down to write yesterday morning, the news came across that instead of ringing in at under 10%, as was widely expected, the nation’s unemployment rang the bell at 10.2%.

While no surprise to our readers, we have steadily worsening unemployment against the backdrop of soaring deficits. It’s called “a rock and a hard place.”

The government answer to unemployment can only be more stimulus. That’s really all they know. But spending like there’s no tomorrow is already raising political chop for the Democrats, evidence of which are the high-profile losses in the just concluded fill-in gubernatorial elections.

At this point, instead of slamming on the brakes, the Democrats appear to have decided on going for broke (a very apt term, if I may say so myself), in the hopes that by the mid-term elections, they will have bribed so many voting blocs that they can retain power. In the short period I was in Argentina, the number of initiatives foisted by the administration and its allies to mollify the plebs and buttress its political fortunes continued to pile up. The following is a hastily assembled, and no doubt incomplete, list…

• Extending unemployment benefits. With the latest extension, an unemployed person can get benefits for up to 99 weeks, or more than two years.
• Health care. The new bill, with a proposed (versus actual) tab of $1.05 trillion, is expected to pass the House perhaps as soon as this weekend.
• Fed pledges to keep rates low for “extended period.” Money for nothing, helping out the banks at the expense of the savers.
• Home buyer tax aid credit extended. Sure, why not?
• Fannie May implements a Deed for Lease program. Homeowners facing foreclosure can remain in their homes by signing their underwater mortgages over to Fannie Mae, and by agreeing to lease the property for a period, with a payment of no more than 31% of their income. It’s a win-win – the former homeowners get to stay in their houses, and Fannie Mae gets to own even more bad loans. What a deal!
• The FDIC allows banks to carry underwater commercial loans at pre-crash values. A commercial real estate crash would be so untidy, it mustn’t be allowed. Therefore, with a wave of its magical wand, the FDIC is allowing banks to carry loans on their books at bubble valuations, even if the underlying properties have fallen by 40% or more. Call it extend and pretend, or fraudulent accounting… the net result is the same: zombie banks that won’t lend because they know that, in time, the piper must be paid.
• Senate passes climate change legislation. Damn the torpedoes, and damn the ultimate cost to industry and consumers.

Unfortunately, I could go on, but won’t. I will, however, comment that when you match up the already insane levels of deficit spending with the added costs of the new initiatives – and the less obvious costs of continuing to bail out institutions that should be allowed to fail – something has to give.

(On that last point, just today, Fannie Mae has stuck her withered hand out for another $12 billion. And the FHA, which delayed releasing its annual audit this week – not a good sign – is experiencing loan losses of upwards of 24% on the hundreds of billions of dollars worth of mortgages it provided backing for in 2007 and 2008.)

The administration knows that it can’t keep running a massive deficit without taking a big political hit come the mid-term elections next November, but likewise, they won’t cut the spending out of fear that it will result in a smoking-ruin economy ahead of those same elections.

Keeping spending, but don’t run up a deficit? Well, there’s only one way to do that – and that’s where you, dear reader, come in.

You see, the only way to pull it off is to boost revenues. As sales and real estate-related tax revenues won’t return to pre-crash levels in our lifetimes and it would be political suicide to raise taxes on the masses, who don’t really pay taxes anyway, all that’s left is to mug the “wealthy.”

It is already understood that in 2011, all sorts of bad things are scheduled to occur for income earners. For instance, the federal tax rate will bump up from 35% to 39.6%, with an additional 5.4% surtax on gross income for high-income individuals now included in the health care bill. In addition, long-term capital gains, now at 15%, will be boosted to as much as 28%.

That latter tax is especially important right now, because investors can always be counted on to act out of self-interest. If it came to be widely believed that the capital gains tax increases would kick in prior to 2011 – say, in 2010, there would be a mad rush to sell appreciated stocks in 2009. Which is to say, between now and midnight on December 31.

One of the advantages of a little gray hair is that one can dip into the memory bank and recall certain useful snippets. For example, that back in August of 1993, President Clinton passed the largest tax increase in history – the Omnibus Budget Reconciliation Act of 1993 (OBRA) – and made it retroactive to January of that year.

Challenged in court, the court held that retroactive tax increases were legal. And this was not the first time this sort of chicanery had been pulled. I well recall how the father of a very dear friend was literally ruined after the government retroactively did away with a tax shelter and demanded he pay up, and big. He fought against the patent unfairness of the situation for a decade, wrecking his health and happiness and losing most of his money.

(You can read more on the topic of retroactive taxes by clicking here.)

So, here’s a prediction for you. Starting early in the new year, the administration is going to begin the process of repealing the Bush tax cuts a year earlier, in 2010 and, when passed, they’ll be retroactive to January 1, 2010.

While you should of course consult your own tax attorney, I personally plan on selling most of the investments I own that are now showing long-term capital gains. I suspect that many big investors in the know will be doing the same.

Of course, if you happen to be a serf in a kingdom other than the U.S., this doesn’t affect you – unless you own U.S. stocks, which continue to be skating on very thin ice. Should investors start suspecting that 2009 may be the last time to get out while the getting is good, the ice could break.

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