Capital Markets Update

By Louis S. Barnes　　　　　　　　　　　　Friday, November 16, 2012　　　　　　　　　　　　　　　　　　　　　　　　　　　　　　　　　　　　　　　　　　

　　　　 Most people seem to feel some sense of relief at the passing of the election, but markets are apprehensive. We need for big stuff to happen, and know that more will happen faster than in years, but we don't know what or to what effect.
　　　　 The daily flow of economic data causes upsets, but reassures markets -- at least we know where we are. For the next month hurricane Sandy will distort to uselessness most of the usual reports, as it did this week's shaky ones for retail sales, unemployment, and industrial production. Maybe a new trend, maybe nothing.
　　　　 Sandy had nothing to do with the rest of the world. Euro-zone industrial production in September fell sharply, down 2.5% in the month. 3rd quarter euro-zone GDP fell .2% annualized, negative for the second-straight quarter and three of the last four. Japan's 3Q GDP sank 3.5%. China's official reports cannot be trusted, not during a leadership change; and nobody outside the new Politburo Standing Committee knows what the change means -- and maybe not even those seven men.
　　　　 Against that backdrop the US has embarked on the most profound change in its finances since the income tax began in 1862. The stock market had a bad day after Mr. Obama's victory, but the cause appeared to be Europe; the straight-down stocks since then seem anticipation of his newly announced tax-negotiating position.
　　　　 "The wealthy don't need a tax cut." Fair enough. However, the reversal of a tax cut 11 years ago will today be a tax increase in every way and effect. But, since the President's proposal affects only the top 2% of income earners, it's a painless way to raise money. So those in favor say. Over ten years, the top bracket increase from 33%-35% to 39.6% will raise $441 billion. Limiting deductions by these taxpayers, another $123 billion. Another $206 billion from new taxes on dividends plus an inevitable increase in capital gains taxes…　 the link to sinking stocks is unmistakable.
　　　　 The very worst of the lies today about taxation: "We have had higher brackets for the rich and not hurt the economy." We have had higher brackets, but nobody paid them in previous systems that were more loophole than collection. Pulling $800+ billion out of the pockets of 2% of taxpayers will have negative economic effect.
　　　　 Some spending cuts will come soon, but very few. There will be no cuts in current social spending (ObamaCare will add), instead reductions in future promises late in the decade. The frontloading of taxes and backloading of spending cuts makes Republican negotiators nervous. And should, based on the history.
　　　　 The great tax reform of 1986 removed many prior loopholes and reduced brackets to two: 15% and 28%. By 1990 that reform did not generate enough revenue to fund social spending above forecast. We raised brackets, closed loopholes. In 1993 Mr. Clinton reached a grand deal: the top bracket to 39.6% in exchange for hard limits on spending -- that, a technology-booming economy, and a stock bobble created a budget surplus. Clinton's deal was fair and effective, but we know now that economy was not authentic, and we will re-apply those brackets now to a far weaker economy.
　　　　 The most extraordinary change coming: for the first time since 1862: a no-loophole system. Thus at any given bracket, the effective rate of tax will be higher than ever.
　　　　 Some think a Cliff deal will reassure business and help the economy. More likely: everyone affected will know that austerity has arrived on our shore, and our hopes will rest on a far more adaptable economy than anywhere else. Good bet, too.
　　　　 Good news for a deal: two hardheads who undermined at a distance John Boehner's efforts in 2011, Paul Ryan and Eric Cantor, will now join the negotiating team. On the other side, all will depend on the extent of Mr. Obama's determination for righteous extraction of cash from people who neither need it nor earned it.
　　　　 Temporary bad news today on another front: the bankruptcy of the maker of Twinkies and Wonder Bread. (In my childhood my mother said they called it that because we wonder if it's bread.) Take heart: the brands will be sold and revived. Couldn't make it through a time like this without an occasional smuggled Twinkie.