Can you afford to bet your financial future on advice that is outdated?

Investors are Overconfident

Image by Alex E. Proimos

I have been investing for a long time and I have seen and made plenty of mistakes.  The biggest mistake is thinking what worked well in the past will work in the future.  It’s called the Normalcy Bias and it has fooled a lot of experienced investors.

For years, financial planners have used projections of 2-3% inflation and a 7-8% investment return.  There was a time when those numbers were realistic.  In the future, they may not be.  I believe inflation is closer to 7% right now and it may rise.  Index funds have returned very little in the past 10 years and that may continue in the future.  We may face another decade like the 70s where the stock market is flat and inflation is high.

Investors aren’t expecting a decade of high inflation or low returns.

Economists are Deceptive

Another problem is that we are constantly being reassured that everything is OK with the economy, when it’s obvious that it isn’t.  Our elected officials care more about their political parties and reelection then the strength of our nation.  The banks care more about fleecing their customers and gambling with derivatives than protecting the global economy.  Not only are they distracted from their mission, they are grossly negligent in their duties.  Ordinary citizens like you and I will have to pay the price for their failure.

The reality is that inflation is close to 7%, when calculated using the 1990 CPI standard.  The unemployment rate is around 23%, when using the 1994 standard, which included short and long-term discouraged workers.  The U3 rate reported by the BLS only includes the 9% of people receiving benefits.  This makes it difficult to judge the economy and plan for the future.  The only thing you can count on is the bias will continue, because the government can’t afford to publish the accurate rates of inflation and unemployment.

Source: shadowstats.com

Never trust anything the government or their economists tell you.

The Deficit is Unsustainable

Everyone knows the federal deficit is out of control.  In fact, it has almost doubled in the five years I have been writing this blog.  While the Budget Super Committee is arguing back and forth about how to cut $1.2 Trillion in the next 10 years, the deficit is growing at $1.3 Trillion per year.  So far, we haven’t suffered any dire consequences from this reckless spending.  But, that day is certainly coming soon and likely sooner than most people expect.

Federal Budget in Summary

• Annual Revenue = $2.3 Trillion
• Annual Expenses = $3.6 Trillion
• Annual Deficit = $1.3 Trillion
• Outstanding Debt = $15 Trillion
• Unfunded Liabilities = $116 Trillion

Source: usdebtclock.org

I don’t have a PHD in Economics, but I’m pretty good in math.  And simple math tells me there is no possible way for the government to repay the deficit.  Even if they cut Federal spending in half tomorrow, it would take over 30 years to pay off the deficit.  That’s at the artificially low interest rates we have today.  If the interest rates were to suddenly shoot up near the real rate of inflation, the annual interest on U.S. debt would surpass $1 Trillion and eat up close to half of the Federal revenue.  If you add in the unfunded liabilities from public pensions, Medicare and Social Security, the budget numbers are hopeless.

There is no possible way for the U.S. Federal government to pay off its debts.

The Dollar is Declining

So far, the Feds have gotten away with overspending using two dirty little tricks.  First, they force exporting nations, like China, to balance the current account by accepting our debt.  Second, they simply print more money.  Both of these scams have consequences.  The Chinese and other nations are growing weary of our debt.  They have been quietly meeting with other countries to find a way to trade around the dollar.  We have recently lost our AAA credit rating and further downgrades could cause investors to dump our Treasury bonds.  We have been printing money like crazy and the inflationary effects are already starting to appear.  The U.S. dollar has fallen nearly 30% since 2002.

Inflation could easily reach double-digits, like it did in 1947 and 1980.

The Government is Desperate

Where will all of this lead us?  Will the Treasury Department try to inflate their way out of debt?  Will they devalue the dollar or raise taxes dramatically?  Will they try to nationalize industries or confiscate private assets?  I know this sounds unrealistic, but there are many historical precedents.  Most American’s probably don’t know the U.S. confiscated all the gold coins and bullion in 1933 and it was illegal to own gold, except as jewelry, until 1974.  People may not realize the British Pound was devalued by 30% before it lost status as the world’s reserve currency.  Most people have no idea how much exposure the U.S. financial system has to shaky European debt.

Unless we change course, it’s not unthinkable the U.S. could:

• Lose Status as the World’s Reserve Currency
• Trigger Hyper Inflation
• Devalue our Currency
• Default on Bonds and Debt Obligations

In a crisis, citizen’s rights will be trampled and private assets coveted.

Surviving the Apocalypse

OK, that’s enough doom and gloom for one post.  There are a number of ways to protect your wealth and reduce your exposure to inflation and currency devaluation.  The most important thing is to diversify from a portfolio of purely financial investments, such as stocks, bonds, CDs and mutual funds.  It is also important to diversify from a portfolio that is exclusively denominated in U.S. dollars.  Real assets tend to hold their value in times of high inflation and it will be important to own a much higher percentage if the dollar hits the fan.

Investments that could buffer inflation and currency problems:

• Real Estate
• Commodities
• Foreign Assets
• Precious Metals

It’s impossible to own the dollars without being exposed to the debt.

The Bottom Line

The bottom line is that it’s no longer practical to stick money in an index fund and expect to prosper.  Anyone who isn’t diversifying both their income and their investments may be risking a difficult future.

“Politicians say they’re beefing up our economy.  Most don’t know beef from pork.”

Harold Lowman

Recommended Reading

Don’t Quit Your Day Job - Quit Worrying about Greece and MF Global
Balance Junkie - Are Low Interest Rates a Solution or a Problem?
The Foundry (Heritage.org) – America Hits $15 Trillion of Debt

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Are CEOs that Valuable?

CEOs made 325 times the pay of an average American worker in 2010.  This is up dramatically from the 269 times in 2009.  The ratio was around 24-1 in 1965, 30-1 in the 1970s and 40-1 in the 1980s.  American CEOs are paid considerably more than their counterparts around the world, even though many American companies lag in performance.  For example, an American CEO makes 16 times what a comparable CEO makes in Japan.  The S&P 500 has been flat for a decade, while executive compensation skyrocketed.  So, the high-paid CEOs aren’t returning value to the shareholders either.

In my opinion, the excessive pay for CEOs is hurting companies and investors, instead of benefiting them.  Between the high pay, stock options, severance packages and outlandish perks, it is definitely hitting the bottom line.  Companies who have held the line on pay have had no problems obtaining executive talent or performance.  And they attract executives who are more focused on the growth of the company than their private jets and villas.  It’s only a matter of time before shareholders start to revolt against excessive pay.  I just wonder what is taking them so long.

Are CEOs Out-of-Touch?

One of my wife’s favorite TV shows is Undercover Boss, where the CEO goes undercover at their company to see how it is run from the bottom up.  If you have ever watched this show, it quickly becomes a rerun after a couple of episodes.  Every week the CEO struggles to keep up at work.  They befriend a financially struggling employee and keep a promissing employee from leaving the company.  The show almost seems like it was scripted by a PR firm.

Observations from watching Undercover Boss:

• CEOs have no clue how daily operations run at their company.
• CEOs fail at any job requiring technical skill, labor or hustle.
• CEOs have no idea how hard it is for their employees to survive.

This leads me to wonder out loud if CEOs are worth even a fraction of their salary.  In fact, I will declare right now that most CEOs are not only grossly overpaid, they are marginal leaders and a poor value to shareholders.  The facts definitely back up my opinion.  There are still some great CEOs in America, but they seem to be few and far-between.

What Defines a Great CEO?

Not all CEOs are created equal.  Some are visionary strategists, fearless leaders and champions of corporate culture.  Some can turn a company around from failure to success.  Others are like the plague to employees and a parasite to shareholders.  They can run a good company into the ground in a very short time and make a fortune doing it.  Here are some of the best and worst CEOs of modern times and the exploits that made them famous or infamous.

CEO Hall of Fame

• Steve Jobs, Apple Inc. - Increased stock price from $4.38 (adjusted) in 1997 to $376.187 during his second tenure. He launched products such as the iPod, iPhone and iPad.  He received an annual salary of $1.
• Bill Gates, Microsoft – Increased stock from 9 cents (adjusted) in 1986 to $19.94 in 2006.  He stepped down from day-to-day operations to concentrate on philanthropy.
• Jeff Bezos, Amazon – Increased stock from $1.50 (adjusted) in 1997 to $210 today.  He created the world’s largest online retailer which is nearly three times the size of its nearest competitor.
• Warren Buffett, Berkshire Hathaway – Increased annual value to shareholders of 20.3% for the last 44 years.  He built Berkshire into the eighth largest publicly traded company in the world.
• Sam Walton, Walmart – Increased stock from 5 cents (adjusted) in 1972 to $10.49 (adjusted) at his death in 1992.  He built Walmart into the world’s largest employer, retailer and company based on revenue.

CEO Hall of Shame

• Ken Lay, Enron - Took Enron from $101 billion in revenue to bankruptcy in two years.  He was convicted of securities fraud, but died before sentencing.
• Bernard Ebbers, MCI/Worldcom - Took company from the largest long distance carrier in the U.S. to chapter 11 in 5 years.  He is currently serving 25 years for $3.8 billion in financial fraud.
• Angelo Mozilo, Countrywide - In mid-2000s Countrywide issued 15% of all home loans in the U.S.  He profited over $300 million by selling his stock ahead of the company’s collapse.
• John Rigas, Adelphia Communications - Built Adelphia into the fifth largest cable provider in the U.S before bankruptcy in 2002.  He is currently in prison after being charged with stealing $100 million from the company.
• Chuck Conway, Kmart - Brought in to turn around Kmart, which declared bankruptcy two years later.  He was charged with defrauding investors and accused of spending company money on planes and houses.
• Dick Fuld, Lehman Brothers - Received nearly half a billion dollars in total compensation from 1993 – 2007, before he drove the company into bankruptcy.  There is ongoing SEC litigation regarding Lehman accounting practices.
• Al Dunlap, Sunbeam - Known as “Chainsaw Al” he tried to turn around companies by laying off thousands of workers.  After being fired for accounting irregularities he was sued by shareholders and the SEC.

The Bottom Line

The bottom line is that executive pay in America has radically diverged from performance.  As companies search for proven leadership, they consistently overpay CEOs who under-perform.  Then, they overpay to get rid of them.  This has to change if America is going to remain a world leader in business.

“My administration is the only thing between you [CEO's] and the pitchforks.”

Barack Obama – President of the United States

Recommended Reading

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New York Times - Where Pay for Chiefs Outstrips U.S. Taxes

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1. Employment is Changing

Image by Tony the Misfit

The conventional wisdom for career success has been to go to college, get a job with a good employer and climb the corporate ladder.  This advice is still relevant and useful, but it’s definitely not a sure thing.  For starters, some college degrees don’t add enough value to a career to even pay back the student loans.  Also, many of the rungs on the corporate ladder are starting to disappear, leaving employees with nowhere to go.  The days of working for one company for an entire career and retiring with a pension and a gold watch are long gone.  Workers starting a career now may have a dozen jobs and a couple of career changes.

Challenges Facing Employees

• Companies are flattening out and reducing middle-management
• Entire industries are being lost overseas, along with those jobs
• Most new jobs created in the past 5 years are low-paying retail jobs
• Jobs are less secure and employers aren’t as loyal as in the past
• The public sector is over budget and many jobs will be eliminated
• Retirees are continuing to work and competing with young workers

How to Prosper

• Save more income to buffer career changes and job loss
• Develop side-income to augment employment income
• Become self-employed to control your future and income
• Keep job and career skills up-to-date for future demands
• Develop a strong professional network to share opportunities
• Select growth areas, such as medical, technical and energy

2. The Economy is Changing

There is no honest way to put a happy face on the economy.  It’s in shambles and there is no easy way to fix it.  In the past, the economy rebounded quickly after each recession and people went back to work. But, that isn’t happening this time for a number of reasons.  First, housing is still too expensive, based on real wages.  Second, the government’s misguided easing and stimulus increased the deficit, but produced no jobs.  Jobs are created by companies and investors, not by economists and politicians.  Most companies are afraid to hire new employees because of economic uncertainty.  The government could help the economy a lot by cutting regulations and presenting a balanced budget.  But, they are too busy pandering to special interests and trying to get reelected.

Challenges Facing the Economy

• Artificially low interest rates and misleading inflation rates
• Decline of American influence in the world economy
• Stifling government regulation and massive public debt
• Complex and unbalanced methods of federal taxation
• Permanent loss of construction and manufacturing jobs
• Enormous amount of foreclosures and underwater homes
• Rising costs for food, energy, education and health care

3. The Market is Changing

There has never been a consistent strategy for investing in the stock market that delivers future performance, based on past results.  The reason is that investors quickly adopt any profitable strategy, which undermines its effectiveness.  Recent examples include tech stocks, hedge funds and index investing.  The investors who will win in the future will anticipate new trends, instead of following old ones.  Dozens of S&P 500 companies will disappear in the next decade and you don’t want to be invested in their stock.

Challenges Facing Investors

• Super-fast computer networks and program trading
• High fees and spread skimming by investment companies
• Massive leverage from derivatives and other instruments
• Millions of baby boomers withdrawing their life savings
• Inadequate regulation and oversight by the government

How to Prosper

• Avoid treasuries and accounts yielding less than inflation
• Invest in rising industries, such as alternative energy
• Accumulate real estate during the weak housing market
• Increase the percentage of global equity investments
• Choose investments with the lowest possible fees

The Bottom Line

The bottom line is that the future is a scary place.  The gap between winners and losers is growing rapidly.  Anyone counting on the status quo is in danger of sliding into the loser’s bracket.  The future will belong to the courageous.

“Change brings opportunity.”

Nido Qubein – President of High Point University

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I want to send a special shout-out to my Mom for forwarding this story. If it wasn’t for her, I may have completely missed it. I read the financial news and dozens of financial blogs every week. Nobody is talking about the results of this audit.

Response from Senator Bernie Sanders (I) Vermont

Audit Results by the General Accountability Office

Treasury Bail-Out Scam

Image by Justin Ruckman

Millions of Americans were appalled at the way bail-out of the financial sector was crammed down our throats.  But, I don’t think anyone realized how much money was involved in this scam.  Everyone was told the bail-out would cost around $800 billion.  And, we were told most of the money was quickly repaid.  Both of these statements were complete fabrications.

The bail-out was sold to the public as being critical for people on Main Street.  But, it’s obvious that it mostly benefited people on Wall Street.  Banks and other recipients simply pocketed the money and no relief trickled down to taxpayers.  There was very little permanent hiring from all of the squandered stimulus.  And, banks stifled the loan modifications they promised to Congress.  US corporations are sitting on mountains of cash, much of it coming from our treasury, and they have no intention of hiring any new employees.

Foreign Interests

One surprising finding of the audit was over $3 trillion in assistance was used to bail out foreign banks and corporations.  Most Americans, including myself, had no idea how much of this money went offshore.  Countries from Scotland to South Korea received hundreds of millions of dollars in financial assistance.  And, there is no clear indication how much of this money is still outstanding.  I’m positive this wouldn’t happen with approval from voters.  And, I’m positive Congress and the President wouldn’t have voted for it while the details were being made public.

Conflicts of Interest

I don’t think anyone would be shocked to learn there were huge conflicts of interest that occurred during the bail-out.  In fact, the Federal Reserve itself is one big conflict of interest, because it puts private bankers in a position of authority over what should be government entities regulating the economy and treasury funds.

Here are some of the shocking findings from the report:

• The Fed provided conflict of interest waivers for employees and contractors, so they could keep their investments in banks and corporations that were given emergency loans.
• The CEO of JP Morgan Chase served on the New York Fed’s board of directors at the same time that his bank received more than $390 billion in financial assistance from the Fed.
• William Dudley, who is now the New York Fed president, was granted a waiver to let him keep investments in AIG and General Electric at the same time AIG and GE were given bailout funds.
• The Fed outsourced virtually all of the operations of their emergency lending programs to private contractors like JP Morgan Chase, Morgan Stanley, and Wells Fargo.  The same firms also received trillions of dollars in Fed loans at near-zero interest rates.
• Two-thirds of the contracts that the Fed awarded to manage its emergency lending programs were no-bid contracts.

Source: sanders.senate.gov

The Bottom Line

The bottom line is that the Federal Reserve cannot be allowed to operate in secrecy to plunder our treasury.  The Federal Reserve System needs to operate  in full view of the public and to be held accountable with the same checks and balances as required in our Constitution.

“No agency of the United States government should be allowed to bailout a foreign bank or corporation without the direct approval of Congress and the president.”

Bernie Sanders – Senator (I) Vermont

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How to Get a Balanced Budget

I love Warren Buffett because he has such simple and practical solutions to the most difficult problems.  Although it sounds far-fetched to kick politicians out of office for running a deficit, it’s the best solution I have heard so far.  Last year, the California state budget was over 100 days late and many government services were shut down.  Angry voters passed an initiative that cut off paychecks to state congressmen if they miss the budget deadline.  So, the California Congress, not wanting to miss a paycheck, passed an unbalanced budget and hid the deficits.  The budget was declared unbalanced by the Controller, the Governor refused to sign it and their paychecks stopped.  They were literally freaking out, because they run their personal finances as badly as the state’s and many members can’t afford to lose a paycheck.  Before the next payday came around, a balanced budget was quickly delivered and signed.

Ending Deficit Spending

One interesting piece of news that has gone largely unreported is the Republican’s proposal, which passed the house this week, contains the requirement to vote on a Constitutional Balanced Budget amendment.  This part of the bill was included to get support from Tea Party and other freshman congressmen, who were sent to Washington with a mandate to cut spending.  I believe it’s a long-shot to pass at this time, but it’s a huge step in the right direction.  If the 2012 election turns out anything like the 2010 election, I wouldn’t want to be the congressman on record voting against a balanced budget amendment.  Voters have had enough of the arrogance and incompetence in Washington.  Anyone up for reelection in 2012 is in real danger of losing their jobs.

Shady Union Deals

According to an article in the Washington Examiner, the Wisconsin Education Association (WEA) was forcing school districts to buy insurance from them at highly inflated prices.  This was costing the Wisconsin school districts millions of extra dollars every year.  But, with the recent law that bars some forms of public collective bargaining, school districts are now able to purchase insurance on the open market.  Why would the WEA force the state to purchase highly inflated insurance from the WEA trust?  One thing is for sure, that money wasn’t going into the classroom for  kids or teachers.  That money was going into the union’s pockets, instead of being spent on education.  I’m glad this has come to an end and I predict much more scrutiny of these types of deals in the future.

Cashing in on the Default

According to an article in Politico, both Democrats and Republicans are using the debt ceiling standoff to hit up their donors for more election money.  Both parties raised roughly 20% more in June than in May.  The campaign supporters (special interests) have gotten so involved in the debate; they are a big reason for the partisan logjam.  Politicians can’t seem to compromise, largely because their supporters don’t want them to.  And, they can’t vote against the wishes of their supporters, while they still have their hands out.  The wishes of voters don’t seem to matter much, at least until the election draws nearer.  And, that annoying debt ceiling problem is just getting in the way of business as usual.

The Bottom Line

The bottom line is that the debt ceiling isn’t the issue, it’s the debt.  Defaulting just raises the interest rates, compounding the problem.  This is a bad time to play chicken with America’s future and a good time to cut spending.

“As I have traveled throughout my Congressional district, the one thing I heard loud and clear was simply please stop spending money you do not have, rein in spending, live within a budget.”

Tim Scott – (R) South Carolina

Recommended Reading

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This post was featured on the Carnival of Personal Finance over at Canadian Finance Blog.  If you aren’t familiar with the Carnival of Personal Finance, you need to check it out. It’s the greatest carnival on the net.

This post was also featured on:

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Thank you for the links to my blog.

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The Affects of Inflation on Consumers

The Federal Reserve is playing a dangerous game by manipulating the interest rates, especially while they are easing.  The new CPI may allow the Fed to claim inflation is under control, but consumers know better.  Prices of critical staples, such as food and gasoline are putting a strain on family budgets and crowding out spending for other items.

My Top 10 List

10. The Dollar is so low Parker Brothers is considering replacing the currency in the Monopoly game with Chinese Won.

9. Toilet paper has become so expensive that the Sears catalog is making a comeback.

8. Gold and other precious metals have soared to dizzying new highs.  Unfortunately, they are barely keeping pace with inflation.

7. Medical costs are so high aromatherapy is now considered an elective procedure.

6. Billionaire hedge fund manager Raj Rajaratnam has been found guilty of insider trading that netted over $63 million in illegal gains.  He claims he was just trying to pay off his student loans.

5. Groceries have become so expensive it’s hard for many families to put food on the table.  The Chief Economist’s response, “Let them eat iPads”.

4. Congress is scrambling to raise the debt ceiling, so the government can continue to operate.  Unfortunately, Goldman Sachs refuses to approve the new credit limit.

3. The U.S. Mint is having trouble printing money fast enough to cover the deficits.  So, they have engaged Groupon to help the government cut back on spending.

2. Reality TV shows are struggling with payroll, so they started voting off the Idol contestants with talent.  Survivor has slashed their wardrobe costs by making contestants appear in their underwear.

1. Gas prices are so high it costs more to fill the tank than to buy an SUV.  In other news, three refineries have closed down due to mysterious fires.

The Bottom Line

The bottom line is that inflation is no joke.  It’s the government’s sneaky little way of stealing from everyone who owns a dollar.  When it comes to investing in assets, I recommend keeping it real.

“If Americans ever allow banks to control the issue of their currency, first by inflation and then by deflation, the banks will deprive the people of all property until their children will wake up homeless.”

Thomas Jefferson – 3rd President of the United States

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A Growing Cause of Budget Problems

The heart of the budget problems, for most states and municipalities, is the exploding cost of pensions and health benefits for public employees.  These costs are demanding an ever increasing share of state budgets and this is affecting other critical public services.  Cities and counties are also struggling, with many teetering on the edge of bankruptcy.  Some have outsourced their public services.  Others have simply stopped making their pension payments.  This problem is definitely going to get worse, as the population ages and a higher percentage of workers start retiring.

A Sense of Fairness

Most people respect and appreciate teachers, police and firefighters.  And, most people want them to make a good living and have decent benefits.  However, most people won’t receive a pension.  And, most people have to pay for part or all of their health benefits.  So, it doesn’t seem fair to some people to have to pay for their own health insurance, save for their own retirement and also be forced to pay for these types of benefits for public employees.  It seems only fair public employees should pay a fair share of their benefit package.

It is my personal opinion that every public employee, from the President of the Unites States to the people who pick up trash in the park, should receive the same type of health and retirement benefits as taxpayers.  I don’t think Congress or any other government entity should be exempt from any laws or requirements forced upon citizens.  I believe the retirement benefits for the President and members of congress are obscene and they should be replaced with a 401K plan.  These are the fundamental principles our country was founded upon.  Our government is not above the law or the people.

The Decline of Unions in America

The government is always a step behind the private sector, when it comes to efficiency and innovation.  And, the fate of unions is a prime example.  Unions have been declining in the private sector for decades.  But, this is just starting to be felt in the public sector.  I believe public sector unions will follow the decline of private sector unions, largely for the same reasons.  The confrontational nature of collective bargaining, combined with standardized pay, lowers productivity, reduces incentive and causes disruptions.

Historically, pensions were the power center of a union.  The wealth locked in the pensions provided a huge amount of leverage and security for the union.  Unfortunately, the aging unionized workforce has turned the pension plan into a liability.  Union pensions are now a Ponzi scheme that can’t possibly grow membership to support the snowballing costs of retirement benefits.  This arrangement isn’t sustainable and it will soon come to an end.  I suspect most younger union workers would be better off with a personal 401K account, than a union pension that will likely become looted or insolvent.

In my second job, I worked as a journeyman retail clerk.  I earned good pay, had great benefits and I enjoyed my job.  But, when I left that company, I decided I would never work union again.  One reason, was that I worked much harder than my coworkers, but received the same pay.  And, this didn’t seem fair to me.  Another reason, was that I hated the confrontational environment between workers and management.  I felt like there should be more of a partnership toward the success of the company.  The union’s role created unnecessary stress and friction in the workplace.

The Bottom Line

The bottom line is that change is necessary to address the budget problems at all levels of government.  Taxpayers simply can’t afford to fund the massive open-ended liabilities from public pensions and other entitlements.

“Look at how other states are following New Jersey … In Wisconsin and Ohio, they have decided there can no longer be two classes of citizens — one that receives rich health and pension benefits and all the rest who are left to pay.”

Christopher Christie – Governor of New Jersey

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The Fed is a Joke, Literally

Whether or not you are interested in politics, economics or the future of our nation, you owe it to yourself to watch this video.  It explains exactly how the Fed is undermining America and why we need to stop them.

What is the Federal Reserve?

Most people think the Federal Reserve is a government agency that answers to our elected officials and ultimately voters.  But, nothing could be further from the truth.  The Fed is actually a central bank, that is primarily a private entity and much of its input comes from member banks.  Although the Chairman testifies in front of Congress and the Board of Governors is appointed by the President, the Fed is virtually unaccountable to the public.

As the nation’s central bank, the Federal Reserve derives its authority from the U.S. Congress. It is considered an independent central bank because its decisions do not have to be ratified by the President or anyone else in the executive or legislative branch of government, it does not receive funding appropriated by Congress, and the terms of the members of the Board of Governors span multiple presidential and congressional terms.

Source: FederalReserve.gov

Why the Fed is Being Criticized

The Fed has gotten touchy lately as the criticism mounts and they have become more vocal in defending their actions.  Bernanke’s speech in Germany is a prime example of the Fed’s attempt to stem the criticism and sell QE2 as necessary for America.  But, it’s increasingly obvious the Fed is working for the benefit of bankers and not for the benefit of Americans.  There are valid reasons for criticism of the Fed and these problems need to be addressed.

• Economic manipulation, causing boom and bust cycles
• Ineffective oversight as a regulator of member banks
• A culture of secrecy and refusal to allow public audits
• Suspicious favoritism in deals with investment banks 
• Questionable economic data compiled and published

Fixing the Problems

Stopping Quantitative Easing - The proposed QE2 program, which benefits investment banks at our expense, needs to be stopped immediately.  America cannot tolerate another $600 Billion in debt, a weaker dollar and dangerous stimulus for inflation.  International economists are universally critical of QE2, because it’s a potential disaster for the global economy.

Federal Reserve Transparency Act - The Federal Reserve should be audited by an independent source and the results of this audit should be made available to the public.  According to the proponents of H.R. 1207, the Federal Reserve hasn’t been audited by Congress since their creation in 1913.  This law would reform the way the Fed is audited and set a deadline for an audit.

Limiting the Fed’s Mandate - I watched Senator Bob Corker (R-TN) on CNBC Wednesday and he proposed limiting the Fed’s mandate to controlling inflation.  A growing number of Republicans want to eliminate the Fed’s mandate for full employment, because it may conflict with the stability mandate.  The Fed’s original stimulus seems to have been ineffective in reducing unemployment, but it provided a huge windfall for banks and businesses.

The Bottom Line

The bottom line is that a growing number of critics are starting to question the motives and allegiance of the Federal Reserve.  And, this is a very good thing for America.  The sooner the Fed’s books are made public, the sooner we can defend our treasury from opportunistic special interests.

“Most Americans have no real understanding of the operation of the international money lenders. The accounts of the Federal Reserve System have never been audited. It operates outside the control of Congress and manipulates the credit of the United States.”

Barry Goldwater – Former U.S. Senator (R-AZ)

Recommended Reading

Balance Junkie - QE Collateral Damage
LOL Fed - When you Mock Ben the Terrorists Win
Online Investing AI - Can the Government Control the Business Cycle?

This post was featured on the Carnival of Personal Finance over at Sweating the Big Stuff.  If you aren’t familiar with the Carnival of Personal Finance, you need to check it out. It’s the greatest carnival on the net.

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My opinion is the economy is a mixed-bag, especially in the long-term.  Some groups of people are going to do very well, while others will face deteriorating financial conditions.  I believe the wealth divergence will continue to grow and the rich will get richer, while the poor get poorer.  I also think the huge deficits are going to cost America in terms of security and opportunity.  But, I’m more interested in your opinion.  What do you think about the economy? 

Unemployment Rate

Source: Bureau of Labor Statistics

The unemployment rate is always the most critical economic indicator.  The more people who are out of work, the longer it is going to take the economy to recover and the more painful the recession is on people.  It’s one thing to have the stock market drop or oil prices go up.  It’s quite another to have people losing their jobs and homes.

My opinion is the unemployment rate isn’t going to drop for a while.  There are too many huge drags on the economy, such as housing and the deficits.  Businesses are taking advantage of the recession to keep productivity high.  So, they are squeezing all of the work out of existing employees, instead of hiring new ones.  There is also a lot of structural unemployment, which means entire industries have disappeared or permanently downsized and those jobs are never coming back.

Housing Foreclosures

Foreclosures were the trigger for the financial crisis and they are the most difficult problem to overcome.  Because housing prices rose so high compared to real wages, young couples couldn’t afford to buy houses.  And, people who bought houses during the peak or refinanced them at the higher values couldn’t afford to keep them. 

My opinion is housing is going to take years to recover and a lot of money will be lost.  No amount of stimulus or government intervention is going to solve this problem.  The only real long-term solution is that housing becomes affordable and loans become available.  This means that housing prices have to drop or real wages have to rise.   Lenders have to wade through their foreclosure mess and start to lend to qualified buyers. 

Quantitative Easing

Without getting too technical about QE2, the Fed’s plan is to use $600 Billion to repurchase their bonds in an attempt to lower the interest rates.  Here is the shaky part; the Fed doesn’t have $600 Billion.  So, they are going to print the money, which may lead to inflation.  The Chinese and most other nations that hold our bonds have soundly criticized the plan.

My opinion is QE2 is a national embarrassment.  It’s like paying off a credit card with an IOU.  The government has to get its spending under control while we still have any shred of credibility left in the world.  The only thing holding up the dollar is the financial mess going on in Europe.  We will see much higher prices for food and commodities in the next couple of years.

Deficit Spending

Now that the election is finally over, the government is attempting to address the deficit.  A bipartisan commission made a number of recommendations, most of which will be difficult to pass.  The proposal includes, cuts to Medicare and Social Security, reductions in federal spending, higher taxes and elimination of the child tax credit and mortgage interest deduction.

My opinion is the government doesn’t have the guts to pull the trigger on this plan, even though it is absolutely necessary.  I would prefer to see them make the spending cuts before they are allowed to raise taxes, otherwise they will fritter away the new tax revenue, instead of reducing the deficit.

The Bottom Line

The bottom line is the economy is in the fragile beginnings of recovery.  The government has to be patient with the poor state of the economy, while avoiding any actions that would disrupt the recovery.

What’s your take on the economy?

“It’s a recession when your neighbor loses his job; it’s a depression when you lose yours.” 

Harry Truman – 33rd President of the United States 

Recommended Reading

Shadow Stats – Shows the real rates of Inflation and Unemployment

Watson, Inc. - Will the Economy Collapse in 2011?
Balance Junkie - If you can’t Change the World
Punch Debt in the Face - Does the Economy Have you Down?

This post was featured on the Carnival of Personal Finance over at Simply Forties.  If you aren’t familiar with the Carnival of Personal Finance, you need to check it out. It’s the greatest carnival on the net.

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Entitlements Gone Wild

Image by Ryan McFarland

According to the Wall Street Journal, nearly half of all Americans live in a household in which someone receives government benefits.  At the same time, American households not paying federal income taxes has also grown to an estimated 45% in 2010, from 39% five years ago.  There are an estimated 10% of tax payers who get refunds, even though they don’t pay any taxes.  And, the percentage of the federal budget spent for entitlements is currently 64%, the highest in history.

Message from Voters

The latest high-profile TEA Party victory in Delaware has rankled the Republican leadership.  They were hoping to use the anti-Obama backlash to retake control of the Senate in November.  Now, they fear they may lose this seat and remain the minority party.  This doesn’t surprise me because the Republicans haven’t shown any kind of fiscal restraint or leadership.  And, they remain oblivious to the message from voters, which is to reduce the size and scope of the government.

Tax Cuts Expiring

The Bush-era tax cuts are set to expire at the end of the year.  And, the trillion dollar question is whether or not to extend these cuts or to let them expire. 

• President Obama wants to allow the tax cuts to expire for the rich, who make more than $250,000 per year.
• Republicans want to extend the tax cuts indefinitely, warning that raising taxes on employers will plunge us back into a recession.
• Democrats initially supported letting the tax cuts expire.  But, as the election approaches, they are starting to cave in to avoid a backlash.

My solution is simple, a good old-fashioned compromise.  Keeping the cuts in place, but raising the long-term capital gains rate from 15% to 20% should allow the recovery to continue, without piling onto the deficit.

Greenspan Changes his Mind

This week, Alan Greenspan surprised everyone by advocating that we let the Bush-era tax cuts expire.  When Alan Greenspan used to run the Federal Reserve, he was all for tax cuts and he strongly supported the current cuts that are set to expire.  But, in typical Greenspan double-speak, he advocates new tax cuts at the same time he warns about the deficit.

“We should not have tax cuts with borrowed money, but we should have tax cuts, and the more as far as I’m concerned the better, but only in the context of bringing the deficit down.  Unless we do that, I think we have very grave problems ahead.”

Unfortunately, he doesn’t give any explanation of how tax cuts would bring down the deficit.  And, he ignores the most obvious solution, which is to cut government spending to reduce the deficit, while keeping taxes lower to stimulate the economy.  How did we listen to this guy for 20 years?

The Bottom Line

The bottom Line is that it’s not going to be easy to rein in spending.  No matter what part of the budget gets cut, someone is going to be unhappy about it.  But, we have to put a stop to the free-lunch mentality, before we all go hungry.

“Three groups spend other people’s money: children, thieves, politicians. All three need supervision.”

Dick Armey – House Majority Leader (1995-2003)

Recommended Reading

Len Penzo - My $114,000 Challenge to Uncle Sam
Invest it Wisely - The Rising Chinese
Squirrelers - Tax Rates by Country

This post was featured on the Carnival of Personal Finance over at Well Heeled Blog. If you aren’t familiar with the Carnival of Personal Finance, you need to check it out.  It’s the premiere carnival for Finance Blogs.

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