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Is this the bottom for precious metals?

Monetary Digest, December 1984

When gold and silver rallied from $300 and $5, respectively, in June 1982 it certainly appeared that the precious metals bear market had ended and that higher prices were ahead. Prices marched steadily upward until February 1983 when cracks suddenly appeared in OPEC.

Anticipating lower oil prices and attendant smaller increases in overall prices, many investors dumped the metals. Precious metals prices have been lower ever since and have drifted back to just above the levels of June 1982.

As this is written, gold is within $10 and silver within $1.25 of their June 1982 lows. Is this the bottom, or will prices drop still further.

Certified Mint has resisted predicting price movements. Forecasting prices with any significant degree of accuracy is extremely difficult, if not impossible. (The exception is to project trends.) At this time, however, we predict the metals will hold above their June 1982 lows, creating textbook “double bottoms” in both metals.

A double bottom, also called a “W formation” by chartists, occurs when a commodity (or stock) drops in price and starts upward. However, the rally fails, and another decline begins, carrying the price near the previous low. From that level a genuine bull market commences, and a double bottom is clearly formed by the price movement.

Many bull markets, some lasting for years, have begun after double bottoms have developed. This may be what’s happening in the precious metals, for certainly the fundamentals are in place for higher prices.

If, however, prices were to fall below their June 1982 lows, we would have no idea what that would portend for gold and silver over the next few years.

The Flat Tax Hox?

The idea of a flat tax is great, provided that the rate is low, say 10%, and everyone pays the same rate. However, the various bills before Congress proposing a “modified flat-tax” are frauds. They would not give us a flat-tax rate but would continue the existing progressive tax structure with fewer brackets.

Much has been written about the various bills now before Congress, and recently the Treasury Department unveiled still another. Like most the other proposed changes, it would reduce the number of tax brackets and eliminate various deductions, resulting in higher taxes for others.

The Treasury’s plan would replace the present 14 tax brackets with three, set at 15%, 25%, and 35%. Under this structure, a couple filing a joint return would be in the 25% bracket at $31,800 and in the 35% bracket at $63,800. At present, the 25% tax rate applies to incomes of more than $24,600, and higher-income couples pay 38% to 50% on incomes over $45,800-clearly a reduction in the tax rate. But it would not result in lower taxes because many deductions frequently taken by middle-and higher-income taxpayers would be eliminated.

According to Treasury estimates, 22% of the individual taxpayers, mostly those who use deductions and exemptions and who receive substantial tax-free fringe benefits, would pay more taxes than under the existing structure. Those who do not itemize would pay less taxes. Now, who itemizes? Those with higher incomes, of course!

The elimination of some deductions and the limiting of others may be Trojan horses.

If the Treasury’s plan, or some semblance of it, were passed, within a few years inflation would propel everyone into the highest tax bracket. Then, we all would be turning over a larger percentage of our earnings to the government.

Of course, when low-income taxpayers reach the 25-35% brackets, they will cry that it’s unfair for them to pay the same rate as the “wealthy.” Then, we’ll have yet another “tax reform.” The low-income might get a few breaks, but the higher-income will see their tax rates raised again–still without the deductions that they have now.

In view of the present “low” 4.5% rate of price inflation, most readers are unimpressed by the above argument and have little fear of bracket creep. Others will remember that most of the proposed bills contain provisions for adjusting tax brackets to inflation.

And if you think inflation is no longer a problem, remember that Richard Nixon imposed wage-price controls because inflation hit 4.5% in the early 1970’s. Today, we consider 4.5% price increases low only because we suffered 12% under Jimmy Carter. Don’t believe that taxpayers will be permitted to gain because of a system that adjusts for bracket creep. The government’s take as a percentage of the Gross National Product (GNP) will increase. It must because government spending is increasing as a percentage of the GNP.

There will be no cuts in spending. The rate of increase in federal spending may be cut, but actual spending will not decrease. The Reagan administration’s goal isn’t to cut spending but to reduce the deficit from the current 5% of GNP to 2% in 1988. To accomplish this, there will be tax increases–under the guise of tax simplification.

Ronald Reagan’s record is one of gargantuan tax increases, as noted in October-November 1984 issue. To expect otherwise is wishful thinking.

Underground Economy Thrives

Recently, articles have appeared about the “underground economy.” In other countries it’s called the black market, but here we refer to the underground economy.

The underground economy is composed of legal business transactions carried out mostly with cash and not reported as income. The IRS doesn’t consider such illegal operations as drug smuggling, gambling, and prostitution part of the underground economy. It doesn’t spend much time trying to collect from the drug pushers, gamblers, and prostitutes because it considers that task “essentially hopeless” and concentrates instead on carpenters, service station owners, and plumbers who might be tempted to cheat on their taxes.

The size of the underground economy is directly related to the tax structure of a country – the higher the marginal tax rates, the greater the activity. With existing tax rates rising to 50%, the underground economy can be expected to continue to flourish.

There is no way to accurately gauge the size of the underground economy, but a recent “Los Angeles Times” article put it at $40 billion dollars for 1981, the most recent year for which the IRS thinks it has good figures. Additionally, the IRS estimates that the money earned from illegal operations, from Americans who deliberately hide part of their income (capital gains, alimony, etc.), and the underground swells unreported income to $250 billion annually. Taxes not paid: an estimated $81 billion.

The reason for not reporting income from legal transaction is to avoid taxes. That’s simple enough. In addition, if the transactions are illegal, reporting them would be evidence of yet another crime. Regardless, many Americans consider the risk minimal, and deem operating in the black market worthwhile. (From the black market comes the term “black cash,” money on which taxes have not been paid.)

The “Times” article pointed out that if taxes were paid on all unreported income, the deficit would be cut nearly in half “without forcing law-abiding taxpayers to cough up another dime.” Rarely do such articles acknowledge that the heavy tax burden is what forces law-abiding citizens into the black market. If the highest tax rate were 10%, few Americans would conceal income.

Advocates of big government are quick to note that a 10% income tax would not produce enough revenue to meet the federal government’s requirements. And therein lies the problem. The people in control of the government are not willing to reduce government spending. They would prefer to give the IRS draconian powers to persecute and unconstitutionally prosecute Americans.

Most of the economic, social, and moral ills of this country stem from big government. Until something happens to reduce the scope and reach of government into areas not authorized by the Constitution, we will continue to have problems in this great land. The underground economy is not one of the problems, it is one of the solutions.

The people selling goods and services in the black market are working for their livings; people on welfare or not. If somehow the government were successful in shutting down the underground economy, even more people would be on welfare, increasing government’s need for more taxes. Until taxes are drastically reduced, the black market will continue to thrive.

Is the Federal Reserve Panicking

On Friday, December 21, 1984, the Federal Reserve lowered the discount rate, its lending rate to banks and other financial institutions, to 8%, the lowest in six years. This was the second drop in four weeks, lowering the rate one full percentage point since November 21.

Some analysts have asserted that the Fed has been using various machinations since August to bring down interest rates because the economy has been weak enough to slip into a recession. Of Course, lowering the rate at which banks can borrow freshly-printed money is a neo-Keynesian method of stimulating the economy. It is also inflationary.

The Fed’s second, sudden drop is evidence that Paul Volcker and Company may be terribly concerned about the economy. Having lowered the discount rate a hefty 1/2 of 1% just one month earlier, the Fed didn’t even wait to see if that was enough to fillip economic activity, opting for still another big drop.

One Fed watcher, David Wyss of Data Resources, Inc., has predicted that the Fed will cut the discount rate again in January 1985 and that interest rates will continue to decline until spring. If Mr. Wyss is right, the Fed may truly be panicking.

In times past, such moves by the Fed would have been challenged as inflationary but not this time. Inflation is no longer the enemy; the recession is. As the “Monetary Digest” has stated many times, the Fed is at all times fighting either a recession or inflation.

Every reader is aware of this. How many times, in the past four years, have you read reports of Paul Volcker’s valiant efforts to stop inflation? Now that this terrible dragon has been slain by Sir Paul, he is off to fight another adversary–recession.

How will he fight the recession?–with lower interest rates and increases in the money supply, both of which are inflationary. Nobody is concerned with inflation, so we won’t hear cries of Mr. Volker’s inflationary moves but accolades for his brillent efforts to forestall a recession.

The Fed’s recent moves are pleasing to the U.S. bankers who have loaned billions of dollars to some very unstable countries, which must export in order to have any hopes at all of ever paying those loans. As the banks see it, the U.S. economy must be kept going at all costs, for it is the “locomotive that pulls the world’s economy.” If our economy wanes, the rest of the world suffers.

As noted in prior issues, the Fed is owned by the banks, and Paul Volcker is a banker having strong ties with Chase Manhattan Bank, which holds some of the worst Third World loans. If the Third World economies turn down, it will be very difficult to maintain the illusion that those loans will be paid. The Fed’s recent moves came at a critical time for the international banks.

Paradoxically, the Fed’s efforts to stimulate the economy could aggravate the deficit problem and the banks’ liquidity problem. As interest rates come down, U.S. investments will be less attractive to foreigners, and they may switch to other currencies, creating a liquidity problem that can be solved only by teh Fed printing huge quantities of money.

If this occurs, we can expect some serious inflation and renewed interest in the precious metals.

High Frontier vs. Star Wars

Conflicting reports regarding the President’s willingness to negotiate with the Soviets about developing a space-based missile defense system continue to surface.

According to a recent article in the “Wall Street Journal,” a senior administration official has said that the U.S. missile defense plan and “our intentions for it have to be on the table when CFR Secretary of State George Schutz meets with the Soviets this January in Geneva. However, AP releases have since reported other administration sources as saying our research efforts will continue.

During the Reagan/Mondale debates, the President said that he would be willing to share our space-based missile defense technology with the Soviets’–a very frightening idea. The main reason today for the Soviets’ military strength is western, primarily U.S., technology. Why give them more?

What is really distressing is that none of the reports state that we now have the technology to implement a missile defense system. It’s called “High Frontier” and could be in place in six years at a low cost (militarily speaking) of $20 billion. In fact, the popularity of High Frontier among Conservatives and moderates have forced the “Liberals” to accept the “Star Wars” concept.

“Liberals,” you see, don’t like High Frontier because it could be implemented now. The Star Wars approach is more appealing to them because it involves research and no implementation for 15 to 20 years, if ever. Mondale is a perfect example; when forced to support a defense initiative, he has never been for one that could be installed immediately. Case in point: he consistently voted against the B-1 Bomber in favor of the Stealth, which is still on the drawing board.

If Soviet ICBMS were ever launched, gold and silver would truly be the only real money for those of us who survive. But I know that you, like I, would prefer to lose on precious metals investments than to face the aftermath of nuclear war.