A Reagan Recession

Monetary Digest, September 1984

During the 1980 campaign, the first half of the year was weak economically, permitting Ronald Reagan to enjoy an enviable advantage over the incumbent Jimmy Carter. By election time it wasn’t certain whether the improvement in the economy was genuine or a just a respite before a devastating plunge. Therefore, Mr. Reagan used this issue (remember all the brouhaha about supply-side economics?) along with several other key ones to defeat Carter.

As it turned out, mid-1980 through 1981 proved to be a “mini-boom,” with recessionary forces again reasserting themselves by mid- 1981, carrying the economic downturn through nearly all of 1982.

Although economic activity isn’t always the deciding issue in a presidential election, it can be the deciding factor for many voter. With less than two months left in this campaign, it appears that President Reagan will enjoy what Mr. Carter didn’t in 1980–a robust economy.

There are signs that the economy is weakening, but it is doubtful that it will slow enough to be a factor in November when the voters go to the polls. However, during his second term, Mr. Reagan may get the blame for a genuine “Reagan Recession.”

The June and July drops were the first consecutive monthly declines in years, indicating a slowing in the economy, or, perhaps, the start of a recession.

Housing starts, according to some experts, have clearly peaked, with sales of new single-family houses at a seasonally adjusted annual rate of 1,537,00 in August. 9Remember the ’70s when the annual rate was in the 2+ million range?) At present there is a 6-1/2 months’ supply of unsold new houses.

Factory shipments have grown steadily since the end of 1982, but now shows signs of “topping out” as the rate of growth dropped significantly the first half of this year. Aluminum production also appears to be “making a top,” with July registering the first significant drop since 1982.

Unemployment appears to be “bottoming at 7.5% level after declining steadily since January, 1982. (Few experts expect the unemployment to fall much below 7% under the best of conditions.)

Average pay for factory workers fell in August both on an hourly and weekly basis. As can be seen from looking at the graphs, there have been other monthly declines since the overall upward trend started in early 1982, but the 1984 trend has been for smaller factory wages.

One of the more reliable indicators of an imminent recession is the inventory/sales ratio, which is obtained by dividing gross business inventory by monthly sales. Note on the graph that whenever the ratio declined to near the 1.4 level, a recession (indicated by the shaded areas) soon commenced.

While recessions have not always followed drops to the 1.4 level (in 1965 it dropped to 1.43, but no recession followed), they do so with enough frequently to warrant respect.

As can be seen, the inventory/sales ratio hit 1.4 in mid-1983 and has not rebounded, registering 1.32 at this time. If prior lead- times hold, a recession could start at any time.

Another factor causing forecasts of economic slowdown is record-high real interest rates. Historically, the economy has not done well when real rates of interest have been high. Some people may take the position that the last two years refute this theory, but two years isn’t long enough to disprove a theory with such a long history of success.

The best measure of the real rate is the 90-day Treasury bill rate minus the year-to-year increase in the Consumer Price Index. At present the real rate of interest is 6.5%, a very healthy rate of return for a “riskless” investment.

This rate of real interest is significantly higher than the historic rate of 0% to 2-1/5%. Therefore, many forecasters have been saying that the current economic boom must quickly come to an end.

All this may not predict an immediate recession, but it is evidence that the robust economy we’ve recently enjoyed might end. Remember that these indicators are some of the many watched by government economists. As these indicators point toward a slowdown in the economy, we can expect calls for the government to “do something.”

That something would mean, under today’s conventional thinking, more government spending and/or an increase in the money supply. Additionally, when there are sign of an economic slowdown, the politicians educated in Keynesian theories refuse to even consider federal spending cuts.

As more signs of a slowing economy appear, we can expect less cries for spending cuts and even calls for more federal expenditures to stimulate the economy. This, of course will be inflationary.

IRA’s & KEOGH’s

Effective this year, self-employed individuals can contribute yearly the lesser of $30,000 or 25% of net earned income to their Keogh retirement plans. Note, the income must be “earned,” i.e., not dividends, interest, etc.

Contributions may be delayed until your tax filing deadline, including extensions, but your plan must be set up prior to year end. So, if you’re eligible for a Keogh plan, now is the time to prepare.

While Keogh plans are only for the self-employed, Individual Retirement (IRAs) can be used by anyone with earned income, including self-employed persons who already have Keogh plans. For IRAs, though, the maximum annual contribution is the lesser of $2,000 or 100% of earned income.

Contributions to Keogh Plans and IRAs are tax deductible, and taxes on any earnings are delayed until you use the funds. Supposedly, at that time you will be in a lower tax bracket, resulting in a tax saving.

Unlike the Keogh Plan, an IRA can be set up after year end, as long as it is done prior to the filing of your taxes. Any withdrawals before age 59-1/2 are subject to a 10% tax penalty; you must start withdrawals at age 70-1/2.

There are numerous investment vehicles approved for Keoghs and IRAs. Among them are savings accounts, whole life insurance, certificates of deposit, annuities, common stock mutual funds, and trust accounts set up for the purpose of investing in combinations of the above. Unfortunately, Krugerrands, silver bullion, and other physical forms of precious metals are not acceptable.

If you want to take advantage of gold and silver’s future price advances in your Keogh Plan or IRA, you will have to do it indirectly through common stocks of precious metals mining companies or mutual funds, of which there are several, that invest in precious metals mining companies.

Unlike oil drilling funds, risky mining ventures, race horses, jojoba farms, etc., Keoghs and IRAs provide the opportunity to put aside money in some sound investment vehicles. Additionally, large sums of money are not needed, and different investments may be made each year.

Remember, if you establish a Keogh prior to year end, you have until your filing deadline to contribute and lower 1984’s tax bite. As for establishing an IRA, you can do it anytime before you file your tax return. The sooner you do so, the better as you will be moving funds from a taxable investment to one that is tax deferred.

Additionally, if you invest in mining shares or a gold stock mutual fund in the near future, you will get low prices as they move in tandem with gold and silver prices.

If you are thinking of establishing a Keogh plan or IRA, or would like to discuss the advantages of switching your existing Keogh or IRA to investments that should perform well in the face of renewed inflation, please call us.

“The Good Old Days”

When the federal income tax was enacted in 1913, there was a 1% tax on total net income, with a “super tax” imposed on higher earnings. On incomes of $20,000 to $50,000 another 1% was added; over $50,000 – 2%; over $75,000 – 3%; over $100,000 – 4%; over $250,000 -5%; and over $500,000 – 6%.

The table below contrasts what a taxpayer would have paid in 1913 with 1983 rates.