Saturday, June 4, 2016

Higher inflation and interest rates are just around the corner

Since 1981, inflation has dropped from 13% to close to 0. In 2008 we were even afraid to have deflation like they do in Japan. Interest rates and inflation are directly linked. Just ad 2% or so to the inflation rate and you typically get the Bank of Canada rate. Of course, we call the difference between an interest rate and inflation the ‘real’ interest rate. Just like we have ‘nominal’ and ‘real’ economic growth. Today, nearly $10.3 trillion of mostly government debt receives nominal negative interest and in many other countries such as in the U.S. and Canada we receive negative ‘real’ interest rates. If you are adding taxes to that, we’re really losing on our fixed income investments. Suppose you’re receiving currently 3% nominal interest and you’re in the top marginal tax bracket. Interest is then in many Canadian provinces taxed at 50%, resulting in an after tax interest rate of 1.5%. Next deduct a 2% inflation rate and you are losing every year 0.5% in purchasing power.
Now in the 1980’s interest rates could be as high as 18% (a leftover from those days are the 19% interest rates we still pay on many credit cards -talking about a lack of competition!). During the Mulroney years, Canada’s debt was not considered much better than that of a third world country and the top marginal tax rate on many provinces exceeded 50%. So 18% times 55% tax leaves 9.9% in the tax payer’s hands; now deduct 13% inflation and investors lost every year 3.1% in purchasing power. No wonder every tax advisor tells you to put your money in the RRSP. That works when in your retirement years your tax bracket is significantly less than in your earnings years. But if you are a successful investor by the time you’re retired that is not likely true and you remain in the top tax bracket. So RRSPs are just a scam and you’re going to give all your ‘real’ profits and more to the beloved tax man when you cash out. Thank you for investing in Canada savings bonds…. Hahahahaha! (that is the evil laugh of your government). Stephen Harper changed that with the TSFA which is the only vehicle, that I know, where you may make a real return on fixed income investments. Now with Justin Trudeau you are suckered again! So much for standing up for the middle class eh?
If you are in the top marginal tax rate in your retirement years, you can forget about collecting Old Age Security and you lose half of your Canada Pension to the tax man. My accountant told me I could count on a generous $6000 per year! That is $500 per month. So the ‘rich’ are taxed a lot higher than their marginal tax rate. If you are not incorporated and employed in your retirement you will be the government’s golden goose that gets milked until you’re in the coffin. Oops, I forgot inheritance taxes! No wonder tax planners are in so much demand and now with the Trudeaus and Notleys in power it will only get worse. You may consider following Murray Edwards and plan to live in tax free havens!
So we’re now in the age of negative interest rates, in other words, you pay the bank to hold your money, and you wonder why people invest in gold these days? Gold is an inflation hedge and it doesn’t cost you anything to own it. In fact, lately with so many top investors switching to gold, you have a good chance that it will appreciate over time (and capital gains taxes – even at the top tax margin are only 25% instead of 50%!)  Just wait for Justin to make a grab for that as well -I am not kidding!   Canada was a good country to live in, but how much longer?
The current government yahoos are running big deficits again, just like good old Pierre – the father. Before you know we need another Mulroney to fight a deficit by increasing your taxes even further! You remember that terrible cycle of rising inflation, rising interest, even higher deficits to pay the interest, yet higher taxes and more inflation?
Currently we have a core inflation of around 2%, but what about food and energy? Falling energy prices have lately kept the cost of living low, but more recently energy prices increased and there is the new carbon tax in Alberta and other idiotic programs in Ontario. Even if energy and other commodity prices were not on the verge of turning around, as they are, all this will show up in the inflation rate. Then there is the ever growing need for food for our ever increasing world population. Many countries try to control their population but many developing nations, in particular African nations, have right now explosive population growth. Why do you think that world oil demand even today, with all our attempts to save energy, is increasing by close to 1.5 MILLION barrels a day each year? If you really believe that inflation and energy prices will stay low then I have a bridge for sale, just for you! J
So inflation is about to turn up with a vengeance, plus the Fed wants to ‘normalize’ interest rates. Yes, sir (my lady), we will see inflation and higher interest rates soon. Brace yourself for the consequences of the actions by your foolish governments. The good news is, that your mortgage and consumer debt will soon be inflated away until the higher interest rates start to kick in. Lock in your rates and build up cash to pay your debt down! Interest paid on investment debt though is tax deductible; yep there is some room to make money.
I think inflation and interest are just around the corner. That is why today, I am investing in real assets not fixed income! I invest in gold and other commodities, I invest in real estate and to some degree in stocks – don’t forget that rents, dividends and corporate profits are the closest things to inflation indexed!  Good hunting!

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