The Federal Reserve, along with the central banks of the European Union, Japan and Britain have flooded their respective economies with surplus cash.  The result has been expanding national debt, which is at historical highs. 

America’s debt is near $18t.  This was made possible by decades of irrespsonsbile budgeting as well as the U.S. Federal Reserve keeping the printing presses (Quantitative Easing) working overtime.  The bulk in the growth of their money supply in the last few years has been created for no other reason than to purchase their own short-term debt in order to keep U.S. interest rates at historical lows.  The Federal Reserve has announced that Quantitative Easing is over and they will now begin withdrawing money from the system.  Do not believe it - it is next to impossible for this to occur without interest rates jumping.

Insead, the printing presses will be working overtime for months to come, or, until Washington is forced to correct the financial mess it is in.  Washington, for years to come, will have to pay close to a trillion dollars annually in interest.  This is cash they do not have, other than via the printing press.

Governments cannot dictate interest rates; the market does it for them.  If this was not the case, lending rates would be uniform across the globe no matter the economy.  The stock markets, which are leading indicators, are telling us that things are not rosy in the immediate future.  If you choose to jump into the market tomorrow, make sure it is in companies that will continue to supply society’s needs, as well as one that offers a dividend yield around 4%.  Or, you can continue to be patient and wait for this market to unfold.  Sacola continues to favor cash for the time being.  Sit tight and check back on November 15^th.

One word you rarely hear from politicians is ‘deflation’.  Yet, we feel it is gaining ground around the world and rising house prices are masking it. 

Zero interest rates are deflationary for the simple reason that savers are experiencing falling returns on their bank deposits and dividend yields.  This translates to falling income.  Interest rates around the world continue to slide. This is contrary to economic theory which states that interest rates must rise during inflationary cycles.  For example, the European Central Bank has lowered its rate to .05 of 1%.  Similarly, German 10 year government bonds have fallen, for the first time, to under 1%.  After taxes and inflation all investors are losing money.  This is 100% deflationary. 

Japanese 10 year bonds yield .5%.  They have been this low for 11 years now.  Japan has had 24 years of negative interest rates, and the country has slid into deflation three times over the same period.  Today, a new threat is taking place; Japan has a falling population and one of the world’s highest numbers of people aged over 65.  This has resulted in a shortage of skilled workers.  Oddly enough, wages are falling for the first time in 24 years.  Japan is showing to anyone who is paying attention that prices and wages can fall.  Too many in the West believe prices, especially those for all forms of real estate and wages can only go increase year after year.

We have been told for many months now that the American economy is on the rebound.  Yet, interest rates continue to fall as 10 year government bonds are bouncing at all-time lows.  With real unemployment at 12% (U.S. Debt Clock), the American economy is going nowhere.  New housing starts are up, however,  there remains thousands of new homes built between 2005-2008 that have yet to be sold.

It appears all of Europe is about to take a slide into deflation.  There is very little governments and Central Bankers can do to stop it from happening.  The only thing they can is to put more money into the consumer’s pocket.  Instead, the Bankers only want to reward people who are deep in debt via low interest rates.

History tells us deflation is a real threat.  In the recent issue of the Sacola Financial newsletter we wrote, “on the last Friday of August in both 1929 and 1987, the Dow Jones Industrial Average traded at the then all time high.  Two months later, the stock markets around the world collapsed”.  As a note of interest, the last Friday of August 1987 was the 29^th, the same as this year. 

       On the 29^th  of August, both  the S&P 500 index and the Toronto Stock Exchange  traded at their all time highs.  The Dow Jones Industrial average closed at .02of 1% from its all time high set July 16^th.  Are we about to repeat the fall months of 1929 and 1987?  We do not know, but only a fool ignores history.  To protect oneself, you should have no debts and some cash in the bank.  Cash becomes King during any deflationary period.

Zero Interest Rates

Not one politician understands what destruction the zero interest rate policy is doing to the economy.  All they see is that people, businesses and governments can borrow cheaply.  Not one sees the opposite effect; low interest rates discourage savings.  Savings is the foundation of the economy.  Without it banks would not lend to consumers to buy houses and businesses to build plants.  An economy that lacks savings eventually creates poverty.

Low interest rates act like a tax increase on savers and pensioners by reducing their income. Today’s monetary policy has transferred income from older savers, to younger borrowers and banks.  For example, since 2008, borrowers with a $100,000 mortgage are over $2,400 better off every year. However, savers with $100,000 in cash or fixed-rate bonds are over $2,750 a year worse off.   How can our politicians expect these people to rush out and buy new homes and cars?  The reality is, savers cannot afford to spend without depleting their savings.

Many corporations and governments have taken advantage of the low rates to borrow and stick the cash ‘in the bank’, whereas the consumer has chosen to borrow more to spend.  As a result, the average Canadian consumer debt is at historical highs which will be a threat to the economic recovery when interest rates do rise.

Corporations are sitting on trillions of cash doing nothing.  If these businesses did see savers spending their money they would be building new plants, expanding markets and hiring skilled people.  Instead, they are hoarding cash for future opportunities rather than investing it today. 

The longer interest rates stay at zero the longer the economy will stay flat.  Even if interest rates were to rise next month it will not help much because too much of the saver's cash is tied up in 1 to 5 year GICs.  If rates do start to increase it will benefit savers in no less than a years’ time.

Today, corporate profits are healthy.  However, a year from now profits will be in a slow decline due to savers being squeezed by low investment returns.  This will be compounded by the over-leveraged consumer.  Stock markets, over the long term, follow the direction of corporate profits.  As a result, a year from now they will begin a slow decline as long as interest rates stay where they are.  The current interest rate policy, which is well into its 6^th year, has proven to offer zero benefit to the economy.  As long as our politicians continue to protect the borrower rather than the saver our economy will go nowhere.

Remain on the sidelines until the CEO’s of the world stop building cash reserves to historic highs and put their money to work. 

All Canadian pipelines will be working at full capacity until the end of 2015.  The producers and the pipeline companies are now in negotiations for space until 2020.  Some producers are asking for contracts to last into 2022. 

                With Gateway not going to be built until at least 2018, and maybe never, plus the Keystone decision being delayed until year end at the earliest, the demand for pipeline capacity will increase substantially.  The earliest Keystone could be in operation is mid-2016.  The southern portion has already been built and is in operation. 

                Especially throughout Alberta, lots of small pipelines are being built today.  These pipelines will be full for the next 6 years at least.  This should result in higher earnings for the pipelines.  And hopefully more dividend increases. 

                We do not see oil rail tanker cars fulfilling the demand.  Plus, railroads are more expensive than pipelines.  If there is another accident like that a year ago in Quebec the demand to use the rails will collapse. 

                The only negative for the pipelines, and it is a small one, is that America is discovering oil via shale rock.  As a result, sometime over the next year Americas demand for Canadian oil will temporarily decline.  However, over the long term America will need as much of our oil we can pump.  Hopefully Ottawa and Victoria will realize this and expedite the approval of the pipelines.  

                We have been holding pipeline shares for 6 to 9 years.  We can see holding for another five due to potential for rising dividends.  We see foreign demand growing with each passing year.

FATCA

On July 1^st, the destructive Foreign Account Tax Compliance Act (FATCA) becomes law.  Twelve countries, including Canada, have agreed to hand over to the IRS all personal information requested.  By 2017, 47 countries will “automatically exchange information once a year dealing with bank balances, interest, dividends, and sales of goods which can result in capital gains taxes”.  No warrants or court orders will be needed under FATCA. 

FATCA will affect anyone who has the slightest connection to America even if they have never stepped foot in the country.  For example, if a parent was born in the U.S. and a child was born in Canada, that child for tax purposes is both an American and a Canadian.  It is expected this law will affect roughly 20 million people from across the globe.  In Canada, there will be roughly one million citizens affected, most of whom do not know it will.  The effects of FATCA will not be so noticeable for a few years but a significant change is coming.  Specifically, it will scare away investment. 

Just on estate taxes alone, which more than 1m Canadians will now have to pay, could see a large chunk of one’s estate handed over to the Internal Revenue Service (IRS).  U.S. estate tax varies between 18 and 40 percent, depending on one’s net worth.  Those who have a net worth of over $3m will be taxed at 40%.  Penalties for not reporting under FATCA can be double the amount owed, plus any interest charges that have accrued.  These Canadians will also have to pay estate taxes to Revenue Canada.

One of the worrying aspects of FATCA is that every Canadian bank has agreed to give up all information on any citizen who falls under FATCA to the IRS if requested.  Failure to do so could result in a $100 million fine and a chance of losing their U.S. banking license.  Not one bank has filed a court case to block this invasion of privacy.  We wonder who Ottawa represents; it certainly is not Canadians.

We have come across some people who will get caught up in FATCA.  They have said that they are not worried because they have small estates of under $1m.  This is probably true for now because the IRS will go after those with larger ones.  However, once the wealthy are taken care of, the IRS will then begin to move down the ladder.  It could take years but everyone on the list will eventually be checked.

As the world becomes more aware of FATCA, we believe one will see more individuals selling off their U.S. assets, especially real estate.  Our reasoning is that it is very easy for the IRS to put a lien on any property within their borders.  There is no point in investing in the U.S. if the IRS might confiscate the assets you have spent a lifetime accumulating on their soil.  People fail to recognize the fact that Washington is bankrupt and desperate for cash so they are taxing everything and everyone. 

Money always flows to where it is most welcome.  The U.S. wants all foreigners’ money but they have neglected to make taxes fair.  This is why so many American corporations have moved trillions of dollars offshore.  Having favorable tax laws would bring this cash home and result in huge tax revenue.  However, after July 1^st we expect a slow but steady selling of U.S. securities and homes owned by foreigners.  European countries, Canada, New Zealand and Australia will become net benefactors of FATCA as these countries will be considered tax havens compared to the U.S. 

Beginning next week, a new era of tax grabs will begin.  It will be the taxpayer who will end up losing because governments will just waste any money found.  Investment will slowly leave America causing American debt to grow out of control even faster.  There are plenty of examples throughout history that shows tax grabs, (which FATCA is), affect governments negatively over the long term.  America has set itself on course to become poorer much faster than the one it was already on.

We suggest all American real estate be sold whether an individual falls under FATCA rules or not.  One should also limit their investing in U.S. shares.  If one owns American shares already, you should plan on selling the majority of them over the next few years. 

FATCA might have a temporary positive effect on the Greenback because it has the potential to lower the budget deficit over the short-term.  However, FATCA should force the Greenback lower against all major currencies over time because it will scare away investment dollars and will force down the value of U.S. assets.  It also supports our belief that Western Canada is, and will be for years to come, the number one place to invest in and live.  Western Canada will easily outperform the U.S. for many years to come.