One of the significant differences between my generation and that of our children was that once the children were born our wives gave up formal employment and became home-makers.
I had always imagined it was a matter of choice, greater job opportunities and better education which led to the fact that the great majority of wives of my children's generation are gainfully employed in a myriad of interesting careers. A discussion with my youngest son who works in the rarefied air of Wall Street has put paid to that illusion. For the majority of his friends and associates, the cost of putting a roof over their heads has made it quite impossible to think of wives not working and the consequence can be seen in a declining US birth rate. It is sheer economic necessity and you can blame Capital Gains Taxation for it.
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In days gone by, the big family home was as much a part of retirement planning as it was a repository of happy family life. When the children had grown up, most couples were happy to shed the burden and move to a smaller retirement cottage close to a good fishing ground or some beautiful mountains where the daily commute to the office was but a hazy memory.
But capital gains taxation and profiteering retirement village developers put an end to that one. Many of my friends have discovered to their horror that when the big four-bedroomed home was sold, it did not realise enough to pay for a dolls house in a new gated community…..and that was before the tax man came knocking demanding his share of the proceeds of the sale.
Elsewhere in the world where property values have not suffered from Zuma-induced recession and emigration, intelligent home owners have learned that the only way to treat the family home in one's retirement years is to rent it out to well-healed tenants. Thus the stock of houses for sale has diminished dramatically and, once regarded as revenue producers in retirement, big family homes have more than retained their value.
Thus in the suburbs of London, New York and Sydney, there is a dearth of houses for sale at affordable prices but plenty available to rent. Why blame Capital Gains Taxation for this? Let me give you an example of the US citizen who 20 years ago received a $250 000 provident fund payout and used the money to buy the house next door as a rental proposition.
If he were to invest this sum in treasury bonds at an interest rate of 2.8 percent it would provide him with an annual income of $21 014 compared with his current rental income of $48 000 a year. Furthermore, since he will be moving out of his home in New Jersey he can rent that out as well giving himself another $48 000.
With the proceeds he can afford to rent a condo in Florida or a hacienda in Mexico where rentals are much lower and where domestic help is also considerably cheaper. It's a no brainer. Why sell the houses when all that Capital Gains Taxation will simply destroy his life savings?
The same scenario is playing itself out in Australia where the government, in the face of a public outcry when the tax was introduced in the 1990s, conceded that there would be no CGT on existing assets. There the smart move is to let the children take over the big family home in Sydney or Melbourne and to rend a flat on the Gold Coast.
And it is playing out wherever CGT has been brought in as a sop to the Socialists who see it as doing something to level the playing fields between rich and poor. The result, however, has been to reduce the supply of housing and thus push up the price of homes for starter families who, by definition, are relatively poor. And, by the way, the US example I cited is a real one and the man involved was a postman; not the kind of occupation which would normally rate one as rich.
So this tax is actually hitting the low-income group worse than it is the wealthy and the irony of it all is that CGT seldom brings in more revenue that it costs to administer. Even here in South Africa where emigration has ensured that house prices have remained low by world standards, CGT is seen as an expensive political ploy which enables politicians to claim they are working towards ending economic inequality.
Worst of all CGT is a retrograde tax that has been shown in case studies all over the world to stunt entrepreneurship and capital growth.
The graph on the right, courtesy of the US Government illustrates the damage CGT has done to capital formation there where growth rates have been falling steadily since the early 1960s.
Here in South Africa, a study by the University of the Witwatersrand School of Economic and Business Sciences, CGT has been shown to be a particular stumbling block in the cause of BEE schemes. The study concluded that "when it comes to these initiatives, the levying of CGT could be tantamount to the State's offering a measure of assistance with the one hand, and then retracting part of it with the other through the application of additional tax.
It added;" Three aspects of CGT were examined as primary examples of government's drive to tackle poverty in South Africa: the taxing of BEE schemes, the taxing of PBOs and clubs, and the taxing of small businesses. The correspondence analysis has shown that, in each of these areas, there may be potential sources of tax-based unfairness. The analysis has indicated that the levying of CGT on BEE schemes, clubs, PBOs and small businesses has, at least, some correlation with double tax, an unfair charge for state services, and a failure to adequately uplift the poor. The study has, therefore, demonstrated an inconsistency between the official policy of ensuring reform of the tax system based on the tenets of fairness.
A study by Federal Reserve of Bank of Minneapolis in the USA found that entrepreneurship is damaged by the tax. Historically entrepreneurs create new businesses and, once up and running, tend to sell them in order to pursue new start-ups. This process is, however, significantly damaged by CGT with the result that the businesses tend not to be sold on to the type of management that could ensure sustainability….loss of entrepreneurship to the nation.
A Study by the National Bureau of Economic research in the US has shown that the benefit of lowering CGT tax rates results in higher rates of tax revenue while Canada's Fraser Institute has found that "Capital gains taxes, like all forms of taxation, raise revenues for the government but also impose economic costs. Unfortunately, the cost of capital gains taxes is not limited to the amount of tax collected.
"Capital gains taxes impose additional costs on the economy because they reduce returns on investment and, thereby, cause individuals and businesses to alter their behavior. As a result, capital gains taxes have a substantial impact on the reallocation of capital, the stock of capital, and the level of entrepreneurship in Canada. Capital gains taxes significantly impede the reallocation of capital from older, less profitable, investments to those with higher rates of return.
Finally, probably the bestl-researched study on the damage CGT does to economies was done by the Joint Economic Committee of the United States Congress which found that "the level of investment in the United States compares unfavorably with that of other countries and with the United States' own history.
"Annual U.S. investment is only half the level it was in the 1960s and 1970s. In addition, net private domestic investment has dropped from an average of 7.4 percent of gross domestic product (GDP) between 1960 and 1980 to an average of only 3.0 percent since 1991.
"This downward trend has serious implications for the economy given the strong relationship between investment and economic growth. The diminishing growth of investment can be partly attributed to high costs of capital. The cost of capital measures the return an investment must yield before a firm or an individual is willing to undertake the investment. High capital gains tax rates lower the return on investment, thus increasing the cost of capital and depressing overall investment in the economy.
"Conversely, a capital gains tax reduction would lower the cost of capital and stimulate investment. The effects of increased capital formation would reverberate throughout the economy in the form of higher wages, rising living standards, job creation, and economic growth.
"Furthermore, the U.S. capital gains tax rate exceeds that of any industrialized nation except that of the United Kingdom and Australia (however, even these countries index gains for inflation, whereas the United States does not). Because the United States must compete internationally for capital, high capital gains tax rates place the United States at a disadvantage relative to its competitors. Some of the United States' major competitors, such as Germany and Hong Kong, exempt long-term gains from taxation altogether; and other countries, such as Japan, tax capital gains very lightly. As a result, these countries typically experience higher saving, investment, and productivity growth rates than the United States.
In the December issue of Prospects I suggested that President Ramaphosa could initiate a significant economic upliftment for the country if he were to announce the end of Capital Gains Taxation. Clearly it is an urgent need worldwide!
I am going to finish with some selected quotes from Klarman's letter, leaving out some of the more incendiary remarks, even though they are no less true. I've posted the full 21-page letter for Over My Shoulder members. You need to read it. Here's Seth.
Does this matter? We think it does. It's hard for our leaders to guide us when we don't agree on our values or even on how we decide what is true. Worse, our enemies, including but not limited to Russia's autocratic government, are using social media and internet postings to confuse us and divide us further. They know which hot buttons to push. Moreover, our willful disbelief of facts, truth, and science increases the chance that we will fail to recognize or take seriously growing threats. In 1993, Senator Daniel Patrick Moynihan, who famously said that "everyone is entitled to his own opinion, but not to his own facts," observed that America was "defining deviancy down." His point was that behavior that had once been seen as deviant was now considered acceptable. To paraphrase Moynihan, today we may instead be defining reality down.
This letter focuses on China's economy. We'll look at some numbers showing the challenges China faces, but they don't explain something important. The way China will meet those challenges is going to be substantially different than we would see in the West. So I want to start with a little context.
– A shrinking labour force.
– Whilst continuing the process of deleveraging the economy.
And that rise won't happen without some hiccups. The US and Chinese economies are co-dependent in ways we can't change quickly. Problems in either country will hurt the other, and both currently have problems.
If you could borrow as much as might wish at close to zero rates of interest for ten or more years you would surely do so. There would be no lack of projects that promised wealth generating returns of at least one per cent p.a.
Of course such funding opportunities are not readily available to any ordinary business or household. Lenders would demand a premium to cover risks of default and would raise the prospective returns potential investors would have to achieve.
But such considerations do not apply to the German, Japanese, Netherlands or even the Brexit stressed UK government or the Swiss that can borrow at negative rates of interest. Lenders pay for the privilege of funding the Swiss government – for ten years and more. These governments can borrow as much as they might wish at very low rates.
Surely an extra bridge or highway, port or pipeline or even a dyke helping to create a productive polder can promise a one per cent per annum return? Governments with such favourable credit ratings neither have to undertake the construction nor the management of such low return projects that can be leased to private operators- who win competitive tenders to do so. And if governments would exercise such opportunities to borrow more at invitingly low rates – also, heaven forbid, to cut income and expenditure tax rates – aggregate demand for goods and services would be stimulated. And businesses would add to their productive capacities, including their work forces. And depressed rates of growth of GDP and accompanying incomes would accelerate.
Demands for credit especially bank credit would be encouraged, bank balance sheets would strengthen, while the national savings rates would decline and interest rates could rise for very good reasons. Because demands for capital to invest would be rising rise faster than supplies of savings.
The failure to respond to respond sensibly to an extraordinary level of savings and the accompanying low interest rates is the essential European economic problem. The rate at which the Germans have saved has increased dramatically since 2000, while the rate at which they have added to their stock of capital fell away.
Germans in 1995 saved about 22% of their incomes- a very high rate for a developed economy. They are now saving 28% of their very large GDP that is forecast to rise further. They add to their capital stock at a 20 per cent of GDP rate. This has meant dramatically larger flows of capital out of Germany into global capital markets. In 2018 outflows of about 400 billion dollars were estimated.
The Dutch are now saving a similarly high proportion of their incomes and the Japanese are a further major source of global savings. The Chinese save at an even higher rate, over 40% of GDP, though the rate at which savings are made and capital formed has been falling. China is no longer a significant contributor to the global savings pool. A fact that may well inhibit its ability to stimulate its economy.
The contribution in 2007 to the global savings pool from China, Germany and Japan amounted to nearly a trillion US dollars – compared to about a mere $100b seven years before. It is now about $600b.
The borrowers to absorb these surpluses at low interest rates were naturally found in the credit hungry US. Inflows of capital to the US expanded dramatically after 1995 – much of it funding houses that had to be abandoned by their owners after 2008. The average US home lost 30% of its pre-global financial crisis value. No mortgage based financial system could hope to survive a collapse in asset values of this magnitude- without a bail out.
US capital inflows 1980- 2023 – A tale of growing dependence.
Less not more austerity is urgently called for in northern Europe- to help save the euro and the European project. The Italian and other populists are on the right track while the German fiscal conservatives perversely continue down a dead end.
Investing may have changed over the years, but the propensity of humans to follow the herd seems as strong as ever.
I was conducting an interview with a prospective employee a few months ago and, in order to see where his thinking was at, I decided to ask him how he might invest a hypothetical R1m. He responded by saying that he would place a significant amount of these monies in a well-known leading JSE-listed share.
Now I'm not passing judgement on this particular share as a security selection – there are far more qualified people than myself to do so – but what intrigued me was why he'd selected this specific security. On pressing him for his reasoning he struggled to articulate his thinking and my conclusion was that he may have succumbed to herd mentality, aka the fear of missing out (FOMO).
Think back to a moment when you were younger, a teenager perhaps, and there was something you wanted to do because it was suddenly cool and it seemed like everyone you know—and many people you didn't—were doing it. Just as you're about to dive into whatever the fad of the season is, someone (a parent, teacher, observant adult) stops you and tells you no. "But everybody's doing it!" You whine. "And if everyone jumped off a bridge, would you do it too?" If this exchange is familiar to you, then you already know something about herd mentality.
People have a tendency to mimic or emulate the actions of other people in a large group. Unfortunately for all of us, we don't always choose to imitate the rational behaviours of others. Sometimes, herd mentality stems from copying the actions of people of high status, but often, herd behaviour is the result of going with the crowd.
We see lots of examples of herd mentality in investing and financial decisions, due in no small part to the fact that many people don't really understand what they are doing when it comes to the markets. Let's start with a classic example of herd mentality: the tulip mania.
In the late 16th century, the Dutch tulip market was booming. Tulips were a novelty for most of the world and were one of Holland's major exports. They were so popular that men were making and losing fortunes in one night. In fact, tulips were selling at as much as 10 times the price of the work from skilled craftsmen. The price of tulips skyrocketed thanks to trading in tulip futures. When the bubble (widely considered to be the first such financial bubble) finally burst in 1637, fortunes were lost. Why would people go crazy for tulips? The simple answer is herd mentality.
From our perspective almost 400 years later, trading on tulip futures seems ridiculous. Why would anyone do that? However, we should not throw stones. Two modern bubbles were almost as ridiculous: the Dotcom bubble at the tail end of the 20th century and the subprime mortgage crisis of 2008. Critics of the cryptocurrency boom of recent years suggest that a similar phenomenon may be taking place in that space.
Modern investment decisions can be fueled as much by emotion as logic, perhaps more so. We observe our peers funneling cash into apparently sound investments—investments that are sure to go up and make us rich! When that happens, most people follow suit. Few individuals take the time and effort to do the research, but rather are swept up in the rising tide of enthusiasm and hype.
In a Twitter thread from author Jim O'Shaughnessy in July, he offered, among other things, these sage observations on the predictability of human nature.
As ever, when it comes to investing, you have to do the research and follow the path of logic and facts, not the way of media hype and enthusiasm from all quarters. If you can learn to use the conscious part of your brain for investment decisions, you can pick up stocks that others might be overlooking— and sell before the next bubble pops.
If indeed you cannot give enough time to doing the research yourself then you should consult with your financial adviser.