In the past week, silver has dropped more than 25% in price, from close to $50 to around $35 or so in overnight trading this evening (May 5-6, 2011). Other commodities have done their own recent swan dives, with oil falling about 10%, gold falling around 5% and copper 3%. These are big and very big price drops for a week's worth of trading. The plunge in the silver market is a crash, to be precise.
Silver prices began their swan dive after the CME (formerly known as the Chicago Mercantile Exchange or the "Merc") started to raise margin requirements on April 25, 2011. Since then, margin requirements have risen about 84%. In other words, contract holders who maintained just the minimum amount of margin required would have had to add 84 cents per dollar down to their accounts in order to avoid liquidation (and that's not counting losses from the market drop, which would have increased their margin requirements). Those contract holders who bought a while ago at much lower prices may still have enough equity in their accounts to avoid having to send in more cash or acceptable collateral. But contract holders who bought recently at or near the peak are likely to be facing margin calls and the potential loss of their holdings. The price swoon in the silver market indicates that a lot of players have been cleaned out of the poker game.
The CME apparently raised margin requirements in order to quell the speculative frenzy that more than doubled silver prices over the past year, with most of the increase in the past six months. By taking this action, the CME implicitly acknowledged that markets can be irrational, and that speculators can do stupid and potentially destructive things. By stopping the insanity now, before prices popped up to, say, $75 or $100 an ounce, the trading losses incurred by a return of prices to a not completely gonzo level may be relatively confined. This is very important, since limiting losses reduces the potential for systemic impact. Some gamblers may have lost their shirts. But as long as taxpayers don't have to lose theirs bailing out market insiders who risked so much as to become a systemic threat, things aren't so bad. Indeed, a stern woodshedding by the CME may be just the sort of character building experience that the wilder market players need to acquire an appropriate appreciation of the virtues of prudence. And, as the sell off spreads to other commodities, the growth in market wisdom may be well worth the short term losses sustained (as long as taxpayers aren't selected for service as bailers again).
Students of monetary theory will not avoid wondering if the Fed's easy money policies contributed to the speculative lunacy in commodities. After all, if you're one of the Wall Street pros who has access to the zero or near zero interest rates imposed by the Fed (retail credit card customers need not apply), borrowing cheaply and using your almost free money to speculate in commodities is a pretty obvious play. There aren't many other places for cash to go, so a little spark in this market could produce some nice price action. And the traditionally lax rules of leverage in the commodities market made speculation a breeze. Fed officials have acknowledged that they'd like money to move into risk assets. Indeed, they've admitted to hoping to foster consumer spending by boosting asset values in order to trigger a wealth effect. This is a most dangerous game, because if the Fed boosts asset values too far, too fast, it creates a bubble. And, as we know from repeated experience with tech stocks, real estate, and financial assets, bubbles eventually burst. If those bubbles get really big before they burst, taxpayer assets are seized by the government and turned over to the well-off and well-connected. Quite a few Americans seem to think this is bad policy.
The CME made the right move by popping the silver bubble before it became a hydra that would spawn numerous painful consequences in the financial markets. It's a shame the Fed has never had the gumption to pop an asset bubble before it rendered huge amounts of collateral damage. The Fed's rules of engagement seem to require massive casualties among innocent civilian and taxpaying bystanders before the central bank will intervene. Maybe there's no elegant economic proposition, statistically established to the 99% confidence level, that allows unequivocal identification of an asset bubble. But a little bit of common sense might go a long way.
Thursday, May 5, 2011
Tuesday, May 3, 2011
Is the Federal Reserve Following Germany's Example?
Germany is Europe's economic engine. Its recent recession wasn't Great, like America's. Its unemployment levels didn't rise as sharply as America's. It has a trade surplus and a strong manufacturing sector at the core of its economy. Considering that West Germany had to absorb moribund formerly Communist East Germany during the past 20 years, one has to wonder how the Germans did it.
Part of the answer is they concentrate on producing high value added goods, taking advantage of their technological know how. The vaunted German machine tool industry makes highly specialized equipment, and constantly seeks to improve, which makes them hard to compete against.
But a crucial part of Germany's success is that wages have been held down. German workers are paid less than French workers (although both nations are well above the EU average). And, surprise! The French economy is weaker. German unions have gone along with wage restraint, in order to promote employment. German workers accepted limited income growth for the sake of fostering national competitiveness in export markets. The American image of Germany is a swirl of Mercedes, BMW, Audi and Porsche logos. The truth is more modest--a nation whose GDP per capita, disposable income per capita and other measures of economic well-being are lower than America's.
The U.S. Federal Reserve is, by all appearances, on a quiet, not for attribution mission to devalue the dollar. Although paying lip service to the sanctity of the Almighty Greenback, the Fed has relentlessly pushed down the dollar's value with a two and a half years and counting zero interest rate policy. Even now, as inflation is rising and central banks in many other nations are raising their rates, the Fed continues to believe that a free dollar is the best dollar (but free only for the financial institutions eligible to borrow at the ultra low rates available in the fed funds market; credit card borrowers can look in the mail for yet another interest rate or fee hike). The free dollar is, on the international currency markets, a falling dollar. That, in turn, raises the costs of imported goods. With the world economy now tightly integrated--some "American" cars have more foreign content than some Hondas and Toyotas--a falling dollar means higher costs for American consumers. This is most evident in the oil markets, where the rising price of gasoline and other petroleum products is the leading factor in pushing up prices. But price pressures are gradually spreading across the spectrum of consumer goods, and the Fed may have to narrow the definition of core inflation if it's going to keep prices down. As prices rise, real wages fall.
By weakening the dollar and, in effect, lowering American wages, the Fed makes America more competitive in the world economy. U.S. exports have been gradually rising, boosting employment (although at 8.8% of the labor force without jobs, we're still a long way from full employment). The price of "recovery" in this manner will be Germany's compromise: more jobs but constrained wages. And American consumers will have to become more like German consumers--tighter with the nickels, making do with last year's model, darning socks, mixing liquid soap with water to make it last longer, and, ugh, saving. Saturday afternoon at the mall will be replaced by Saturday afternoon in the kitchen home canning tomatoes grown in the back yard. The Model T in grandpa's barn will have to be fixed up and put back on the road. But it was and can still be a great car.
The Fed now prescribes America's economic policy. Congress and the Administration manage only to offset each other in a bipolar tango between partisan confrontation and distasteful compromise. Fiscal policy is virtually nonexistent. Only the limited tools available to the central bank are being put to use. And we will have to live with the consequences, because there are no other options.
Part of the answer is they concentrate on producing high value added goods, taking advantage of their technological know how. The vaunted German machine tool industry makes highly specialized equipment, and constantly seeks to improve, which makes them hard to compete against.
But a crucial part of Germany's success is that wages have been held down. German workers are paid less than French workers (although both nations are well above the EU average). And, surprise! The French economy is weaker. German unions have gone along with wage restraint, in order to promote employment. German workers accepted limited income growth for the sake of fostering national competitiveness in export markets. The American image of Germany is a swirl of Mercedes, BMW, Audi and Porsche logos. The truth is more modest--a nation whose GDP per capita, disposable income per capita and other measures of economic well-being are lower than America's.
The U.S. Federal Reserve is, by all appearances, on a quiet, not for attribution mission to devalue the dollar. Although paying lip service to the sanctity of the Almighty Greenback, the Fed has relentlessly pushed down the dollar's value with a two and a half years and counting zero interest rate policy. Even now, as inflation is rising and central banks in many other nations are raising their rates, the Fed continues to believe that a free dollar is the best dollar (but free only for the financial institutions eligible to borrow at the ultra low rates available in the fed funds market; credit card borrowers can look in the mail for yet another interest rate or fee hike). The free dollar is, on the international currency markets, a falling dollar. That, in turn, raises the costs of imported goods. With the world economy now tightly integrated--some "American" cars have more foreign content than some Hondas and Toyotas--a falling dollar means higher costs for American consumers. This is most evident in the oil markets, where the rising price of gasoline and other petroleum products is the leading factor in pushing up prices. But price pressures are gradually spreading across the spectrum of consumer goods, and the Fed may have to narrow the definition of core inflation if it's going to keep prices down. As prices rise, real wages fall.
By weakening the dollar and, in effect, lowering American wages, the Fed makes America more competitive in the world economy. U.S. exports have been gradually rising, boosting employment (although at 8.8% of the labor force without jobs, we're still a long way from full employment). The price of "recovery" in this manner will be Germany's compromise: more jobs but constrained wages. And American consumers will have to become more like German consumers--tighter with the nickels, making do with last year's model, darning socks, mixing liquid soap with water to make it last longer, and, ugh, saving. Saturday afternoon at the mall will be replaced by Saturday afternoon in the kitchen home canning tomatoes grown in the back yard. The Model T in grandpa's barn will have to be fixed up and put back on the road. But it was and can still be a great car.
The Fed now prescribes America's economic policy. Congress and the Administration manage only to offset each other in a bipolar tango between partisan confrontation and distasteful compromise. Fiscal policy is virtually nonexistent. Only the limited tools available to the central bank are being put to use. And we will have to live with the consequences, because there are no other options.
Monday, May 2, 2011
The End for Osama Bin Laden
The Chinese have a saying: a gentleman's revenge takes ten years. Thus it was that America administered a just ending to Osama Bin Laden's life.
Sunday, May 1, 2011
Penalty-Free Early Withdrawals From a Retirement Plan
As the Great Recession rumbles on and on for just about everyone except those in the top 10% of income brackets, people are increasingly tapping into their IRAs. If you're not 59 and 1/2 or older, you'll pay a penalty of 10% of the amount withdrawn, on top of applicable federal and state income taxes. There is a way, however, to dodge the penalty: substantially equal periodic payments plans (SEPPs). These plans let you withdraw IRA funds without penalty, although regular federal and state income taxes will still have to be paid. SEPP plans can be complex, and you may want the assistance of a tax accountant or financial planner if you're going to use one. Here's a general picture of how they work.
A SEPP plan runs for a minimum of five years or until you reach age 59 and 1/2, whichever is longer. If you start a SEPP plan at age 57, you have to stick with it until you reach age 62. If you're younger than 54 and 1/2, the plan has to continue until you reach 59 and 1/2. So, if you start a SEPP plan at age 45, you'll have to stick with it for 14 and 1/2 years. If you don't stick with the plan and complete it, the IRS will assess a 10% penalty on everything you withdrew before the time you dropped the plan. Since you presumably instituted the SEPP because you were short of cash, that penalty could be painful.
During the time the plan is in effect, you get payments each year (which can be monthly, if the plan is set up that way). The distributions are calculated one of three ways: the amortization method, the annuitization method, and the required minimum distribution method. The first two are somewhat like what you would get from a commercial annuity purchased with the amount of money in the SEPP plan (although this is just an approximate description). You have a fixed amount that is paid out each year, and that amount never changes over the life of the plan. But, unlike a commercial annuity, this payment is not guaranteed and if the investment performance of your IRA lags, you could drain off the balance faster than you expected. (In fact, you can run out of funds before the plan is over; but the IRS won't penalize you for inability to complete the plan because of investment losses.)
The third method, required minimum distribution, is like the formula used for regular required minimum distributions from IRAs (i.e., those for people 70 and 1/2 or older). You take the SEPP account balance and divide it by the owner's life expectancy as estimated by the IRS. The resulting number is paid out. But the distribution has to be recalculated each year (using the owner's ever shortening life expectancy). So the required minimum distribution method is likely to pay out different amounts each year. It also tends to result in smaller payments than the first two methods. But the nature of the required minimum distribution formula means that you'll never run out of the money. You just won't know for sure how much you'll get every year--potentially more after a year of investment gains, and possibly less after a year of investment losses.
If you start with either the annuitization or amortization method, you can make a one-time switch to the required distribution method. This would be advisable if the original method is depleting your account balance faster than you feel comfortable with. Thus, you can reduce the impact that investment losses have on your account balance, but you'll get much lower periodic payments.
You can use some or all of the funds in an IRA for a SEPP plan. If you're going to use less than all the funds, transfer part of your IRA into a separate IRA that is used for the SEPPs. If your retirement money is in an employer sponsored retirement plan like a 401(k) or a 403(b), you cannot do a SEPP plan--it's allowed only for individually owned retirement plans. But if you're no longer employed at that employer, you can transfer the funds to an IRA and do a SEPP plan from the IRA.
A SEPP plan isn't useful for making one-time withdrawals, such as getting a downpayment for a car or house. It's a long term proposition, with a measured payout for each year of the plan. If you need a short term boost in cash flow, look elsewhere, or make the one-time withdrawal and pay the 10% penalty along with income taxes.
The amount you can take out at any one time through a SEPP plan is limited to whatever you can get per year under one of the three permitted methods of withdrawal. You can't use a SEPP plan to take out half the balance of your retirement account at once, or some other ad hoc amount that suits your needs at the moment.
Don't do a SEPP plan unless it's really necessary. You'd be burning up retirement resources earlier in life, which means your golden years may be less golden. Of course, sometimes life isn't kind and you need access to the money in your retirement account. The fact that a SEPP plan avoids the 10% penalty may be significant if you have to make long term withdrawals. For more information, you can visit the IRS website at http://www.irs.gov/retirement/article/0,,id=103045,00.html.
A SEPP plan runs for a minimum of five years or until you reach age 59 and 1/2, whichever is longer. If you start a SEPP plan at age 57, you have to stick with it until you reach age 62. If you're younger than 54 and 1/2, the plan has to continue until you reach 59 and 1/2. So, if you start a SEPP plan at age 45, you'll have to stick with it for 14 and 1/2 years. If you don't stick with the plan and complete it, the IRS will assess a 10% penalty on everything you withdrew before the time you dropped the plan. Since you presumably instituted the SEPP because you were short of cash, that penalty could be painful.
During the time the plan is in effect, you get payments each year (which can be monthly, if the plan is set up that way). The distributions are calculated one of three ways: the amortization method, the annuitization method, and the required minimum distribution method. The first two are somewhat like what you would get from a commercial annuity purchased with the amount of money in the SEPP plan (although this is just an approximate description). You have a fixed amount that is paid out each year, and that amount never changes over the life of the plan. But, unlike a commercial annuity, this payment is not guaranteed and if the investment performance of your IRA lags, you could drain off the balance faster than you expected. (In fact, you can run out of funds before the plan is over; but the IRS won't penalize you for inability to complete the plan because of investment losses.)
The third method, required minimum distribution, is like the formula used for regular required minimum distributions from IRAs (i.e., those for people 70 and 1/2 or older). You take the SEPP account balance and divide it by the owner's life expectancy as estimated by the IRS. The resulting number is paid out. But the distribution has to be recalculated each year (using the owner's ever shortening life expectancy). So the required minimum distribution method is likely to pay out different amounts each year. It also tends to result in smaller payments than the first two methods. But the nature of the required minimum distribution formula means that you'll never run out of the money. You just won't know for sure how much you'll get every year--potentially more after a year of investment gains, and possibly less after a year of investment losses.
If you start with either the annuitization or amortization method, you can make a one-time switch to the required distribution method. This would be advisable if the original method is depleting your account balance faster than you feel comfortable with. Thus, you can reduce the impact that investment losses have on your account balance, but you'll get much lower periodic payments.
You can use some or all of the funds in an IRA for a SEPP plan. If you're going to use less than all the funds, transfer part of your IRA into a separate IRA that is used for the SEPPs. If your retirement money is in an employer sponsored retirement plan like a 401(k) or a 403(b), you cannot do a SEPP plan--it's allowed only for individually owned retirement plans. But if you're no longer employed at that employer, you can transfer the funds to an IRA and do a SEPP plan from the IRA.
A SEPP plan isn't useful for making one-time withdrawals, such as getting a downpayment for a car or house. It's a long term proposition, with a measured payout for each year of the plan. If you need a short term boost in cash flow, look elsewhere, or make the one-time withdrawal and pay the 10% penalty along with income taxes.
The amount you can take out at any one time through a SEPP plan is limited to whatever you can get per year under one of the three permitted methods of withdrawal. You can't use a SEPP plan to take out half the balance of your retirement account at once, or some other ad hoc amount that suits your needs at the moment.
Don't do a SEPP plan unless it's really necessary. You'd be burning up retirement resources earlier in life, which means your golden years may be less golden. Of course, sometimes life isn't kind and you need access to the money in your retirement account. The fact that a SEPP plan avoids the 10% penalty may be significant if you have to make long term withdrawals. For more information, you can visit the IRS website at http://www.irs.gov/retirement/article/0,,id=103045,00.html.
Wednesday, April 27, 2011
Washington Today: End Game in Afghanistan, No End Game in Financial Markets
The war in Afghanistan will wind down for NATO troops. That's clear from today's news. Leon Panetta will take over the Defense Department from Robert Gates. Gen. David Petraeus will get Panetta's job running the CIA. Adm. Mike Mullen, Chairman of the Joint Chiefs of Staff, isn't eligible to be renominated. The chain of command that presided over last year's surge in Afghanistan is being dismantled. That's one of the easiest ways in Washington to change policy. Top officials don't have to change their minds; they just change jobs.
By drawing down forces in Afghanistan, President Obama would keep a campaign promise, and satisfy the wishes of the majority of Americans who recent polls indicate want the U.S. out of the war. Besides, there's more than one way to skin this cat. Today's Wall Street Journal reports on P. 1 that the Pakistani government has urged the Afghan government to join in an alliance with Pakistan and China. The Pakistanis, who may be worse enemies of America than the Afghans, are now more aggressively undermining America than ever before. America's relations with India are improving, and we may be better off easing out of Afghanistan and Pakistan, and exercising influence in South Asia by strengthening ties with New Dehli.
Meanwhile, back at the Fed, Chairman Bernanke did a fairly decent imitation of Alan Greenspan at the Fed's first ever press conference. Bernanke said . . . well, try to figure out what he said. The reaction of most listeners was to parse, then parse some more, and then parse some more. Greenspan was famous for lengthy vocalizations that meant little except, "I'm keeping my options open." Looks like Bernanke prepared for today by watching old game films from the Greenspan era.
The Fed itself released a statement earlier today, following its April meeting, in which it said it would stay the course. So the sum total of this month's Fed meeting and today's press conference is we know pretty much what we knew before. The stock market took it all positively, assuming that the Fed will keep the monetary printing presses rolling 24/7. Maybe. But Bernanke did keep all options open. His remarks that could mean QE3 is coming could also mean that the Fed will drain liquidity, depending on circumstances.
And that's the problem with today's Fed. Even though Ben Bernanke has said he wants to provide greater transparency, the tendency of the markets to pop or swoon over a lifted eyebrow or a hint of a frown has forced him to be measured, and then cautious, and today, simply ambiguous. He ends up telling us very little, which lets the markets interpret his remarks as they wish and force the Fed to follow their lead. Today's positive market reaction highlights the financial system's dependence on subsidies from the Fed, and increases the cost to the Fed of changing its policies. A fall in the stock market is virtually guaranteed whenever the Fed changes policies, and that puts enormous political pressure on the Fed to keep printing money indefinitely. By purporting to provide transparency, but not actually doing so, the Fed is losing control over monetary policy. All this is fine if no amount of money printing leads to significant inflation. If only we lived in Wonderland, where one can believe as many as six impossible things before breakfast.
By drawing down forces in Afghanistan, President Obama would keep a campaign promise, and satisfy the wishes of the majority of Americans who recent polls indicate want the U.S. out of the war. Besides, there's more than one way to skin this cat. Today's Wall Street Journal reports on P. 1 that the Pakistani government has urged the Afghan government to join in an alliance with Pakistan and China. The Pakistanis, who may be worse enemies of America than the Afghans, are now more aggressively undermining America than ever before. America's relations with India are improving, and we may be better off easing out of Afghanistan and Pakistan, and exercising influence in South Asia by strengthening ties with New Dehli.
Meanwhile, back at the Fed, Chairman Bernanke did a fairly decent imitation of Alan Greenspan at the Fed's first ever press conference. Bernanke said . . . well, try to figure out what he said. The reaction of most listeners was to parse, then parse some more, and then parse some more. Greenspan was famous for lengthy vocalizations that meant little except, "I'm keeping my options open." Looks like Bernanke prepared for today by watching old game films from the Greenspan era.
The Fed itself released a statement earlier today, following its April meeting, in which it said it would stay the course. So the sum total of this month's Fed meeting and today's press conference is we know pretty much what we knew before. The stock market took it all positively, assuming that the Fed will keep the monetary printing presses rolling 24/7. Maybe. But Bernanke did keep all options open. His remarks that could mean QE3 is coming could also mean that the Fed will drain liquidity, depending on circumstances.
And that's the problem with today's Fed. Even though Ben Bernanke has said he wants to provide greater transparency, the tendency of the markets to pop or swoon over a lifted eyebrow or a hint of a frown has forced him to be measured, and then cautious, and today, simply ambiguous. He ends up telling us very little, which lets the markets interpret his remarks as they wish and force the Fed to follow their lead. Today's positive market reaction highlights the financial system's dependence on subsidies from the Fed, and increases the cost to the Fed of changing its policies. A fall in the stock market is virtually guaranteed whenever the Fed changes policies, and that puts enormous political pressure on the Fed to keep printing money indefinitely. By purporting to provide transparency, but not actually doing so, the Fed is losing control over monetary policy. All this is fine if no amount of money printing leads to significant inflation. If only we lived in Wonderland, where one can believe as many as six impossible things before breakfast.
Monday, April 25, 2011
A Question for the Chairman: Is the Fed Doing Its Part to Reduce the Federal Deficit?
This week, Chairman Ben Bernanke of the Federal Reserve holds the first ever press conference by a Fed Chairman. The wisdom of opening himself up to volleys of dumb, loaded, and unfair questions isn't crystal clear. Since, however, he's voluntarily decided to position the seat of his pants in the middle of a firing range, here's a question that should be posed to him.
It's Econ 101 that the lower the price of something, the more of it people will consume. Isn't the Fed making it easy for the federal government to run massive deficits by keeping interest rates ultra low?
The stated purpose of low interest rates is to stimulate the economy. But they also stimulate government borrowing. Look at Japan. Its public debt is something like 200% of its GDP (America's is around 70%). But interest rates in Japan are so low that the government's annual bill for borrowing all this moola isn't terribly painful. Most Japanese government debt is held by Japanese citizens, who seem perfectly willing to refinance the government every time its debt falls due, asking for scarcely any interest income at all. From an economic standpoint, it makes sense for the Japanese government to keep borrowing. Since it can roll over maturing debt at will for ultra low rates, it never really needs to control its deficits and can keep borrowing more at minimal interest expense. The U.S. Treasury, too, can easily roll over its debt at historically low prices. So its need to reduce deficits isn't pressing.
The Fed's low interest rate policy is inflating commodities and equities, but its impact beyond that is unclear. Big banks aren't increasing the net amounts of their loan portfolios and small businesses still limp along with working capital from their owners' credit cards. Real estate remains moribund, with more of the same expected for the future. Raising interest rates will make financial markets speculators unhappy. But let's remember that central bank manipulation of asset prices doesn't produce lasting prosperity, but indeed the opposite (for further reading, see 2007-08 financial crisis).
For all the political hoopla over deficits, reality is that money talks and bullsh . . . uh, political dialogue walks. What's forced Greece, Ireland, Portugal and other Euro bloc nations to rein in their spending? Not frowning bureaucrats in Brussels, but rising interest rates demanded by their creditors. Chairman Bernanke recently scolded Congress and the administration for not doing enough to reduce the deficit. Well, remember, Mr. Chairman, money talks and bu . . . well, you know. If you want the government to reduce the deficit, make it pay for borrowing.
It's Econ 101 that the lower the price of something, the more of it people will consume. Isn't the Fed making it easy for the federal government to run massive deficits by keeping interest rates ultra low?
The stated purpose of low interest rates is to stimulate the economy. But they also stimulate government borrowing. Look at Japan. Its public debt is something like 200% of its GDP (America's is around 70%). But interest rates in Japan are so low that the government's annual bill for borrowing all this moola isn't terribly painful. Most Japanese government debt is held by Japanese citizens, who seem perfectly willing to refinance the government every time its debt falls due, asking for scarcely any interest income at all. From an economic standpoint, it makes sense for the Japanese government to keep borrowing. Since it can roll over maturing debt at will for ultra low rates, it never really needs to control its deficits and can keep borrowing more at minimal interest expense. The U.S. Treasury, too, can easily roll over its debt at historically low prices. So its need to reduce deficits isn't pressing.
The Fed's low interest rate policy is inflating commodities and equities, but its impact beyond that is unclear. Big banks aren't increasing the net amounts of their loan portfolios and small businesses still limp along with working capital from their owners' credit cards. Real estate remains moribund, with more of the same expected for the future. Raising interest rates will make financial markets speculators unhappy. But let's remember that central bank manipulation of asset prices doesn't produce lasting prosperity, but indeed the opposite (for further reading, see 2007-08 financial crisis).
For all the political hoopla over deficits, reality is that money talks and bullsh . . . uh, political dialogue walks. What's forced Greece, Ireland, Portugal and other Euro bloc nations to rein in their spending? Not frowning bureaucrats in Brussels, but rising interest rates demanded by their creditors. Chairman Bernanke recently scolded Congress and the administration for not doing enough to reduce the deficit. Well, remember, Mr. Chairman, money talks and bu . . . well, you know. If you want the government to reduce the deficit, make it pay for borrowing.
Monday, April 18, 2011
Did the Fed Add to the Fall in Stocks?
Today, Standard and Poor's lowered its outlook on long term U.S. Treasury debt from "stable" to "negative". What happened? U.S. Treasuries went up in value.
Huh?
Market forces would have dictated that Treasuries should have fallen. In fact, they did drop immediately after the announcement. But then they rose, even while stocks fell. If anything, one would have expected stocks to do comparatively well. Investors might logically ditch Treasuries and buy stocks.
So what happened? One serious possibility is that the Fed was buying in the Treasury market big time today, as part of its quantitative easing program and perhaps as part of its open market operations as well. The last thing the Fed wants to see is a rise in interest rates. If a downdraft hits the Treasury market, the Fed would move quickly to counteract it.
All that's understandable, given the Fed's statutory mandate to maximize employment. But it's possible that the fast traders on Wall Street--which would be most of the market today-- saw an arbitrage opportunity. If you know the Fed will be a heavy buyer of Treasuries, then you'd think about ditching stocks to raise cash, buying Treasuries quickly when they first drop, and reselling them at a profit to the Fed as it revs up its buying. The smart traders on the Street like to take advantage of large buyers and sellers, who often provide such arbitrage opportunities. The really cynical smart money would, indeed, short sell stocks to profit from the expected downdraft. That, if it occurred, would have added to the downward spiral of stocks.
The Fed also doesn't want stocks to drop. That might cool the consumption of the well-to-do and hamper the economic recovery. But the Fed is a lumbering cow in a market full of wolves, and today's weird market action indicates the wolf packs were probably voracious.
Huh?
Market forces would have dictated that Treasuries should have fallen. In fact, they did drop immediately after the announcement. But then they rose, even while stocks fell. If anything, one would have expected stocks to do comparatively well. Investors might logically ditch Treasuries and buy stocks.
So what happened? One serious possibility is that the Fed was buying in the Treasury market big time today, as part of its quantitative easing program and perhaps as part of its open market operations as well. The last thing the Fed wants to see is a rise in interest rates. If a downdraft hits the Treasury market, the Fed would move quickly to counteract it.
All that's understandable, given the Fed's statutory mandate to maximize employment. But it's possible that the fast traders on Wall Street--which would be most of the market today-- saw an arbitrage opportunity. If you know the Fed will be a heavy buyer of Treasuries, then you'd think about ditching stocks to raise cash, buying Treasuries quickly when they first drop, and reselling them at a profit to the Fed as it revs up its buying. The smart traders on the Street like to take advantage of large buyers and sellers, who often provide such arbitrage opportunities. The really cynical smart money would, indeed, short sell stocks to profit from the expected downdraft. That, if it occurred, would have added to the downward spiral of stocks.
The Fed also doesn't want stocks to drop. That might cool the consumption of the well-to-do and hamper the economic recovery. But the Fed is a lumbering cow in a market full of wolves, and today's weird market action indicates the wolf packs were probably voracious.
Thursday, April 14, 2011
The Point Missed in the Budget Debate
It's become all the rage in Washington to froth over the federal deficit and produce sound bite-driven proposals on how to reduce it. In the relentless quest for media coverage, everyone involved in the budget debate has something accusatory to say about someone else. As in sports, trash talking and cheap shots get more attention than real accomplishments.
The lack of attention to real accomplishments allows an important point about the budget deficit to go unnoticed. When we talk about splitting up a pie, the size of the pie is crucial. A large, fast growing pie is much easier to divide than a smaller, slowly growing pie. A stagnant or shrinking pie can be poisonous to the debate. Right now, we have a slowly growing pie that may go stagnant or shrink soon given the rising costs of energy and food. And the debate is indeed poisonous.
We need to focus more on expanding the pie, not in the Federal Reserve short term-next quarter, money printing, inflation-risky way, but for the long term. We also can't look to the federal government to solve all our problems. At the risk of asking Americans to behave like adults, it would be better if we looked for some non-federal ways to boost long term economic growth. There is a limit to the effectiveness of federal policies, which are mostly subsidies and handouts, and we pretty much surpassed that limit a while ago. What should be done?
Embrace Innovation. Innovation was the key to America's spectacular growth in the past two centuries. Railroads, the telegraph, the telephone, the airplane, automation of farming, new energy technologies, electronics and computers were essential factors in making America an economic powerhouse. We celebrate the concept of innovation today, but don't encourage it enough. Immigration rules for the highly educated should be relaxed--we'll never recapture manufacturing from Asia, but we can try to bring more of their brainpower to America. Many of Asia's smartest people want to live here, at least for a while and maybe for the rest of their lives. Brains produce innovation; tariffs don't. America's economic future will be in the production of high value added goods and services. (And not, contrary to what the Fed thinks, a revival of housing, which can't be revived by the government because it remains buried under a crushing load of bad debt, and only politically unacceptable levels of taxpayer subsidies will revive housing.) Innovation was the key to America's past prosperity and will be the key to its future.
Hug nerds. America's educational system is roundly criticized for failing to teach many students the basics. That's a valid point, but we're too focused on making America's schools training facilities for corporate employers. Schools should also be a place for exploration and creative thinking. They're not. Today's elite universities' admissions standards place enormous emphasis on being well-rounded, having not only fantastic grades, but athletic achievement, public service, experience in the arts, internships left and right, and international travel. The people admitted will make good corporate executives, management consultants, corporate lawyers, accountants, and doctors. Those with good math skills may become Wall Streeters. Most likely, none will create innovative technologies or establish major businesses. It's not an accident that Bill Gates, Steve Jobs, and Larry Ellison were all college dropouts. (So was Mark Zuckerberg, although it's not yet clear if Facebook is a transformational company or a fad-and-fade like Yahoo.) America's leading universities don't embrace original thinkers; they favor compliant kids who know how to manipulate and please their elders. Today's elite schools don't encourage or even tolerate the wacked out thinking that transformational economic change requires. Gates, Jobs and Ellison had to swim upstream to accomplish what they did. One can only wonder how many dozens, hundreds and maybe thousands of other free thinking, but slightly less determined kids have been discouraged from fostering innovative change. We need to think outside the box to make America grow again, and one way would be to encourage, and indeed embrace, kids who think outside the box.
Improve transportation and communications. America is a big country. Look on a globe, and you'll find very few other countries as large. We need really good transportation systems, because ultimately goods and many services need to be physically delivered. One can't live off Internet access alone. State and federal governments in the 19th Century did a much better job in this respect than their counterparts today. The Erie Canal was sponsored by New York state. The railroads were subsidized by the federal government. In the 20th Century, air transportation and the interstate highway system were creations of federal policy, and local governments took on much of the burden of building suburban infrastructure. America became wealthy from the massive markets permitted by these government supported transportation systems. Today, highways need to be maintained, bridges repaired, and subway systems renovated and expanded. Suburban roads need maintenance and improvement--remember that most economic growth is in suburban areas, in spite of renewal in a few urban areas. Roads and other transportation systems don't have powerful lobbyists, so they are easily ignored. That is a serious mistake.
Fostering high-speed Internet access for all should be a priority. This would include hard wired access and wireless access. The easier it is to communicate, the more innovation we'll have. And, let's face it, the more consumption we'll have since we're approaching the point where you can buy almost anything over the Internet. Way too many people share way too much about themselves in the Internet. But speed of communication speeds up economic activity. Even if some people are tacky and tasteless, others will increase their productivity--and, along with it, our prosperity.
The lack of attention to real accomplishments allows an important point about the budget deficit to go unnoticed. When we talk about splitting up a pie, the size of the pie is crucial. A large, fast growing pie is much easier to divide than a smaller, slowly growing pie. A stagnant or shrinking pie can be poisonous to the debate. Right now, we have a slowly growing pie that may go stagnant or shrink soon given the rising costs of energy and food. And the debate is indeed poisonous.
We need to focus more on expanding the pie, not in the Federal Reserve short term-next quarter, money printing, inflation-risky way, but for the long term. We also can't look to the federal government to solve all our problems. At the risk of asking Americans to behave like adults, it would be better if we looked for some non-federal ways to boost long term economic growth. There is a limit to the effectiveness of federal policies, which are mostly subsidies and handouts, and we pretty much surpassed that limit a while ago. What should be done?
Embrace Innovation. Innovation was the key to America's spectacular growth in the past two centuries. Railroads, the telegraph, the telephone, the airplane, automation of farming, new energy technologies, electronics and computers were essential factors in making America an economic powerhouse. We celebrate the concept of innovation today, but don't encourage it enough. Immigration rules for the highly educated should be relaxed--we'll never recapture manufacturing from Asia, but we can try to bring more of their brainpower to America. Many of Asia's smartest people want to live here, at least for a while and maybe for the rest of their lives. Brains produce innovation; tariffs don't. America's economic future will be in the production of high value added goods and services. (And not, contrary to what the Fed thinks, a revival of housing, which can't be revived by the government because it remains buried under a crushing load of bad debt, and only politically unacceptable levels of taxpayer subsidies will revive housing.) Innovation was the key to America's past prosperity and will be the key to its future.
Hug nerds. America's educational system is roundly criticized for failing to teach many students the basics. That's a valid point, but we're too focused on making America's schools training facilities for corporate employers. Schools should also be a place for exploration and creative thinking. They're not. Today's elite universities' admissions standards place enormous emphasis on being well-rounded, having not only fantastic grades, but athletic achievement, public service, experience in the arts, internships left and right, and international travel. The people admitted will make good corporate executives, management consultants, corporate lawyers, accountants, and doctors. Those with good math skills may become Wall Streeters. Most likely, none will create innovative technologies or establish major businesses. It's not an accident that Bill Gates, Steve Jobs, and Larry Ellison were all college dropouts. (So was Mark Zuckerberg, although it's not yet clear if Facebook is a transformational company or a fad-and-fade like Yahoo.) America's leading universities don't embrace original thinkers; they favor compliant kids who know how to manipulate and please their elders. Today's elite schools don't encourage or even tolerate the wacked out thinking that transformational economic change requires. Gates, Jobs and Ellison had to swim upstream to accomplish what they did. One can only wonder how many dozens, hundreds and maybe thousands of other free thinking, but slightly less determined kids have been discouraged from fostering innovative change. We need to think outside the box to make America grow again, and one way would be to encourage, and indeed embrace, kids who think outside the box.
Improve transportation and communications. America is a big country. Look on a globe, and you'll find very few other countries as large. We need really good transportation systems, because ultimately goods and many services need to be physically delivered. One can't live off Internet access alone. State and federal governments in the 19th Century did a much better job in this respect than their counterparts today. The Erie Canal was sponsored by New York state. The railroads were subsidized by the federal government. In the 20th Century, air transportation and the interstate highway system were creations of federal policy, and local governments took on much of the burden of building suburban infrastructure. America became wealthy from the massive markets permitted by these government supported transportation systems. Today, highways need to be maintained, bridges repaired, and subway systems renovated and expanded. Suburban roads need maintenance and improvement--remember that most economic growth is in suburban areas, in spite of renewal in a few urban areas. Roads and other transportation systems don't have powerful lobbyists, so they are easily ignored. That is a serious mistake.
Fostering high-speed Internet access for all should be a priority. This would include hard wired access and wireless access. The easier it is to communicate, the more innovation we'll have. And, let's face it, the more consumption we'll have since we're approaching the point where you can buy almost anything over the Internet. Way too many people share way too much about themselves in the Internet. But speed of communication speeds up economic activity. Even if some people are tacky and tasteless, others will increase their productivity--and, along with it, our prosperity.
Monday, April 11, 2011
Corporate Earnings Will Be the Ball Game For Stocks
The headwinds in the stock market are rising. Government accommodation in major parts of the world is being dialed back. China is raising interest rates to cool growing inflation and a runaway economy. The Euro bloc is raising interest rates to combat inflation, in spite of a slow growing economy. Brazil is growing, but will have to battle serious inflation. Oil prices keep rising; $4 a gallon gas is a reality in most of the U.S., even if statistical averages haven't quite gotten there.
Black swans fill the air. Arab unrest has a whack-a-mole quality to it. No matter what is done to calm things down, eruptions get bigger and more widespread. Libya has stalemated, putting pressure on Western nations to join the ground war. Japan just elevated its nuclear crisis to Chernobyl status. And that's just the part the Japanese government has told us about. Considering that it hasn't been a paragon of transparency, one can only wonder what we don't know. Japan keeps having aftershocks that would qualify as big earthquakes anywhere else. Things aren't settling down there.
Portugal has just gone to the EU, hat in hand, to ask for a loan in the range of 80 billion Euros plus, following the path paved by Greece and Ireland. The Euro crisis is sliding downhill more or less as predicted. (Watercooler gossip has it that Spain will be next in line for a bailout.) As France takes the lead to spend Germany's money bailing out weaker EU nations, the markets snooze in the belief that creditors will be paid 100 cents on the Euro. Some day that won't be true. If you look at the Euro bloc as a whole, it's awash in debt. We have the lesson from the U.S. and other real estate markets that too much mortgage debt leads to bad things. That will also be true for sovereign debt.
The U.S. Federal Reserve is keeping its monetary printing press going 24/7. A majority of governors say they don't see any inflation, but would welcome it if it happened. That way, they can keep paying the print shop staff overtime no matter what. Meanwhile, back at the ranch, the poor consumer, whose wages aren't rising now or any time soon, is cutting back on driving while trying really hard to believe that beans and franks make a fine meal. Walmart just announced a return to every day low prices. That, as much as anything, tells you the consumer is under pressure. Since the U.S. economy is two-thirds consumption, the economy will soon be under pressure, too.
Stocks have more than doubled since their 2009 lows. Just about the only thing that can keep the bull running would be glowing corporate earnings. Alcoa was at the top of the order today, and whiffed. It reported greater earnings but disappointing revenues. Its stock is off about 3% in afterhours trading. Not a good beginning to the earnings season. If other companies follow Alcoa's lead, well . . . just tell yourself that beans and franks make a fine meal.
Black swans fill the air. Arab unrest has a whack-a-mole quality to it. No matter what is done to calm things down, eruptions get bigger and more widespread. Libya has stalemated, putting pressure on Western nations to join the ground war. Japan just elevated its nuclear crisis to Chernobyl status. And that's just the part the Japanese government has told us about. Considering that it hasn't been a paragon of transparency, one can only wonder what we don't know. Japan keeps having aftershocks that would qualify as big earthquakes anywhere else. Things aren't settling down there.
Portugal has just gone to the EU, hat in hand, to ask for a loan in the range of 80 billion Euros plus, following the path paved by Greece and Ireland. The Euro crisis is sliding downhill more or less as predicted. (Watercooler gossip has it that Spain will be next in line for a bailout.) As France takes the lead to spend Germany's money bailing out weaker EU nations, the markets snooze in the belief that creditors will be paid 100 cents on the Euro. Some day that won't be true. If you look at the Euro bloc as a whole, it's awash in debt. We have the lesson from the U.S. and other real estate markets that too much mortgage debt leads to bad things. That will also be true for sovereign debt.
The U.S. Federal Reserve is keeping its monetary printing press going 24/7. A majority of governors say they don't see any inflation, but would welcome it if it happened. That way, they can keep paying the print shop staff overtime no matter what. Meanwhile, back at the ranch, the poor consumer, whose wages aren't rising now or any time soon, is cutting back on driving while trying really hard to believe that beans and franks make a fine meal. Walmart just announced a return to every day low prices. That, as much as anything, tells you the consumer is under pressure. Since the U.S. economy is two-thirds consumption, the economy will soon be under pressure, too.
Stocks have more than doubled since their 2009 lows. Just about the only thing that can keep the bull running would be glowing corporate earnings. Alcoa was at the top of the order today, and whiffed. It reported greater earnings but disappointing revenues. Its stock is off about 3% in afterhours trading. Not a good beginning to the earnings season. If other companies follow Alcoa's lead, well . . . just tell yourself that beans and franks make a fine meal.
Tuesday, April 5, 2011
Roth IRA versus Traditional IRA: a Snapshot of Our Tax Dilemma
Should you have a Roth IRA or a traditional IRA? That's the question for many of today's savers. The answer illustrates a basic problem in America's system of taxation, one that doesn't appear likely to be fixed any time soon.
Traditional IRA. The more or less standard reasons for choosing a traditional IRA is that you can deduct the contributions now, and defer taxation until you begin withdrawals. Generally, speaking, you must wait until you're 59 and 1/2 before you can take withdrawals. You can defer withdrawals, though, and let your savings continue to grow on a tax-deferred basis until age 70 and 1/2. Then, you must begin to withdraw a minimum amount each year or face tax penalties.
You can contribute up to $5,000 a year in 2011 (or $6,000 if you're 50 or older), or the amount of your earned income, if less. You can deduct the contribution if you and your spouse (if you have one) aren't covered by an employer retirement plan. If either of you is covered by an employer retirement plan, the amount of your deduction in 2011 begins to shrink if your adjusted gross income is $56,000 or more (if single), or $89,000 or more (if married and filing jointly). To get a headache reading about the mindlessly complex rules concerning deductibility, go to IRS Publication 590 at http://www.irs.gov/publications/p590/ch01.html#en_US_2010_publink1000230433. Keep reading for a while, because the rules really do go on at some length.
The conventional wisdom is that a traditional IRA is good for people who can deduct all or most of their contributions, and are likely to fall into a lower tax bracket in retirement. In essence, the traditional IRA lets you "borrow" the taxes that would otherwise be due on the income contributed and use them for a while to generate investment returns. You'll pay taxes eventually, but eventually could be decades away. This is one of the few loans you can take that might actually make sense.
Roth IRA. The Roth IRA is funded with aftertax dollars, up to $5,000 a year (or $6,000 if you're 50 or over), or the amount of your earned income, if less. You get no deduction from your current tax bill. Note that the $5,000/$6,000 limit is a combined annual limit for all contributions to whatever traditional and Roth IRAs you might have. For example, if you have both types of accounts and contribute $2,000 to a Roth, you can't contribute more in the same year than $3,000 to the traditional IRA.
If you maintain the Roth for at least five years, you will be able to withdraw the earnings tax free beginning at age 59 and 1/2. However, you don't ever need to make withdrawals and can keep the money in the Roth accumulating tax free investment returns until the end of your life. In such circumstances, the beneficiaries you designate will be required to gradually withdraw the funds over their lives, but they won't need to pay income taxes on those withdrawals. The Roth account will be included in your estate for federal estate tax purposes, so it may be taxed in that way if you're well-off enough. But consider yourself fortunate if you have this problem. For those with a very long term perspective, the Roth is a good estate planning device.
The conventional wisdom is that a Roth IRA is good for people who expect to be in a tax bracket equal to or higher than the one they're in currently. That would mean that Roths are basically good for relatively high earners who expect to retire relatively well off. Another consideration is that Roths are administratively easier than traditional IRAs. You don't need to fuss with calculations of minimum annual withdrawals when you get older. You can take withdrawals as and when you choose, and they aren't taxed. Or you can pass the money along to your designated beneficiaries and they aren't taxed.
The Tax Dilemma. All this is well and good if you can reasonably predict what future tax rates will be. But the current modus operandi in Washington is to jury rig ad hoc short term tax provisions, where rates, deductions and other important aspects of the tax code have very limited half-lives. Most recently, the 2010 tax compromise between President Obama and the House Republicans resulted in a two-year tax cut program that will increase, rather than decrease, the federal deficit. So you can now plan as far as two years ahead. After that, it's anyone's guess where tax brackets will be. Realistically speaking, taxes will have to rise in order to bring deficits under control. But politically speaking, the likelihood of tax increases is low, but may be more likely for moderate and low income Americans than the well-off. (If you think I'm kidding, take a look at the 2010 tax compromise: the progressive $400 Making Work Pay credit was eliminated and a less progressive 2% point cut in Social Security taxes was substituted.)
When it comes to a choice between a traditional IRA or a Roth IRA, the bottom line is no one knows for sure what's best, and most likely you won't know in the future, either. Much of life involves operating on limited information in foggy conditions. One approach would be to split your contributions between a traditional and a Roth, thereby hedging your bets. Another approach is to use only a Roth. While it's more expensive to fund, a Roth is easier administratively on the back end--when you're 83 and juggling a half a dozen prescription medications, you won't want to fool around with the IRS formula for minimum required distributions from your IRA. And a Roth may be a beneficial estate planning tool if you want to leave money to someone else.
Note to the truly frugal. If you have a moderate or low income, you may actually be able to get a tax credit of up to $1,000 for contributions to a traditional or Roth IRA. The credit is available in 2011 only if your income is $55,500 if married and filing jointly, $41,625 if you file as a Head of Household, or $27,750 if single, married filing separately or a qualifying widow(er). This credit offers a dollar-for-dollar reduction of your tax liabilities, so it's worth claiming if you can (in essence, the government funds your IRA up to $1,000). It isn't easy to save at these income levels, but the 7 or 8 Americans who manage to do so can get a nice tax credit.
Traditional IRA. The more or less standard reasons for choosing a traditional IRA is that you can deduct the contributions now, and defer taxation until you begin withdrawals. Generally, speaking, you must wait until you're 59 and 1/2 before you can take withdrawals. You can defer withdrawals, though, and let your savings continue to grow on a tax-deferred basis until age 70 and 1/2. Then, you must begin to withdraw a minimum amount each year or face tax penalties.
You can contribute up to $5,000 a year in 2011 (or $6,000 if you're 50 or older), or the amount of your earned income, if less. You can deduct the contribution if you and your spouse (if you have one) aren't covered by an employer retirement plan. If either of you is covered by an employer retirement plan, the amount of your deduction in 2011 begins to shrink if your adjusted gross income is $56,000 or more (if single), or $89,000 or more (if married and filing jointly). To get a headache reading about the mindlessly complex rules concerning deductibility, go to IRS Publication 590 at http://www.irs.gov/publications/p590/ch01.html#en_US_2010_publink1000230433. Keep reading for a while, because the rules really do go on at some length.
The conventional wisdom is that a traditional IRA is good for people who can deduct all or most of their contributions, and are likely to fall into a lower tax bracket in retirement. In essence, the traditional IRA lets you "borrow" the taxes that would otherwise be due on the income contributed and use them for a while to generate investment returns. You'll pay taxes eventually, but eventually could be decades away. This is one of the few loans you can take that might actually make sense.
Roth IRA. The Roth IRA is funded with aftertax dollars, up to $5,000 a year (or $6,000 if you're 50 or over), or the amount of your earned income, if less. You get no deduction from your current tax bill. Note that the $5,000/$6,000 limit is a combined annual limit for all contributions to whatever traditional and Roth IRAs you might have. For example, if you have both types of accounts and contribute $2,000 to a Roth, you can't contribute more in the same year than $3,000 to the traditional IRA.
If you maintain the Roth for at least five years, you will be able to withdraw the earnings tax free beginning at age 59 and 1/2. However, you don't ever need to make withdrawals and can keep the money in the Roth accumulating tax free investment returns until the end of your life. In such circumstances, the beneficiaries you designate will be required to gradually withdraw the funds over their lives, but they won't need to pay income taxes on those withdrawals. The Roth account will be included in your estate for federal estate tax purposes, so it may be taxed in that way if you're well-off enough. But consider yourself fortunate if you have this problem. For those with a very long term perspective, the Roth is a good estate planning device.
The conventional wisdom is that a Roth IRA is good for people who expect to be in a tax bracket equal to or higher than the one they're in currently. That would mean that Roths are basically good for relatively high earners who expect to retire relatively well off. Another consideration is that Roths are administratively easier than traditional IRAs. You don't need to fuss with calculations of minimum annual withdrawals when you get older. You can take withdrawals as and when you choose, and they aren't taxed. Or you can pass the money along to your designated beneficiaries and they aren't taxed.
The Tax Dilemma. All this is well and good if you can reasonably predict what future tax rates will be. But the current modus operandi in Washington is to jury rig ad hoc short term tax provisions, where rates, deductions and other important aspects of the tax code have very limited half-lives. Most recently, the 2010 tax compromise between President Obama and the House Republicans resulted in a two-year tax cut program that will increase, rather than decrease, the federal deficit. So you can now plan as far as two years ahead. After that, it's anyone's guess where tax brackets will be. Realistically speaking, taxes will have to rise in order to bring deficits under control. But politically speaking, the likelihood of tax increases is low, but may be more likely for moderate and low income Americans than the well-off. (If you think I'm kidding, take a look at the 2010 tax compromise: the progressive $400 Making Work Pay credit was eliminated and a less progressive 2% point cut in Social Security taxes was substituted.)
When it comes to a choice between a traditional IRA or a Roth IRA, the bottom line is no one knows for sure what's best, and most likely you won't know in the future, either. Much of life involves operating on limited information in foggy conditions. One approach would be to split your contributions between a traditional and a Roth, thereby hedging your bets. Another approach is to use only a Roth. While it's more expensive to fund, a Roth is easier administratively on the back end--when you're 83 and juggling a half a dozen prescription medications, you won't want to fool around with the IRS formula for minimum required distributions from your IRA. And a Roth may be a beneficial estate planning tool if you want to leave money to someone else.
Note to the truly frugal. If you have a moderate or low income, you may actually be able to get a tax credit of up to $1,000 for contributions to a traditional or Roth IRA. The credit is available in 2011 only if your income is $55,500 if married and filing jointly, $41,625 if you file as a Head of Household, or $27,750 if single, married filing separately or a qualifying widow(er). This credit offers a dollar-for-dollar reduction of your tax liabilities, so it's worth claiming if you can (in essence, the government funds your IRA up to $1,000). It isn't easy to save at these income levels, but the 7 or 8 Americans who manage to do so can get a nice tax credit.
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