Social Security: No 2011 Increase

On Friday, the Federal Government announced that there would be no rise in Social Security benefits next year. This will mark the second year in a row nearly 60 million senior citizens will not receive an inflation adjustment on their payments. According to CNNMoney.com, inflation has been low in the past two years and the Bureau of Labor Statistics reported on Friday that prices were up only slightly over last year. The article continues:

The last Social Security inflation adjustment was in 2009: Beneficiaries got a higher-than-normal 5.8% increase because of a temporary spike in energy prices in the third quarter of 2008.

Soon after, however, energy prices plummeted. Then the bottom fell out of the economy and by the third quarter of 2009 overall price levels had fallen 2.1% from the same period a year earlier. That meant no increase in 2010 Social Security benefit checks.

This year, while there has been some inflation, prices remain lower than they were in the third quarter of 2008 -- and that's the quarter that counts.

Gold Hits Fresh Record on Inflation Fears

From FT.com:

Gold prices continued to set fresh highs on Wednesday, as fears about rising inflation kept the yellow metal in demand.

After overtaking its December high of $1,226.10 an ounce on Tuesday, gold reached a fresh peak of $1,243.90 in early European trade.

Gold bugs have been snapping up coins, particularly in Germany and Switzerland, amid fears over the potential inflationary impact of the European Central Bank’s decision to buy eurozone government bonds to tackle the region’s debt crisis.

Edel Tully, precious metals strategist at UBS in London, said that the €750bn eurozone rescue package agreed on Sunday night had done little to slow demand for gold. “The continuation of this heightened appetite after the bail-out was announced shows that these fears have not been allayed.”

Gold prices in euro terms also hit a fresh all-time high of €981.49 an ounce, up 28 per cent since the beginning of the year.

The Return of the Inflation Tax

From the Wall Street Journal:

All of those twentysomethings who voted for Barack Obama last year are about to experience the change they haven't been waiting for: the return of income tax bracket creep. Buried in Nancy Pelosi's health-care bill is a provision that will partially repeal tax indexing for inflation, meaning that as their earnings rise over a lifetime these youngsters can look forward to paying higher rates even if their income gains aren't real.

In order to raise enough money to make their plan look like it won't add to the deficit, House Democrats have deliberately not indexed two main tax features of their plan: the $500,000 threshold for the 5.4-percentage-point income tax surcharge; and the payroll level at which small businesses must pay a new 8% tax penalty for not offering health insurance.

This is a sneaky way for politicians to pry more money out of workers every year without having to legislate tax increases. The negative effects of failing to index compound over time, yielding a revenue windfall for government as the years go on. The House tax surcharge is estimated to raise $460.5 billion over 10 years, but only $30.9 billion in 2011, rising to $68.4 billion in 2019, according to the Joint Tax Committee.

Americans of a certain age have seen this movie before. In 1960, only 3% of tax filers paid a 30% or higher marginal tax rate. By 1980, after the inflation of the 1970s, the share was closer to 33%, according to a Heritage Foundation analysis of tax returns.

These stealth tax increases—forcing ever more Americans to pay higher tax rates on phantom gains in income—were widely seen to be unjust. And in 1981 as part of the Reagan tax cuts, a bipartisan coalition voted to index the tax brackets for inflation.

Dollar Adds to Gains As Investors Mull U.S. Jobs Data

From MarketWatch.com:

"This past Friday may have been a turning point in that relationship and we need to be alert to more traditional fundamental factors coming back to drive foreign exchange," said Brian Dolan, chief currency strategist at Forex. "A brightening U.S. outlook may increasingly begin to support the dollar."

The dollar index, a measure of the greenback against a trade-weighted basket of currencies, rose to 79.365 from 78.940 in late North American trading on Friday.

The euro traded at $1.4135 versus the dollar, down from $1.4179 Friday.

Since the credit crisis reached its peak, the dollar has tended to lose ground on favorable economic news and rallying equity markets, while rising on bouts of safe-haven buying on negative news and falling equities.

The U.S. currency rose on Friday along with equities, indicating a correlation directly to the economic outlook may be reasserting itself. More typically, the dollar rises along with positive economic news -- and the potential for rising interest rates, boosting yields on the country's bonds -- as those qualities make a nation's currency more attractive compared to other countries where the growth outlook and interest rates may not be as appealing to investors.

In that regard, the U.S. looks more likely to emerge from the recession before both Europe and Japan, making the dollar more attractive than the euro and yen.

"If currencies were to trade on cyclical differences from here on, the U.S. dollar would be set for clear outperformance," said currency strategists at Citigroup. The firm expects the U.S. economy to grow 2.1% in 2010, which the euro-zone grows just 0.5%.

All markets are also on edge before the Federal Reserve's monetary policy meeting on Tuesday and Wednesday. Analysts expect little change to officials' statement about leaving interest rates unchanged for an extended time. See story on Fed rate policy.

The Price of Recovery: Are You Inflation Ready?

From USAA.com:

In the first quarter of 2009, consumer prices, as measured by the Consumer Price Index, decreased by 2.4%. The Personal Consumption Expenditures Price Index, the Fed's preferred inflation gauge, was down 1%. The most recent data shows there is no evidence of inflation in the U.S. economy.

The government is spending trillions of dollars using a broad swathe of initiatives to fight deflation, which is the opposite of inflation. And therein lies the rub. Should the government's efforts succeed, and there are some signs that they may, the huge new debt issuance that's supporting them could lead to a spike in inflation that we have not experienced since the 1970s.

The deftness and agility that will be required in the pivot from fighting deflation to fighting inflation is tremendous. In essence, the government has to provide enough monetary stimuli to get the economy firmly on the growth path, while standing ready to reverse course without stepping on the recovery. At USAA, our view is that the government will err on the side of letting inflation run a while, rather than risk a double-dip recession.

In response, we are acting now to build additional inflation-protection tools into our asset allocation products. In doing so, we are being driven by the following principles:

While inflation is not likely in the next few months, it is the likeliest outcome over the mid- to long-term.

U.S. Treasury-backed securities without inflation protection are probably in a bubble, and will suffer price declines amid all of the new issuance when the Treasury and the Fed take their foot off the monetary gas.

There are certain asset classes that should perform better than others in an inflationary environment, and it will be important as asset allocators to have the ability to shift assets to these vehicles across our product lines as the deflation/inflation pivot occurs.

USAA: Building an Intelligent Inflation-Fighting Toolbox

As always, we study what's happened in the past as a strong guide for how markets will behave in the future. Here's a rundown of how some important asset classes have performed.

Common stocks overall have had no correlation with inflation since 1926. We believe that our preference for active management would benefit given our sub-advisers' abilities to shift among sectors. For instance, exporters would benefit from the fall in the dollar that would accompany inflation, as would commodity-based companies in growth-driven markets.

Real estate has been positively correlated with inflation, as both rent and value tend to go up along with rising prices in other portions of the economy. The data on equity real estate investment trusts is less conclusive, and in fact these vehicles have been uncorrelated with inflation since 1972. We think recent changes in equity REIT structures should make them perform more like direct real estate in a coming inflationary period.

Gold is positively correlated with inflation, and also acts as a currency substitute that would rise in the face of a falling dollar.

Commodities have a relatively strong correlation to inflation, and are especially good for inflation caused by excessive demand, as opposed to inflation sparked just by increases in money supply. Commodities are also a powerful diversification tool, since they are negatively correlated with both stocks and bonds.

Bonds tend to suffer because inflation eats into the purchasing power of both income and principal repayment. Shorter-term bonds do better than longer-term issues, bonds with credit risk are less sensitive to inflation and rising rates than Treasuries, and there is a new class of inflation-linked securities and derivatives, including Treasury Inflation-Protected Securities.

IRS Issues 2009 Inflation Adjustments

According to their newest press release, the IRS has issued new inflation adjustments for the year 2009. “By law, the dollar amounts for a variety of tax provisions must be revised each year to keep pace with inflation. Consequently, more than three dozen tax benefits, affecting virtually every taxpayer, are being adjusted for 2009. Key changes affecting 2009 returns, filed by most taxpayers in early 2010, include the following:

• The value of each personal and dependency exemption, available to most taxpayers, is $3,650, up $150 from 2008.
• The new standard deduction is $11,400 for married couples filing a joint return (up $500), $5,700 for singles and married individuals filing separately (up $250) and $8,350 for heads of household (up $350). Nearly two out of three taxpayers take the standard deduction, rather than itemizing deductions, such as mortgage interest, charitable contributions and state and local taxes.
• Tax-bracket thresholds increase for each filing status. For a married couple filing a joint return, for example, the taxable-income threshold separating the 15-percent bracket from the 25-percent bracket is $67,900, up from $65,100 in 2008.
• The maximum earned income tax credit for low and moderate income workers and working families with two or more children is $5,028, up from $4,824. The income limit for the credit for joint return filers with two or more children is $43,415, up from $41,646.
• The annual gift exclusion rises to $13,000, up from $12,000 in 2008.”