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My wife and I have been unable to contribute to Roth IRAs for the past several years due to the Roth IRA income limits. We have Roth IRAs from years that we were eligible, and we both have rolled over 401(k)s from previous employers to IRAs. I was planning to take advantage of the back door into the Roth IRA for people like ourselves. We were going to fund after-tax , traditional IRAs for 2009 and 2010 this month, and then immediately convert them to Roth IRAs, which we had hoped would be tax-free, since all of the money converted would be after-tax money. However, I read in a Wall Street Journal article that you can’t convert only your nondeductible contributions. You have to calculate your “basis” and deduct that portion.
My follow-up question is: Are my rollover IRAs from previous 401(k) plans considered part of my total balance in IRAs? Or can I only count the traditional IRAs that I’m converting as my IRA balance?
—Swastik Lahiri, Plano, Texas
Individual retirement accounts funded with 401(k) assets count among your traditional IRA assets during a Roth IRA conversion.
The language is confusing, since many custodians refer to such accounts as rollover IRAs. But they are technically traditional IRAs. Any IRA labeled as a SEP, SIMPLE or contributory is included, as well.
As you point out, you could fund traditional IRAs for 2009 and 2010 anytime between now and April 15 (and you could fund a 2010 IRA contribution up through April 15, 2011). There are no income limits for making nondeductible IRA contributions. But there are income limits for making Roth IRA contributions: Individuals whose modified adjusted gross income for 2010 is $120,000 or more can’t contribute. For couples who file joint tax returns, the cutoff is $177,000. (You can figure out your modified adjusted gross income using a work sheet on page 59 of Publication 590 at http://www.irs.gov.)
Here is where the “back-door” method comes into play: As of Jan. 1, the federal government has lifted the $100,000 household income limit (again, modified adjusted gross income) on converting traditional IRA assets to a Roth. Having that limit removed makes it possible for people with higher incomes to move assets from traditional IRAs to Roth IRAs. First, you would fund a traditional IRA and then you could convert those assets to a Roth.
But people, including our readers here, who have rollover IRAs from past employment will have to include those assets when they figure out how much tax they owe on such a conversion. You can convert all, or part of, your traditional IRA assets to a Roth, but you owe tax proportionately on the amount that wasn’t taxed previously.
That is where the Internal Revenue Service’s pro rata rule comes into play. Basically, you can’t cherry-pick the assets you convert. Instead, the IRS says you must first take the balance in your IRA, or the combined balances of multiple IRAs, and then divide any nondeductible contributions by that balance. This gives you the percentage of any conversion that is tax-free.
Let’s say your rollover IRA has a balance of $23,000, and the new IRAs you fund are worth $13,000, including $12,000 in nondeductible contributions. You would divide $12,000 by $36,000, to find that 33%, or one-third, of your conversion would be tax-free.
There is one possible way around the tax. If your current employer has a retirement plan, you may be able to roll the pretax assets from your rollover IRA into it, if the plan’s rules allow such a move, leaving only your nondeductible contributions subject to the pro rata rule. Remember, the pro rata rule is tied, in large part, to the balance of all your IRAs (except for Roth and inherited IRAs). So, the smaller the proportion of tax-deferred assets and earnings in the accounts, the more money you can convert tax-free. And some company retirement plans do let participants roll assets from an IRA back into a 401(k). The key: Assets in a 401(k) or similar retirement plan aren’t included in pro rata calculations.
Even if you work part-time as an independent contractor, it may be worth it to open an individual 401(k) for that side business, says Julie Schatz, a certified financial planner in Menlo Park, Calif. That way, you could roll some IRA assets into your own 401(k) to help limit the tax bite on a conversion.
Of course, some employer-sponsored 401(k)s may have fewer investment options than an IRA, and many people want to move as much money as possible into a Roth, where withdrawals eventually can be tax-free. (once you meet the holding requirements). So this is mainly a strategy to consider if you are facing a significant tax bill.
When the Fed Stops the Music
by John Mauldin |
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In this issue: When the Fed Stops the Music Who Wants the Old Maid? It’s the Deleveraging, Stupid! London, Monaco, and Zurich |
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Last week we delved into the uncertainties that face us and that make forecasting for 2010 problematical. Will the government actually increase taxes as much as they say, with unemployment still likely to be at 10%? Or will cooler heads prevail? Would such an increase cause a recession? Will the markets anticipate the effects of such a major increase in advance? How will the mortgage market react when the Fed stops buying mortgage securities at the end of March? There are so many things in the air, and today we explore more of them, as I continue (perhaps foolishly) to try and peer into what is a very cloudy crystal ball. When the Fed Stops the MusicThe Federal Reserve has been very clear about the fact that they intend to stop the quantitative easing program at the end of March. What that means in practice is that they are going to stop buying mortgage securities. That does two things. As Bill Gross so aptly points out, those mortgage purchases helped keep mortgage rates low. But they also financed the US government fiscal deficit, albeit indirectly. It seems that funds and banks that sold the mortgage securities turned around and bought US government debt or put the cash right back at the Fed. Who Wants the Old Maid?Why, therefore, would anyone want to be long the dollar or treasuries? The dollar may be the worst currency in the world, except for all the others. What’s an emerging-market central banker to do? Where do you put your reserves? It’s the Deleveraging, Stupid!The reason this recession is different is that it is a deleveraging recession. We borrowed too much (all over the developed world) and now are having to repair our balance sheets as the assets we bought have fallen in value (housing, bonds, securities, etc.). A new and very interesting (if somewhat long) study by the McKinsey Global Institute found that periods of overleveraging are often followed by 6-7 years of slow growth as the deleveraging process plays out. No quick fixes.
You can read the whole report at their web site. The ten-page summary is also there. http://www.mckinsey.com/mgi/publications/debt_and_deleveraging/index.asp London, Monaco and ZurichIt is getting time to hit the send button, and still no word about Walt. But they are still rescuing people from the hotel. Life is so uncertain. I just didn’t see that one coming – which is how it is with surprises. John Mauldin |
John Mauldin, Best-Selling author and recognized financial expert, is also editor of the free Thoughts From the Frontline that goes to over 1 million readers each week. For more information on John or his FREE weekly economic letter go to: http://www.frontlinethoughts.com/learnmore
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New tax rules are about to give more people access to a Roth individual retirement account, one of the most effective vehicles in which to accumulate money for retirement or heirs.
Roth IRAs are currently off-limits to a whole group of people. Individuals with modified adjusted gross income of $120,000 or more can’t contribute to one of these accounts. For married couples, the threshold is $176,000. And individuals with modified adjusted gross income of more than $100,000 and married taxpayers who file separate returns are barred from moving assets held in traditional IRAs into Roth IRAs.
But starting Jan. 1, Uncle Sam will permanently eliminate both the income and filing-status restrictions on transferring money from a traditional IRA to a Roth — a procedure known as converting. So, anyone willing to pay the income taxes due upon making such a move will be able to funnel retirement savings into a Roth, where it can grow tax-free.
Under the new rules, high-income taxpayers who wish to contribute to a Roth IRA are still out of luck: Income limitations on funding these accounts will remain in effect. However, Uncle Sam’s decision to allow high earners to convert will give these individuals a back-door way to fund a Roth on a continual basis.
How so? Each year, these taxpayers can open a traditional IRA (which has no income limits) and contribute the maximum (currently, $6,000 for individuals age 50 and older) on a pretax or aftertax basis. Then, they can convert the assets to a Roth IRA.
Why bother with a conversion? Roths have several advantages over traditional IRAs.
Perhaps the biggest one concerns taxes — or a lack thereof. For the most part, withdrawals from Roth IRAs are tax-free as long as an account holder meets the rules for minimum holding periods. If you convert assets to a Roth from other IRAs or retirement plans, you have to hold those assets in a Roth for five years, or until you turn age 59½, whichever comes first, to make penalty-free withdrawals on your converted amounts. Each conversion has its own five-year clock.
Another benefit: no required distributions. With a traditional IRA, individuals are required to begin tapping their accounts — and to pay taxes on those withdrawals — after reaching age 70½. Roth accounts aren’t subject to mandatory distributions, so the money in a Roth can grow tax-free for a longer period of time.
If you are planning to leave your IRA to heirs, Roths have yet another advantage. Although people who inherit both traditional and Roth IRAs must make annual withdrawals from those accounts (based on their life expectancies), Roth beneficiaries owe no income tax on the money.
Still, there is a cost to converting to a Roth — namely, the income-tax bill. When you withdraw money from your traditional IRA, you will have to pay income tax on the withdrawal, or, more precisely, on the portion of it that represents pretax contributions and earnings.
In 2010, Uncle Sam is offering taxpayers who convert a special deal: They can choose to report the amount they convert on their 2010 tax returns, or they can spread it equally across their 2011 and 2012 returns. (If you are worried that Congress may raise tax rates, consider paying the tax bill in 2010.)
To determine whether it makes financial sense for you to convert, it’s important to consider various factors. For example, converting may be the right move if you expect to pay higher future tax rates or if the value of your IRA account is temporarily depressed, says Ed Slott, an IRA consultant in Rockville Centre, N.Y. In either case, by converting to a Roth today you’ll lock in a lower tax bill than you would otherwise pay.
To estimate your potential tax bill, first calculate your “basis.” Expressed as a percentage, this is the ratio of two numbers: aftertax contributions you have made to your IRAs (if any), and the total balance in all your IRAs.
For example, if you contributed $40,000 aftertax to your IRAs and have a total of $250,000 in those accounts, your basis would be 16% (or $40,000 divided by $250,000). As a result, if you plan to convert $100,000 to a Roth, 16% of that $100,000 (or $16,000) could be transferred tax-free.
Another factor is how long you can afford to leave the money in a Roth. Because the Roth’s major advantage lies in its ability to deliver tax-free growth from age 70½, the longer you can afford to forego withdrawals, “the more converting plays to your advantage,” says Aimee DeCamillo, head of personal retirement solutions at Merrill Lynch Wealth Management.
Before pulling the trigger, speak to a financial adviser. You also can crunch the numbers using online calculators at sites including RothRetirement.com and Fidelity.com/rothevaluator.
If you determine that it pays to convert, the following strategies can help you maximize the benefit:
Financial experts say it’s ideal to have money to pay the taxes due upon conversion from a source other than your IRA. That allows you to retain a bigger sum in your tax-sheltered retirement plan.
Keep in mind that you don’t have to convert your entire IRA. It might make sense to do it piecemeal, as you can afford it, over a number of years.
Put converted holdings into a new account, rather than an existing Roth. That way, if the value falls after you’ve paid the tax bill, you can change your mind, “recharacterize” the account (meaning you move the money back into a traditional IRA) and wipe out your income-tax liability.
You have until Oct. 15 of the year following the year of conversion to recharacterize. For example, if you were to convert your IRA to a Roth in 2010, you would have until Oct. 15, 2011 to recharacterize it. Later on, you could choose to convert the assets to a Roth again.
Better still: Consider opening a separate Roth for each type of investment you hold. That way, you can recharacterize the ones that perform poorly and leave the winners alone.
FOXBusiness
While 2009 has seen many Americans struggle to make mortgage payments, cut back on spending and become acquainted with the “staycation,” there are still other ways to save. You may be able to cut your 2009 tax burden with some last-minute tips, keeping some of that hard-earned money in your own pocket.
But you’ve got to act quickly – these tips will only work in 2009.
First, ask yourself two questions.
1. Did I buy a house?
If so, the first-time homebuyer credit could put up to $8,000 back into your pocket.
To qualify:
Big exception: homeowners who sell the house within three years of purchase must pay the credit back.
2. Did I buy a car?
You might qualify for the new-car sales tax deduction. You can deduct state and local sales tax paid on a new set of wheels purchased this year between Feb. 17 and Dec. 31, regardless of whether you itemize your deductions.
The deduction is limited to the first $49,500 of a vehicle’s price, and your income as a single can’t exceed $125,000, or $250,000 as a married couple.
Here are some things to do before year-end.
Give to charity
Aside from your usual charitable contributions you can distribute up to $100,000 per year from your IRA directly to a qualified charity without paying any tax on the distribution. This exclusion is available if you are 70 1/2 or older.
Big note: This tax break is scheduled to expire at the end of 2009.
Go green
Thinking about buying a more energy-efficient furnace this winter? Remember there are nearly $300 million in rebates earmarked for new “green” appliances. The rebates will typically range from $50 to $250 and take effect as early as the end of this year (dates, amounts, and method of redemption will vary by state).
While there’s no deadline, when the money is gone the program will be over. Go to energystar.gov and click on Tax Credits for Energy Efficiency to see if you qualify.
Reap your losses
Don’t forget to try and match your capital gains and losses. If you sold something at a gain, you will owe capital gains taxes on that sale. But you probably have some losers in your portfolio that you’ve been dying to offload.
If you sell a stock, bond, or mutual fund in a taxable account for less than you paid, you can use the losses to offset any other gains you may have. Have more losses than gains? The IRS lets you deduct up to $3,000 in remaining losses from ordinary income. The rest can be used on future returns.
Prep for the Alternative Minimum Tax
AMT is convoluted and annoying. The best way to muddle through the calculation is to plop your 2009 income into a tax preparation software package and see where you stand.
If you are an AMT victim then you need to make some adjustments before year-end.
The good news is that many of those tax prep programs will walk you through them step by step, but this area of our tax system is confusing, so you might want to get some professional help.
So, while dealing with your taxes might sound almost as bad as going to your in-laws for Thanksgiving, doing a little legwork now could save you some money come April.
NEW YORK (CNNMoney.com) — It’s officially official.
The Obama administration on Friday said the government ran a $1.42 trillion deficit in fiscal year 2009.
That made it the worst year on record since World War II, according to data from the Treasury and the White House Office of Management and Budget.
Tax receipts for the year fell 16.6% overall, while spending soared 18.2% compared to fiscal year 2008. The causes: rising unemployment, the economic slowdown and the extraordinary measures taken by lawmakers to stem the economic meltdown that hit in fall 2008.
Consequently, the annual deficit rose 212% to the record dollar amount of $1.42 trillion, from $455 billion a year earlier.
As a share of the economy, the deficit accounted for 10% of gross domestic product, up from 3.2% in 2008. As breath-taking as that may be, it’s still not in the same stratosphere as the 1945 deficit, which hit 21% of GDP.
Fiscal year 2009, which ended Sept. 30, had all the right ingredients for a record-breaking deficit.
While tax revenue overall took a big hit, corporate receipts led the way, falling 55%. Individual income tax revenue fell 20%.
At the same time spending jumped in large part because of the various economic and financial rescue measures undertaken. The Treasury and the OMB noted that the $700 billion Troubled Asset Relief Program and the $787 billion American Recovery and Reinvestment Act, not all of which has been used, accounted for 24% of the deficit total.
As a result, the country is very near to breaching its so-called debt ceiling, currently set at $12.1 trillion. Lawmakers, however, are expected to vote to raise that ceiling this fall.
At the end of September, the country’s total debt — which is an accumulation of all annual deficits to date plus other obligations — stood at $11.9 trillion.
In August, the OMB projected a 10-year deficit of $9 trillion, assuming President Obama’s 2010 budget proposals are put in place.
A deficit of that magnitude means the debt held by the public would approach 82% of gross domestic product. That’s double the 41% recorded in 2008.
Most budget experts blanch at the thought, especially given that the country’s fiscal future was already a source of concern before the economic crisis because of expected shortfalls over time in funding for Medicare and Social Security.
The financial and economic meltdowns of the past year have accelerated the strain on federal coffers. So much so that now the 10-year forecast as well as the longer-term outlook are considered unsustainable, according to deficit experts William Gale and Alan Auerbach.
In a report this week, the Government Accountability Office noted that the deficits born from the financial crisis are not the biggest crux of the problem.
“While a lot of attention has been given to the recent fiscal deterioration, the federal government faces even larger fiscal challenges that will persist long after the return of financial stability and economic growth,” the GAO said.
The GAO further cautioned that the yawning deficit problems should be addressed sooner rather than later.
“The longer action to deal with the nation’s long-term fiscal outlook is delayed, the larger the changes will need to be, increasing the likelihood that they will be disruptive and destabilizing.”
The Obama administration is promising to put a plan in place to lessen the deficit when the economy recovers.
“It was critical that we acted to bring the economy back from the brink earlier this year. As we move from rescue to recovery, the president recognizes that we need to put the nation back on a fiscally sustainable path,” said OMB director Peter Orszag in a statement. “As part of the FY2011 budget policy process, we are considering proposals to put our country back on firm fiscal footing.”
NEW YORK (CNNMoney.com) — Despite concerted government-led and lender-supported efforts to prevent foreclosures, the number of filings hit a record high in the third quarter, according to a report issued Thursday.
“They were the worst three months of all time,” said Rick Sharga, spokesman for RealtyTrac, an online marketer of foreclosed homes.
During that time, 937,840 homes received a foreclosure letter — whether a default notice, auction notice or bank repossession, the RealtyTrac report said. That means one in every 136 U.S. homes were in foreclosure, which is a 5% increase from the second quarter and a 23% jump over the third quarter of 2008.
Nevada continued to be the worst-hit state with one filing for every 23 households. But even tranquil Vermont, where the foreclosure crisis has barely brushed the housing market, saw foreclosure filings jump nearly 170% compared with the third quarter of 2008. Still, that resulted in just one filing for every 5,023 households in the state — the best record in the country.
The RealtyTrac report also unveiled the results for September, and it found that there was slight relief from foreclosure filings. Last month, notices totaled 343,638, down 4% compared with August. Unfortunately, that total accounts for 87,821 homes that were repossessed by lenders.
That deluge contributed significantly to the quarter’s record 237,052 repossessions, a 21% jump from the previous three months. So far this year lenders have taken back 623,852 homes.
“REO activity increased from the previous quarter in all but two states and the District of Columbia, indicating that lenders may be starting to work through some of the pent-up foreclosure inventory caused by legislative delays, loan-modification efforts and high volumes of distressed properties,” James Saccacio, RealtyTrac’s CEO, said in a statement.
Most disturbing is that all foreclosures — not just repossessions — are rampant despite efforts to corral them. Not only has the Obama administration’s Making Home Affordable foreclosure prevention program taken a bite out of REOs but lenders themselves have scaled back repossessions over the past few months to give the program time to work.
And in some low-price markets, lenders simply aren’t following through on foreclosures, according to Jim Rokakis, treasurer for Cuyahoga County, Ohio, which includes Cleveland.
“They’ll even set the date for the sheriff’s sale, but they don’t file the final papers,” he said. “They hold it in abeyance and let the residents stay in the house.”
In ever more frequent cases, delinquent borrowers want out of the mortgage worse than the lenders. There are no firm statistics for it, but many industry watchers claim the percentage of REOs caused by borrowers voluntarily walking away from their homes is skyrocketing.
A study of the trend by the Chicago Booth School of Business and the Kellogg School of Management determined that when home price declines drop home values 10% below the mortgage balances, people start to give up their homes. When “negative equity” approaches 50%, 17% of households default, even when they can still afford their mortgage payments.
The foreclosure crisis may not diminish anytime soon. “The fastest growing area is in the 180 days late-plus category, the most seriously delinquent borrowers,” Sharga said. “It’s going to be a lingering problem.”
Plus, the RealtyTrac statistics may understate the depth of the foreclosure mess because lender and government actions have delayed many filings. As a result, some delinquencies have not been counted on the foreclosure tallies. That means the crisis may not end quickly.
And because there are so many delinquent borrowers, Sharga predicts the banks will be slow to take back their properties and put the repossessed homes back on the market.
“It’s hard to envision [the banks] putting millions on properties up for sale and cratering prices,” he said. “Recovery will be slow and gradual. I don’t see home prices getting much better until 2013.”
By Susanne Walker
Oct. 13 (Bloomberg) — Treasuries rose for the first time in three days on speculation the dollar’s decline will spur demand from foreign investors as the Federal Reserve keeps interest rates at a record low through late 2010.
Today’s rally follows the biggest weekly decline in Treasuries in two months and comes as the dollar slid to the weakest level against the euro since before the bankruptcy of Lehman Brothers Holdings Inc. Fed Bank of St. Louis President James Bullard said yesterday that a falling unemployment rate is a precondition for an increase in the target interest rate from near zero.
“A decline in the dollar makes Treasuries cheaper,” said Michael Pond, an interest-rate strategist in New York at Barclays Plc, one of 18 primary dealers that trade with the Fed. “That could encourage some buying. If that trend is expected to continue, then foreign investors should expect a decline in the value of their foreign holdings.”
The yield on the 30-year bond fell five basis points to 4.18 percent at 12:52 p.m. in New York, according to BGCantor Market Data. The 4.50 security due August 2039 increased 7/8, or $8.75 per $1,000 face amount, to 105 1/2. The yield rose 23 basis points last week, the most since it gained 31 basis points over the five days ended Aug. 7.
The Dollar Index, which IntercontinentalExchange Inc. uses to track the greenback against the currencies of six major U.S. trading partners, dropped as much as 0.5 percent to 75.738, the lowest level since Aug. 11, 2008.
‘Double-Edged Sword’
“It’s a double-edged sword because the weaker dollar is good for exports and the economy, but as a reserve currency you don’t want people losing faith in the value,” said Thomas Tucci, head of U.S. government bond trading at RBC Capital Markets New York, another primary dealer. “We’ve seen the reinvestment of dollars in the front end of the curve over the course of the last three months. It has helped to keep the curve steeper.”
Trading of Treasuries was closed yesterday in the U.S., Japan and London, because of a public holiday in North America. U.S. 10-year note futures expiring in December rose 0.2 percent yesterday, and were little changed at 118 19/32 today.
‘All Dimensions’
Treasuries fell last week after Fed Chairman Ben S. Bernanke said policy makers will tighten monetary policy once the economic outlook improves. The Fed will hold off raising interest rates until its August 2010 meeting, according to a October survey of 47 economists by Bloomberg News.
“You want to see the economy start to recover in all its dimensions, output and trade” before raising rates, Bullard said in a Bloomberg Radio interview in St. Louis. “We do have some of those turning around now.”
The jobless rate rose to a 26-year high last month of 9.8 percent, the Labor Department said on Oct. 2.
Retail sales in the U.S. probably fell in September as auto showrooms sat empty after the “cash for clunkers” program expired, economists said ahead of the Commerce Department report tomorrow.
Retail Sales
Purchases dropped 2.1 percent after rising 2.7 percent in August, according to the median forecast of 72 economists surveyed by Bloomberg News. Other reports this week may show inflation and factory production cooled last month, according to Bloomberg surveys.
“There is no one data series that will be the ultimate catalyst for the Fed to raise rates or for the removal of monetary policy,” said Barclays’ Pond. “It’s expectations on sustainable growth and how quickly the output gap will close.”
The financial crisis started with the collapse of the U.S. property market in 2007 and has triggered $1.62 trillion of writedowns and credit losses at banks and other institutions, according to data compiled by Bloomberg.
Now investors are preparing for another potential crisis: a surge in the cost of living spurred by the $11.6 trillion the Fed and the government has lent, spent or guaranteed to shore up the economy and the financial system.
Cheap TIPS
BlackRock Inc., Pacific Investment Management Co. and Vanguard Group Inc., which together manage $3.45 trillion, say investors are pouring money into inflation-linked debt even as consumer prices post the longest series of contractions since Dwight D. Eisenhower was president in 1955.
“Investors are really taking the long view and trying to hedge inflation risk,” said Mihir Worah, who oversees the $15.4 billion Real Return Fund for Newport Beach, California-based Pimco, the world’s biggest bond manager. “That’s the biggest reason why we’re seeing the flows.”
Treasury Inflation Protected Securities, or TIPS, have gained 7.9 percent this year, according to Merrill Lynch & Co. indexes, while Treasuries overall lost 2.8 percent. That’s the biggest outperformance since the U.S. first issued TIPS in 1997.
More Bearish
Bernanke said at a Board of Governors conference Oct. 8 in Washington that while “accommodative policies” will be in place for an extended period, the central bank will be prepared to tighten monetary policy “to prevent the emergence of an inflation problem down the road.”
TIPS remain cheap by historical measures. The difference in yield between 10-year TIPS and 10-year notes is 1.85 percentage points, compared with an average of 2.18 over the past five years.
To contact the reporters on this story: Susanne Walker in New York at swalker33@bloomberg.net.
By Ambrose Evans-Pritchard, International Business Editor
Published: 11:59PM BST 14 Sep 2009
Professor Tim Congdon from International Monetary Research said US bank loans have fallen at an annual pace of almost 14pc in the three months to August (from $7,147bn to $6,886bn).
“There has been nothing like this in the USA since the 1930s,” he said. “The rapid destruction of money balances is madness.”
The M3 “broad” money supply, watched as an early warning signal for the economy a year or so later, has been falling at a 5pc annual rate.
Similar concerns have been raised by David Rosenberg, chief strategist at Gluskin Sheff, who said that over the four weeks up to August 24, bank credit shrank at an “epic” 9pc annual pace, the M2 money supply shrank at 12.2pc and M1 shrank at 6.5pc.
“For the first time in the post-WW2 [Second World War] era, we have deflation in credit, wages and rents and, from our lens, this is a toxic brew,” he said.
It is unclear why the US Federal Reserve has allowed this to occur.
Chairman Ben Bernanke is an expert on the “credit channel” causes of depressions and has given eloquent speeches about the risks of deflation in the past.
He is not a monetary economist, however, and there are indications that the Fed has had to pare back its policy of quantitative easing (buying bonds) in order to reassure China and other foreign creditors that the US is not trying to devalue its debts by stealth monetisation.
Mr Congdon said a key reason for credit contraction is pressure on banks to raise their capital ratios. While this is well-advised in boom times, it makes matters worse in a downturn.
“The current drive to make banks less leveraged and safer is having the perverse consequence of destroying money balances,” he said. “It strengthens the deflationary forces in the world economy. That increases the risks of a double-dip recession in 2010.”
Referring to the debt-purge policy of US Treasury Secretary Andrew Mellon in the early 1930s, he added: “The pressure on banks to de-risk and to de-leverage is the modern version of liquidationism: it is potentially just as dangerous.”
US banks are cutting lending by around 1pc a month. A similar process is occurring in the eurozone, where private sector credit has been contracting and M3 has been flat for almost a year.
Mr Congdon said IMF chief Dominique Strauss-Kahn is wrong to argue that the history of financial crises shows that “speedy recovery” depends on “cleansing banks’ balance sheets of toxic assets”. “The message of all financial crises is that policy-makers’ priority must be to stop the quantity of money falling and, ideally, to get it rising again,” he said.
He predicted that the Federal Reserve and other central banks will be forced to engage in outright monetisation of government debt by next year, whatever they say now.
Taken from Bloomberg.com
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