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The stability principle

May 28 2014 07:50
*Edward Ingram
LAST week a reader asked how RSA retail bonds compare with wealth bonds. I replied:

Retail bonds come in two forms - fixed interest (unsafe – read this) and inflation-linked.

The problem with retail bonds is that inflation-linking connects the capital value of the bonds to the wrong index – to prices, not to incomes.

Here is an illustration:

Grandpa was very wealthy in 1914 and he placed half of an average person's lifetime income into an index-linked bond, linked to prices.

That amounts to 20 national average incomes worth of his savings.

In 2014, after only 3% p a difference between the rate at which incomes grew and the rate at which prices grew, the fund has only one national average income left. That is because incomes outpaced the prices index.

This was not what Grandpa had expected.

I have assumed that the interest on the retail bonds has been spent. People usually think that interest is income.

This means that investors are taking a gamble on whether or not - even if the interest on the retail bonds had been reinvested - the interest added to the bond would have been enough to bridge the 3% p a gap so as to hold onto the 20 national average incomes that grandpa had invested.

Readers can now see that most of the tax on interest, and on capital gains, is a tax on wealth.

Looking to the future

The gap, the difference between the rate at which incomes rise and the rate at which prices rise, is approximately the rate of real economic growth, so just now that gap is small, even negative during a recession.

However, if the South African economy gets properly organised it will grow at 6% p a or more – the gap, the rate at which retail bands fall behind average incomes, will be about 6% p a.

To lose 6% of your wealth every year is not a good idea. That is what would happen to your capital if you spent the interest earned on these bonds.

I do not like to see savings locked in for years either - the penalties for early withdrawal on retail bonds are severe.

A serious complaint I have is that when economists and advertisers offer you figures on their investments, they never adjust for the rate of increase in average incomes.

Carefully chosen to mislead

This makes a huge difference between the truth and the facts. The facts are carefully chosen to mislead. The truth is that the public is being seriously misled when they are invited to compare any growth rate with inflation.

Principles

Last week I said that it is time to explain the principles behind the ideas for reform of the economies upon which I have based my ideas.

Economics happens at ground level, where contracts like fixed interest bonds and index linked bonds are written, used and enforced. It is contracts such as these that redistribute wealth and change spending patterns as the level of aggregate demand in an economy changes.

We do not have a well-balanced economy, because the way we borrow and lend to each other and the way taxation taxes interest destroys those balances AND TAKES OUR CONFIDENCE AWAY.

In a well-balanced economy the price of everything, and the cost and the value of everything including debt repayments, debt value, savings and so forth, should theoretically respond to any change in aggregate spending levels.

A 1% increase in the level of average incomes should eventually filter through into a 1% increase in aggregate demand and a 1% increase in all prices, compared to what they would have been otherwise, and if the change is 1% p.a. this should include a 1% increase in the rate of interest.

Such changes should not be taxed.

This would have meant that Grandpa’s fund would have kept its wealth. It would mean that we at ground level could write contracts with each other in which wealth is borrowed and wealth is lent, and the wealth does not get sent all over the place in the way that it does today.

It would mean that the cost of a mortgage would not jump up and down and house prices would not do that either.

I strongly recommend that all governments all over the world should think seriously about what they are doing to their people and their economy by using and enforcing taxation and other contracts like fixed interest and index linked savings that are at variance with this principle.

Not only do such contracts create instability and confusion in at least three-quarters of a nation’s wealth and lending, increasing the cost of borrowing because of the risk to wealth, but they slow economic growth and cause social issues such as the wealthy getting wealthier, while the rest of us lose our wealth.

Here is the link to the 30 other columns I have written on this and related subjects.

 - Fin24

* Edward Ingram has a strong and growing support base. One American has started a petition asking President Barack Obama and/or his senate committees to look into these ideas. Ingram says: “Why not here in South Africa? The ideas are universal.” 

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edward ingram  |  money  |  investments

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