Federal Reserve Balance Sheet and Inflation

The U.S. Federal Reserve’s balance sheet consists of the Fed’s portfolio of U.S. Treasury and government-guaranteed mortgage-backed securities (MBS).

The balance sheet is one of the Federal Reserve’s main instruments for conducting monetary policy and for fulfilling the Federal Reserve’s dual mandate that requires it to ensure both stable prices and maximum employment.

The traditional tool the Fed used to accomplish these goals was the adjustment of the federal funds rate, the short-term interest rate that determined how much it costs for banks to lend to each other overnight.

The 2007-2008 financial crisis, however, demonstrated that even lowering the interest rate to zero was considered insufficient to shore up economies in freefall, and the Fed turned to more unusual tactics.

One of these measures was what the Fed refers to as “large-scale asset purchases,” which is more commonly known as “quantitative easing.” Just as with any other firm, securities that the Fed purchases through quantitative easing are considered assets and therefore are represented on the Fed’s balance sheet.

The value of the balance sheet of the Federal Reserve increased overall since 2007, when it stood at roughly $0.9 trillion U.S. dollars.

As of September 6, 2022, the Federal Reserve had $8.82 trillion U.S. dollars of assets on its balance sheet.

This dramatic increase can be traced back to two black swan events that had a disastrous impact on the U.S. economy:

  • the 2008 financial crisis and
  • the COVID-19 pandemic,

Both events led to a negative annual growth of the real gross domestic product (GDP) of the United States, writes Thomas Wade is the Director of Financial Services Policy at the American Action Forum. Therefore, the Federal Reserve’s response to these crises was to adopt expansionary monetary policies to stimulate employment and economic growth.

Increasing the money supply — an expansionary monetary policies which intends to increase the amount of money circulating in the economy — tends to increase inflation, states Statista.com, which destabilizes the economy and erodes purchasing power. Currently, the inflation rate in the United States reached 8.5 percent in 2022, the largest value in four decades.

Bottomline is that by expanding its balance sheet—i.e., by buying government bonds and MBS—the Fed expands the nation’s money supply in the hope of lowering interest rates and stimulating the economy; contracting the balance sheet should have the opposite effect.

However, by expanding the money supply too much, the Fed ran the risk of igniting inflation [“Inflation is one form of taxation that can be imposed without legislation.” Milton Friedman], while overly contracting it may stifle economic activity, including increasing unemployment and triggering an economic recession.

Inflation’, quipped Milton Friedman, ‘is always and everywhere a monetary phenomenon, in the sense that it cannot occur without a more rapid increase in the quantity of money than in output.

Inflation is a loss of purchasing power over time, meaning your dollar will not go as far tomorrow as it did today.


References:

  1. https://www.statista.com/statistics/1121448/fed-balance-sheet-timeline
  2. https://www.americanactionforum.org/insight/tracker-the-federal-reserves-balance-sheet/#ixzz7esb8x4vu
  3. https://www.fxcm.com/markets/insights/federal-reserve-balance-sheet/

Social Security cost of living for 2023 could increase 8.7%

Inflation is a loss of purchasing power over time, meaning your dollar will not go as far tomorrow as it did today. New York Times

More than 70 million Americans receiving Social Security benefits could see the largest annual cost-of-living increase in more than four decades in 2023, considering the government CPI inflation data.

The Social Security Administration will announce the formal 2023 figure around October 13, after the release of September CPI inflation data. However, the August CPI point to a Social Security cost-of-living adjustment, known as the COLA, of 8.7 percent, according to an estimate by the Senior Citizens League that lobbies for seniors and reported by The New York Times.

The COLA is calculated annually using a formula detailed in federal law. It uses one of the broadest government measures of inflation, known as the Consumer Price Index for Urban Wage Earners and Clerical Workers‌, or CPI.‌

Social Security averages together the CPI figures during the third quarter of each year, and compares that with the previous year’s figure. For example, the 2023 COLA will be calculated by averaging together the CPI figures for the third quarter of 2022 and comparing that with the same averaged figures for 2021.

Rapid inflation typically results in trouble for equity stocks and the overall market. Financial risk assets have historically performed badly during periods of inflation, while tangible assets like real estate have held their value better.


References:

  1. https://www.nytimes.com/2022/09/14/business/social-security-cola-increase.html
  2. https://www.ssa.gov/
  3. https://www.whio.com/news/trending/social-security-boost-cost-of-living-increase-2023-pace-be-largest-since-1981/

Social Security is a program run by the federal government. The program works by using Social Security taxes paid into a trust fund to provide benefits to people who are eligible. Eligibility for Social Security retirement benefits starts at age 62 (the earliest you can receive them) to age 70 (when you hit your greatest amount).

Warren Buffett Investing Lessons

“Most people get interested in stocks [or assets like Bitcoin] when everyone else is. The time to get interested is when no one else is. You can’t buy what is popular and do well.” – Warren Buffett

Warren Buffett, Chairman and CEO, Berkshire-Hathaway, the Oracle of Omaha, has been the most successful investor of the 20th Century and is considered by many to be one of the greatest investors of all time.. His investment track record is simply remarkable with compounded annual returns over 20% over the last 55 plus years.

Essentially, if you had invested $10,000 USD in his investment firm Berkshire-Hathaway in 1965, that $10,000 USD would today be worth over $280 million US dollars.

What follows are several investing lessons all investors can learn from Buffett:

Investing Lesson 1: Risk Comes From Not Knowing What You are Doing

Many first-time investors have started trading in stocks and cryptocurrency without really understanding how these asset classes work. Buffett has advised investors to not chase everything that is new and shiny, and instead to only focus on the opportunities that they painstakingly researched and understand.

Stick to your circle of competence. Try not to be good at all things, and instead try to be great at one thing and give it all you`ve got. It`s better to be known for one thing than nothing.

“Never invest in a business you cannot understand.” Warren Buffett.

Investing Lesson 2: System Overpowers the Smart

Buffett advises that retail investors use a low-cost index fund. Investing via index funds gives you the advantage of a system, it allows for a disciplined investing cycle via SIPs and keeps emotions away from corrupting that framework. In other words, Buffett wants retail investors to follow a system over everything else.

And the system and a clear investing framework finding great business at good reasonable prices that have powered Berkshire Hathaway for the last five decades.

Change the way you see setbacks. You will make mistakes, probably lots of them, as long as you choose to swing for the fences. Buffett believes you can do well if you program your mind to see opportunities in every setback.

“A low-cost index fund is the most sensible equity investment for the great majority of investors.” Warren Buffett.

Investing Lesson 3: Have an Owner’s Mindset

Buying a stock is effectively buying a business and investors should follow the same kind of rigorous analysis and due diligence as one would do when buying a business.

The lesson here is that instead of getting too caught up in the recent movement of the stock price, you should spend more time analyzing the business fundamentals behind the stock price.

You can only genuinely value a business if you can accurately predict future cash flows. This is impossible without an understanding of the company’s operating environment and fundamentals.

And once you have answers to the pertinent questions, invest in a business that you would like to own for the next 10 to 20 years.

On how to invest in stocks. His response is a simple five-word answer: “Invest in the long term.”

“That whole idea that you own a business you know is vital to the investment process.” Warren Buffett

Investing Lesson 4: Be Fearful When Others are Greedy and Be Greedy When Others are Fearful

The stock markets work in cycles of greed and fear. When there is greed, people are ready to pay more than what a business is worth. But when fear sets in, then great businesses are available at huge discounts for anyone who is ready to keep their gloomy emotions aside.

In Berkshire’s 2018 shareholder letter, Buffett wrote, “Seizing opportunities does not require great intelligence, a degree in economics or a familiarity with Wall Street jargon such as alpha and beta. What investors need instead is an ability to both disregard mob fears or enthusiasms and to focus on a few simple fundamentals. A willingness to look unimaginative for a sustained period — or even to look foolish — is also essential.”

In other words, Buffett encourages investors to not follow the herd. And strip away emotions when making investment decisions, which is likely to open up more profitable opportunities.

“What investors need is an ability to both disregard mob fears or enthusiasms and to focus on a few simple fundamentals.” Warren Buffett

Investing Lesson 5: Save and Preserve Capital for A Golden Rainy Day

Warren Buffett goes by the philosophy – hold onto your money when money is cheap and spend aggressively when money is expensive.

Financial expert criticized Buffett for holding onto billions of dollars in cash and not deploying it in stocks. But Buffett was saving all that cash to be used when companies come down from the then astronomical valuations to more reasonable prices.

“Every decade or so, dark clouds will fill the economic skies and they will briefly rain gold. When a downpour of that sort occurs. It is imperative that we rush outdoors carrying washtubs and not teaspoons.” Warren Buffett

Investing Lesson 6: Never Invest Just Because a Company is Cheap

A cheap business may be cheap for a very good reason, but may not be a profitable or favorable investment.

His investing approach is to look at a business’s competitive advantage, intangibles like brand value, cost superiority and its strong growth prospects.

This goes hand-in-hand with his Buffett’s first rule of investing is “don’t lose money.” His second rule is “never forget rule number one.” In short, investors should try to avoid significant losses at all costs, but avoiding all losses is impossible.

“It is far better to buy a wonderful company at a fair price than a fair company at a wonderful price,” Warren Buffett

Investing Lesson 7: Time is The Friend of The Wonderful Business

Patience and time are important in investing and has investors can reap the benefits of compounding.

Additionally, “cash is king” and investors must avoid debt at all costs. Buffett has always had a strong net cash position. Cash gives optionality and means you’re unlikely to have to make hard decisions when the market becomes volatile and eventually turns.

Considering volatility, Buffett said, “There is simply no telling how far stocks can fall in a short period. Even if your borrowings are small and your positions are not immediately threatened by the plunging market, your mind may well become rattled by scary headlines and breathless commentary. And an unsettled mind will not make good decisions.”

Buffett is not a fan of the kind of debt that can leave consumers broke and helpless, especially when the markets go down.

“It is insane to risk what you have and need in order to obtain what you don’t need,” Warren Buffett

Investing Lesson 9: Keep It Simple

An element of simplicity is important. Buffett himself follows a simple to understand investing framework, which can best be defined as buying stakes in a business where the price you pay is far lower than the value you derive. He wants investors to invest in simple and understandable instruments only and using a process that one can easily digest.

For example, if you don’t understand cryptocurrency, don’t invest, trade, or speculate in Bitcoins or glamorous-looking investment vehicles we are exposed to every year.

“If you are uncomfortable with the asset class that you have picked, then chances are you will panic when others panic,” Warren Buffett

Finally, treat your body and mind like the only car you could have. If someone offered you the most expensive car in the world with a single condition that you never get another one, how will you treat this car?

With this analogy in mind, Buffett urges you to treat your body and mind the same way you treat your one, and only car. If you don’t take care of your mind and body now, by the time you are forty or fifty you’ll be like a car that can’t go anywhere.

Investing Bottomline

Buffett’s lessons are simple and straightforward. He submits to keep it simple, improve upon what you know, stay within your circle of competence and comfort zone, and there are enough opportunities for one to thrive in investing.


References:

  1. https://www.etmoney.com/blog/9-lessons-in-investing-by-warren-buffett/
  2. https://thetotalentrepreneurs.com/business-lessons-warren-buffet/
  3. https://addicted2success.com/life/5-lessons-we-can-all-learn-from-the-life-of-warren-buffett/
  4. https://finance.yahoo.com/news/5-warren-buffetts-most-important-224429018.html

Recession…recessions always come with significant increase in unemployment. It’s basically definitional. Employment and gross domestic product fall together during a recession.

Inflation Remains at Four Decade High in August

Inflation, which is a loss of purchasing power, is likely to stay elevated thanks to a variety of structural forces.

The Labor Department reported an 8.3% year-over-year increase in the total Consumer Price Index (CPI) for August. It was a bigger gain in inflation, which is a loss of purchasing power, than expected. Economists and financial strategists agreed that the latest data show inflation is sticky.

Sticky inflation is underlying inflation, or inflation in areas where prices tend to change relatively slowly. Additionally, inflation is structural, meaning the floor is higher than many might assume, and the potential implications go beyond recession.

Vincent Deluard, director of global macro strategy at StoneX Financial, says the current period of inflation is the result of three shortages: labor, energy, and trust.

  • Labor. The U.S. labor market is still about seven million workers short of pre-pandemic levels.
  • Energy. The transition to green energy requires moving down the energy-density ladder for the first time in history, meaning the green transition will consume more resources for similar output. And, when withdraws from the strategic petroleum reserve (SPR) stops, it will remove a downward force on oil prices.
  • Trust. Inflation is inversely proportional to the level of trust between a country’s citizens. “Inflation is a fever that tells you an economy has an underlying ailment of weakening trust, then the fever weakens the body, and it all worsens,” opined Deluard. Inflation is “always and everywhere a psychological phenomenon,” where the problem worsens the longer it persists, Deluard states, as he modifies Milton Friedman’s take on inflation.

Additionally, the August’s CPI report puts the “peak inflation” assumption into question and shows that the labor market and demand -– not supply — problems are driving price increases.

More volatile inflation in categories such as food and energy, which economists and policy makers back out of inflation readings to get to what they call core inflation.

The Fed’s attempt to front-load interest-rate increases is one attempt to regain public trust and restore price stability. The “transitory” inflation argument that has been retired in speeches but not in spirit.

Investors, and central bankers themselves, may therefore be underestimating what the Fed must do to curb inflation, while simultaneously underestimating the odds that inflation remains well above 2% for longer.


References:

  1. https://www.barrons.com/articles/inflation-cpi-labor-shortage-energy-prices-51660265410
  2. https://www.barrons.com/articles/cpi-inflation-report-july-2022-data-51660078098?mod=article_inline

Life Purpose in Five Minutes

Adam Leipzig gave a TED talk regarding discovering your Life Purpose in 5 minutes. In his talk, he discusses a five step process to find meaning and purpose in your life.

In a non-scientific survey of Yale University classmates attending a college reunion, Adam Leipzig discovered to his dismay — despite financial, material and career success — that:

  • The majority of attendees, eighty percent (80%), were unhappy with their lives, and
  • A minority of attendees, twenty percent (20%), were happy

He explained that the people who were happy with their lives knew their life purpose.  For this to take 5 minutes, you need to already know the answers to these 5 things or questions:

  1. Who you are
  2. What you do
  3. Who you do it for
  4. What those people want or need to better their lives
  5. How the people you serve change or transform as a result of what you gave or did for them.

The most successful and happy people in almost every field and walk of life  are outward focus and focus on the people they serve first and foremost.

So, when people ask you, “what do you do”, just respond how what you do changes the lives of people. For example: “I help people build wealth, better manage their money, and achieve financial freedom”.  In a way, this can become your personal brand and elevator pitch. And it can be that simplite.

Adam Leipzig is a producer, executive and distributor. and has produced more than 300 stage plays and live events, and one of the founders of the Los Angeles Theatre Center.

Your Life Purpose comes down to what you really want to do to serve others and what you really enjoy doing to serve other, in the end. What you feel the most alive and happy doing while serving others.


References:

  1. https://www.transcendyourlimits.com/find-life-purpose

Inflation: Decline of Purchasing Power

Inflation is the decline of purchasing power of a given currency over time and it is a result of central banks printing money (increasing the money supply M2).

In 2022, inflation surged during COVID in large part due to loose money policy by the Federal Reserve, writes Brian Wesbury, Chief Economist, First Trust Advisors. It is the increase in the money supply initiated by the Fed that’s responsible for inflation.

Inflation is based on decisions made by the Federal Reserve and other sovereign central banks. It doesn’t matter whether government spending or the budget deficit is high or low, whether the labor supply is growing or shrinking, whether free trade is waxing or waning.

If the money supply grows too fast, you get more inflation; if the money supply grows too slowly or shrinks, you get deflation. If the central bank does its job right, you get stable prices, opines Wesbury.

Photo by Pixabay on Pexels.com

The Federal Reserve kept short-term rates artificially low and the M2 measure of the money supply soared.  Add supply chain bottlenecks and disruptions, U.S. consumers are experiencing near double digit inflation rates. inflation problem that existed before Putin ordered the invasion of Ukraine and, we think, will continue even if the invasion (hopefully) ends.

Inflation is measured by the Consumer Price Index and the Producer Price Index. And, all eyes will be focused on inflation data as CPI is expected to be released Tuesday and PPI expected on Wednesday.

According to Bloomberg’s economists’ survey, expectations are 8.0% year over year growth in CPI and 8.8% year over year growth in PPI, these are important data points for future Fed rate hikes and are likely going to move equity markets as a result.

  • The Consumer Price Index (CPI) is a measure that examines the weighted average of prices of a basket of consumer goods and services, such as transportation, food, and medical care. It is calculated by taking price changes for each item in the predetermined basket of goods and averaging them. Changes in the CPI are used to assess price changes associated with the cost of living.
  • Core CPI, which strips out the volatile food and energy components of the report and is closely tracked by the Federal Reserve
  • The Producer Price Index (PPI) is a group of indexes that calculates and represents the average movement in selling prices from domestic production over time. Producer Price Index represents a reading on inflation from the production side of the economy, measures the change in the prices paid to U.S. producers of goods and services,

Despite some signs inflation is abating, Federal Reserve officials have acknowledged continued tightening is likely needed to restore price stability to the central bank’s target rate.

In June 2022, the Federal Reserve (the “Fed”) raised the Fed Funds Target Rate by 75 basis point (“bps”), the largest increase since 1994. Along with a stunning large hike, there was a reiteration that reigning in of inflation was the top priority no matter the economic costs.

Central bankers, such as the Fed, have the mission and ability to adjust monetary policy so that higher inflation doesn’t result. It is ultimately the increase in the money supply that’s responsible for inflation.

Which is why inflation is going to keep exceeding the Federal Reserve’s supposed 2.0% long-term target for a long time to come until the money supply ceases growing rapidly and the Fed hikes the federal fund rates and tightens the money supply. Currently, the money supply is nowhere close to being tight and tight it will have to get in order to tame the inflation.


References:

  1. https://www.ftportfolios.com/Commentary/EconomicResearch/2022/3/14/its-the-money
  2. https://www.ftportfolios.com/Commentary/Insights/2022/7/25/alternatives-update-2nd-quarter-2022
  3. https://www.ftportfolios.com/retail/blogs/marketcommentary/index.aspx

Dare to be Daring

“I believe that the most important single thing, beyond discipline and creativity, is daring to dare.” ~ Maya Angelou

Risk-taking is the act of exposing yourself to potential failure, danger, harm, or loss.

While that might not always sound like a great idea and may push you beyond your personal comfort zone, the adage, “No risk, no reward” rings true regardless of how you feel about potential failures. You have to put yourself out there and move beyond your comfort zone in order to get what you want and to succeed.

History is repeat with those individuals who took the biggest risks and fought against the greatest odds and they were the ones that have been remembered. “You can’t outwit fate by standing on the sidelines placing little sidebets about the outcome of life. Either you wade in and risk everything you have to play the game or you don’t play at all. And if you don’t play you can’t win,” states Judith McNaught.

“It’s not because things are difficult that we dare not venture. It’s because we dare not venture that they are difficult.” Seneca

Thus, dream boldly and reach for the stars. You, and most people, are more capable and able to live their dreams and achieve the big audacious goals if only they’re willing to believe, focus, work hard, be patient and persist. “It seems to me that people have vast potential. Most people can do extraordinary things if they have the confidence or take the risks. Yet most people don’t. They sit in front of the telly and treat life as if it goes on forever,” writes Philip Adams


References:

  1. https://www.inhersight.com/blog/career-development/taking-risks-quotes
  2. https://www.maverickmindsets.com/blog-posts/quotes-on-risk-taking/

“Twenty years from now you will be more disappointed by the things you didn’t do than by the ones you did. So throw off the bowlines, sail away from the safe harbor, and catch the trade winds in your sails. Explore. Dream. Discover.” ~ Mark Twain

Lessons on Business and Life

10 best lessons regarding business and life.

1. Hard work and working smart will always outweigh talent. Nothing beats hard work and working smart. Hard work and working smart outweigh talent and intelligence and are necessary if you want to succeed. This not only means working hard and working smart when things are going well, but working harder and smarter when things are not.

2. Believe in yourself; have faith in your abilities. Be confident enough to acknowledge your talents and accept your faults. No person is perfect or a complete failure, and everyone has faults and talents, no matter how successful or unsuccessful they may be. Don’t waste your time trying to cover up your faults or deny your talents. Instead, accept them, face reality and do your best to work around these faults and to utilize your talents. There is no greater sign of confidence than self-acceptance.

3. Learn and grow from the past. So many people focus on the future, and while having a plan in place is important, it is equally important to never forget to learn lessons and grow from the past. Don’t be afraid to look back. Your past performance actually can reflect future performance. You must make mistakes to learn, grow, build character and to make yourself a better. Make sure to look back on these mistakes and learn and grow from them.

4. Education in yourself is the best investment you can make. Successful individuals know that there is no better investment than an education. That is one reason they read voraciously. Invest heavily and regularly in your education, but only on things that truly interest you and that can enhance your life. And, education must be a lifelong process.

5. Never make a decision based solely on financial gain. Making money can be a huge motivator in all of our lives, but you should never travel down a road just because there is a promise of financial reward. You need to have a real passion and purpose for what you are doing and the choices you are making for your decision to be worth it.

6. Life is about relationships. Give respect to others and love to your friends and family. No matter where you go in the world, you will find that all people share one similar trait: they all want to be loved and respected. Respect every person you meet, no matter who they are or their socioeconomic status. As for your friends and family, love them unconditionally, and never forget to display your love for them no matter how busy you are.

7. Don’t automatically dismiss any opportunity that presents itself. When presented with opportunities, you should never judge or dismiss any opportunity without thought. You may be presented with a business or personal opportunity that is completely foreign to you. Don’t say no to hastily just because it is outside of your wheelhouse or comfort zone — you never know what this new opportunity could mean in the future.

8. Health is Wealth. Nothing is more important than your physical, mental and emotional health and well-being. Never sacrifice your health for anything, not even success and money. Nothing is as important as your health and nothing ever will be.

9. Don’t be afraid to start small. So many people are afraid to get started because they think they need a lot of capital and resources to succeed in this world. Don’t be afraid to start small. Everyone has to start somewhere, and you don’t need a lot of capital or resources to do it.

10. Take risks, but calculate that risk first. It is wise to take calculated risks. In fact, it’s essential to take risks. However, these need to be calculated risks. Taking risks without weighing your cost/benefit options is just foolish and reckless, but calculated risks tend to lead to the biggest rewards.

“If you don’t go after what you want, you’ll never have it. If you don’t ask, the answer is always no. If you don’t step forward, you’re always in the same place.” ~ Nora Roberts

No matter where your journey might take you in life or where your professional goals might take you, there are certain life lessons that you can always apply to your own journey or to your own “road less taken”.


References:

  1. https://www.entrepreneur.com/leadership/the-10-best-life-and-business-lessons-ive-learned-so-far/245385
  2. https://www.inhersight.com/blog/career-development/taking-risks-quotes

“A Plan Rarely Survives First Contact With Reality”.

Mindset Matters: Aging

Thinking Positively About Aging Extends Life. Positive self-perceptions about aging can prolong life expectancy.

Thinking positively about aging and getting older extends one’s life by seven-and-one half years. This is more than the longevity gained from low blood pressure or low cholesterol or by maintaining a healthy weight, abstaining from smoking and exercising regularly, a study by Yale University researchers have found.

“We found that those individuals who reported more positive self perceptions of aging demonstrated significantly longer survival than those who reported more negative self perceptions of aging,” said Becca Levy, assistant professor in the Yale University Department of Epidemiology and Public Health.

Researchers found that those respondents with more positive views on aging live longer, even after taking into account factors such as age, gender, socioeconomic status, functional health, self-reported health and loneliness.

“We found that the median survival of those in the more positive self perceptions of aging group was 7.6 years longer than those in the more negative aging self stereotype group,” the authors said.

The effects of positive attitudes about aging had a greater impact on longevity than low blood pressure and cholesterol, each of which is associated with a longer life span of about four years.

Positive attitudes about aging also had a greater impact on longevity than lower body mass index, not smoking and regular exercise – each of which extends life by one to three years.

“Our study carries two messages,” the authors said. “The discouraging one is that negative self perceptions can diminish life expectancy; the encouraging one is that positive self-perceptions can prolong life expectancy.”


References:

  1. https://news.yale.edu/2002/07/29/thinking-positively-about-aging-extends-life-more-exercise-and-not-smoking

Taxing Unrealized Gains: A Politically Dum Ideal

“Honestly, I [Mark Cuban] don’t think Elizabeth Warren knows that’s all what she’s talking about when she deals with this. I think she just likes to demonize people that are wealthy, and that’s fine, it’s a great political move for her, but I just don’t think that they really understand the implications of taxing unrealized gains.” ~ Mark Cuban

U.S. Senator Ron Wyden, D-Oregon., has proposed a so-called mark-to-market version of the capital gains tax. Put more simply, investors would pay capital gains taxes each and every year in which their assets go up in value, instead of only when they are sold.

Additionally, President Joe Biden wants to introduce a new tax that targets the wealthiest families in the country. It’s called the Billionaire Minimum Income Tax—except that it doesn’t only tax billionaires, it isn’t a minimum tax, and it’s not really a tax on “income” either. But it is a tax . . . so at least they got that part right!

A wealth tax would apply to assets traded in liquid markets, like stocks and bonds, and to illiquid assets like real estate, private companies and complex investments.

This tax on unrealized gains would be not only difficult to implement but also could devastate markets, especially liquid markets, where stocks, bonds and commodities trade.

The annual tax would also apply to illiquid investments like the value of a private company, real estate and other complex investments.

This means that every year, these assets need to be revalued to determine if their worth went up or down (you can write off the estimated loss if the value of the company, or real estate, if realized), but this means annual appraisals for essentially every investment you own.

Unrealized Capital Gains

Capital gains—which are profits (or potential profits) from an investment that goes up in value after you buy it—can either be realized or unrealized.

Unrealized capital gains show you how much your investment has increased in value before you sell it. Once you sell an investment for a profit, you now have realized capital gains.

The difference is that unrealized gains are only on paper—they’re not really real —while realized gains represent real money that’s in your pocket.

Whenever a stock or investment you own is worth more than what you bought it for, you can sell it for a profit—and those profits are called capital gains.

If you decide to hold on to the stock and not sell it, then what you have are unrealized capital gains. After all, you can’t just walk up to your grocery store cashier and pay for milk and eggs with your stock—no matter how much it’s worth on paper.

Problems With an Unrealized Capital Gains Tax

There are three significant reasons why any proposal to make this a reality probably won’t make it too far.  

1. A new unrealized capital gains tax would be a headache to enforce.

For a tax like this to work, thousands of taxpayers would need to evaluate the value of all of their assets every single year. That raises the question: How in the world would the IRS—which is already understaffed and overburdened as it is—be able to audit all those filings?3

2. The proposed tax probably doesn’t have enough support in Congress.

“wealth tax” proposals have hit a brick wall on Capital Hill every time it has been proposed. It doesn’t look like this one is any different.

It’s important to remember, Congress treats the release of the budget from the White House more like a list of suggestions than something that’s written in stone.

3. A tax on unrealized capital gains might be unconstitutional.

It may be ok legal to tax unrealized capital gains. The Constitution makes it extremely tough for the government to impose direct taxes. In fact, Congress had to pass a constitutional amendment just to put a federal income tax in place.6

Basically, any tax that is passed must be spread evenly among every person in every state. And a tax on unrealized capital gains could be considered a direct tax because it’s a tax on the personal property of a select group of people.


References:

  1. https://www.foxnews.com/media/mark-cuban-screw-you-elizabeth-warren-declares-her-everything-wrong-politics
  2. https://www.cnbc.com/2019/04/03/top-democrats-proposed-capital-gains-tax-would-be-devastating-for-markets.html
  3. https://www.ramseysolutions.com/taxes/unrealized-capital-gains-tax