Better to Bank with Cyprus Than the United States?

with 5 Comments

Cyprus

Imagine that five years ago, you could put your money either with a bank in Cyprus or America. After those five years, the bank in Cyprus will confiscate 10% of your money with a onetime tax. Where would be the more favorable place to deposit your savings?

If you answered America, you would have lost more money. In an American bank, with an average interest rate of 1%, it would take almost 70 years to double your assets. By year 5, you’d have seen growth of only 5.1%.

But in the Cypriot banks, with an average interest rate of 5%, you double your money every 14 years. By year 5, your assets would have grown 27.6%. At year 5, almost 22% of your account is interest. Although the 10% tax skims half the interest off the top, you are still left with more assets than the American bank.

If each bank account started with $1 million, after five years and the 10% tax, the U.S. account would have almost $98,000 less.

Without any authorizing legislation, the U.S. government has quietly confiscated more value than Cyprus. With a long-term annual inflation of approximately 4.1% and only a 1% annual interest rate, your assets are guaranteed to lose value over time.

The creation of money through quantitative easing and bank bailouts has made dollars cheap and plentiful. The purchasing power of American bank account holders has dropped accordingly.

These U.S. policies have made cash one of the riskiest long-term investments. And inflation poses an impending threat to securing sufficient funds for your retirement.

In 1996 the government began measuring inflation differently, lowering the reported number significantly. Now if the quality of a commodity increases more than its price, the quality increase is counted as deflation. This so-called hedonic deprecator is justified on the grounds that you are getting more hedonism for the same price as before.

Also, they only count a portion of price increases as inflation. When beef prices rise, some choose to buy chicken instead, an effect called “creative substitution.” If chicken prices rise, some choose another meat. So it is argued that when prices rise, not all of the price increase should be counted as inflation.

With these changes in how the Consumer Price Index (CPI) is computed, Social Security cost-of-living adjustments no longer keep up with actual price increases. Seniors are left living Amish lives in a digital age because the official inflation numbers do not reflect reality.

According to the CPI, $100 today has the same buying power as $67.58 in 1996. By its spendthrift printing of money, the government has taxed you at least 32.42% of whatever cash assets you had during those 17 years.

Over the same time period, the government has kept statistics on the rising cost of various commodities. Chicken is up 59.1%. Coffee is up 65.0%. Eggs are up 67.4%. Beef is up 89.3%. The average Big Mac costs 83.5% more. And gasoline is up 227.1%.

Assuming a 65% actual cost increase, we have experienced annual inflation 1.7% higher than the official numbers. Social Security recipients have received a 32.5% cut in their purchasing power over the same time period. This underreporting of inflation hurts the poorest Americans who rely on Social Security for their retirement.

Monetary policy is one of the 10 economic freedoms measured annually in the Heritage Foundation’s Index of Economic Freedom. The United States has dropped to a rating of 75 out of 100. Of the 181 countries analyzed, the United States ranks 95th, just barely in the top half.

Our government’s monetary policy makes cash especially risky, but U.S. bonds aren’t safe either. They pay a fixed rate of return in diminishing dollars. Inflation-indexed bonds, although better, only adjust according to the underreported official inflation. Foreign bonds in a currency with more monetary stability than the dollar can help. The debt of Australia, New Zealand, or emerging markets like Chile may provide a good alternative for stable fixed-income investments.

Equity investments fare even better though. They appreciate about 6.5% over actual inflation. Although they are more volatile in the short term, they provide a better chance of achieving the appreciation necessary to ensure a comfortable retirement.

Among equity investments, the best hedge against inflation is resource stocks that own or produce an underlying natural resource. Investing in resource stocks is not the same as investing directly in commodities. Buying gold bullion or an oil futures contract is an investment in raw commodities or their volatility. On average, the increased value only keeps up with inflation.

Buying a gold mining or oil company is a resource stock investment. Any increase in the value of the underlying commodity further increases the company’s profits. As the dollar drops in purchasing power, the price of the commodity and the profits of the company go up proportionally, providing you a hedge against inflation.

Some people say the market is “hitting new highs,” so it “must correct.” But some of the recent appreciation in the stock markets may simply be a devaluation of the U.S. dollar. If that is true, no significant correction needs to occur. Either way we should probably be more wary of the constant gradual erosion of our dollars through inflation than the volatility of the stock market.

A balanced portfolio holding U.S. stocks, foreign stocks and resource stocks is the best tactic to hedge against inflation and secure the financial independence necessary for retirement.

Capital gains, interest and dividends do trigger taxes when these investments are held in a taxable account or tax-deferred account. Equity investments in Roth accounts are the best strategy to avoid government devaluation of the dollar and a later tax on that inflation.

Wealth management is based on the idea that over time very small changes have very large effects. Inflation is a small decrease in the value of your “safe dollar” savings that can jeopardize your retirement. However, good financial planning allows you to make the small changes necessary to protect your retirement against government inflation and taxation.

Follow David John Marotta:

President

David John Marotta is the Founder and President of Marotta Wealth Management. He played for the State Department chess team at age 11, graduated from Stanford, taught Computer and Information Science, and still loves math and strategy games. Favorite number: e (2.7182818…)

Follow Megan Russell:

Chief Operating Officer

Megan Russell has worked with Marotta Wealth Management since 2005. She loves to find ways to make the complexities of financial planning accessible to everyone. Her most popular post: The Complete Guide to Your Washing Machine

5 Responses

  1. David John Marotta
    |

    Social Security recipients have been given a terrible deal as the government underreports the CPI index and fails to allow benefits keep up real inflation. Now Bloomberg News reports in “Obama Budget To Include Social Security Deficit-Cutting Plan” that the administration is going to further reduce cost-of-living increases. They have also successfully laid all the blame for this on their opposition. We read in the story:

    President Barack Obama‚Äôs budget plan will incorporate deficit-cutting proposals that include changing the calculation for Social Security cost-of-living increases and tax brackets, according to a White House statement. …

    The plan includes a new inflation gauge that would effectively reduce cost-of-living increases for Social Security beneficiaries, a measure that is sure to draw opposition from many Democrats. It also proposes using the calculation for adjusting income tax brackets, which would mean higher payments for many taxpayers.

    Had Americans been able to put what has been deducted from their paychecks into private account that they would own and be able to leave to their heirs, the average Social Security recipient would have been vastly better off financially. Instead they are at the mercy of government austerity toward them and government largess toward politicians and government workers.

    • Dale
      |

      David, Some time ago I calculated what I would have in savings assuming 8% a year return instead of Social Social Security. Over one million. With that I could withdraw 4%/yr and have the same monthly income as SSS and have the one million.
      Dale

  2. Luis
    |

    I’m surprised by the Heritage Foundation stat. Last time I see a figure on indexes for economic freedom was three years ago and US was fourth, one spot ahead of New Zealand. Please link HF’s most recent chart, thanks.

    • Megan Russell
      |

      You can read about the United States here. We were citing the U.S. Monetary Freedom score (which is 75 out of 100). You might be remembering the U.S. world rank (which is currently 10th). Both have dropped over the past few years.

  3. Richard Gregg
    |

    I agree, without proper money management, your savings are slowly losing purchasing power. We did not use your services because we did not meet your minimum criteria, but were fortunate to use a fund offered to us by our bank, at some risk of course, The fund is staying even despite our withdrawals…some kind of minor miracle !
    Steve Gregg