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The election results and the Fed’s announcement of QE2 have been well discounted in the market’s runup over the last few months, but now the focus shifts to a guessing game about whether the current tax code will be changed, extended, or allowed to expire. I suppose there are some political points to be gained by referring to a tax code that has been in place since 2003 as a tax cut. Only in Washington would continuing a 7-year-old tax code have a new 10-year cost forecast associated with it, especially when we haven’t yet passed a budget.

The final agreement on taxes will likely have a profound effect on the pileup of corporate and individual liquidity. In fact, there is a rapidly developing fear that a spike up in commodity prices, caused by too much liquidity, sovereign debt troubles and the Fed’s QE2 plan, will create rising inflation. The reasoning further suggests that strong demand which will accompany any rising inflation will force the government to tighten bank reserves. While I can’t really find fault with this logic since we’ve never been able to have it both ways, such a tightening could, nevertheless, be quite wrenching.

Wal-Mart put out a survey of grocery prices indicating that inflation is already here as food prices have risen by .6% over the last two months. Before hitting the panic button, let’s step back and put a little perspective in order.

According to the U.S. Department of Agriculture, about 10% of American’s disposable income is spent on food. About 6% is food consumed at home. Comparable food at home data for France and Germany would be in the mid-teens, China high 20%’s, India 40% and Indonesia about half. It seems clear that our efficient American farmers have given us a distinct competitive advantage when it comes to eating. The data also suggests that higher ag-commodity prices will be more of a problem for emerging country consumers than ourselves.

China’s recent inflation problems now point to a possible link with the Chinese Central Bank’s currency policies. Such tightly managed economic growth, achieved through currency exchange rate management, invariably comes at a stiff price.

At the same time, Europe is erupting with more credit problems, bringing back fears of the recent past. Now there are rumors spreading about a pre-packaged devaluation for Greece and others. Perhaps much of the commodity run-up in prices is really currency related. Also, this may be good reason not to be carried away with a weak dollar outlook.

The leaders of President Obama’s bipartisan deficit commission recently suggested a new individual income tax system with only three rates: 8%, 14% and 23%. Alternative suggestions have come in from other bipartisan sources calling for lower rates as well. All proposals include a much lower corporate tax. Suddenly, the President’s long held recommendation of higher rates for the most successful Americans seems like a ridiculous idea compared to what serious people now want to do to sync up our tax system with a goal of strong economic growth and more jobs.

Perhaps all this perspective is beginning to point to America as the growth engine for the free world. Shocking.

About the Author

Harlan J. Cadinha
Founder, Chairman and Chief Strategist




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