Annual Financial Section

Avoiding hard-money ripoffs, buying (or not buying) that house, profiting from privatization, figuring the South African market, and protecting your privacy.

Bad Guys. Bad Buys

Self-defense against hard-money scams.
Michael H. Ketcher

Sit down. This may shock you. But as a liberty-loving reader of REASON, you should know the truth: The government isn't the only one out to grab your money.

In fact, among those trying to separate you from your savings could well be those who are ostensibly your allies—hard-money coin and metal dealers, capitalistic stock and commodity brokers, and antitax offshore trust, banking, and fund promoters. It's amazing how people who are so skeptical of government—not to mention other institutions—can so often be taken to the cleaners by people who push the right ideological buttons.

But it happens, and far too often. It's not that every self-professed hard-money maven selling an investment is a swindler. Of course, they're in the business to do I well for themselves, but most are probably honest businessmen and women. But, partly due to the unregulated "nature of the hard-money investment industry as well as the trusting innocence of its philosophically inclined investors, crooks and incompetents abound.

Caveat emptor should be the watchword. Unfortunately, distinguishing the good guys from the bad guys is often impossible. You can't prove that someone is honest. When it comes to money, your best defense is to ignore the philosophical leanings of the promoter and protect your own interests. Maintain a healthy skepticism. If there is one rule worth following, it is never to assume anyone is honest. Always assume they will cheat you if given half a chance. There is absolutely nothing unfair in this. In fact, it's the very policy that nearly all the country's banks and brokerage firms follow when dealing with you. It's simply good business sense.

Beyond that, a few general guidelines will help. You many not want to use all of them all the time, but by using some you will considerably reduce your risk of being defrauded.

• Before dealing with any broker or dealer, ask what protections he offers against dealer fraud and bankruptcy. Make sure these protections go beyond relying on the firm's longevity and history of good customer relations. You should seek objective protections that have some teeth.

• Get independent verification of every material fact. Say, for example, you ask a dealer the question mentioned above. He may reply, Don't worry, your funds (or metals, or whatever) are insured. Your next step would be to get the name of the firm's insurance agent or a copy of the insurance policy. Determine from these exactly which risks are covered and which are not. One word of caution here: In many companies employees are bonded, usually to cover minor embezzlement. Management is rarely bonded. You're covered against petty pilfering by secretaries and salesmen, but you're not protected against the president of the company flying off to Brazil with customer funds.

Another response you might get is, Don't worry, your funds are segregated from company assets or are in a trust account. Again, you can get independent verification of this simply by calling the firm's bank or depository institution and determining under exactly what circumstances company employees or officers might have access to your property.

• Support your local dealer. If possible, it's almost always better to deal with someone close to home. Checking references is easier, and face-to-face meetings can foster friendly business relationships much better than cross-country telephone conversations. Also, if you ever do have problems, it's easier and cheaper to find people, file lawsuits, and file charges when you're in your home town.

• Where possible, avoid potential conflicts of interest. Do not get your buy-and-sell advice from the same people who are selling you investments, and do not purchase investments from the same people who are giving you advice.

• Avoid firms with hard-sell tactics. Firms with aggressive salespeople who badger you with frequent and unsolicited telephone calls, try to get you to buy immediately, and make promises that seem too good to be true are often the least trustworthy.

• Rely on yourself as much as possible. The more unsolicited advice you get from third parties, who may or may not have your best interests at heart, the more likely you will become involved in fraudulent or failed investments.

Let's Make a Deal
When buying or selling bullion or bullion coins (or any investment, for that matter), comparison shop. Prices can vary considerably among dealers. Call at least six, getting the full price, including commissions, insurance, shipping, and any other charges. Trade with the one who gives you the best price. Make sure he delivers immediately, that is, within two weeks.

The chief danger is that, should the dealer fail or disappear during the delivery period, you will likely lose your money. To prevent this, use what is called a sight draft, in which the metals are sent to your bank, the bank transfers payment to the dealer's bank, and upon your approval of them the metals are released to you. Most dealers think sight drafts are a nuisance, but the better ones will grudgingly provide them on larger orders for a slight extra fee.

The other alternative is cash and carry. It's more anonymous than mail order, but it's also more expensive in states where a sales tax is charged on precious metals. For help in avoiding these, get a copy of the November 1986 issue of Mark Skousen's newsletter Forecasts & Strategies, available for $5.00 from Phillips Publishing Co., 7811 Montrose Rd., Potomac, MD 29854. It lists those states that exempt precious metals from sales tax.

The best rule to follow in storing bullion is don't store with a dealer. For most people, storing the bulk in a safe deposit box, with perhaps a small amount well-hidden in your home, will suffice. Larger investors who prefer foreign or private warehouse storage should see Chris Weber's Complete Guide to Safe Storage of Silver & Gold, available from Silver & Gold Report, P.O. Box 510, Bethel, CT 06801. At $68, it's expensive but perhaps the only report that explores the many alternatives impartially and in detail.

Margin, or leverage, schemes are popular with precious metals investors because of the enormous profit potential. But the dangers are often understated.

One who knows the dangers and doesn't understate them is Bob Meier, a research consultant for brokerage and money management firms and the former head of his own commodity trading firm. According to Meier, the emotionalism of precious metals combined with leverage creates such a heady brew that "only one in 100 investors can use leverage in precious metals successfully."

Leverage comes in several varieties: commodity futures, commodity options, extended or deferred delivery programs, leverage contracts, and bank loan programs. None of these is appropriate for most investors. If you think you're that one in 100 who can handle leverage in precious metals, then stick with commodity futures, where your funds are protected from fraud and bankruptcy in a trust account and you aren't charged the high interest rates or excessive fees of other vehicles. Commodity options are also appropriate for the more sophisticated speculators—just comparison shop to avoid being overcharged by one of the many boiler-room operations. Understand all risk disclosure documents thoroughly.

With rare coins, the biggest problems are overgrading and overpricing. The latter can be avoided by simply keeping on top of the market. To do so, subscribe to the weekly Coin Dealer Newsletter, P.O. Box 11099, Torrance, CA 90510. Many dealers use this as a guide to pricing their coins.

The best way to avoid overgrading is to learn how to grade coins yourself. This can take years, especially if you try to learn how to grade all the types of U.S. coins on the market. The most investors can do is concentrate on a particular popular series, such as silver dollars or U.S. commemoratives.

The best way to learn is to develop a friendly business relationship with dealers in your area. Visit their shops. Ask them questions about what makes a coin a certain grade. Examine the coins they have on display. Tell them you want to learn about grading and the more helpful they are, the more business you'll give them.

Dealers will tell you that they learned to grade by simply examining hundreds, even thousands, of coins. By doing the same before you buy a single coin, you can develop expertise on your own. Numerous books, periodicals, and grading guides available from coin dealers can also help.

The alternative to becoming an expert is to buy your coins from a dealer who seems trustworthy and, to keep him honest, have those coins evaluated by an independent grading agency. I prefer those firms that have a 30-day approval period, during which they will either refund your money or replace your coins. This gives you sufficient time to get the coins graded and return them if they're unsatisfactory.

Several grading agencies have popped up in recent years. All considered, the American Numismatic Association's grading program is the best. It's the only one that has withstood the test of time, has almost universal industry-wide acceptance, and can grade your coins quickly enough. It can also authenticate your coins, thus protecting you against counterfeits. For nonmembers it charges $12.50 a coin to authenticate, $12.50 a coin to grade, and $1.00 per $1,000 in value to insure. The address is: ANACS, 818 N. Cascade Ave., Colorado Springs, CO 80903.

You need not have evaluated every single coin you buy from a particular dealer. But you will certainly want to spot check your initial purchases, as well as your purchases over time, just to make sure the dealer stays honest.

Related to rare coins are manufactured rarities—coins or medallions produced in limited editions, often by well-known mints, and sold at enormous premiums. Although a few of these do well, most soon fall below their issue price. Secondary markets are thin at best. It's generally better to avoid them altogether and stick with the proven rarities—coins at least 10 years old.

Gold Diggers and Gurus
Mark Twain has been widely quoted as saying that a gold mine is "a hole in the ground surrounded by liars." With many of today's penny mines, you don't even have the hole in the ground. But you do have the liars.

Nearly everyone who recommends penny mining stocks is either a broker selling them or an investment advisor who has a position. In fact, Twain, who was perhaps the first hard-money investment writer, describes in his book, Roughing It, a trunk full of gold mining stocks he received as favors for writing articles about those firms. Not much has changed since Twain's time. It's rumored in the industry that many of today's best-known investment newsletter writers will gladly endorse a particular mining stock in exchange for a few thousand shares. All of which makes reliable, impartial information about penny mining stocks nearly nonexistent.

Still, rises of several hundred percentage points are not uncommon in these shares, which range from a few cents to a few dollars in price. They're a tantalizing opportunity for high-rolling investors. The most important defense here is, first, don't gamble with more money than you're willing to lose. Second, use the approach outlined by Norman Lamb in his book, Small Fortunes in Penny Gold Stocks: Buy a selection of 10 or 20 of these stocks at random, hold them for a few years, and hope that the gold market moves up. If it does, your losers probably won't fall very far, but your winners will likely soar. Unfortunately, the book is out of print. Check your local library or used bookstore.

The alternative is to make penny mining stocks your hobby. Subscribe to several industry publications and tout sheets, visit the mines, talk to the promoters and geologists, open accounts at several brokerage firms, and, in the words of one occasionally successful penny stock investor, "compare one liar against another."

For glamour and excitement, who doesn't want a foreign bank account in an exotic locale, if for no other reason than to brag about it? Of course, that defeats the entire purpose of having one. But, sadly, that's the main reason many people get one.

There are really only two reasons for foreign investments: One is to diversify into harder currencies; the other is to keep some of your assets out of the political jurisdiction of the U.S. government.

For the first, you need not go offshore. You can obtain currency diversification in other ways, such as putting money in U.S.-based stock, bond, or currency funds that invest in foreign markets. It's much safer than going offshore, where regulatory controls are more lenient and customer protections often nonexistent.

The second reason, political diversification, is generally only appropriate for larger and more sophisticated investors. The best place to start is with a major foreign bank, such as a Swiss, Austrian, or British bank. Their capable and experienced officers can help you choose other offshore investment vehicles.

Be especially wary of the more widely promoted offshore investment entities, such as small mutual funds, trusts, or start-your-own-bank promotions, especially those that are incorporated in high-profile tax havens like Panama or the Turks and Caicos Islands. These are usually headed by some flashy, charismatic, even pompous hard-money or antitax guru who often claims a phenomenal track record and may suggest he has all the answers to your problems with the Internal Revenue Service. Many firms fitting such a pattern have turned out to be nothing more than exotic Ponzi schemes.

If You Get Burned
If you have problems with a broker or dealer, such as a missed or slow delivery, a mix-up in your order, or a late or lost payment, it could be a simple mistake or missed communication. Or it could be indicative of more serious problems, such as poor cash flow or even fraud. You should view such irregularities as an urgent warning sign and take immediate action.

Unfortunately, most investors approach it wrongly. They think that if they're pleasant and cooperative, these people will expedite a solution. Wrong. In the cases we've seen, it is almost always the noisiest, most troublesome investors who get paid first.

Don't be nice, be a nuisance. Call the president of the firm and demand immediate satisfaction. If you don't get it, complain to the Better Business Bureau, the police, the state consumer watchdog agency, the industry trade organizations, the local consumer TV or radio reporter, the media outlets through which the firm advertises, and anyone else who can exert pressure on the firm. Don't write letters; it takes too long. Use the telephone.

See if there are any private agencies through which you might arbitrate. At this point, you should probably hire an attorney—and learn a whole new set of guidelines: protecting yourself from libertarian lawyers. But that is another story.

Michael H. Ketcher is associate editor of INVESTigate: The Journal of Investment Protection. He's been ripped off more than once himself in his 15 years as a hard-money investor.

The Young and the Investless

Maybe you shouldn't buy a house—but you'd better do something.
Doug Thorburn

Baby boomers are at the time in their lives when they have a host of financial decisions to make. They wonder, Should we buy a house, or should we rent? How much can we afford? Should we begin to invest for our children's education? Or should we invest for ourselves instead? Should investments be made with only retirement in mind, or should they be flexible enough to be usable for, perhaps, buying or starting a business later in life? What kinds of investments are appropriate for these goals? What kinds of risks should we take? (Or should we forget all this and just have a good time?)

There are no "correct" answers to these questions. It's a matter of judgment and probabilities. Furthermore, everybody's financial and psychological profile is different, so everybody's answers will be different, too. But a few general guidelines are worth considering.

To Buy or Rent
Many young couples' primary goals are to have babies and to have a home for the babies to grow up in. A home lends a certain stability to one's life (although I'm not sure about the babies), but, contrary to popular opinion, it's not appropriate for everybody to own one.

As a tax and financial planner, I have many clients who ask me not whether they should buy, but how much they should spend. But the "whether" must be discussed first.

One young couple wanted to buy so badly that they borrowed the down payment on their charge cards (the banks don't allow that, but if you accumulate cash for several months by living off the cards, you get around the rules). Unfortunately, two years later the husband lost his job and the couple (with baby) got a divorce. They tried to sell the house for enough to retrieve their down payment, made the mortgage payment for a few extra months, and eventually realized that not only had the price of the house not gone up enough to pay the selling costs, it had actually fallen. They lost the house, along with their down payment, sadly discovering the downside effect of leverage. Because of bankruptcy, the cards were never paid off.

The idea that everyone should own his home became sacrosanct in the inflationary 1970s. Baby boomers growing up with inflation learned that a dollar spent today buys more than a dollar spent tomorrow. That idea fueled a real estate boom and forced prices to valuations which, combined with the high interest rates of the early '80s, made no economic sense. When real estate that cost $1,500 a month to own could be rented for only $600, it was obvious that, without 60 percent marginal tax rates (and full deductibility for all losses if the buyer was an investor), it was far cheaper to rent than to own.

The real estate boom, however, led most investors to believe that the price of real estate could do nothing but go up. When people thought prices would never be lower, those who wanted to buy did so—until no buyers were left. Demand slackened, and prices fell. Nominal prices for real estate in Southern California, for example, stayed flat or decreased by as much as 30 percent from 1980 to 1984. Inflation-adjusted prices fell 10–50 percent, and even more in many resort areas. Other parts of the country took similar hits. An old saying on Wall Street proclaims that "value will out," meaning that fundamental value will eventually prevail in any market. Sometimes it just takes time.

Those who thought they'd be better off renting than buying in the early '80s were considered foolish. Rent money was "money down the drain." The problem with owning, however, is that most of the money you pay the bank goes toward interest, not the principal. If you want to increase your equity, you can prepay the mortgage or shorten its life, but that does not make your investment grow in value. In fact, it puts you at greater risk if prices drop, because you lose all your investment before the bank loses any. If the price of the property doesn't increase, you not only don't make any money, you lose the buying and selling costs. Your rent money no more goes down the drain than mortgage money paid to a lender on a property with steady or falling value.

Among the many factors to consider when deciding whether to rent or buy, first and foremost from a financial point of view is the after-tax cost of owning versus renting. The cost of ownership includes interest on the mortgage and property taxes. It also includes many factors totally overlooked by most people: the cost of insurance; the risk of loss for problems that are either uninsurable or not covered, such as earthquakes, floods, and insurance deductibles; the costs of maintenance and depreciation; and the opportunity cost of the down payment.

The cost of interest and taxes must be determined on an after-tax basis, using your marginal tax rate (the rate on your last dollar of income). The maximum tax bracket will (supposedly) be 33 percent in 1988 (not 28 percent, as the government has fraudulently advertised). The after-federal-tax-deduction cost (the real cost) of (state income taxes must also be added in. For most individuals in a position to purchase their first home, the maximum bracket will be about 25–35 percent. Multiply that bracket by the taxes and interest to determine the tax savings; subtract that savings from out-of-pocket costs and you have the real net cost.

Another complicating factor, however, is often overlooked even by experienced tax specialists. Many individuals will not get the full benefit of all interest and tax deductions. You can deduct the greater of the actual deductions or the standard deduction from your taxable income. The standard deduction for married couples will be $5,000 in 1988 ($3,000 for singles). This means that a couple will need $5,000 in itemized deductions (which are severely limited under the new tax law) before the home mortgage and taxes begin to save anything on the income tax bill.

Once you've figured the costs of interest and taxes, you must add in the other costs of ownership. Home maintenance involves recurring costs for such things as pest control, painting, gardening, and the value of your labor if you do the work yourself. Real depreciation—the wear and tear on roofs, carpets, even plumbing, heating, and wiring systems—can be very expensive. Maintenance and depreciation costs generally average 1–3 percent of the value of the property per year, depending on age and condition. That's $85–$250 per month on a $100,000 property.

Don't forget the opportunity cost of the down payment—the value of the money if you had done something else with it. The down payment, if invested, might earn only 3–4 percent per year (after taxes) at current interest rates, but that same money might earn as much as 20 percent (sometimes in three months) in the stock market. In addition, many people in effect borrow their down payment again after they buy, in order to purchase furniture, appliances, improvements, etc. The cost of borrowing is still as high as 18 percent, and under the new tax law, the interest may not be deductible (unless, in certain circumstances, you give the lender a trust deed on the house).

Furthermore, if you spend $20,000 on a down payment, that's $20,000 less that you could put in a diversified portfolio inherently safer (and much easier to get at in an emergency) than one very illiquid house. Because of all these factors, I usually figure an after-tax opportunity cost of 12 percent on the cash down payment, including closing costs.

The total of all these costs of ownership must be compared with the cost of renting; then other factors must be considered. One advantage to owning is avoiding the risk of being forced out by a landlord at an inconvenient time. In addition, home owners don't have to worry about rent increases. But because the nationwide vacancy rate has risen over the last year, the potential for rent increases is currently very low in many parts of the country.

Personal stability is yet another factor. How long are you going to stay in your new home? The shorter the stay, the greater the risk. Before any money can be made in property, the costs of buying and selling—generally around 10 percent—must be recovered. Therefore, the price must rise by 10 percent before you begin to make any money. People who change jobs frequently, single persons who might get married, and people with growing families are at great risk.

If you're relatively unstable in terms of where you live, or in the size of the house you currently need; if the cost of renting in your area is low relative to the total cost of ownership; if the area isn't growing, or, even if it is, if plenty of land is available for new construction (thus keeping a bearish influence on prices); then renting may be preferable to owning.

Saving for the Down
All right, you've decided to buy anyway. You either have the money, or you must borrow or save it. (If you must save it, you'll have to look at the situation all over again when you're ready to take the plunge.)

Saving for a down payment typically takes one to five years. There are only two good things to put money into over the next couple of years—money market funds and stocks. I like stocks because, if Elliot Wave technician Robert Prechter is correct, this bull market has more to go. And I like money market funds for safety, since they invest in a wide array of extremely liquid short term debt.

Money market funds are virtually riskless in the short term, while stocks are very risky unless you're an expert market timer and you know how to cut your losses. Stocks, however, do better in longer time horizons. Over time frames of 15 years or more, stocks have always done better than money markets; stocks are riskier over three-to-five-year time frames, but the odds are still with them. Over shorter time frames, money markets are preferable, even at today's low rates.

Because gold, silver, and coins do not produce income and do not by themselves increase wealth (they're merely a store of wealth), they are vastly inferior to stocks. Stocks represent ownership of corporations that produce income and either retain it for the internal growth of the company or distribute it in the form of dividends.

Real Estate Aside…
If you already own—or you've decided to rent indefinitely—where do you put your excess cash? What excess cash? It's all being spent on vacations, kids, toys (for big kids)…there isn't anything left! All right, time to Arkad.

Arkad was the wise old seer in George S. Clason's classic, The Richest Man in Babylon, who admonished the young to keep 10 percent of all they earn. In other words, invest in your future before you spend your money. That's how the IRS does it to employees—it takes your money before you even see it, and magically, you never miss it. You can do the same thing to yourself. Invest a percentage of your earnings first, then live off the balance.

If you're young enough, investing 10 percent of what you earn will probably be enough to provide for your old age. If you're 20 years old, for example, a dollar, at a 10 percent rate of growth, grows to $72.89 by age 65. If you're 30, that dollar grows to only $28.10. At 40, it grows to $10.83, and at 50, to $4.18. A 50-year-old, if he has little or nothing saved, should probably invest 25 percent of all he earns and hope he does better than average. Don't count on unsocial insecurity to provide you with the retirement you probably deserve.

The time frames for retirement and for children's education are usually substantially longer than for down payments, making stocks the investment of choice. This conflicts with popular opinion, exemplified by the high percentage of people who invest their IRA funds in banks rather than stocks and mutual funds. If you're saving for retirement 30 years down the road, for the kids' education in 10–15 years, or for anything else with a long time frame, stocks are generally the way to go.

Because stocks are extremely difficult to pick, and it's usually inefficient to buy individual stocks and properly diversify, pick a good stock mutual fund with a long-term track record. Don't pick last year's best-performing fund, since such funds often do very poorly the following year.

You can find out which funds have superior track records by looking them up in Barron's quarterly Lipper report on mutual fund performance, or by contacting Weisenberger Financial Services (a division of Warren, Gorham, and Lamont, 210 South Street, Boston, MA 02111). A good broker (hard to find) can give guidance, but you'll pay a commission. If you want to do it yourself, numerous newsletters specialize in recommending mutual funds and, in some cases, tell when to invest in them, such as Dick Fabian's trend-following Telephone Switch Newsletter (P.O. Box 2538, Huntington Beach, CA 92647) and Robert Prechter's Elliot Wave Theorist (New Classics Library, Inc., P.O. Box 1618, Gainesville, GA30503).

If you can save for retirement inside a deductible retirement plan, do it. Many companies have 401(k) plans that allow you to decide, within certain parameters, how much to invest. Bear in mind that there is now a 10 percent tax penalty for early withdrawal from all retirement plans, not just IRAs, in addition to the regular income tax. Don't invest nondeductible dollars in such plans, since, when you pull out the money, a pro-rated portion will be deemed to be from deductible dollars and thus fully taxable (with penalties if you're under age 59½, unless you're disabled or dead, which isn't a good way to avoid penalties).

If you can't invest in fully deductible plans, consider life insurance, which has undergone a complete metamorphosis over the last five years. Consumer dissatisfaction with whole life insurance finally prompted insurance companies to completely redesign their policies. We now have a variety of sometimes excellent investments disguised as life insurance. Most are still interest-rate-based, but variable interest rate options are available. In addition, several variable stock-market-based policies are available, with tax-free switching privileges inside the policies.

Single-premium whole life insurance (SPWL) has some of the best advantages of other investment options. Like a money market fund, it has no up-front sales charges. Like a CD, it has a guaranteed interest rate (if you want it). Like a home, the value of SPWL can grow tax-free, you can borrow tax-free against that growth, and if you die the growth is never subjected to income taxes. And like a municipal bond, the earnings aren't taxed as long as you keep the policy.

Since single-premium products currently require a minimum investment of $5,000, and you generally can't add to them, universal life insurance may be better for those who want to periodically invest smaller amounts. Universal life insurance has many of the advantages of SPWL, but it usually costs a bit more to borrow out of the policy. Universal also has minor sales charges, fees, mortality charges, and expenses that SPWL products don't have.

So buy insurance—or deductible retirement funds or mutual funds or whatever. What's important is to make investment decisions that suit your needs. Study your options and make a plan. With luck, when you reach your golden years you'll be able to buy your dream toys.

Doug Thorburn is an enrolled agent (to represent taxpayers before the IRS), a certified financial planner, and a real estate broker in Granada Hills, California.

Shrink the State, the Money's Great

How to profit from privatization
Glen Feighery

One of your greatest investment opportunities may be the result of a mistake. That mistake was assuming that government could, even should, operate a wide variety of businesses, from running railroads to delivering the mail. Predictably, it hasn't worked—at least not well.

Now, driven by constituents' demands for more efficient services and by a pressing need to cut costs, the federal government and scores of local governments across the country have begun to sell off some services to the private sector. In other cases, governments continue to pay for services but hire private contractors to provide them.

This process of privatization (or, in the case of contracting out, quasi-privatization), represents an enormous opportunity to invest in freedom: the freedom of consumers to choose who will provide a particular service and the freedom of companies to compete for business. It has practical appeal for investors, too.

"Privatization offers the sophisticated investor a whole new menu of financial opportunities." says Philip E. Fixler, Jr., director of the Reason Foundation's Local Government Center, which maintains a directory of companies involved in privatization. These investment opportunities, notes Fixler, include utility and infrastructure projects, profit-making health and human services, and contract services to government.

The last few years have brought a steady stream of initial public offerings (IPOs) by companies involved in a wide range of privatization activities. Most dramatically, the federal government's sale of Consolidated Rail Corp. (Conrail) in March raised about $1.65 billion—making it the largest IPO ever by a U.S. company. Demand for the new stock issue was so heavy that the opening price of $28 a share was some $6 a share higher than had been expected, demonstrating investors' eagerness to participate in privatization.

Unlike Conrail, which is now traded on the New York Stock Exchange, most privatization investments will be found in the over-the-counter market. Some examples: Corrections Corp. of America, a prison-management company based in Nashville, Tennessee; Judicate Inc., a Philadelphia-based firm that lets clients bypass the court system to resolve disputes; and Municipal Development Corp., a New York City company that develops and manages infrastructure projects such as water facilities and has even proposed a private toll highway (see Trends, April 1987). Each of these companies is listed in one of the Wall Street Journal's daily over-the-counter stock tables.

Of course, there's no such thing as a sure investment bet. And involvement in privatization per se is no guarantee that a company is going to do well. Moreover, many privatization ventures are performed by small firms that do not issue stock. They may provide opportunities for limited partnership activity, but this requires greater capital involvement and carries greater risk than buying stock.

And in assessing stock buys, "you can't make a blanket statement on what's going to be profitable and what isn't," cautions a public-finance analyst with a New York brokerage house. "This is a deal-by-deal business, and you need to apply your own rules."

How much risk are you willing to accept? Do you want to invest in companies that do only privatization work—"pure plays"—or would you be interested in large diversified business, such as ARA Services Inc. or Wackenhut Corp., that include some privatization work among their operations? Are you a long-term investor looking for capital gains, or do you want the assurance of regular dividends? What industries are you interested in?

"If you believe that privatization is going to grow, pick a specific area or industry, and call brokers about this," advises one long-time privatization watcher. While most brokers have probably never heard the term privatization, they do follow specific industries and can give you stock information if you ask the right questions.

Once you've decided on your personal investment criteria, it's time to sort out the good deals from the bad. Perhaps the most important consideration is politics. In some cases—prison services, for example—private companies work under contract with a state or county government. And such contracts are subject to change. Even if such a service is provided directly to consumers (for example, individuals or neighborhoods contracting with private garbage collectors), politics may still intervene, particularly if disaffected customers grumble to the local government.

One hedge against political disruption is diversification. If a company has a broad customer base or offers a broad range of services, the loss of one contract from a political dispute can be offset in other areas. One such company, says Tom Postek, an analyst at William Blair & Co. in Chicago, is Ontario-based Laidlaw Transportation Ltd. Laidlaw collects and disposes waste for commercial, industrial, and residential customers and also runs a school bus service. The company, whose stock is traded over the counter, operates from a broad geographic base, serving customers in 18 states and six Canadian provinces, and for the fiscal year ended August 31, 1986, it earned a net income of $66.2 million (Canadian) on revenue of $717.9 million (Canadian).

Although school buses and garbage trucks may seem an improbable combination, both represent businesses with steady growth potential as the privatization trend accelerates. "School districts do a lot of things already without worrying whether their buses are going to start in the morning," says Postek. And a large-scale company like Laidlaw, which has been buying up smaller bus companies, seems to have an advantage in the school busing market. "Most school bus contractors are small, and it's hard for large school districts to get someone to take that over," he says.

As for waste collection, Postek notes that "one-half of housing units are served by contractors rather than by municipalities," providing a strong precedent for local governments that are considering privatizing their garbage collection. An added incentive: it saves money.

Postek cites a Columbia University study showing that private companies can collect customers' garbage for about 40 percent less than government agencies can. "In an academically rigorous way, it confirmed what many people had suspected," he says.

Numerous waste-management companies, including several that handle hazardous waste as well as garbage, are publicly traded. But the politics of hazardous waste can be hazardous for the investor, making research imperative. Fortunately, both the business press and brokerage houses follow such New York Stock Exchange companies as Browning-Ferris Industries Inc., of Houston, and Waste Management Inc., of Oak Brook, Illinois, and can be good sources of information about not only specific companies but also the waste management industry in general.

Another promising area for investment is the record-keeping business. Governments have only recently begun to farm out this sort of work, so a large market remains untapped, waiting, quite possibly, for companies' offers to take these chores off government hands. Much of the labor involved in record keeping can be computerized, making it more efficient. But governments frequently fail to automate, either because bureaucrats fight for their jobs or because voters hesitate to allocate the money needed for new capital equipment.

The bottom line is positive for the private sector. "There's a tremendous amount of business out there. You have opportunity for high growth," with a commensurate rate of return, says Phil Orlando, an analyst at the New York firm Donaldson, Lufkin & Jenrette.

He is particularly bullish on Dallas-based Cronus Industries Inc., which recently restructured to focus strictly on managing government information, paring away unrelated businesses like metal buildings. This move freed I the company's energies to drum up new government contracts, Orlando says.

Cronus now has three core businesses: record keeping for county governments, election services, and financial and accounting services for cities and counties. Its customers include major jurisdictions like Los Angeles County, Chicago's Cook County, and Dallas County. It also serves smaller cities in Minnesota and Alabama.

Cronus's approach has two distinct advantages, Orlando says: It takes advantage of strong demand and operates in a market with lower turnover. Orlando estimates the industry turnover rate at less than 5 percent—which means those companies with contracts represent potentially strong investments.

"The most impressive thing about record keeping is that Cronus will do it and make a profit, and the government that's contracting out can also profit—without carrying that overhead," says Orlando. "So everyone benefits."

Including the consumer and the taxpayer. Which, ultimately, is why numerous opportunities to take over government activities promise to be a strong source of economic growth. With advance study, money to invest, and some luck, you can strike a blow for freedom—and laugh all the way to the bank.

Glen Feighery is a business reporter with the Jackson, Mississippi, Clarion-Ledger.

Chaos and Commodities

What does South Africa's turmoil mean for gold and other goodies?
Mark Tier

South Africa is experiencing a political crisis, to the confusion of many investors. But, in the words of the now well-known Chinese saying, "Every crisis brings opportunity." The crisis causes people to panic, to sell assets at fire-sale prices. Investments are pulled out; people leave and take with them whatever they can retrieve.

And so the opportunity to buy at bargain prices.

Of course, just because something is a bargain now doesn't mean its price won't fall even lower later on. A couple of years ago, real estate in Beirut seemed an excellent opportunity. Since then, the situation has deteriorated even further. Perhaps that market has now reached its ultimate bottom—but who knows?

Any crisis offers two different kinds of opportunities: investments that will profit if the crisis worsens, and investments (such as Beirut real estate) that will improve if the crisis passes.

Gold, platinum, and diamonds are the investments that would rise in price were South Africa's crisis to deepen significantly, cutting the supply of these commodities and thereby raising their prices. By contrast, just about any investment located in South Africa would benefit if a peaceful solution results. This latter category includes South African gold mines (whose operations would likely be disrupted by political turmoil), stocks in South African companies, real estate, and businesses in that country.

Whither South Africa?
The situation within South Africa is too complex—there are too many conflicting forces—to make a firm prediction about the future. There are basically four scenarios:

• The current indecisive status quo could continue for many years.

• Far right Afrikaners could gain dominance and impose a white-ruled totalitarian state.

• An African National Congress-led violent uprising could result in a black-ruled totalitarian state or some other socialist system (which in many ways probably wouldn't be much different from the current controlled economy); during the interim, of course, investments in South Africa would become temporarily valueless.

• There could be a peaceful solution along the lines of Leon Louw and Frances Kendall's book, South Africa: The Solution. (The U.S. edition will be available shortly from Laissez Faire Books.)

Unfortunately, the South African state is very well entrenched, very powerful within the country, and very effectively pursuing a policy of divide and rule amongst the white and nonwhite communities. The chances are there will be very little radical change in South Africa in the next two to three years.

Any judgment of the political risk associated with an investment can be no more than an educated guess, however. And whatever probabilities one places on each possible scenario, there always remains a risk, however small, that a political explosion would cause a 100 percent loss of one's investment.

The Moral Question
Investing in South Africa is hardly fashionable these days—one of the reasons there are so many bargains available. It's important to consider the moral questions before making any investment there. The system of apartheid is an anathema, and I have no desire to support it in any way, shape, or form. So the question becomes not merely, Which investment will make the most money? But, Which investment will also further change toward a freer society? It's insufficient, if true, to say that any investment you make will have an infinitesimal effect upon the conditions in South Africa—or anywhere else for that matter.

As one observer put it, "the choice for South Africa is between Leon Louw and chaos." Anything that will delay the chaos will increase the chances of a Louw-style solution. Sanctions and disinvestment will have the reverse effect of those intended; they will contribute to the destabilization of South Africa, increase the likelihood of a violent uprising, and reduce the chances of a peaceful settlement. On this basis I have no moral doubts about investing in South Africa.

Indeed there is one form of investment, which I'll come to later, that combines the desire to make a profit with the desire to help effect peaceful, libertarian change in South Africa. Then you can have the best of both worlds: make money by promoting freedom.

When to Bet on Gold
But what of more conventional investments—platinum, gold, and diamonds? Clearly, these three commodities would increase in price most should the crisis worsen. Already, political speculation has led to dramatic fluctuations in their prices.

If you want to bet on collapse in South Africa, it would be best to buy gold, either bullion or coins. Should the country fall into chaos, gold production would undoubtedly decline, cutting the international supply and raising prices. (The same would hold for platinum and diamonds, but I advise buying them only for diversification—if you feel you already own too much gold.)

The nature of South Africa's gold mining operations makes a drop in production an even more likely consequence of political upheaval. South Africa's gold is in "reefs"—long, thin veins of ore that run up to two or three miles underground. Because of the reefs, most South African gold mines consist of a deep, vertical access shaft, with dozens of horizontal tunnels leading to the mine face. Everything must go in and out via this single shaft: miners, equipment, ore, power, air conditioning, and most important of all, pumps to prevent the mine from flooding.

Such a mine could be closed down for years by a small terrorist action at that single crucial point: the ground level access to the mine shaft. The major problem would not, by the way, be clearing the access shaft of rubble; it would be clearing the entire mine of water.

If just one such mine was closed this way, the price of gold would soar. And if such sabotage did occur, chances are it would affect gold, not platinum, simply because there are more gold mines. (Unless, of course, the ANC has invested all its spare cash in platinum futures.)

Investing in gold doesn't necessarily mean buying South Africa's own gold coin—the Krugerrand—but it may. And that decision again requires some consideration of international politics. The Krugerrand has been the major target of sanctions around the world. Countries such as the United Kingdom and Hong Kong, which have not followed the United States in imposing broad sanctions, have banned the import of Krugerrands.

Last year, in an emotional overreaction to the threat of sanctions, the price of the Krugerrand fell to the point where in several months of 1986 one could buy Krugerrands for less than the price of bullion itself! While the Krugerrand's premium over its bullion value has recovered, it still remains far lower than either the American Eagle or the Canadian Maple Leaf and is on a par with the Austrian corona.

As a result of the Krugerrand's dwindling popularity, fewer dealers in the United States and Canada now make a market in the coin, preferring to invest their inventory dollars in the Eagle and Maple Leaf. So Krugerrand investors may find it difficult to sell their coins—at least for a good price.

The two markets where there is no liquidity problem in Krugerrands are Switzerland and Hong Kong. So unless one is into buying 400-ounce bars of gold for that portion of one's assets held in a Swiss bank account—and I believe everyone should have an account of that kind—you will get more gold for your money by buying Krugerrands than any other coin. The downside risk of owning any bullion coin is the melt value, a maximum of one percent under the price of gold. If worse comes to worst, you can sell Krugerrands for melting.

Gold Stocks: What Lies Ahead
Just as the premium on the Krugerrand was knocked down by the market last year, so South African gold stocks fell as foreigners dumped South African investments. The South African crisis affects the outlook for South African gold stocks in two ways: The danger that a particular mine—probably the single South African stock you happen to own—will be shut down indefinitely by terrorist action; or, as a London broker once put it to me, any significant rise in the price of gold will increase the price of South African gold stocks by far less than that of other gold stocks, for the simple reason that the international market, pessimistic about South Africa's future, has discounted the value of the South African stocks to zero in about five years' time.

Nevertheless, South African gold stocks are bound to boom for four reasons:

• Because ot the coming—and, I believe, dramatic—rise in the price of gold.

• Because the impact of this rise on the South African economy will be an even greater expansion of an already rapidly rising money supply. South African exchange controls make it almost impossible for South African money to get out. With nowhere else to go, it ends up on the stock market, pushing up all prices, but especially gold stocks, which are seen as international values.

• Because the return of inflation and rising commodity prices in general will push up the value of currencies in countries like South Africa where most export earnings come from commodities.

• Because South African gold stock prices have indeed been knocked down and are very low in dollar terms, so for the moment there is simply nowhere else to go if you want to buy gold stocks on the cheap.

For Libertarian Entrepreneurs
The most exciting opportunity now available in South Africa is for those who wish to make money while promoting freedom.

Ciskei, one of the four independent "homelands"—recognized only by South Africa and each other—has taken a radical free-market turn, abolishing almost all regulations and taxation. (See John Blundell's article on Ciskei in the April 1985 issue of REASON.) So effective has the Ciskei "experiment" been that South Africa is reforming its own tax laws to make it much more difficult for South African citizens and businesses to utilize Ciskei as a tax haven.

Because Ciskei stayed within the South African customs union and the rand monetary area, it is within the exchange control barriers and tariff wall that surround South Africa. As a result, there are absolutely no economic or other barriers between Ciskei and South Africa. There aren't even any border markings.

The opportunity here is for an entrepreneur to operate from a base with effectively no tax or regulation; from a Third World cost structure; with First World management from South Africa itself; and to sell into a First World market where one's competitors are bound hand and foot by extensive, socialist-style regulation and a far higher cost structure compounded by very high taxes. For more information on doing business in Ciskei, contact Cecil Vanda or David Hart at the Ciskei People's Development Bank Ltd, P.O. Box 66, Bisho, Republic of Ciskei, Southern Africa. Phone [phone], Telex 25-0134.

Meanwhile, I'm in the advanced planning stages of putting together a project in Ciskei, which will invest in new businesses there. It will provide the opportunity to demonstrate that freedom is the only solution that works—and that individuals like you and me can make a difference and make a profit.

Mark Tier is editor of the Hong Kong-based investment newsletter World Money Analyst and author of How to Get a Second Passport and South Africa's Coming Revolution: Peaceful or Violent?

Snooping Sam

Big government invades your privacy. What are you doing about it?
Mark Skousen

In London, if you deposit a million dollars in a British bank, no cash transaction report will be sent to the British government. In Zurich, the Swiss government itself does not know whether a citizen has a Swiss bank account. In Montreal, there is no automatic reporting of dividends or interest to Canadian tax authorities. In Vienna, an investor can have a passbook savings account in bearer form. In Tokyo, a speculator can make a million-dollar capital gain and pay no taxes.

But in the United States of America, supposedly the land of the free, you can do none of the above—legally, anyway. Privacy has been sacrificed to the rallying cry of "full disclosure."

Most Western nations don't impose any of the disclosure requirements that the United States does. In major financial centers such as London and Zurich, there are no cash reporting requirements; no 1099s on dividends, interest, or capital gains; and no fishing expeditions conducted by the government. Virtually all stocks and bonds are held in bearer form (no owner's name is recorded and whoever holds the security receives the dividends or interest, as well as the right to trade it). If a country hasn't adopted a financial secrecy law, it has at least a tradition of bank secrecy. In short, confidentiality in financial affairs is a matter of common civility.

Perhaps one reason other nations have been able to maintain the old tradition of financial privacy is that they have adopted automatic tax withholding on interest and dividends. Britain withholds 30 percent on bank interest, Switzerland 35 percent. But the U.S. government has no withholding and instead opts for automatic reporting.

Under the European system, banks withhold taxes on all national accounts and send a lump-sum quarterly payment to the government without revealing the names of account holders. The same concept applies to the value added tax. The government gets its money without delving into the private lives of its citizens, who don't file returns on these off-the-top taxes. (Unfortunately, European nations also have an income tax, which is a blatant invasion of people's financial affairs.) From a privacy point of view, if a government is going to tax, then anonymous levies such as sales taxes, customs duties, and withholding at the source are the best methods.

The Bahamas and other tax havens have adopted this approach. I lived in Nassau for two years and witnessed an incredible degree of financial privacy and freedom. If you ask Bahamians about filing an annual financial statement to the government, they don't know what you are talking about: They have never filed income tax forms in their entire lives! The Bahamas has no tax on interest, dividends, capital gains, or income. The government's main source of revenue is high customs duties—in effect, a national sales tax, since the Bahamas imports nearly everything—and administration fees from banks, corporations, and insurance companies.

But Bahamians are not the only ones who live private lives. During my stay in the Bahamas, I became acquainted with many expatriates from England, Germany, and Canada, all of whom maintained their native-country citizenship but were not required to file income tax forms to their governments. Only we Americans had to continue filling out the dreaded 1040, living in fear of an IRS audit (the IRS has agents assigned to each U.S. embassy—you don't escape when you leave the country).

The Fourth Amendment to the Constitution protects your right to be secure in your person, house, papers, and effects "against unreasonable searches and seizures." It also establishes the basic American principle of "probable cause" in any police or government investigation and requires a court warrant to conduct a search at an individual home or business.

But the Fourth Amendment might as well be torn up as far as financial privacy is concerned. The IRS, for example, audits millions of tax returns every year without any probable cause or evidence of wrongdoing. The filing of the return itself is a violation of your right to privacy in your personal papers. The IRS requires you to divulge all sorts of private details about your monetary affairs and, upon audit, demands disclosure of anything related to a tax issue—all without a court warrant.

Nor does government prying stop with the IRS. Under several sweeping laws and with the assistance of huge computers, the government is steadily moving toward a single goal: to monitor every single financial transaction.

The Bank Secrecy Act of 1970, for example, invades your right to financial confidentiality in numerous ways, all in the name of catching drug dealers and tax evaders. This act gives the Treasury secretary virtually unlimited authority to set rules on reporting of financial transactions. The government today requires institutions to report and maintain records on all kinds of financial dealings—bank account transactions, uses of credit, large cash payments, the existence of foreign bank accounts and foreign corporations and trusts, investment income, and the sales of stocks, bonds, precious metals, and real estate.

The $10,000 cash reporting requirement is another case in point. Anyone who deposits or withdraws more than $10,000 in cash at a financial institution or business is supposed to file Treasury Form 8300. Again, the object is to catch drug dealers, who frequently use large sums of cash as an anonymous way to do business. The targets have their techniques of escaping detection, while the innocent can easily get caught in the drug net.

Last year I went into a bank in Florida with $3,000 in cash to purchase traveler's checks. I was on my way to Europe for the summer. The bank teller wanted me to file a "currency transaction report" (CTR). I told her that I didn't want to be on a suspected drug dealers list, and besides, I insisted, the reporting requirement is $10,000, not $3,000. After talking to her superior, she let me buy the traveler's checks without filing the form.

But I wonder how many naive banking customers would file the form without knowing the regulations and without knowing that as a result they could be investigated for drug dealing or tax evasion without their knowledge or permission. (The IRS announced in March that it would audit individuals who filed a CTR.) Needless to say, you should avoid this kind of form at all costs—unless you enjoy being hounded by government agents. Keep all cash transactions under $10,000.

Even if you keep cash deposits under $10,000, you still can get into trouble. The Money-Laundering Control Act of 1986 makes it a felony to make several under-$10,000 deposits to avoid filing a CTR. Moreover, banks are now required to report transactions of less than $10,000 that involve people who look suspicious (they have an Italian last name or speak with a foreign accent?).

But the Treasury is not the only agency that violates your constitutional right to financial privacy. The Securities and Exchange Commission works hand in hand with the stock exchanges, searching for illegal insider trading and other "fraudulent" schemes. The exchanges cooperate with the government by monitoring "highly profitable" trades through electronic market-surveillance systems and transaction-audit trails. If private speculators make a sudden profit from individual stocks or stock options, their names are immediately turned over to the SEC for possible insider-trading violations.

So if you make a huge windfall, you may be treated as a guilty party. The SEC's action is a classic fishing expedition. Despite the admission by SEC chief John John Shad that only 1 percent of all stock transactions involve insider-trading violations, the SEC is determined to investigate anyone and everyone who makes "too much money" in the stock market. Private speculators, beware!

Also beware if you're leaving or entering the United States—neither U.S. Customs nor the Immigration and Naturalization Service recognizes your right to privacy. Under the Comprehensive Crime Control Act of 1984, Customs can open foreign mail, authorize wire taps on those suspected of transporting money overseas, or search you when you leave the country—all without a warrant. In fact, customs agents occasionally board outgoing airplanes to search randomly for cash, valuables, etc. The 1984 act also created a "paid informers program," similar to one used by the IRS.

The Tax Reform Act and the Immigration Control Act, both passed last year, will also make it much easier for the government to monitor and control people. The new tax legislation requires all dependents age five and over to have a Social Security number, in effect creating a universal "national identity card" system similar to those existing in socialist and totalitarian countries. (Australia plans to issue a national identity card which must—a favorite bureaucratic term—be shown in order to carry on any business transaction.)

The Immigration Act requires all new workers to provide proof of citizenship or residency—again, you can't be hired until you prove you're "legal." And employers are falling over backwards to comply. Ah, "compliance," the buzzword of the '80s for those with the "accountant mentality." Just as businesses everywhere are starting to adopt the bureaucratic nine-digit zip code!

Happily, many conscientious citizens aren't giving in to the privacy invaders and are doing everything they can to protect their wealth from excessive taxation, harassment, snooping, lawsuits, and fraud. Here are my recommendations:

• First, maintain a low profile. This is the cardinal rule of financial privacy. Stay away from "high profile" cars, houses, license plates, etc. Don't become a target for fraud peddlers and IRS agents.

• Second, invest in "private" nonreportable investments that are not reported on public records in your name. This may include gold and silver coins (purchased with cash anonymously from local coin dealers or coin shows), collectibles, and non-dividend-paying stocks (purchased through discount brokers).

• Third, invest wisely and quietly abroad, where confidentiality is still considered a virtue. In this regard, I have good news for the private investor. The Treasury Department has just increased the "small account exemption" on foreign financial accounts to $10,000. Now you can open a foreign bank account worth up to $10,000 and not have to report its existence to the U.S. government.

This new exemption on foreign accounts makes offshore investing more versatile, especially if done with a variety of other investment opportunities in foreign real estate, precious metals, safe deposit boxes, credit lines, or insurance products. You would be surprised how much you can invest offshore without getting involved in detailed financial reporting to the Treasury. (For people interested in more details, I've written a special report, The Offshore Loophole: Techniques for Investing Abroad with Safety and Privacy.) In an age of declining financial privacy, this exemption is a real breath of fresh air and a great opportunity. Don't pass it up.

Finally, every American ought to ask this: How much personal and financial freedom are we losing in the name of catching drug dealers, tax evaders, illegal aliens, and insider traders? And what are we doing about it?

Mark Skousen is the editor of the monthly financial newsletter Forecasts & Strategies and the author of The Complete Guide to Financial Privacy (Simon & Schuster, 1983). He is adjunct professor of economics and finance at Rollins College in Winter Park, Florida.

Hide and Seek: The Games Savers Play

Virginia I. Postrel

Americans are, countless articles and gurus tell us, incredible spendthrifts—and getting worse. We save about 3 percent of our disposable income, compared to almost 8 percent five years ago. Even more striking is the contrast with other industrialized nations: The Japanese save 16 percent of their disposable income, the Germans and the Swiss about 13 percent. Do savings habits have an economic cause—or are they strictly a matter of thrift and virtue?

The Germans, Swiss, and Japanese aren't more moral than Americans, argues a recent article. They're just more, shall we say, private about their financial affairs, specifically their interest earnings. "For the most part, they do not pay taxes on any interest earned on savings. That is often illegal but never immoral because the governments are in cahoots with the people," reports Business Week columnist Bruce Nussbaum.

Switzerland, he notes, exempts the first $33 of savings account interest from its automatic 35 percent withholding. So the Swiss, it seems, open enough savings accounts to keep each one's earnings under $33 a year. And this practice isn't even really illegal.

In Germany, where the exemption is $442 a year, savers "tend to forget to inform the authorities" when they make more than that, says Nussbaum. This is illegal, but banks aren't required to file individual account data with the government, so the tax dodging goes undetected.

The Japanese can put about $60,000 in three tax-free savings accounts. When that runs out, they commonly resort to fictitious names to stash their cash under. "In a land of tightly controlled social behavior, this widespread lawbreaking could never occur if it was not allowed by the government," writes Nussbaum.

His conclusion: It's probably no coincidence that the countries with the highest savings rates are also the ones that provide the greatest incentives—legal and illegal—for saving. Back when Americans didn't report most savings interest, before the feds cracked down, our savings rate was higher, too—more than double the paltry 2.7 percent it is now. Minding your own business seems good for business. And for the economy.