I usually try to avoid political commentary in this space, because it has become so personal to so many people. If I point out that a particular program of the “left” is smart, or cleverly put together, then half of my readership is annoyed; if I point out the same about the right, then half of my readership is angry. It doesn’t really make sense to waste article space except on those occasions when a policy has a clear effect on inflation over time, such as when the structure of the ACA made it clear that it would put upward pressure on inflation (as I pointed out in 2013) or in response to someone else’s flawed analysis of a policy, as I did last year when I tackled the San Francisco Fed for their weak argument about how the ACA would hold down inflation because the government would demand lower prices. Actually, there is no policy I have written about more than the ACA over the years – but again, this was economic commentary and not political commentary.
This article will be short, but different in that I am writing it to express frustration with the absolute lack of intellectual clarity on the part of the Republicans in making a particular argument that immediately impacts the debate over health care but also extends far into other policies. And, because the argument is simple, direct, and has tremendous empirical support, I couldn’t restrain myself. I expect this article will not be picked up and syndicated in its usual channels since it isn’t directly about economics or markets, but it needed to be said.
I’ve been stewing about this topic since Tuesday (March 14th), when I happened to catch part of the daily White House press briefing. Press Secretary Sean Spicer was asked a question about the President’s health care proposal, and tap danced away from the question:
Q Thanks, Sean. You mentioned the call with the CEO of Anthem Health. Can you tell me what this proposal of the President means for health insurance companies? Will their profits go up or down under the President’s proposal?
SPICER: Well, I don’t think that’s been the focus of the President’s proposal. It’s not about them, it’s about patients. But I think what it means for them is that they finally get to create more choice and more plans and allow people to choose a plan that fits them. Right now, they don’t have that choice. And, frankly, in more and more markets, companies like Anthem, UnitedHealth, Signa are pulling out — Aetna — because they don’t have the choice and because of the government mandate. I think what we want to do is allow competition and choice to exist so that they can offer more options for the American people.
Q But will those companies make more money under the President’s plan or less?
SPICER: I don’t know the answer to that. That’s not been the focus of what we’re doing now. And at the end of the day, right now they’re pulling out of market after market, leaving the American people with fewer and fewer choices. So right now it’s not a question of — from the last I checked, I think many of them were doing pretty well, but it’s the American people and its patients that are losing under the current system. So I think that there’s a way you can do a little of both.
Spicer’s response was the usual drivel that the Republicans have adopted when they run in fear from any question that includes the word “profits.” To summarize, the question was basically, “you’re doing this to throw a sop to fat-cat insurance companies, aren’t you?” and the answer was “we don’t think about that. No idea. Profits? Who said anything about profits? It’s about patients and choice. And, if anyone gets more profits, it wasn’t on purpose and we didn’t have anything to do with it.”
But this was actually a softball question, and the answer ought to have been something like this:
Q But will those companies make more money under the President’s plan or less?
BIZARRO SPICER: Well, I hope so. After all, the insurance companies want every person in America to have health care – which is the same thing that we want – because the more people they sell their product to, the more money they can make. The insurance companies want to sell insurance to every person in the U.S. The insurance companies also want costs to be lower, and constantly strive to lower the cost of care, because the lower that costs are, the more profit they can make in the short run. But they don’t want lower costs at the expense of health – clearly, the best outcome for their profits is that most people covered by insurance are healthy and so don’t require the insurance they’ve paid for. So, if we just get out of the way and let companies strive for better profits, we are likely to get more coverage, lower costs, and a healthier population, and that is the goal of the President’s plan.
The reason we don’t already have these things is that laws we have previously passed don’t allow insurance companies to offer certain plans, to certain people, which both sides want but which politicians think are “unfair” for one reason or another. Trying to create a certain preconceived Utopian outcome while limiting profits of insurance companies is what caused this mess in the first place.
If you want to beautify gardens in this city, does it make sense to limit the amount of money that gardeners can make? If you did, you would find fewer gardens got tended, and gardeners would not strive to make improvements that they didn’t get paid for. We can see this clearly with gardeners. Why is it so hard to understand with the companies that tend to the nation’s health? Next question.
For some reason, Republicans think that saying “profits are good” is the same thing as saying “greed is good” and leads to caricatures of conservatives as cigar-smoking industrialists. But while at some level it is the desire for a better material outcome – which I suppose is greed, but aren’t there degrees of greed? – that drives the desire for profit, we cannot dismiss the power of self-interest as a motive force that has the effect of improving societal outcomes. “It is not from the benevolence of the butcher, the brewer, or the baker that we expect our dinner, but from their regard to their own interest,” after all.
Of course, Republicans must also remember that profit without competition is a different animal. If an insurance company creates an innovation that lowers medical care costs, but does not face competitive pressure, then the benefit of the innovation accrues to the company alone. There is no pressure in such circumstances for the company to lower the price to the customer. But consider what happened to air fares after the deregulation of 1978, or to the cost of telephone service when the AT&T monopoly was broken up in 1984, as competition was allowed and even encouraged. Competition, and the more brutal the better, is what causes companies to strive for an edge through innovation, and it’s also what causes the benefit of that edge to eventually be accrued by the end customer. The government didn’t invent cell phones. Motorola did, in order to try and gain an edge against AT&T, but until the telephone monopoly was broken up there were no commercial versions of the cell phone. The first cell phones cost $10,000 in 1983, about $25,000 in today’s dollars, but now they are ubiquitous and cost about 2% as much in real terms. But this didn’t happen because of a government program to drive down the cost of cell phones. It was the profit motive, combined with competition. All that government did was create the conditions that allowed innovation and competition to happen. And wouldn’t we like health care to be as ubiquitous and cheap as cell phones are?
This is not a hard thing to get right. It isn’t hard for people to understand. But for some reason, it seems incredibly hard for politicians to believe.
Note that nothing I have written here should be construed as an opinion about the President’s health care plan, which I have not read. My remarks are only meant to reflect on the utter inability of Republicans to properly convey the reasons that a different approach – one where the government’s involvement is lessened, rather than increased – would make more sense.
 The first cell phone call was made by the inventor, Martin Cooper at Motorola, who called his competition with it: the head of the cellular program at AT&T. According to him, he said “Joel, I’m calling you from a cellular phone, a real cellular phone, a handheld, portable, real cellular phone” and he said it got really quiet on the other end of the line.
**NOTE – please see the announcement at the end of this article, regarding a series of free webinars that begins next Monday.**
Whatever else the election of Donald Trump to be President of the United States has meant, it has meant a lot of excitement in precincts that worry about inflation. This is usually attributed, among the chattering classes, to the faster growth expected if Mr. Trump’s expressed preference for tax cuts and spending increases obtains. However, since growth doesn’t cause inflation that isn’t the part of a Trump Presidency that concerns me with respect to a continuing rise in inflation.
In our latest Quarterly Inflation Outlook, I wrote a short piece on the significance of the de-globalization movement for inflation. That is an area where, if the President-Elect delivers on his promises, a lot of damage could be done in the growth/inflation tradeoff. I have written before about how a big part of the reason for the generous growth/inflation tradeoff of the 1990s was the rapid globalization of many industries following the end of the Cold War. Deutsche Bank recently produced a research piece (I don’t recall whether it had anything to do with inflation, weirdly) that contained the following chart (Source: as cited).
This chart is the “smoking gun” that supports this version of events, in terms of why the inflation dynamic shifted in the early 1990s. Free trade helped to restrain prices in certain goods (apparel is a great example – prices are essentially unchanged over the last 25 years), by allowing the possibility of significant cost savings on production.
The flip side of a cost savings on production, though, is a loss of domestic manufacturing jobs; it is this loss that Mr. Trump took productive advantage of. If Mr. Trump moves to increase tariffs and other barriers to trade, and to reverse some of the globalization trend that has driven lower prices for the last quarter-century, it is potentially very negative news for inflation. While there was some evidence that the globalization dividend was beginning to get ‘tapped out’ as all of the low-hanging fruit had been harvested – and such a development would cause inflation to be higher than otherwise it would have been – I had not expected the possibility of a reversal of the globalization dividend except as a possible and minor side-effect of tensions with Russia over the Ukraine, or the effect the Syrian refugee problem could have on open borders. The election of Mr. Trump, however, creates the very real possibility that the reversal of this dividend might be a direct consequence of conscious policy choices.
I don’t think that’s the main reason that people are worried about inflation, though. Today, one contributor is the news that OPEC actually agreed to cut production, in January, and that some non-OPEC producers agreed to an additional cut. U.S. shale oil producers are clicking their heels in delight, because oil prices were already high enough that production was increasing again and they are more than happy to take more market share back. Oil prices are up about 15% since the announcement.
But that’s near-term, and I don’t expect the oil rally has legs much beyond current levels. Breakevens have been rallying, though, for weeks. Some of it isn’t related to Trump at all but to other initiatives. One correspondent of mine, who owns an office-cleaning business, sent me this note today:
“Think of you often lately as I’m on the front line out here of the “instant” 25% increase in min wage. Voters decided to move min wage out here from 8.05 to $10 jan 1. Anyone close to 10/hr is looking for a big raise. You want to talk about fast dollars, hand a janitor a 25% pay bump and watch the money move. Big inflation numbers pending from the southwest. I’m passing some through but market is understandably reacting slower than the legislation.”
Those increases will definitely increase measured inflation further, though by a lot less than it increases my friend’s costs. Again, it’s an arrow pointing the wrong way for inflation. And, really, there aren’t many pointing the right way. M2 growth continues to accelerate; it is now at 7.8% y/y. That is too fast for price stability, especially as rates rise.
All of these arrows add up to substantial moves in inflation breakevens. 10-year breaks are up 55bps since September and 30bps since the election. Ten-year inflation expectations as measured more accurately by inflation swaps are now at 2.33%. Almost all of that rise has been in expectations for core inflation. The oft-watched 5y5y forward inflation (which takes us away from that part of the curve which is most impacted by energy movements) is above 2.5% again and, while still below the “normal” 2.75%-3.25% range, is at 2-year highs (see Chart, source Bloomberg).
So what is an investor to do – other than to study, which there is an excellent opportunity to do for the next three Mondays with a series of educational webinars I am conducting (see details below)? There are a few good answers. At 0.46%, 10-year TIPS still represent a poor real return but a guaranteed positive 1/2% real return beats what is available from many risky assets right now. Commodities remain cheap, although less so. You can invest in a company that specializes in inflation, if you are an accredited investor: Enduring Investments is raising a small amount of money for the management company in a 506(c) offering and is still taking subscriptions. Unfortunately, it is difficult to own inflation expectations directly – and in any event, the easy money there has been made.
What you don’t want to do if you are worried about inflation is own stocks as a “hedge.” Multiples move inversely with inflation.
Unlike prior equity market rallies, I understand this one. It is plausible to me that a very business-friendly President, who cuts corporate and personal taxes and reduces regulatory burdens, might be good for corporate earnings and even for the economic growth rate (although the bad things coming on trade will blunt some of that). But before getting too ebullient about the potential for higher corporate earnings, consider this: if Trump is business-friendly, then surely the opposite must be said about President Obama who did essentially the reverse. But what happened to equities? They tripled over his eight years (perhaps they “only” doubled, depending on when you measure from). That’s because lower interest rates and the Fed’s removal of safe securities in search of a stimulus from the “portfolio balance channel” caused equity multiples to expand drastically. So, valuations went from low, to extremely high. Multiples matter a lot, and right now even if you think corporate earnings over the next four years might be stronger than over the last four you still have to confront the fact that multiples are more likely to move in reverse. In short: if stocks could triple under Obama, there is no reason on earth they can’t halve under a “business-friendly” President. That’s not a prediction. (But here is one: equities four years from now will be no more than 20% higher than they are now, and might well be lower.)
Also, remember Ronald Reagan? He who created the great bull market of the 1980s? Well, stocks rallied in the November he was elected, too. The S&P closed November 1980 at 140.52. Over the next 20 months, the index lost 24%. It wasn’t until almost 1983 before Reagan had a bull market on his hands.
An administrative announcement about upcoming (free!) webinars:
On consecutive Mondays spanning December 5, December 12, and December 19 at 11:00ET, I will be doing a series of one-hour educational seminars on inflation. The first is “How Inflation Works;” the second is “Inflation and Asset Classes;” and the third is “Inflation-aware Investing.” These webinars will also have live Q&A. After each session, a recording will be available on Investing.com.
Each of these webinars is financially sponsored by Enduring Investments.
So I see today that former Fed Chairman Alan Greenspan says this is the worst crisis he has seen. Bigger than the 1987 Crash? Bigger than Long Term Capital? Bigger than the internet bubble collapse? Bigger than the Lehman (et. al.) collapse? Really?
As humans, we tend to have short memories and (ridiculously) short planning horizons. Greenspan, especially in his apparent dotage, has a shorter memory even than he had previously – maybe this is convenient given his record. I don’t want to comment on his planning horizon as that would seem uncharitable.
Why is Brexit bad? The trade arrangements and treaties do not suddenly become invalid simply because the UK has voted to throw off the shackles of her overlords and return to being governed by the same rules they’ve been governed by basically since the Magna Carta. But Jim Bianco crystallized the issue for me this week. He pointed out that while Brussels could let this be a mostly painless transition, it has every incentive to make it as painful as possible. In Jim’s words, “if it isn’t painful then hands shoot up all over Europe to be the next to leave.” That’s an astute political observation, and I think he’s right. The EU will work hard to punish Britain for having the temerity to demand sovereignty.
But Britain survived the Blitz; they will survive Brexit.
Indeed, Britain will survive longer than the Euro. The sun is beginning to set on that experiment. The first cracks happened a few years ago with Greece, but the implausibility of a union of political and economic interests when the national interests diverge was a problem from the first Maastricht vote. Who is next? Will it be Greece, Spain, Italy, or maybe France where the anti-EU sentiment is higher even than it is in the UK? The only questions now are the timing of the exits (is it months, or years?) and the order of the exits.
As I said, as humans we not only have short memories but short planning horizons. From a horizon of 5 or 10 years, is it going to turn out that Brexit was a total disaster, leading to a drastically different standard of living in the UK? I can’t imagine that is the case – the 2008 crisis has had an effect on lifestyles, but only because of the scale and scope of central bank policy errors. In Iceland, which addressed the imbalances head-on, life recovered surprisingly quickly.
These are all political questions. The financial questions are in some sense more fascinating, and moreover feed our tendency to focus on the short term.
A lot of money was wagered over the last few weeks on what was a 52-48 proposition the whole way. The betting markets were skewed because of assumptions about how undecideds would break, but it was never far from a tossup in actual polling (and now perhaps we will return to taking polling with the grain of salt it is usually served with). Markets are reacting modestly violently today – at this writing, the US stock market is only -2.5% or so, which is hardly a calamity, but bourses in Europe are in considerably worse shape of course – and this should maybe be surprising with a 52-48 outcome. I like to use the Kelly Criterion framework as a useful way to think about how much to tilt investments given a particular set of circumstances.
Kelly says that your bet size should depend on your edge (the chance of winning) and your odds (the payoff, given success or failure). Going into this vote, betting on Remain had a narrow edge (52-48) and awful odds (if Remain won, the payoff was pretty small since it was mostly priced in). Kelly would say this means you should have a very small bet on, if you want to bet that outcome. If you want to bet the Leave outcome, your edge was negative but your odds were much better, so perhaps somewhat larger of a bet on Brexit than on Bremain was warranted. But that’s not the way the money flowed, evidently.
Not to worry: this morning Janet Yellen said (with the market down 2.5%) that the Fed stood ready to add liquidity if needed. After 2.5%? In 1995 she would have had to come out and say that every week or two. A 2.5% decline takes us back to last week’s lows. Oh, the humanity!
Just stop. The purpose of markets is to move risk from people who have it to people who want it. If, all of a sudden, lots of people seem to have too much risk and to want less, then perhaps it is because they were encouraged into taking too much risk, or encouraged to think of the risk as being less than it was. I wonder how that happened? Oh, right: that’s what the Fed called the “portfolio balance channel” – by removing less-risky assets, they forced investors to hold more-risky assets since those assets now constitute a larger portion of the float. In my opinion (and this will not happen soon), central banks might consider letting markets allocate risk between the people who want it and the people who don’t want it, at fair prices. Just a suggestion.
One final point to be made today. I have seen people draw comparisons between this episode and other historical episodes. This is refreshing, since it reflects at least some thoughtful attempt to remember history. Not all of these are apt or useful comparisons; I saw one that this is the “Archduke Ferdinand” moment of this generation and that’s just nuts. Europe is not a military powderkeg at the moment and war in Europe is not about to begin. But, to the extent that trade barriers begin to rise again, the idea that this may be a “Smoot-Hawley” moment is worth consideration. The Smoot-Hawley tariff is generally thought to have added the “Great” to the phrase “Great Depression.” I think that’s probably overstating the importance of this event – especially if everybody decides to respect Britons’ decision and try to continue trade as usual – but it’s the right idea. What I want to point out is that while rising tariffs tend to produce lower growth and lower potential growth, they also tend to produce higher inflation. The fall of the Berlin Wall and the opening of Eastern Europe is one big reason that inflation outcomes over the last few decades have been lower than we would have expected for the amount of money growth we have had. The US has gone from producing all of its own apparel to producing almost none, for example, and this is a disinflationary influence. What would happen to apparel prices if the US changed its mind and started producing it all domestically again? Give that some thought, and realize that’s the protectionist part of the Brexit argument.
We can cheer for a victory for independence and freedom, while continuing to fight against any tendency towards economic isolationism. But I worry about the latter. It will mean higher inflation going forward, even if the doomsayers are right and we also get lower growth from Brexit and the knock-on effects of Brexit.
I was convinced last week that the stock markets, as well as the inflation markets, were underestimating the importance of the Ukrainian conflict. I thought that I had a little more time to write about that before the crisis came to a head, which turned out not to be true. However, it seems that markets are still underestimating the importance of the Ukrainian conflict.
About the best possible outcome at this point is that Putin stops with an annexation of the Russian equivalent of the Sudetenland, with the episode merely pointing out (again) the impotence of Western leaders to respond to Russian aggression but not actually damaging much besides our pride. Even in that case, to me this signals a dangerous new evolution in the development of Russia’s relationship with the West. But the worse cases are far worse.
The angry fist-shaking of the old democracies is moderately amusing; less amusing are the stupid threats being made about economic sanctions. Let us stop for a minute and review what the West imports from Russia.
According to this article from Miyanville (from early 2013), Russia is the world’s largest producer of chromium (30% of the world market), nickel (19%), and palladium (43%), and is the second-largest producer of aluminum (10%), platinum (12%), and zirconium (19%). It has the largest supply of natural gas (although we are gaining rapidly), the second largest supply of coal, and the 8th-largest endowment of crude oil. The Ukraine itself is the third largest exporter of corn and the sixth-largest exporter of wheat. Meanwhile, the top 10 exports to Russia include engines, aircraft, vehicles, meat, electronic equipment, plastics, live animals, and pharmaceuticals.
So, we are fundamentally exporting “nice to haves” while importing “must haves.” Who needs trade more?
Let me make a further, suggestive observation. I maintain that the tremendous, positive trade-off of growth and inflation (high growth, low inflation) that the U.S. has experienced since the 1990s is at least partly a story of globalization following the end of the Cold War. Over the last couple of years, I have grown fond of showing the graph of apparel prices, which shows a steady rise until the early 1990s, a decline until 2012 or so, and then what appears to be a resumption of the rise. The story with apparel is very clear – as we moved from primarily domestically-sourced apparel to almost completely overseas-sourced apparel, high-cost production was replaced by low-cost production, which dampened the price increases for American consumers. It is a very clear illustration of the “globalization dividend.”
Of course, mainstream economic theory holds that the inflation/growth tradeoff suddenly became attractive for the U.S. in 1991 or so because inflation expectations abruptly became “anchored.” Why look for a good reason, when you can simply add a dummy variable to an econometric model??
But suppose that I am right, and the fall of the Soviet Union in 1991 played a role in the terrific growth/inflation tradeoff we have experienced since then. Incidentally, here are some data:
- Cold War (1963, immediately following the Cuban missile crisis, until the fall of the USSR): U.S. annual growth averaged 3.4% (not compounded); inflation averaged 5.4%. The DJIA rose at a compounded nominal rate of 5.6%.
- Post-Cold-War (1991-2013, including three recessions): U.S. annual average growth 2.6%; annual average inflation 2.4%. The DJIA rose at a compounded nominal rate of 7.5%.
This is not to say that globalization is about to end, or go into reverse, necessarily. It is to illustrate why we really ought to be very concerned if it appears that the Bear appears to be back in expansion mode – whether it is something we can prevent or not. And it is also to illustrate why putting a firm end to that expansion mode, rather than sacrificing global trade and cheap energy to a resurrection of the Cold War, is probably worth considering.
I still don’t think that equity investors understand the significance of what is going on in the Ukraine.
Investors have learned the same wrong lessons over the last couple of years that they learned in the run-up to 2000, evidently. I remember that in the latter part of 1999, every mild equity market setback was met immediately with buying – the thought was that you had to jump quickly on the train before it left the station again. There was no thought about whether the bounce was real, or whether it “made sense”; for quite a number of them in a row, the bounce was absolutely real and the train really did leave the station.
Then, the train reached the end of the line and rolled backwards down the mountain, gathering speed and making it very difficult to jump off. I remember getting a call from my broker at the time, recommending Lucent at around $45 – quite the discount from the $64 high. I noted that I was a value investor and I didn’t see value in that stock, and to not call me again until he had a decent value idea. He next called with a recommendation later that year, with a stock that had just hit $30…a real bargain! And, as it turned out, that stock was also Lucent. The lesson he had learned was that any stock at a discount from the highs was a “value” stock. (Lucent ended up bottoming at about $0.55 in late 2002 and was eventually acquired by Alcatel in 2006).
This lesson appears to have been learned as well. On Thursday and Friday a furious rally took stocks up, erasing a week and a half of decline. This happened despite the fact that Friday’s Employment number was just about the worst possible number for equities: weak enough to indicate that the December figure was not just about seasonal adjustment, but represented real weakness, but nowhere near weak enough to influence the Federal Reserve to consider pausing the recent taper. We will confirm this fact tomorrow, before the market open, when new Fed Chairman Janet Yellen delivers the Monetary Policy Report (neé Humphrey-Hawkins) testimony to the House Financial Services Committee (her comments to be released at 8:30ET). While I believe that Yellen will be very reluctant to raise rates any time soon, and likely will seize on signs of recession to stop the taper in its tracks, she will be reluctant to be a dove right out of the gate.
And that might upset the apple cart tomorrow, if I’m right.
I have been fairly clear recently that I see a fairly significant risk of market volatility to come, both on the fixed-income side but especially on the equity side. I think stocks are substantially overvalued and could fall markedly even without any important change in the underlying economic dynamics. But there is actually good news which should be considered along with that fact: when markets were last egregiously overpriced, financial institutions were also substantially more-levered than they are today. The chart below (source: Federal Reserve) shows that as a percentage of GDP, domestic financial institutions are about one third less levered than they were at the 2008 peak.
Now, this exaggerates the deleveraging to some extent – households, for example, appear to have deleveraged by about 20% on this chart, but the actual nominal amount of debt outstanding has only declined from about $14 trillion to about $13.1 trillion. Corporate entities have actually put on more debt (which made sense for a while but probably doesn’t now that equity is so highly valued relative to earnings), but in terms of a percentage of GDP they are at least not any more levered than they were in 2008.
The implication of this fact is some rare good news: since the banking system has led the deleveraging, the systemic risk that could follow on the heels of a significant market decline is likely to be much less, at least among U.S. domestic financial institutions. So, in principal, while it was clear that a decline in equity and real estate prices in 2007-2008 would eventually cause damage to the real economy as the financial damage was amplified through the financial system, this is less true today. We can, in other words, have some reasonable market movements without having that automatically lead to recession. The direct wealth effect of equity price movements is very small, on the order of a couple of percent. It’s the indirect effects that we have to worry about, and the good news is that those indirect effects are smaller now – although I wouldn’t say those risks are absent.
Now for the bad news. The bad news is that significant market volatility – say, a 50% decline in stock prices – would likely be met with “help” from the federal government and monetary authorities. It is that help which likely would hurt the economy by increasing business uncertainty further. It is probably not a coincidence that the last couple of months, which correspond to the implementation of the Affordable Care Act, have led to some weaker growth figures. Whether change is perceived as positive or negative, it’s the constant changing of the rules – and especially now that these rules are increasingly changed by executive fiat without the moderating influence of Congress (I never thought I would write that) – that damages business confidence.
In other words, I wouldn’t be concerned about the direct economic effect of a 50% decline in equity prices; but I would be concerned if such a decline led to meddling from the Fed, the Congress, or the White House.
While investors learned the hard lessons after 2000 and 2008 about the wisdom of automatically buying dips, they eventually forgot those lessons. But that makes them almost infinitely smarter than policymakers, who have refused to learn the obvious lesson of the last few years: your ministrations do little to help, and most likely hurt. So, maybe it really is true that there are two types of people: those who listen to everybody, and those who listen to nobody. The former become investors, and the latter enter government service!
Since I wrote a blog post in early December on “The Effect of the Affordable Care Act on Medical Care Inflation,” in which I lamented that “I haven’t seen anything of note written about the probable effect of the implementation of the Affordable Care Act on Medical Care CPI,” several things have come to my attention. This is a great example of one reason that I write these articles: to scare up other viewpoints to compare and contrast with my own views.
In this case, the question is not a trivial one. Personally, I approach the issue from the perspective of an inflation wonk, but the ham-handed rollout of the ACA has recently spawned greater introspection on the question for purely political reasons. This is awkward territory, because articles like that by Administration hack Jason Furman in Monday’s Wall Street Journal do not further the search for actual truth about the topic. And this is a topic on which we should really care about a number of questions: how the ACA is affecting prices, how it is affecting health care utilization and availability, how it is affecting long-term economic growth, and so on. I will point out that none of these are questions that can be answered definitively today. My piece mentioned above speculated on possible effects, but we simply will not know for sure for a long time.
So, when Furman makes statements like “The 7.9 million private jobs added since the ACA became law are themselves enough to disprove claims that the ACA would cause the sky to fall,” we should immediately be skeptical. It should be considered laughably implausible to suggest that Obamacare had a huge and distinguishable effect before it was even implemented. Not to mention that it is very bad science to take a few near-term data points, stretching only for a couple of years in a huge and ponderous part of the economy, to extrapolate trends (this is the error that Greenspan made in the 1990s when he heralded the rise in productivity growth that was eventually all revised away when the real data was in). Furman also conflates declines in the rate of increase of spending with decelerating inflation – but changes in health care spending include price changes (inflation) as well as changes in utilization. I will talk more about that in a minute, but suffice to say that the Furman piece is pure politics. (A good analysis of similar logical fallacies made by a well-known health care economist that Furman cites is available here by Forbes.)
I want to point you to another piece (which also has flaws and biases but is much more subtle about it), but before I do let’s look at a long-term chart of medical care inflation and the spread of medical care inflation to headline inflation. One year is far too short a period to compare these two things, not least because one-time effects like pharmaceuticals losing patent protection or sequester-induced spending restraints can muddy the waters in the short run. The chart below (source: Enduring Investments) shows the rolling ten-year rise in medical care inflation and, in red, the difference between that and rolling ten-year headline inflation.
You can see from this picture that the decline in medical care inflation, and the tightening of the spread between medical care inflation and headline inflation, is nothing particularly new. Averaging through all of the year-to-year wiggles, the spread of medical care has been pretty stable since the turn of the century (which, since this is a 10-year average, means it has been pretty stable for a couple of decades). Maybe what we are seeing is actually the anticipation of HillaryCare? (Note: that is sarcasm.)
Now, the tightening relative to overall inflation is a little exaggerated in that picture, because for the last decade or so headline inflation has been somewhat above core inflation due to the persistent rise in energy prices throughout the ‘00s. So the chart below (source: Enduring Investments) shows the spread of medical care inflation over core inflation, which demonstrates even more stability and even less reason to think that something big and long-term has really changed. At least, not that we would already know about.
The other piece I mentioned, which is more worth reading (hat tip Dr. L) is “Health Care Spending – A Giant Slain or Sleeping?” in the New England Journal of Medicine. The authors here include David Cutler, whom Forbes suspected was tainting his views with politics (see link above), so we need to be somewhat cautious about the conclusions but in any event they are much more nuanced than in the Furman article and the article makes a number of good points. And, at the least, the authors distinguish between spending on health care and inflation in health care. A few snippets, and my remarks:
- “Estimates suggest that about half the annual increase in U.S. health care spending has resulted from new technology. The role of technology itself partly reflects other underlying forces, including income and insurance. Richer countries can afford to devote more money to expensive innovations.” This is an interesting observation that we ought to think carefully about when professing a desire to “bend the cost curve.” If we are reining in inflation, that’s a good thing. But is it a good thing to rein in innovation in health care? I don’t think so.
- The authors, though, clearly question the value of technological innovation. “The future of technological innovation is, of course, unknown. But most forecasts do not call for a large increase in the number of costly new treatments… some observers are concerned that a wave of costly new biologic agents (for which generic substitutes are scarce) will soon flood the market.” Heaven forbid that we get new treatments! “The use of cardiac procedures has slowed as well.” This is a good thing?
- “Health spending has clearly been associated with health improvements, but analysts differ on whether the benefits justify the cost.” Personally, it makes me uncomfortable to leave this question in the hands of the analysts. If the benefits don’t justify the cost, and the market was free, then no one will pay for those improvements. It’s only with a highly regulated market – replete with “analysts” doing their cost/benefit analysis on health care improvements – that this even comes up.
- Some of the statistical argument is a little weak. “The recent reduction in health care spending appears to have been correlated with slower employment growth in the health care field; this suggests that such changes may continue.” I’m not sure that the causality runs that way. Surely tighter limits on what health care workers can earn might cause slower employment growth? That’s at least as plausible as the direction they are arguing.
That sounds very critical, but I point these things out mainly to make them obvious. Overall, the paper does a very good job of discussing the possible causes of the recent slowdown in health care inflation (although they focus inordinately on “the first 9 months of 2013”, a period during which we know the sequester impacted health care prices), give plenty of credit to reforms instituted far before ACA implementation, correctly distinguish between utilization and prices, and highlight some of the promising trends in health care costs – and yes, there are some! The authors are clearly supportive of the ACA, which I am not, but by and large they raise the salient questions.
It matters less if we instantly agree on the solution than that we agree on the questions.
Note: The following blog post originally appeared on January 25th, 2010. I have removed the references to then-current market movements and otherwise cut the article down to the interesting bits. In this case, I have also updated the charts and clarified the text for the additional data we have since then. You can read the original post here.
…However, it supports my belief that the slide late last week isn’t (yet) the beginning of a slide into oblivion. Also supporting that point, Greece managed to sell €8 billion bonds quite easily today. I don’t really understand why it was so easy. I suppose there is a deep reservoir of people who don’t want to see a European sovereign go bust – for example, other Europeans – but it isn’t as if that 8 billion will carry Greece forever. They are in dire straits, and as I’ve pointed out here before they can’t print money and that fact is what makes a default possible. I do believe this could be the beginning of the end for the Euro, but I don’t think that end is imminent. Institutions have selfish memes and tend to protect themselves vigorously. In this case, I suspect that other European central banks, big European investors, European corporate entities…they all have a very strong vested interest in holding the Euro together, and they will do so as long as it is possible. And it will be possible for a while.
An interesting factoid that I saw on CNBC today: of companies announcing Q4 earnings so far, 9% have beaten earnings-per-share (EPS) estimates, but 65% have beaten revenue estimates. What does that mean? I think it means that margins have been lower than analysts expected (although there’s a statistical caveat, because the number of misses may or may not correlate to the size of the miss), which means that they’re buying business through lower prices or, on the other hand, are holding prices down while input costs rise. One is a disinflationary spin and one is an inflationary spin. The data suggest the latter, as inflation-other-than-housing has been percolating some, but wage growth (a big input) hasn’t exactly been robust either. I’ll call it a tie on that evidence (with respect to inflation implications), but either way tightening margins are a sign of economic weakness.
But my bigger worry is that some sharper near-term imbalances are brewing. Economic weakness we can work through, if the basic capital markets and economic structures are left in place and government doesn’t take too much of the productive capacity of the country (these assumptions are somewhat in doubt these days, but let’s look past that). What worries me in the reasonably short-term is that there are some big imbalances that are following on the heels of the imbalances that just blew up…and those just about cracked the edifice of Western civilization.
All of these imbalances are of our own making, but none has been created as fast as this one. I will do my best to explain it, and I hope that somewhere my logic falls down and someone can correct me.
When the government runs a deficit, where does it get the money so that its expenditures can exceed its revenues? It borrows, from essentially two places: domestic savers and foreign savers. In recent years, domestic savings have been low, and the government has financed its deficits more and more with money lured from foreign investors who hold dollars. Because the only reason these folks hold dollars is because we are buying more stuff from them than they are buying from us, we have a trade deficit. If domestic savings is stable, then over time the budget deficit and the trade deficit must equal; but a better way to think of this is that budget deficit = (trade deficit plus domestic savings).
This is why folks talk about the “twin deficits,” trade and budget. Large deficits can only be financed entirely from within if there is substantial domestic savings, but we have been discouraging savings for a couple of decades now. The graphic relationship is sloppy, partly because we’re not great at measuring these values and partly because domestic savings ebbs and flows, but you can see that the larger trade deficit in recent decades seems to be at least of similar magnitude as the budget deficit (Source: Economagic.com):
Well zowie…those last few points are interesting, are they not? The government is running an epic deficit, as we all know, but the trade deficit has actually improved since 2008. How is that possible? It is possible because domestic savings has been growing by trillions of dollars over the last few years.
Now, you might say “that’s great news!” except that it isn’t great news at all. The largest part of that “savings” is the money that the Fed has printed by buying Treasuries, agencies, and other collateral. This is where the rise in the money base (see chart below) is showing up.
To tie these charts together, I will note that the total rise in the balance sheet assets since August 27, 2008 has been $3.0 trillion. And the cumulative difference in the budget deficit, less the trade deficit, has been $3.1 trillion.
That’s right: the improvement in the trade deficit, despite the huge budget deficit, comes almost entirely because the Fed has provided the needed savings with its checkbook. But now here’s the problem. The Fed declares that they are not going to keep doing that, which means that (a) they’re lying, or (b) there is going to be a massive improvement in the budget deficit, soon, or (c) the trade deficit is going to start looking really, really, really bad, pretty soon.
Any guesses for (a), (b), or (c)? [Editor’s note: with hindsight, it seems that (a) really was the correct answer. It isn’t clear whether that is the correct answer today. I suspect there will be come combination of (a), (b), and (c).]
Assuming that the Fed isn’t lying, and assuming that the federal government isn’t going to find fiscal Jesus and slash a couple trillion from the deficit (as I’ve noted though, if they just don’t have any emergencies this year the deficit ought to improve a few hundred billion), then the trade deficit is going to start to look ugly. Epic ugly. Medusa-ugly.
And this leads to the worry – if the trade deficit explodes, then two other things are going to happen, although how much of each I can’t even guess: (I) protectionist sentiment is going to become very shrill, and fall on the ears of a President who is looking to burnish his populist creds, and (II) the dollar is going to be beaten like a red-headed stepchild (being a red-headed stepchild, I use that simile grudgingly).
Others – Warren Buffet is one – have publicly toted up the numbers and observed that it’s hard to figure out how we finance such deficits unless most of it comes from overseas. To entice such largesse, the currency unit will need to be cheaper, and rates will have to be higher.
This is my worry – not a global meltdown, but a U.S.-specific meltdown. Higher rates, higher inflation, lower equities, and a lot of volatility. And it may happen quickly, when it happens. [Editor’s note: Thanks to the Fed pursuing the policy in (a) above, it hasn’t yet happened!]
When might this happen? Putting dates on nightmare scenarios is ordinarily a useless chore. It is usually far better to merely be alert to possibilities and to move quickly when the rock looks like it’s toppling. But in this case, there is a particular time period I am especially concerned about: the end of March (as in, about two months from now).
The Fed is gradually reducing its purchases of MBS, with the intention of ending those purchases…in March. Also, Japanese year-end is in March, and lest we forget the Japanese represent some 20% of the foreign ownership of Treasuries. There is a reason that seasonals for the bond market are weak in the spring. If we can skate past April 1 without something serious happening, then I will breathe a sigh of relief and go back to balanced-rock-watching. But in the meantime, I sleep fitfully.
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