Home Prices – June 2009

August 29, 2009 · Posted in General Economics · 1 Comment

Home prices have risen for the second month in a row. The composite home price index rose by 1.46% from May to June. Home prices are still down 15.13% from a year ago.

Top 3 monthly price increases:

1. Cleveland, OH: 4.18%
2. San Francisco, CA: 3.78%
3. Minneapolis, MN: 3.38%

Tags: case shiller, home prices, june 2009

Federal Government Revises Deficit Forecasts as Expected

August 26, 2009 · Posted in Government · Comment

In February I wrote:

The president’s budget estimates tax receipts of $2.2 trillion, $2.4 trillion, $2.7 trillion, and $3 trillion for 2009, 2010, 2011, and 2012, respectively. These estimates are laughable. My projections for tax receipts, as I explained in The Coming US Tax Receipt Shortfall:

Federal tax receipts will fall to $2.25 trillion in 2009, to $2 trillion in 2010, to $1.75 trillion in 2011, and to $1.5 trillion in 2012. (…)

Now that we have updated figures on coming expenses it’s time to update the deficit predictions:

$1.65 trillion for 2009

$1.6 trillion for 2010

$1.95 trillion for 2011

$2.2 trillion for 2012

If President Obama keeps spending like this, and really wants to cut the deficit in half by 2013, he will at one point be faced with no other choice but to raise taxes on all Americans, rich, middle class, and poor.

Half a year later, this “surprising” and “unexpected” data finally makes it to government’s own accounting office:

In a chilling forecast, the White House is predicting a 10-year federal deficit of $9 trillion — more than the sum of all previous deficits since America’s founding. And it says by the next decade’s end the national debt will equal three-quarters of the entire U.S. economy.

But before President Barack Obama can do much about it, he’ll have to weather recession aftershocks including unemployment that his advisers said Tuesday is still heading for 10 percent.

Overall, White House and congressional budget analysts said in a brace of new estimates that the economy will shrink by 2.5 to 2.8 percent this year even as it begins to climb out of the recession. Those estimates reflect this year’s deeper-than-expected economic plunge.

The grim deficit news presents Obama with both immediate and longer-term challenges. The still fragile economy cannot afford deficit-fighting cures such as spending cuts or tax increases. But nervous holders of U.S. debt, particularly foreign bondholders, could demand interest rate increases that would quickly be felt in the pocketbooks of American consumers.

Amid the gloomy numbers on Tuesday, Obama signaled his satisfaction with improvements in the economy by announcing he would nominate Republican Ben Bernanke to a second term as chairman of the Federal Reserve. The announcement, welcomed on Wall Street, diverted attention from the budget news and helped neutralize any disturbance in the financial markets from the high deficit projections.

The White House Office of Management and Budget indicated that the president will have to struggle to meet his vow of cutting the deficit in half in 2013 — a promise that earlier budget projections suggested he could accomplish with ease.

“This recession was simply worse than the information that we and other forecasters had back in last fall and early this winter,” said Obama economic adviser Christina Romer.

The deficit numbers also could complicate Obama’s drive to persuade Congress to enact a major overhaul of the health care system — one that could cost $1 trillion or more over 10 years. Obama has said he doesn’t want the measure to add to the deficit, but lawmakers have been unable to agree on revenues that would cover the cost.

What’s more, the high unemployment is expected to last well into the congressional election campaign next year, turning the contests into a referendum on Obama’s economic policies.

Republicans were ready to pounce.

“The alarm bells on our nation’s fiscal condition have now become a siren,” said Senate Minority Leader Mitch McConnell of Kentucky. “If anyone had any doubts that this burden on future generations is unsustainable, they’re gone — spending, borrowing and debt are out of control.”

Even supporters of Obama’s economic policies said the long-term outlook places the federal government on an unsustainable path that will force the president and Congress to consider politically unpopular measures, including tax increases and cuts in government programs.

“The numbers today portend the biggest budget fight we’ve probably had in decades in the United States,” said Stan Collender, a former congressional budget official.

The summer analyses by the White House budget office and by the Congressional Budget Office reached similarly bleak conclusions. The CBO’s 10-year deficit figure was smaller — $7 trillion — but that is because it assumes that all tax cuts put into place in the administration of former President George W. Bush will expire on schedule by 2011. Obama’s budget baseline, however, hews to his proposal to keep the tax cuts in place for families earning less than $250,000 a year.

Both budget offices see the national debt — the accumulation of annual budget deficits — as more than doubling over the next decade. The public national debt, made up of amounts the government owes to the public, including foreign governments, stood Tuesday at a staggering $7.4 trillion. White House budget officials predicted it would reach $17.5 trillion in 2019, or 76.5 percent of the gross domestic product. That would be the highest proportion in six decades.

And of course the public debt to GDP ratio’s increase to 76% should not come as a surprise either. In fact, I would be surprised if it didn’t blow right pass that. I shall conclude with more of what I already said a while back:

From 1989 on, the Japanese government has launched one stimulus after another to no avail, leaving Japanese taxpayers with the largest public debt per capita of all industrialized nations.

A burden that the US government seems to be more than willing to have its taxpayers shoulder over the years to come unless someone picks up a history book and tries not to feverishly repeat mistakes others made in the past.

Thus the long term outlook for the US economy is the fate Japan took: A long lasting correction supercycle with one failing “stimulus” program after another, and with on and off periods where the economy slips out of and back into recessions from time to time.

There is an easy way to be on top of such developments: Don’t listen to what the government and all its apologetics tell you. Listen to your own logic and your own reason and you won’t need to be surprised as the inevitable truth comes out sooner or later.

Tags: budget deficit, federal government, public debt

Roubini Sees Risk of Double Dip Recession

August 23, 2009 · Posted in General Economics · Comment

Reuters writes:

Nouriel Roubini, one of the few economists who accurately predicted the magnitude of the world’s recent financial troubles, sees a “big risk” of a double-dip recession, according to an opinion piece posted on the Financial Times’ website on Sunday.

Roubini, a professor at New York University’s Stern School of Business, said it appears the global economy will bottom out in the second half of this year, and that U.S. and western European economies will likely experience “anemic” and “below trend” growth for at least a couple of years.

Yet he warned that policymakers face a “damned if they do and damned if they don’t” conundrum in trying to unwind their massive fiscal and monetary stimuli to keep the global economy from toppling into a depression.

He said that if policymakers try to fight rising budget deficits by raising taxes and cutting spending, they could undermine any recovery.

On the other hand, he said if they maintain large deficits, worries about excessive inflation will grow, causing bond yields and borrowing rates to rise and perhaps choking off economic growth.

Roubini said another reason to worry is that energy, food and oil prices are rising faster than fundamentals warrant, and could be driven higher by speculation or if excessive liquidity creates artificially high demand.

He said the global economy “could not withstand another contractionary shock” if speculation drives oil rapidly toward $100 per barrel. U.S. crude oil futures traded Friday at about $73.83.

Roubini said the anemic growth he expects would follow a couple of quarters of rapid growth, as inventories and production levels recover from near-depression levels.

This is more or less consistent with my long term outlook.

Thus the long term outlook for the US economy is the fate Japan took: A long lasting correction supercycle with one failing “stimulus” program after another, and with on and off periods where the economy slips out of and back into recessions from time to time.

Tags: double dip recession, roubini

Baltic Dry Shipping Index Drops to 3 Month Low

August 21, 2009 · Posted in Investing · 6 Comments

Today the Baltic Dry Shipping Index dropped to a 3 month low:

This certainly does not bode well for commodity bulls. On a related note, please consider Commodities Poised to Crash Again Soon?.

Tags: baltic dry index, baltic dry shipping index, commodities

The Austrian Business Cycle Theory – Insufficient (but NOT Wrong) at Explaining the Current Financial Crisis

August 21, 2009 · Posted in General Economics · 15 Comments

Recently a fellow Austrian commented on my post Austrian Economists Need to Get Their Business Cycle Theory Straight. I will post his statements from Correction on the Austrian Business Cycle Theory and comment on them when necessary:

One criticism that has come up is that the Austrian theory does not fit the fact that during the boom years there was both an increase in capital-goods and in consumer-goods. The assumption is that the Austrian theory suggests that during the boom years there is an increase in the production of capital-goods and a decrease in the production of consumer-goods. This is incorrect. The Austrian theory takes into consideration an increase in both, which is what causes unsustainable economic growth.

No, this was not my criticism. First of all, I am not criticizing the ABCT as such. It explains properly all the events that ensue upon credit expansion of credit that is used to purchase capital goods. But it leaves out the possibility that the majority of new credit might not be used to purchase factors of production, but to purchase consumer goods instead. In fact, such an event, as Rothbard himself admits does NOT fall under the workings of the ABCT:

Mises did not deal with the relatively new post-World War II phenomenon of large-scale bank loans to consumers, but these too cannot be said to generate a business cycle. Inflationary bank loans to consumers will artificially deflect social resources to consumption rather than investment, as compared to the unhampered desires and preferences of the consumers.

But they will not generate a boom-bust cycle, because they will not result in “over” investment, which must be liquidated in a recession. Not enough investments will be made, but at least there will be no flood of investments which will later have to be liquidated. Hence, the effects of diverting consumption investment proportions away from consumer time preferences will be asymmetrical, with the overinvestment-business cycle effects only resulting from inflationary bank loans to business.

I am merely pointing out that what happened over the past 20 years is simply not covered by a theory that primarily focuses on the excessive extension of business credit.

My criticism is not that it doesn’t explain why we had an increase in both capital and consumer goods. A theory that deals with government intervention doesn’t assert absolutes. It merely analyzes why certain developments deviate from what would have happened in the unhampered market. We may very well have both capital and consumer goods production rise in absolute terms throughout the entire episode of credit expansion.

What I am saying is that it doesn’t explain why over the past 20 years, inside the US businesses have produced more consumer goods than they would have, and produced fewer investment goods than they would have, had the market been unhampered. The relative ratio of consumer goods produced to capital goods produced grew, for the most part, constantly from 1981 through 2006:

By the way: Even if you wanted to count houses as capital goods for whatever reason, you would STILL end up with a relative growth in the production of consumer versus capital goods.

It is this phenomenon that the conventional ABCT simply doesn’t cover and, I may add to Mises’ defense, doesn’t want to cover. We will see later to what misconceptions, misinterpretations this leads when we try to apply Mises’ business cycle theory to current and recently past events.

The difference is that the Austrian theory forecasts that the capital-goods sector will be hit harder than the consumer-good sector, and so far that has proven to be true.

Ironically, it is precisely this that has not proven to be true. One look at the current employment and business landscape shows us: Most people are losing their jobs and most businesses are failing or reporting losses in real estate, residential construction, autos, and mortgage banking. In addition to that we are on the brink of a collapse in commercial real estate due to unprecedented shop and mall vacancies.

Throughout the boom years an excessive number of huses was built, and excessive number of homes were flipped, an excessive number of cars was produced, strip malls, nail salons, beauty salons, Starbucks cafes, and the like popped up left and right. Numerous people were employed in all these fields and in that field which fueled it all: banking. Naturally everyone frets about a decline in the production of consumer goods, simply because this constituted until recently over 90% of production in the US (again, see chart above).

Meanwhile, we were able to witness the opposite trend when it came to the capital goods industry. Factories and production of machinery was, as a tendency, outsourced to China, Mexico, Germany, Japan, and other countries. It would be, at the very least, quite a stretch to say that our recent excesses were visible in the capital goods industry, while they were everything but screaming at you in the consumer goods sector.

Again, this change in ratio between consumer and capital goods production is not covered by the conventional ABCT.

In fact, the entire theory bases its argument on the fact that there was a decrease in the rate of savings during the years of the money supply boom. It is believed that businesses are pushed to invest when there is a rise in the rate of savings, due to a fall in the interest rates of loans. In the case of a credit boom, the artificial decrease of interest rates due to the expansion of the monetary base by the Federal Reserve leads businesses to invest.

… and to invest means to purchase factors of production, capital goods. And factors of production are purchased when loans for such purposes are made. But when the majority of excessive loans are made for the purpose of purchasing consumer goods, viz mortgage loans, car loans, credit cards and the like, investment falls behind, purchases of capital goods fall behind, and consumption along with the production of consumer goods gains in relative terms against the production of capital goods, as I explained above. Thus much more than pushing businesses to invest, the recent credit expansion pushed consumers to consume.

At the end of this boom, whether when the Federal Reserve decelerates the creation of money or when the people lose confidence in the value of the currency being used, businesses find that without a corresponding increase in the rate of savings their investments failed to pay off, because nobody put aside savings to purchase these once future-goods. And so, it would only make sense that there was an increase in consumer spending during the boom years.

Again, the author is going to have a hard time to explain contemporary phenomena via the above paragraph. First of all, the boom came to a halt when lenders realized that money that was loaned out would not be paid back, when people began to foreclose on loans at an accelerating pace. The loaned money was spent on consumption, and thus did not increase the borrower’s productivity to pay off his loans. But contrary to what the author said above, these goods were already purchased. All the homes, cars, and credit cards that could never be paid off were already obtained in the past, it is not that people expected them to be purchased in the future. It is not true that “investments failed to pay off, because nobody put aside savings to purchase these once future-goods”. The goods were purchased in the past, what was lacking in the future was money earned to repay the loans made, due to a lack of increased productivity.

When it became clear that most loans would never be paid back a scramble for real, earned cash ensued along with evaporating credit claims, a deflation. This is the exact opposite of a “loss of confidence in the currency used”.

When people realized they hadn’t saved enough, they cut down on consumption. When they cut down on consumption, all those consumer based businesses that at this point made up over 90% of the US economy were facing inventory overhang, they now have to cut prices, cut production, some of them have to go out of business. This is what we are in right now. The only way the US is going to come out of this malaise it to cut down on the production of consumer goods from previous levels, and make room for the production of capital goods, a restoring of the balance back to historical averages in the ratio between the production of consumer vs. capital goods.

Economic historian Thomas Woods explains it for the layman:

The central bank’s lowering of the interest rate therefore creates a mismatch of market forces. The coordination of production across time is disrupted. Long-term investments that will bear fruit only in the distant future are encouraged at a time when the public has shown no letup in its desire to the consume in the present. Consumers have not chosen to save and release resources for use in the higher stages of production. To the contrary, the lower interest rates encourage them to save less and thus consume more, at a time when investors are also looking to invest more resources. The economy is being stretched in two directions at once, and resources are therefore being misallocated into lines that cannot be sustained over the long term (Woods, Meltdown, 68).

Interestingly I talked to Tom Woods about precisely this: Again, he correctly argues what happens during an expansion of business credit. Yes, I do understand it. I wrote about it myself in what I call the production business cycle. But he does not explain how increased consumption demand from consumers is actually met with increased production from producers of consumer goods vs. just price increases of consumer goods. He then pointed me to Robert Murphy’s article The Importance of Capital Theory, which is perfect because ironically it confirmed my thesis. In response to this article I wrote:

Robert Murphy’s Sushi is actually a perfect example for what I propose to call the consumption business cycle. In his example, more resources are allocated to the production of consumer goods (gathering rice, catching fish), and fewer are being allocated to the upkeep of capital goods (maintenance of boats and fishnets).

During the equilibrium state 25 people were employed in the capital goods industry. After Krugman’s advice it’s only 10 people, out of which only 5 perform the criucial task of boat maintenance. He perfectly explains the phenomenon of increased consumption and corresponding production of consumer goods, but it does not occur due to a channeling of resources away from short term projects toward longer term projects. In fact, it occurs due to the exact opposite. Resources are taken from projects that yield an output at a later point in time (maintaining boats), and are directed toward projects that yield an immediate output (collecting rice, fish, and combining the two).

The Austrians’ focus on the capital-goods industry is simply based on the fact that the capital-goods industry is usually hit worse than that of consumer-goods. At the end of the boom stage, ventures that were once considered profitable are found to be unprofitable. There is a sudden decrease in investment. Capital-goods which were manufactured for new investment projects are suddenly found unused, as businesses are no longer willing to risk investment.

But please, look around you. Do you think this crisis primarily came about due to an overhang in the production of industrial robots, unfinished production facilities, an excessive number of energy plants, oil rigs, and the like? Is this what you see when you walk through the streets, look at the news, read the papers?

Isn’t it rather obvious that we are primarily faced with a massive overhang in consumer goods, such as houses, cars, strip malls, Starbucks branches, nail salons, beauty salons, energy drinks, shampoos, fast food stores, kitchen appliances, flat screen TVs, etc. ?

Isn’t it, furthermore, obvious that we have, at least as a tendency, lost most of our productive capacity to foreign countries, precisely because we have neglected it relative to consumer goods?

You can change reality by squeezing it into a concept that doesn’t apply to what actually happened. But then you have done just that: You have changed reality. The purpose of scientific discourse, however, is to interpret reality, not to violate it. :)

This may come about due to an increase in the interest rate, or because it is a time of uncertainty (a more likely explanation for the current recession, given that interest rates are still near zero). A drop in demand for consumer-goods necessarily follows. There is an increase in frictional unemployment, as workers which once labored in the capital-goods industry must find employment elsewhere (Rothbard, America’s Great Depression, p. 21). Also, a degree of economic uncertainty contributes to an increase in the rate of savings, and households are forced to save due to an increase in household debt during the boom years (credit was easy to access, allowing households to spend beyond their paycheck). Rothbard writes in America’s Great Depression:

A favorite explanation of the crisis is that it stems from “underconsumption”—from a failure of consumer demand for goods at prices that could be profitable. But this runs contrary to the commonly known fact that it is capital goods, and not consumer goods, industries that really suffer in a depression. The failure is one of entrepreneurial demand for higher order goods, and this in turn is caused by the shift of demand back to the old proportions (Rothbard, 19).

As can be seen the Austrians do not claim that during a credit boom there is a lack of increase in the demand for consumer goods. In actuality, the claim is the exact opposite. Austrians criticize the simultaneous increase in demand for capital and consumer goods, given that they believe that true economic growth is brought about through capital accumulation, or savings.

And again, this completely misses the point. I never said that the Austrians claim that there is a lack of increase in the demand for consumer goods. I said that the conventional ABCT, as even admitted by Rothbard himself, was not conceived to explain an expansion of consumption credit and the ensuing tendency in the economy to produce relatively more consumer goods than capital goods.

Tags: austrian business cycle theory, business cycle

Fixing US Health Care Once And For All – 5 Crucial Steps

August 20, 2009 · Posted in General Economics · 6 Comments

The root causes of the problems with health care in the US

The problem with health care in the US, but in virtually every other country in the world as well, is a simple one: The goods (products and services) offered on the market that address illnesses and and improve our well being are offered at prices that are so high that most consumers are unable to afford a sufficient amount to address their demands.

On top of that, these prices are continuously rising. All other health care issues stem from this simple fact. Health insurance premiums, for example, are charged based on the prices that competing insurers expect to end up paying for health care goods. Thus, naturally, health insurance premiums are on the rise as well, even in the current deflationary environment. The rapid increase in government expenses for its entitlement programs Medicare and Medicaid, too, is simply the result of these ongoing price increases. It is thus not a coincidence that today the US government spends more than any other industrialized nation on health:

On the market, such imbalances are, under free competition, swiftly addressed via a simple process: High prices for certain consumer goods indicate a high demand and an insufficient supply. Thus profit seeking entrepreneurs have an incentive to shift from what they are currently doing to focusing on producing more of such highly demanded goods, by employing more commensurate factors of production that turn out the demanded goods. This leads to a decline in their prices, moving the market closer to equilibrium and thus restoring balance.

But when a group of people which obtains its means of operation via aggression and theft, the government, imposes decrees that prevent the voluntary market participants to perform such balancing acts, and threaten them with imprisonment and fines should they not oblige, the imbalance will persist. If that group’s actions are such as to bring about even more shortages for the demanded goods, the imbalance will grow, prices will keep rising.

As an outcome of such an interventionist policy, there will always be a small group of entrepreneurs that benefits from the protection awarded against competition and voluntary action on the part of consumers and new entrepreneurs. They naturally reap the benefits from the ability to charge prices that are not being bid down by potentially competing entrepreneurs. It is important to keep this fact in mind when members of such groups utter statements that attempt to justify the policies that have brought about and continue to maintain the imbalance.

If those who run the government desire, as they profess, to remedy such an imbalance, the course of action they need to take is just as simple as the problem: lift all those decrees that hinder consumers and entrepreneurs from fixing the imbalance.

Moving forward, I will outline 5 simple steps that the US government needs to take in case it is interested in addressing the precise pain points that have precipitated the imbalance outlined above:

5 steps toward affordable health care

1. Get rid of government enforced AMA privileges, restrictions, and monopolies

The American Medical Association (AMA) has, over the course of the past 160 years, done everything possible to utilize government power in order to restrict the amount of health care services, the number and efficiency of health education facilities, the access to drugs in pharmacies, price transparency and negotiation, and the practice of alternative health approaches. It has deliberately and happily reduced the availability of goods that address consumers’ health care needs, leaving many consumers in a desperate situation at the benefit of those doctors whose privileged position it has been protecting.

It is certainly not easy to back up such an outrageous charge against the AMA. Fortunately we have a rather reliable companion to corroborate our accusation – the AMA itself:

… in 1901 the Journal of the American Medical Association released the following statement: “The growth of the profession must be stemmed if individual members are to find the practice of medicine a lucrative profession.”

In order to achieve these objectives, the AMA lobbied heavily with state and federal government institutions – with remarkable success. As Lew Rockwell notes:

To help bring about a higher-paid profession, the AMA in 1904 created the Council on Medical Education, which sought to shut down more than half the existing medical schools by rating them on a scale of A to C. In cooperation with State medical boards composed of what Arthur Dean Boran, head of the council, called the “right sort of men,” the AMA succeeded in cutting the number of schools to 131 by 1910, from a high of 166.

Then the council’s secretary N.P. Colwell helped plan (and some say write) the famous 1910 report by Abraham Flexner. (…)

The Flexner Report was more than an attack on free competition funded by special interests. It was also a fraud. For example, Flexner claimed to have thoroughly investigated 69 schools in 90 days, and he sent prepublication copies of his report to the favored schools for their revisions. Homeopaths noted that his authority derived solely “from an unlimited access to the pocketbook of a millionaire.” Homeopaths did not use synthetic drugs, of course. John E. Churchill, president of the Board of Education of New York, called the report a “menace to the freedom of teaching.” Years later, Flexner admitted that he knew nothing about medical education. But he did not need to in order to serve his employers’ purposes.

Flexner’s attack, stepped up by the AMA’s Council on Medical Education and its State medical boards, closed 25 schools in three years, with more over the years to come, and cut the number of students attending the remaining schools in half. All non-mainstream practitioners were targeted. For example, from the early part of the century, consumers preferred optometrists to ophthalmologists on grounds of both service and price. Yet the AMA derided the optometrists as quacks, and in every State, the AMA-dominated medical boards imposed restrictions on these and other “sectarian” practitioners when they could not outlaw them entirely.

Homeopathy still had a remnant of about 13,000 practitioners, supported by a fiercely loyal customer base, but decades of well-financed attacks had taken their toll. The battle-weary Homeopaths eventually gave in, conceding major parts of their doctrine, but the AMA was not satisfied with anything less than total victory, and today, American Homeopaths practice mostly underground.

With its monopoly, the AMA sought to fix prices. Early on, the AMA had come to the conclusion that it was “unethical” for the consumer to have any say over what he paid. Common prices were transmuted into professional “fees,” and the AMA sought to make them uniform across the profession. Lowering fees and advertising them were the worst violations of medical ethics and were made illegal. When fees were raised across the board, as they frequently could be with decreased competition, it was done in secret.

The AMA, in its constant quest for higher incomes through lower competition, also battled churches and other charities that gave free medical care to the poor. Through lobbying, it attempted to stamp out what it called “indiscriminate medical charity.” A model 1899 law in New York put the control of all free health care under a State Board of Charities dominated by the AMA. To diminish the amount of free care, the board imposed fines and even jail terms on anyone giving treatment without first getting the patient’s address and checking on his financial status.

Then there was the problem of pharmacists selling drugs without a doctor’s prescription. This was denounced as “therapeutic nihilism” and the American Pharmaceutical Association, controlled by the AMA, tried to stamp out the low-cost, in-demand practice. In nearly every State, the AMA secured laws that made it illegal for patients to seek treatment from a pharmacist. But still common were pharmacists who refilled prescriptions at customer request. The AMA lobbied to make this illegal, too, but most State legislatures wouldn’t go along with this because of constituent pressure. The AMA got its way through the federal government, of course.

There were other threats that also had to be put down: “nostrums,” treatments that did not require a visit to the doctor, and midwives, who had better results than doctors. Also a danger was “contracting out,” a company practice of employing physicians to provide care for its workers. This was “unethical,” said the AMA, and should be illegal. Fraternal organizations that contracted out for their members were put out of business with legislated price controls, and hospitals – whose accreditation the AMA controlled – were pressured to refuse admittance to patients of contracting-out doctors.

By the end of the Progressive Era, the orthodox profession as led by the AMA had triumphed over all of its competitors. Through the use of government power, it had come to control education, licensure, treatment, and price. Later it outcompeted fraternal medical insurance with the State-privileged and subsidized Blue Cross and Blue Shield. The AMA-dominated Blues, in addition to other benefits, gave us the egalitarian notion of “community rating,” under which everyone pays the same price no matter what his condition.

Thus, more importantly than anything else, the federal government needs to lift all federal laws, rules, and decrees that restrict the supply of health care services and stifle competition between health care providers. Regulatory hurdles for alternative medicine and services performed by non-doctors, such as registered nurses need to be removed.

There is a hole slew of health services that can be performed without knowledge of biochemistry, neural sciences, or similar fields. Lots of diseases can be diagnosed rather easily and treated just as easily.

Interestingly, nurses are very popular with many people because they are known to take a more holistic and personable approach to dealing with patients’ concerns.

Anyone in favor of the status quo, such as AMA members will come up with an entire list of arguments against such changes in the system. This should not surprise us, as I outlined above: There will always be a small group of entrepreneurs that benefits from the protection awarded against competition and voluntary action on the part of consumers and new entrepreneurs (in this case alternative practitioners and nurses).

There will be the most popular argument of safety and protection against quacks. But how about we let the consumers and independent rating agencies make this decision? What gives us the right to force them into arrangements? If these potential competitors are all quacks, then surely their customers and professional raters will post horrible reviews on Yelp.com and other sites and drive tons of traffic back to AMA approved doctors. On top of that, how do we know the state commissioners are such better raters than the customers and competing agencies?

To bring up an example in a different field, when you are looking for a good restaurant, whom do you trust more? Private raters such as Zagat and Michelin, or the FDA? Who trusts a monopoly institution which has no pressure of performing over a profit seeking entrepreneur whose very existence depends upon making successful recommendations? I will not here delve into the terrible judgment that the FDA has displayed again and again when it came to approving drugs, and the many people whose lifes have been destroyed, if not taken, due to malpractice on the part of these bureaucrats.

In fact, ironically, under free competition consumers would be a lot more safe than they are under a system where the current sellers are constantly protected against and unchecked by potential competitors. If state licensure were so indispensable, why don’t we do away with free competition in all other fields? Why not let all services be sanctioned by a federal board and protected against more apt service providers? Because it doesn’t make any sense at all.

All other arguments you will hear against free enterprise from those who are privileged by a government enforced monopoly can be debunked just as easily and need not concern us at this very point.

2. Legalize importation of drugs

What I wrote regarding doctors and the AMA applies almost verbatim to pharmaceuticals and the The Food and Drug Administration (FDA). Pharmaceutical corporations in the US have, over decades, pushed through federal regulation that shields them from competition. The Food and Drug Administration (FDA) acts as their protector and deliberately restricts the supply of pharmaceuticals that are available on the market, all in the name of “drug safety”.

An important part of limiting the supply of goods is always restricting importation from abroad. Federal legislation, as per US Code Title 21, 384 prohibits and restricts the importation of prescription drugs from abroad. Where it permits it, it imposes burdensome rules and restrictions, the compliance with which costs time and money which, again, makes these goods more expensive to the consumer than they could be.

The quickest and most effective way to put an end to this would be to lift the ban on the importation of drugs from abroad. If our domestic drugs are so much better an safer, then surely the domestic producers should be delighted about an influx of inferior products which will only reaffirm their position as producers of quality. But what if the imported drugs are actually just as good, or better, or cheaper than domestically produced drugs. Well, this would precisely constitute the other piece of our puzzle.

While the AMA has, through federal and state legislation, restricted the number of practitioners available, and prolonged the process of educating such professionals, the pharmaceutical corporations have, through the FDA, limited the amount of drugs on the market and prolonged their approval processes, shutting out small innovative entrepreneurs with less means at their hands, and foreign producers who might have better and certainly cheaper drugs to offer.

Allow at least pharmacists and doctors to import pharmaceuticals from abroad, and prices for such goods will fall rapidly, getting us closer to a state of affairs where medication is affordable to everybody.

3. Allow Medicare/-aid to negotiate prices with drug companies

The federal government collects Medicare and Medicaid taxes from employees to pay for these two programs. This in itself is bad enough. But at the very least, if they do so, they should assure us that they put this tax money to proper use and that they will try to get the best deals out of any purchases they make on our behalf. This in itself is virtually impossible due to the Trouble With Bureaucracy. But it is downright destructive if the law completely prohibits Medicare/-aid purchasers from negotiating with the drug companies. Such is unfortunately the case, due to a program called Medicare Part D:

By the design of the program, the federal government is not permitted to negotiate prices of drugs with the drug companies, as federal agencies do in other programs. The Veterans Administration, which is allowed to negotiate drug prices and establish a formulary, pays 58% less for drugs, on average, than Medicare Part D. For example, Medicare pays $785 for a year’s supply of Lipitor (atorvastatin), while the VA pays $520. Medicare pays $1,485 for Zocor, while the VA pays $127. Former Congressman Billy Tauzin, R-La., who steered the bill through the House, retired soon after and took a $2 million a year job as president of Pharmaceutical Research and Manufacturers of America (PhRMA), the main industry lobbying group. Medicare boss Thomas Scully, who threatened to fire Medicare Chief Actuary Richard Foster if he reported how much the bill would actually cost, was negotiating for a new job as a pharmaceutical lobbyist as the bill was working through Congress.

This creates nothing but a giant bonanza for these corporations, and ends up driving up costs to everyone.

Change these nonsensical laws, allow the DHS to negotiate drug prices and another important step toward lowering health care cost is taken.

4. Repealing the Kefauver Harris Amendment from 1962.

I outline why in more detail here:

It is being estimated that drugs could cost about 80%(!!) less if it weren’t for these burdensome regulations. In addition to that, innovation has been stifled immensely. Most people don’t even begin to realize what a great health system would be possible if our government simply reduced its excessive meddling.

… ideally, just scrap the entire monstrosity that is the FDA and be done with it.

5. Abolish Patent Laws

Patent laws are mostly favored by supposed free marked economists. But patent legislation leads to nothing but another state enforced monopoly. Pharmaceutical companies have been the biggest beneficiaries of US patent law as can be seen in their margins and profitability, keeping away competition and pushing up prices. Moreover, there is no historical evidence or tenable conceptual logic that corroborates the notion that patent laws foster competition, in fact, quite the opposite is true.

By the way, here is a very informative and entertaining lecture on patent law by patent lawyer and Austrian economist Stephen Kinsalla.

Moving forward

There are many other things that can and must be done in the long run. The government will have to get out of the way of restricting competition between health insurance providers across state borders, Medicare and Medicaid will have to be phased out for new workers who join the workforce, by enabling them to choose between paying taxes or paying the money into their own health savings account. And there are probably myriad other things that the government needs to be removed from in order to allow for a dynamic and efficient health care market.

But without addressing the 5 steps I outlined above, all other efforts will be completely and absolutely futile. Without addressing the root of high health care costs, it does not matter whether we let government alone take care of health insurance, or whether we completely liberalize the health insurance market. Nothing would change substantially. We would still be paying high premiums that go into a pool that pays for overly expensive health care products and services. We would still be faced with an inherent shortage of health care goods and services.

If the cost for medical products and services were to come down significantly, it won’t even be necessary to have an insurance for regular treatments and checkups. Most expenses could be paid out of pocket. There exists no other market where routine procedures and operations are so expensive that people need insurance to cover them. Insurance, by its very definition and in every other field, is supposed to be for rare and catastrophic events only.

Only by tackling the root structural, regulatory, and political causes of our problems will we make the dream of affordable health care for everyone a reality.

Update: I added points 4 and 5 after publishing this post.

Tags: health care, medicaid, medicare

Bank Loans Marked to Fantasy – The Next Bubble to Burst

August 19, 2009 · Posted in General Economics · Comment

I came across this interesting Bloomberg article in Mish’s blog, Next Bubble to Burst Is Banks’ Big Loan Values: Jonathan Weil:

Check out the footnotes to Regions Financial Corp.’s latest quarterly report, and you’ll see a remarkable disclosure. There, in an easy-to-read chart, the company divulged that the loans on its books as of June 30 were worth $22.8 billion less than what its balance sheet said. The Birmingham, Alabama-based bank’s shareholder equity, by comparison, was just $18.7 billion.

So, if it weren’t for the inflated loan values, Regions’ equity would be less than zero. Meanwhile, the government continues to classify Regions as “well capitalized.”

While disclosures of this sort aren’t new, their frequency is. This summer’s round of interim financial reports marked the first time U.S. companies had to publish the fair market values of all their financial instruments on a quarterly basis. Before, such disclosures had been required only annually under the Financial Accounting Standards Board’s rules.

The timing of the revelations is uncanny. Last month, in a move that has the banking lobby fuming, the FASB said it would proceed with a plan to expand the use of fair-value accounting for financial instruments. In short, all financial assets and most financial liabilities would have to be recorded at market values on the balance sheet each quarter, although not all fluctuations in their values would count in net income. A formal proposal could be released by year’s end.

Recognizing Loan Losses

The biggest change would be to the treatment of loans. The FASB’s current rules let lenders carry most of the loans on their books at historical cost, by labeling them as held-to- maturity or held-for-investment. Generally, this means loan losses get recognized only when management deems them probable, which may be long after they are foreseeable. Using fair-value accounting would speed up the recognition of loan losses, resulting in lower earnings and reduced book values.

While Regions may be an extreme example of inflated loan values, it’s not unique. Bank of America Corp. said its loans as of June 30 were worth $64.4 billion less than its balance sheet said. The difference represented 58 percent of the company’s Tier 1 common equity, a measure of capital used by regulators that excludes preferred stock and many intangible assets, such as goodwill accumulated through acquisitions of other companies.

Wells Fargo & Co. said the fair value of its loans was $34.3 billion less than their book value as of June 30. The bank’s Tier 1 common equity, by comparison, was $47.1 billion.

Please also consider what I posted in April regarding GE & Mark to Market:

The world’s biggest maker of jet engines and power turbines told shareholders last week that 2 percent of GE Capital Corp.’s assets are being valued based on market prices. The remaining $624 billion is being carried at levels that GE, the last original member of the Dow Jones Industrial Average, established in many cases years ago, according to CreditSights Inc.

“The notion of having 98 percent opaque and 2 percent valued with clarity is something that by its very nature would make investors nervous,” said Robert Arnott, founder of Research Affiliates LLC, which oversees $30 billion in Newport Beach, California and owned 481,201 GE shares as of Dec. 31. “Having some clarity on what the other 98 percent is worth is valuable.”

98% valued at fantasy prices, 2% at real world prices means that there is nothing but trouble down the road for GE.

I noted recently in Total US Credit and Loans – How Much Contraction Since Peak?:

Since the peak in October 2008, total credit and loans/leases outstanding have fallen by $725 billion, a 4.3% drop. And this doesn’t even take into account the decline in outstanding bond prices and unfunded liabilities. It is, indeed, tough to ascertain whether there is a decline in the net present value of unfunded liabilities. Thus we shall ignore them for now. However, bond prices have definitely declined across the board.

On top of that, I don’t think that people are oblivious to the fact that there is absolutely no way that all social security and medicare benefits will ever be paid. Thus it would only be reasonable to conservatively assume that the present value of those liabilities has dropped by the same amount. This would almost double the total contraction to around $4 trillion.

It is rather questionable whether all this credit is marked to market. I would say that all this number gives us at the moment is at the low end of the range.

The real contraction is obviously much more than stated in official reports. This may change in case the FASB follows through on its planned changes to accounting rules. It is rather remarkable that in spite of false over reporting of loan values, credit is contracting at this pace. I ask: How much will it be once they have to report real losses?

Whether they change the rules of this delusion game sooner or later or not at all. Bank loans are reported at ridiculous values and there is no chance of a substantial recovery until and unless the bad apples are sorted out.

Tags: bank loans, credit, loans, mark to market

Producer Prices July 2009 – All Time Record Declines Across the Board

August 18, 2009 · Posted in General Economics · 1 Comment

The BLS Reports Producer Price Data for July 2009:

The Producer Price Index for Finished Goods declined 0.9 percent in July, seasonally adjusted, the Bureau of Labor Statistics of the U.S. Department of Labor reported today. This decrease followed advances of 1.8 percent in June and 0.2 percent in May. At the earlier stages of processing, prices received by manufacturers of intermediate goods moved down 0.2 percent in July after rising 1.9 percent in the prior month, and the crude goods index fell 4.5 percent following a 4.6-percent increase in June. (See table A.)

The downturn in finished goods prices was broad based. The index for energy goods fell 2.4 percent in July after climbing 6.6 percent a month earlier, prices for consumer foods decreased 1.5 percent following a 1.1-percent advance in the previous month, and the index for goods other than foods and energy edged down 0.1 percent compared with a 0.5-percent rise in June.

Before seasonal adjustment, the Producer Price Index for Finished Goods decreased 0.9 percent in July to 172.6 (1982 = 100). From July 2008 to July 2009, prices for finished goods fell 6.8 percent, the index for intermediate goods decreased 15.1 percent, and crude goods prices dropped 44.8 percent, all of which are record 12-month declines. Over the same period within finished goods, the index for energy goods fell 29.7 percent, prices for consumer foods moved down 4.2 percent, and the index for goods other than foods and energy rose 2.6 percent.

Seasonally adjusted, producer prices fell by 11.7 percent from 1 year ago, also an all time record:

… as we can see, deflation not only continues to run its course, but its impacts are showing at an accelerated pace and increasing magnitude.

Tags: july 2009, ppi, producer price index

Federal Reserve Continues to Push on a String

August 17, 2009 · Posted in General Economics · 1 Comment

The AP noted today that With credit tight, Fed extends consumer loan plan:

With banks limiting the availability of auto, student and other consumer loans, the Federal Reserve said Monday it would extend a program intended to help spur more lending at low rates.

The program is set up to provide up to $1 trillion in low-cost financing to investors to buy securities backed by consumer and commercial loans. But private economists said the program, Term Asset-Backed Securities Loan Facility, or TALF, has so far provided little benefit for consumers and businesses still struggling to get credit.

The program, originally set to expire at the end of the year, has two parts.

The part aimed at boosting consumer and business lending is being extended through March. The part geared toward boosting new commercial real estate lending will run through June, because of the extra time typically needed to complete such deals. Delinquency rates on such loans have soared as companies have downsized or closed their doors, the Fed has said.

TALF was created in March, part of the efforts by the Fed and the Obama administration to ease credit, stabilize the financial system and fight the recession. Under the program, the Fed allows for low-rate financing for investors to buy securities backed by credit card debt, auto loans, student loans and loans to small businesses. The market for such loans essentially froze up last fall with the eruption of the worst financial crisis since the Great Depression.

The program has the potential to generate up to $1 trillion in lending, according to the government. But participation has been scant: As of Aug. 12, the value of loans outstanding stood at just $29.6 billion.

To get an idea of how successful the Fed’s program to bring back consumer lending has been, please consider the latest update on consumer credit:

In June 2009 total consumer credit volume dropped to $2.48 trillion. It fell by $17.2 billion (0.7%) from May 2009 and a total of $110.5 billion (4.3%) since its peak in December 2008; an ongoing corollary of deflation, overall contraction, and ending consumerism.

It is important to understand what is so misguided about these ideas. We hear it again and again, how the Fed will continue to push for more credit, borrowing, lending, consumption, etc. Rarely ever do we hear the question asked “Do people want any more debt?”. The simple answer: No. People are sick and tired of debt. The Fed can try as much as it wants, it won’t be able to force lending. When people have had enough they have had enough.

Since this causality is not intuitive for everyone to understand, Robert Prechter came up with a neat example that explains the concept a little better, I already posted it before:

Jaguar Inflation

I am tired of hearing people insist that the Fed can expand credit all it wants. Sometimes an analogy clarifies a subject so let’s try one.

It may sound crazy, but suppose the government were to decide that the health of the nation depends upon producing Jaguar automobiles and providing them to as many people as possible. To facilitate that goal, it begins operating Jaguar plants all over the country, subsidizing it with tax money. To everyone’s delight , it offers these luxury cars for sale at 50 percent off the old price. People flock to the showrooms and buy. Later, sales slow down, so the government cuts the price in half again. More people rush in and buy. Sales again slow, so it lowers the price to $900 each. People return to the stores and buy two or three, or half a dozen. Why not? Look how cheap they are! Buyers give Jaguars to their kids and park an extra one on the lawn. Finally, the country is awash in Jaguars. Alas, sales slow again, and the government panics. It must move more Jaguars, or, according to its theory – ironically now made fact – the economy will recede. People are working three days a week just to pay their taxes so the government can keep producing more Jaguars. If Jaguars stop moving the economy will stop. So the government begins giving Jaguars away. A few more cars move out of the showrooms, but then it ends. Nobody wants any more Jaguars. They don’t care if they’re free. They can’t find a use for them. Production of Jaguars ceases. It takes years to work through the overhanging supply of Jaguars. Tax collections collapse, the factories close, and unemployment soars. The economy is wrecked. People can’t afford to buy gasoline , so many of the Jaguars rust away to worthlessness. The number of Jaguars – at best – returns to the level it was before the program began.

The same thing can happen with credit.
It may sound crazy, but suppose the government were to decide that the health of the nation depends upon producing credit and providing it to as many people as possible. To facilitate that goal, it begins operating credit production plants all over the country, called Federal Reserve Banks. To everyone’s delight , the banks offer the credit for sale at below market rates. People flock to the banks and buy. Later, sales slow down, so the banks cut the price again. More people rush in and buy. Sales again slow, so it lowers the price to 1 percent. People return to the banks and buy even more credit. Why not? Look how cheap it is! Borrowers use credit to buy houses, boats and an extra Jaguar to park out on the lawn. Finally, the country is awash in credit. Alas, sales slow again, and the banks panic. They must move more credit, or, according to its theory – ironically now made fact – the economy will recede. People are working three days a week just to pay the interest on their debt so the banks can keep offering more credit. If credit stops moving the economy will stop. So they start giving credit away at zero percent interest. A few more loans move through the tellers’ windows, but then it ends. Nobody wants any more credit. They don’t care if they’re free. They can’t find a use for it. Production of credit ceases. It takes years to work through the overhanging supply of credit. Interest payments collapse, banks close, and unemployment soars. The economy is wrecked. People can’t afford to pay interest on their debts , so many bonds deteriorate away to worthlessness. The value of credit – at best – returns to the level it was before the program began.

This is exactly the situation we have in the US. People took on way more credit than they could ever pay off. They have over borrowed, over spent, over consumed. The contraction we see now is the deflationary payback for years of unprecedented profligacy. When people have had enough of something, they’ve had enough. Jaguars? Anyone?

Tags: consumer credit, credit, federal reserve bank, talf

Long Term Treasury Securities – Foreign Demand Rises

August 17, 2009 · Posted in Investing · Comment

As deflation continues to run its course, debt destruction goes on, and people seek save haven investments Foreign demand for long-term US securities rises:

Foreign demand for long-term U.S. financial assets rebounded in June even though China and Russia trimmed their holdings.

The Treasury Department said Monday that foreigners purchased $90.7 billion more in long-term U.S. securities than they sold in June. That’s a significant rebound from May when they sold $19.4 billion more than they purchased.

“There is little evidence in recent (Treasury) reports to suggest that foreign investors are growing weary of buying U.S. securities,” Jay Bryson, a global economist at Wells Fargo Securities, wrote in a note to clients. The increased appetite for Treasury securities was partly because their yields rose in early June, he added.

The Treasury is auctioning record amounts of debt to cover what it estimates will be a $1.85 trillion budget deficit this year. If overseas buyers don’t continue purchasing U.S. debt, some economists worry that would mean falling demand at Treasury debt auctions and rising interest rates.

China, the largest foreign holder of U.S. Treasury securities, trimmed its holdings, to $776.4 billion in June from $801.5 billion in May. Russia also reduced its holdings 3.7 percent to $119.9 billion in June.

China’s holdings are a direct result of the huge trade deficits the U.S. runs with the emerging Asian power. The Chinese take the dollars Americans pay for Chinese products and invest them in Treasury securities.

American manufacturers argue that gives China unfair trade advantages by keeping the dollar overvalued against the Chinese currency, which makes U.S. goods more expensive for Chinese consumers and Chinese products cheaper here.

Both the Bush and Obama administrations have argued that China should allow its currency to rise faster in value against the dollar, but the yuan has stopped appreciating against the dollar in recent months.

Japan, the second largest holder of U.S. Treasury securities, increased its holdings 5.1 percent to $711.8 billion in June. And the United Kingdom, the third largest holder of Treasuries, increased its holdings nearly 31 percent to $214 billion.

Foreign governments purchased $22.5 billion of Treasury bonds and notes, the department said, after selling $21.8 billion in May. Overseas governments sold $5.9 billion in bonds issued by mortgage giants Fannie Mae, Freddie Mac and other government agencies.

Private foreign investors purchased $78 billion in Treasury bonds and notes in June, the department said, up from sales of $800 million in May.

Today yields on ten year notes are currently at 3.49 percent. I am still as bullish as I have been before on Treasury Notes and Bonds:

Back in November 08 I called for significantly lower Treasury Yields between 2% amd 2.5%. They then fell from 3.09% to just below 2.5% in January 09. I then expected for technical reasons that they will move higher to the upper end of the range which would be around 3.3%. They actually overshot and went as high as 3.99%. I then said that Treasurys are a good call again. Yields have since then fallen to around 3.30%:

Click on image to enlarge.

I think Treasurys will continue to act well. There maybe some upward pushes here and there so long as inflation expectations pop up once in a while, but the mid-term trend remains unchanged: It is likely that yields are headed for new lows.

Just recently someone commented as a response to my post on consumer prices:

Bullish long term treasuries?

If so, I think your arguments should directly go to the trash.

Even though private lending is not increasing, it is currently being replaced by government debt or money. Yes stocks are risky, but the dollar is even riskier.

Maybe I am wrong and there is a flaw in my thinking. If so, then nobody has successfully pointed it out yet. Statements like the above reflect the commonly spread notions of the public who does not like to bother with details and easily falls for simple platitudes. This just reaffirms my beliefs. But we shall let reality be the final arbiter. I believe that Treasury yields are headed lower for the remainder of this year.

As far as my thoughts on the Yuan:

In 2005 the Chinese government ended the peg against the US dollar and switched over to a currency basket. From 2005 though June 2008, the value of one Dollar dropped from RMB 8.28 in 2005 to about RMB 6.83 by June 2008.

Since then, it seems, the fall of the dollar has stopped and the Yuan/Dollar exchange rate remained suspiciously stable. This has gone on through right now. The chart below illustrates this:

The stabilization of the Dollar against the Yuan has almost coincided the reversal of the Dollar’s fall against other major currencies. It thus appears as if, since mid 2008, the Yuan/Dollar peg has been reinstated and continues to be in place as these lines are written. What is also noteworthy is that the US current account deficit has been declining sharply since then.

A first look at the above chart leads one to believe that Chinese and US authorities aimed at putting an end to the fall of the Dollar, and thus intervened accordingly. However, another possibility which I would like to propose is that the Dollar had fundamentally and truly begun to stabilize at the level of RMB 6.83 at that point and was actually in for a major revaluation upwards. Thus the current intervention by Chinese authorities could actually be aiming at a stabilization of its own currency at a higher level than the market would mandate.