Tuesday, December 31, 2013

2013: Better than Expected by Guest Blogger Buck Klemkosky

Note: this summary for 2013 is provided by Guest Blogger Buck Klemkosky. Because it is long, you will see below his introduction and summary with 12 topics in the middle. Any of these topical areas can be read in full by scrolling down to the appropriate footnote number.

Americans, especially investors, have a lot to be thankful for in 2013. Remember, the year started with everyone worrying about falling off the fiscal cliff. Due to the budget impasse, automatic federal spending was cut through the sequester, and taxes were raised for the wealthy. Economic forecasters and other pundits were predicting that the sequestration would hamper economic growth or possibly cause a recession.

The Economy – The U.S. economy has performed better than expected with annual real GDP growth expected to be 2.4 percent for the year. The economy was bolstered by auto sales, housing and the consumer. It is difficult for the economy to have any meaningful growth without consumers being part of it, and they were in 2013, overcoming the supposed “fiscal drag” of the sequester and the austerity measures of state and federal governments. Economic prognosticators had forecast 2013 economic growth of less than 2 percent, so the economy performed better than forecast and the third and fourth quarter numbers suggest a stronger trajectory for the economy and consumer spending going into 2014.

Industrial Production[ii]
The Fed[iii]
Deficits and Defaults[iv]
The Volker Rule[v]
The Financial System[vi]
The Corporate Sector[vii]
Household Debt[ix]
Household Wealth[x]
Investable Assets [xii]

2013 – Recessions caused by financial crises take longer to recover from than normal cyclical recessions because debt has to be taken out of the system. This appears to have been completed in the U.S. for the household and financial sectors in 2013. Hopefully, this has set the foundation for continued economic growth in 2014 and beyond. The corporate, household and financial sectors in the U.S. are all in better shape than any time in the last decade or longer. The European economies and financial systems appear to have stabilized, and Abenomics in Japan has produced positive economic growth and stock returns in excess of 60 percent in 2013. China’s economic growth has come down over the last five years but still a solid 7.5 percent. Global and U.S. economic growth should be higher in 2014, with U.S. economic growth expected to be around 2.5-3.0 percent. Don’t expect 2014 stock market returns to replicate 2013; in 2013, markets anticipated and reflect economic momentum and other positive developments expected to occur in 2014.

The one big unknown is what if any problems have been created by the Fed’s zero interest policy and QE. It has created stock and bond market wealth and now housing again. Hopefully it has not created any significant bubbles or misallocations in the economy. So Fed actions and other macroeconomic events will continue to make headline news in 2014 and influence financial markets. Financial markets have performed much better than the real economy for several years, including 2013.

[i] The views on inflation have been all over the map. Many are worried about the enormous amounts of liquidity pumped into a global financial system by central banks and the potential for hyperinflation. Others worry that deflation may be the problem going forward. The inflation rate in 2013 was 1.1 percent, less than the 2 percent the Fed is targeting, as are the European Central Bank and the Bank of Japan. The most obvious danger of too-low inflation is the risk of falling into outright deflation of persistently falling prices. As Japan’s experience shows, deflation is damaging economically and hard to rectify. So central banks are more concerned about deflationary pressures than inflation.

[ii] U.S. industrial production, which measures the output of manufacturers, utilities and mines, hit a milestone in November 2013 when the index surpassed the pre-recession peak of December 2007. While manufacturing is still below its 2007 peak, overall production is up 21 percent since the end of the recession in June 2009 and up in 2013 relative to 2012.

[iii] The U.S. Federal Reserve celebrated its 100th anniversary in 2013 and perhaps never in its history has it faced the complexity and risk it now does. At the end of 2013, three rounds of quantitative easing (QE) have inflated the Fed balance sheet to $4 trillion, up from $800 billion before QE started in 2008. QE3 started in September 2012 and entailed purchasing $85 billion monthly of U.S. Treasury bonds and mortgage-backed securities. Annualize that and it comes to more than $1 trillion a year of bond purchases that end up in the Fed’s balance sheet. QE3 is not sustainable and the Fed just announced that it will start tapering in 2014 by reducing monthly bond purchases by $10 billion. Chairman Bernanke announced in May 2013 the possibility of reducing or tapering the amount of bond purchases but delayed any final decision until December 2013, his last major decision as his second four-year term ends in January 2014. From May to December, tapering or lack thereof was the most talked-about and analyzed event in 2013 and it will continue to be as long as QE3 exists.

The Fed also will continue its accommodative monetary policy by keeping short-term interest rates close to zero even after unemployment rates fall below 6.5 percent unless inflation exceeds 2.5 percent. Janet Yellen takes over as Fed chair in February 2014 and is expected to continue Bernanke’s monetary policies.

[iv] Congress passed a 21-month budget resolution in December 2013, the first since 2010. While many applaud the ability of a dysfunctional Congress to even pass a budget, few seem to be happy about it. As a percentage of GDP, the federal deficit has fallen from more than 10 percent in 2011 to 4 percent in 2013 and less than 4 percent projected in 2014. Prerecession, a deficit of 4 percent of GDP used to be considered reckless; now some consider it austerity and a fiscal drag on the economy.

While a flawed budget deal may be better than no budget deal, one of the flaws in the U.S. fiscal policy is that congressional voting on spending is separated from voting on borrowing via the debt ceiling. The debt ceiling law has been in effect since 1917 but was not a political issue until the 1970s. Since the Carter administration, Congress has voted 45 times to increase the debt ceiling. Linking the vote to borrow to the vote to spend would seem logical, but don’t count on congressional rationality in this day of partisan politics. This will become headline news again in February 2014, when the federal debt is again expected to approach the debt ceiling of $16.7 trillion.

[v] The Federal Reserve Act, passed in 1913, was 31 pages long. The Dodd-Frank law, passed in 2010, was 2,391 pages long. It entails 398 rules, of which 161 have been finalized, and the Volker Rule is the latest. From its conception to finalization by five government regulatory agencies, the rule has grown to 963 pages, containing 2,826 footnotes and posing 1,347 questions. All this verbiage is to basically prevent proprietary trading by banks. They can still trade for clients, but most banks had already eliminated proprietary trading in anticipation of the rule. Full compliance is not required until July 2015. Monitoring and compliance will be complicated, and there may be unanticipated consequences such as less liquidity and more cost to trade less actively traded issues such as corporate bonds.

[vi] In 2013, the U.S. financial system was much stronger and transparent than before the financial crisis. Dodd-Frank, Basel III and other regulatory changes have taken debt and leverage out of the system, increased capital and monitoring not only of banks but also non-bank financial institutions. Hopefully regulators now understand how complex and interconnected the financial system is. One thing that has not been fully resolved is the too-big-to-fail issue. The 10 largest financial institutions in the U.S. in 2013 had more than $11 trillion of assets, compared with $7.8 trillion at the end of 2006. The market share of the 10 largest has increased, and thus their potential for systemic risk.

[vii] Corporate profits relative to GDP remain at historically high levels in 2013: 10 percent versus an average of 6 percent. While revenue growth was subpar, corporations were able to grow earnings through cost controls and share buybacks. Corporations today spend 60 percent more on share buybacks than on dividends, even though dividend growth has been positive. Because of economic and political uncertainty, corporate investment has not kept pace with profitability. Another reason is that the capacity utilization rate is slightly below 80 percent at the end of 2013, so there is no urgent need for capital expenditures until utilization picks up another 5 or 6 percent. Corporate balance sheets are in great shape and corporate cash as a percent of assets is at historical high levels. Even so, U.S. corporations set records in 2013 for issuing bonds, both investment grade and high yield, taking advantage of historically low interest rates. Two of the largest bond issues of all time occurred in 2013; Verizon issued $49 billion to finance an acquisition, and Apple $17 billion, even though the company had $70 billion in the bank, half of that overseas for tax reasons.

[viii] Job growth averaged about 190,000 monthly in 2013. The unemployment rate fell to 7.0 percent at the end of 2013 but not all of the improvement in the rate was due to job growth. The labor participation rate fell to a 30-year low of 63 percent, meaning millions of people have left the labor force for whatever reason. Still, at the end of 2013 there are 1.2 million fewer people working in the U.S. than at the end of 2007.

[ix] Financially, households have put their houses in order, so to speak. They have paid down more than $1 trillion of debt since the financial crisis, mostly mortgage debt which comprises about 70 percent of household debt. The debt service ratio, debt payment as a percent of disposable income, also fell to a 30-year low in 2013 as it approached 10 percent. With household balance sheets in better shape and consumers more confident, U.S. household debt increased in 2013, the first annual increase since 2008. One area of debt that is of concern is student loans; the amounts outstanding surpassed $1 trillion in 2013 and they had the highest delinquency rates at 12 percent.

[x] U.S. households lost $19 trillion in the financial crisis: $9 trillion in stocks, $7 trillion in housing and $3 trillion in other assets. This didn’t all happen simultaneously as stock prices started to increase in March 2009 and housing prices continued to drop through 2011. The peak loss was approximately $15.0 trillion. Household net worth, the value of assets minus debt, set a record of $77.5 trillion in 2013. However, adjusted for inflation, this amount is in real terms about the same as the $69 trillion of household net worth in 2007. Add in population growth and average household net worth is still below 2007. Less debt, housing prices up 12 percent in 2013, and stock prices up 29 percent have all contributed to the record levels of household net worth. One thing that has  not contributed has been interest rates; historically low interest rates, both short and long-term, have caused financial repression for households. Since 70 percent of household assets are financial in nature, interest rates and stock prices are the main drivers of household wealth.

Household net worth is 615 percent of after-tax income in 2013 compared to a peak of 662 percent in 2007, so households may not feel as wealthy today versus 2007. Plus the distribution of net worth is more unequal today than any time since the 1920s. The same is true of the distribution of incomes.

[xi] One of the major milestones in 2013 was that the U.S. became the world’s largest producer of energy, surpassing Russia. This is mainly due to natural gas production, but oil production also is ramping up. Because of horizontal drilling and fracking, the U.S. has the potential to become North American energy independent. The U.S. has started to export liquefied natural gas and has become the leading exporter of products derived from oil and natural gas. Lower energy costs have given the U.S. a real competitive cost advantage over European and Asian manufacturers, and the U.S. has started to attract direct foreign investment to the U.S. because of cheaper energy. This cost advantage should be sustainable for a decade or longer.

[xii] The star of 2013 was the stock market; the S&P 500 had a return of 29 percent, including dividends, the best one-year return since 1998. The consensus forecast at the beginning of 2013 was 8 percent. The NASDAQ and Russell 2000 did even better. In 2013, the Dow Jones Industrial Average hit 16,000 for the first time and the S&P 500 1,800. The NASDAQ crossed 4,000 for the first time in 13 years, except back then it was on its way down from its peak of 5,048 in 2000 and in 2013 on the way up. Bonds have been a mixed bag in 2013 with corporate bonds, both investment grade and high yield, providing positive returns of 5-7 percent.

However, long-term U.S. Treasuries did have negative returns. The big losers in 2013 were most commodities, especially gold, which fell more than 30 percent from its peak price of $1,800 per troy ounce. Some believe the commodity super cycle that started in 2000 may be over. Short-term money market instruments were also losers, as the Fed continued its zero interest rate policy. Real short-term interest rates were negative after adjusting for inflation.

Tuesday, December 24, 2013

Merry Christmas and a Happy New Year

Thanks for being part of my blog this year. Betty and I want to wish you a wonderful holiday. I hope your Christmas is filled with everything you want and that you have time to reflect on all the goodness and beauty around us. Sprouting has been a blessing for me in retirement and a great way to communicate with so many of my neighbors, friends, former colleagues and students, and family. We don't always agree with each other but it sure is fun hashing it out.

Next week we will have a special summary of 2013 from our frequent guest blogger Buck Klemkosky. So stay tuned and have a wonderful holiday.

Tuesday, December 17, 2013

S&P Newtonians – Have they lost their apples?

As November came to an end and shoppers duked it out at Macy’s and Victoria Secret, the financial news heralded the stellar performance of the stock market. Much of the news documented in one way or another how much the stock market valuations have grown this year and in the past few months. Some Newtonians concluded that what goes up must come down. Other analysts believe there is more room for stock prices to rise. Which is it—up or down?

As you know I am a humble macroeconomist and not a finance whiz and therefore I admit to treading in shark infested waters. What I read tells me that the risks lie toward mean-reverting behavior. After stocks have gone up so much it seems reasonable that they would take a breather. While that sounds pretty rational I think that view is missing some vital information. I see several reasons why stocks could continue rising and therefore I am more optimistic than many of the pundits.

Let’s face it the majority view has a lot going for. For one thing a look at stock market behavior over time does underscore a tendency of markets to deviate from and then return to longer term trends. And the famous PE (price to earnings) ratios mostly support the view that stocks cannot keep up rapid price increases. Stock prices have raced ahead of earnings – especially since earnings are slowing down. If you expect earnings to continue to slow as the world economy struggles then price to future earnings look high today – thus there is plenty of room from the PE camp to suggest a slowing or a retraction in stock prices.

So how can I support a more optimistic view of future stock prices? One point is that earnings have been volatile. During the recession them plummeted. After the recession earnings moved dramatically upward. It is natural they would fall off that rapid acceleration to something more normal. Thus, a slowing in earnings does not bode poorly for now or for the future.

My second point is based on an even longer-term view of stock prices. I am going to use the S&P 500 average for my analysis but what I am about to say works for most broad measures of US stock prices. The S&P 500 bottomed out in the recession at 676 in March 2009. That represented a major contraction relative to the heady days of pre-2008. Since March 2009 the S&P 500 rose to around 1,800 . From the bottom in March 2009 to July 2013 the S&P 500 rose by 166%.  That is pretty spectacular and you can see why some people think that behavior cannot be maintained.

But there is more to the story. If you compare this so-called high stock price level in November 2013 to the previous peak in November of 2007 of 1,520, you see that in a time period of six years the market has gone above that previous peak but is only 18% higher.  A gain of 18% in four years is not spectacular. Do not forget that those stock returns buy less because the prices of goods and services were rising during those six years. The Consumer Price Index rose by 14% in those six years. So you could conclude that in purchasing power terms, the peak level of the S&P 500 is only about 4% higher than it was six years ago. That peak resembles the humble Smokies more than the Rockies!

If we compared today’s so-called high level of stock prices to the previous peak in 2000 of 1,527, then today is 18% above that peak. Today’s peak is only 18% above the peak of 13 years ago! With inflation of 37% since 2000, the buying power of today’s market high is about 19% less than the peak in 2000.

We have a market high recently but when we compare it realistically to previous highs, it doesn’t look very spectacular and therefore does not imply a major contraction is ahead of us. The S&P 500 would have to rise from the 1,800 range to something greater than 2,200 to be comparable in buying power terms to the peak of 2000.  I am not predicting anything like that. But the US economy is growing. Companies are making profits. The fear of another major global collapse is receding. Employment is gathering steam. Smaller investors are getting back into the US markets. There is no reason why stock prices cannot continue their upward trajectory. If only the Fed and Congress would do their respective parts by not mucking up the economy.

Monday, December 9, 2013

Obama Reversing Undesirable Changes in the Income Distribution

I read the following quote in an article on Bloomberg last week. “President Barack Obama, setting out a theme that he’ll pursue in the final years of his presidency, said growing income disparity in the U.S. is the “defining challenge or our time” and Washington must confront it.

And then I remembered why I started this blog – to drink more JD. Geez Mary, what is our President trying to say? Let’s try some possibilities:
          1.   I discovered recently that income disparity is growing and we need to get together and do something about it.
           2.  I have spent the last six years focused on nothing but income disparity and only got this Boehner T-shirt   
 3.  I have spent my life devoted to correcting income disparity and have not succeeded so I am going to use the last years of my Presidency to doing more of the same.

The good thing is that this president is loyal to his goal of income redistribution. The bad thing is that he doesn’t have a clue about how to go about getting what he wants. Even if he waived a magic wand and turned all the Republicans into card-carrying liberal democrats, he would not get what he wants.

How can I support such an outrageous statement? Let me count the ways? First, the bull in the China shop is right in front of him but he doesn’t see it. Is he going to switch gears to income distribution before he is finished with employment? I mean which way is it? Which is his main goal? Some of what he hopes to get with reducing income disparity comes when the economy is growing again and employing more people. Did he relegate economic growth and employment to position #2? Or #3? Is that really the way to help people with low incomes catch up?

Second, he already made headway on policies to redistribute income. If Obamacare does not redistribute money to the poor, I don’t know what it does? But that’s not enough. He raised taxes on the rich in the last “kick the can down the road” exercise, increased spending and participation in most social programs, plans to reduce what the government pays to doctors, medical device companies, etc. Even with all that the data seems to show little to no improvement in the lot of people with lower incomes. Maybe he should go back to point 1 above – fix the economy.

Third, as it relates to income redistribution his plan is a repeat of very old dogma that got us to where we are now. There is not one new trick in this deck of dog-eared cards. Increase social spending, increase the minimum wage, raise taxes on the rich, have the government spend more on infrastructure, and so on. Come on! We did all that for 50 years and we have more poor people now than ever. And more rich people too. And guess what? While there are ways to measure the successes of some government programs it is not going to be easy to repeat those successes again starting tomorrow.

The infrastructure idea sounds nice but it will take decades to impact income distribution. Remember all those shovel-ready jobs of a few years ago? The problem Mr. President is not that we need to spend more on social programs or infrastructure. It is that we need to create an environment of short-term expansion and long-term economic growth. I already discussed the former above, now let’s think about the long-run.  

Why hasn’t the economy snapped back and resumed normal economic and job growth? Answer: because there is stuff wrong with the economy. If there is stuff wrong with the economy then you fix it. Don’t push the blood back into the bullet hole – sew the hole shut! A guy walks into an emergency room after being run over by a cement truck and has multiple injuries and asks if he can bum a cigarette and a few band-aids. What’s a good doctor to do? Surely not give the guy what he is asking for. 

I doubt I will be exhaustive but consider what needs to be attended to:
            Demographics mean labor force growth is much lower than it used to be subtracting close to 1% per year from economic growth
            Financial reform and regulation remains incomplete some five years after the recession providing an aura of uncertainty
            Housing reforms  remain incomplete. Banks still do not know the definition of a qualified mortgage.
            Global competition from countries that have lower wages eat away at low and middle skills jobs
            As more and more jobs are growing in highly technical fields, US education cannot produce graduates that place better than the median in world  comparisons of 15 year-olds
             Reams of pages of new regulations on firms
National debt is 100% of GDP

Okay I must have left something out. I know, I left Obamacare out on purpose. But do you really think we should be spending our precious time the next two years debating emotionally and heatedly about adding or not adding a  few points to tack onto the tax bill of rich doctors and lawyers? Let me say this as loudly as I can – I TOTALLY AGREE THAT WE NEED TO BOLDLY FACE INCOME DISTRIBUTION PROBLEMS.  I totally agree that income disparity is very wrong both economically and morally. But there are ways to do this that will work and other ways that won’t work.

The next ten years will not be like the last five. They will not be like your grandfather’s business cycle. We have a mess of problems that hurt lower income people. Some problems are short-run oriented related to the recession. Others have more to do with negative longer-term trends playing out. Raising the minimum wage or taxing the rich takes the eye off the ball. The term is worn out but we have a perfect storm affecting lower income people. The usual life vests are not going to be enough. We need to focus on what it takes to generate a decade or two of stronger economic growth. 

Tuesday, December 3, 2013

Obamacare’s Medical Devices Tax is a Heart Stopper

Almost exactly two years have gone by since I posted about the Medical Devices Tax (Obamacare, Jobs, and Global Competitiveness, November 22, 2011). In that post I worried about the negative impacts of the new tax on US employment. Two years later there is evidence that the worries were well founded even though the tax has not yet begun to bite. Since Congress may have the chance to save the day for the Medical Device Tax yet in 2013 and since there are some who would not repeal this part of Obamacare, I thought I would wade into this topic one more time.

This time I am spouting about an article written by Kent Gardner, chief economist for the Center for Governmental Research (Rochester Business Journal, November 15, 2013).  Gardner alleges that “Joint replacement earns a whopping profit for the implant manufacturers and a very good living for the surgeons and hospitals involved. And private insurers, Medicare, Medicaid and the Veterans Administration pay most of the bills.” He thinks these firms are doing just fine and uses three arguments to explain why the tax won’t have negative effects”:
1.     These firms are cartels and therefore medical device firms won’t pass the tax along to higher prices
2.     The tax will not cause US jobs to go overseas
3.     The tax will not cause any reductions in innovation and competitiveness

So let’s take a closer look at Gardner’s arguments. He says medical device firms are like cartel members. Wikipedia offers this definition of a cartel,
a formal (explicit) "agreement" among competing firms. It is a formal organization of producers and manufacturers that agree to fix prices, marketing, and production.[1] Cartels usually occur in an oligopolistic industry, where the number of sellers is small (usually because barriers to entry, most notably start-up costs, are high) and the products being traded are usually homogeneous.
Implicit in this definition is that the cartel brings the members high or excessive profits. 

So Gardner is wrong on a lot of counts. First, there is no formal agreement among medical devices companies as there is in OPEC. Second, if there is an informal agreement to do all this bad stuff, then this is against the law – and these guys must be pretty good to have eluded the regulators for so long.

Third, these companies are not homogeneous. There is a relatively large number of medical device companies, and there is plenty of entry and exit, especially among the smaller innovative firms. . While there might be small numbers of companies in very specific segments of the industry, this is what one should expect when advanced science is behind specialization, continuous invention, and innovation. A company that leads in a particular kind of product, for example, may enjoy a monopoly position for a little while. But this is also true for cellular phones and many other electronic products – do we want to put additional taxes on Apple and Samsung because they lead their industry? Probably not. A small number of firms doing everything they can to take leadership is good for product price and quality and, of course, the consumer. Think Nokia if you want evidence that even a small number of firms can produce real competition.

Fourth, most of the data I am finding does not support the notion that these companies are making obscene or even risqué profits. I looked at rankings of profit measures by industry –published by Yahoo Finance and a consulting company, Analyxit . These rankings generally show that the Healthcare and Medical Devices sectors make very reasonable net profits as a percentage of revenue. For example Yahoo Finance found Medical Devices had a net profit ratio of about 13%, ranking it 42nd among industries. In contrast Finance sectors had returns ranging from 36% to 81%.  The return on equity ranking showed Medical Devices at 14% with a ranking of 82nd. Analyxit ranked Healthcare, including Medical Devices, as eighth among nine sectors based on net profits as a percentage of revenue. Again financial companies led the list with returns averaging 17%. Healthcare’s percentage was 4%. In the middle of the pack were utility companies with a ratio of 8%.

Gardner says these firms will not pass the extra cost of the tax onto consumers. He reasons… “When firms hold significant market power – as they do in this industry – the connection between cost and price has been weakened. Price is largely driven by demand factors, not cost: Monopolists already charge what the market will bear.” Gardner’s argument flies in the face of what we teach freshmen in economics every year. Market power translates into an inelastic demand curve -- which means that firms without much competition do not have to worry much about losing customers when they increase prices – and would as a matter of fact pass the extra costs caused by the tax into higher prices.

I would agree that these firms will eat the tax as a reduction in profits and not pass the cost along to medical consumers in the short-run. But this is not because these firms have market power. The main reason that profits will fall is that medical device manufacturers have long term contracts with hospitals and other health providers and cannot easily increase revenues to offset rising costs from the new tax. Won’t these firms benefit from a tidal wave of new enrollees in Obamacare? Probably not. Many of the newly insured will be younger and not require medical devices like new hips and knees.

What I showed two years ago is that while a 2.3% tax on revenue sounds trivial, the result is that the tax is a much larger percent of a company’s profits. While some people think profit is a dirty word, the fact is that profits are used to invest in research, product development, safety, and other critical outlays that invent and improve products. The more the government takes of these profits the less is available for increasing product quality and being competitive. Large for-profit firms are already seeking foreign locations and will be followed by private companies. And the negative impact on smaller entrepreneurial firms is disproportionate because in the early years a company often makes small or no profits despite having rising revenues. The upshot is that a 2.3% revenue tax will mean business losses and an end to these small businesses. Inasmuch, the bigger firms will gobble their assets and this will lead to less, not more, competition. A correlated worry is that all these firms will turn away from devices that cannot promise immediate returns or serve smaller markets. This bodes ill for future important improvements in the device industry.

But aren’t corporate taxes low? The answer is that despite some loopholes, US corporate income taxes are among the highest in the world. Domestic companies are already reducing employment and globalization means many are seeking production and market opportunities globally. The medical device news is full of stories about layoffs and new joint ventures, both domestic and foreign. Combining a high corporate tax with another 10-30% of income going to a medical device tax makes it more desirable for medical devices companies to find locations and markets where better profits can be made. China, India, Ireland, Costa Rica, Singapore and a growing list of countries are quite willing to compete on corporate profits as a way of winning production as well as R&D facilities.

The upshot is that this tax is not good for US employment nor US-based innovation and competitiveness. The US should be happy to have the world’s leading medical device companies and it should be fighting to keep it that way. Worse yet is the misleading contention that this tax increase will break up this medical devices cartel and lead to more competition. It will do just the opposite as large US companies get larger by combining with suppliers and competitors – and as they move more and more operations abroad. 

Tuesday, November 26, 2013

The Economics of Thanksgiving

For those of you who do not live in the USA you might not know about Thanksgiving. Americans celebrate it on the fourth Thursday of each November because apparently it was too complicated to just have it on the 24th of every November. It is okay to have Christmas on the 25th and May Day on the 1st and Cinco de Mayo on the Mayo – but no, Thanksgiving had to be different. So that’s why numerically-challenged Americans appear to be confused in November and often resort to counting on their fingers.

I have to say that I know that Koreans, Kanadians and Kardashians also have Thanksgiving holidays in their countries and while I don’t want to seem small I will say that their celebrations are copycats and should not be confused with the REAL thing here in the USA, eh.

Thanksgiving got started because after the famous Tea Party incident Americans were very happy and thankful that we didn’t have to drink all that tea during the winter. That explains why we never drink tea on Thanksgiving and why most American families drink copious amounts of champagne and JD that day.

The central focus of Thanksgiving is around the cooking of the turkey. Turkeys can be baked, barbq’d, smoked, grilled, or boiled and preferably all this is done after your local Kroger store has removed the feathers, the beak, and Nancy Pelosi. But no turkey is complete and no meal is planned that doesn’t supplement the turkey with enough food to feed an entire turkey farm. Of course on Thanksgiving many of us down a small keg of Wild Turkey (no offense to JD). My family believes that eating copious starches on Thanksgiving gives you good luck for 7 years and that is why we have mashed potatoes, sweet potatoes, dressing from inside the turkey, dressing cooked outside the turkey, three breads, and of course kimchi fried rice.

If the starches don’t kill you there are the sweets. Cranberry sauce accompanies the turkey, the starches and of course grandma. Despite being so full you could explode after all that food, the coup d’etat comes at the end when grandma proudly unveils the pies – of apple, cherry, pecan, pumpkin, rhubarb, and whatever else Marie Calender provided from the shelves at Kroger late on Wednesday night.

Don’t think there aren’t any vegetables on the table. It seems some item in this cornucopia ought to be good for you. But nay even the vegetables have been cooked with fried onion rings, creamy gravies, and God-knows what other toppings designed to make them equally damaging as the rest of the components of the meal. Did I mention that Wild Turkey goes swimmingly on the turkey, the starches, vegetables, grandma, and on most desserts?

My favorite part of the meal is when the crane lifts me to the liquor cabinet where I bring out the cognac. There is something about a nice cognac filtering through the congested digestive tract that brings on a feeling of calm and overall spirituality. That is, cognac makes a nice nap ever so possible and enjoyable.

Of course the meal is just part of the Thanksgiving Celebration. This holiday brings together the entire family including some members who do not seem to be so thankful and some who do not even seem to belong in your family. But let’s not be picky. Every family has those people who seem like they came from outer space. And that is precisely why we drink heavily before, throughout, and then after the meal. Once that nice haze comes over me it is amazing how interesting and funny I am. But then Betty puts an end to that. After several hours of washing the dishes, I am permitted to return to the social part of the day and of course to another round of Wild Turkey shots.

Since it is coming on Thanksgiving, I thought I would tell you that I don’t really have the energy to write about the macro environment or the turkeys in Washington D.C. this week but I did want you to know that Betty and I wish you the very best this week – whether you celebrate Thanksgiving or Chuseok or the Maple Leafs. Translated – you get the week off from the usual blog paranoia. So enjoy! When I recover next week I promise to return to form unless I am captured by aliens.

Tuesday, November 19, 2013

Alan Blinder Gets an F in Healthcare 101

Cartoon by Jim Gibson

On November 2, 2012 I wrote a post titled “Alan Blinder gets an F in Econ 101”. At that time I took issue with his contention that a government deficit of 8.5% of GDP was not a significant economic stimulus. Now Blinder is writing in the Wall Street Journal again about Obama Care (“Despite a Botched Rollout, the Health-Care Law is Worth it”, WSJ, November 12, 2013, page A17.) I have no problem with people making their views known even when their views depart from mine. :-)  But I do take offense when a writer makes a conjecture and comes to a conclusion without any real explanation. It makes one seriously wonder if he is acting as an economist and analyst or is just showing support for his party.
Blinder’s article reads like a condemnation of Obama care but viola near the end he concludes with “America cannot be a humane society if we leave 15% of our population uninsured. America cannot be an efficient society if we spend 50% to 100% more of our incomes on healthcare than other countries." The bottom line is that Blinder says that Obamacare is going to make the US more humane and more efficient. So I hunted and hunted through his 16 paragraph article and I could not find one bit of discussion, analysis, or evidence that would support such a conclusion. For starters the terms “humane” and “efficient” are never defined or discussed in any way.
First consider his condemnation part. These are quotes from his November 12, 2013 article that reflect what he believes,
  • The botched rollout of ACA has been an unmitigated disaster. Choose your favorite adjective: horrible, embarrassing, inexcusable.
  • …virtually no one understands how the new law works….
  • Thus tech “glitches” make the law’s critics look better and make the administration look like the gang that couldn’t shoot straight.
  • Becoming a national laughingstock is worse than getting off to a bad start. It undermines trust in health-care reform and more generally in the government’s ability to solve problems.
  • “If you like your (Health Insurance) plan you can keep it.” Well, it turns out that maybe you can’t.
At this point in the article I was ready to stop reading because it sounded like Blinder had become a card-carrying member of the Tea Party . But then Blinder makes three allegations:

  • But even with all the delays, most of the uninsured will get covered.
  • Millions of people under the age of 26 are already benefiting by being kept on their parent’s policies.
  •  He worries that cost containment might be delayed now but then concluded “But there is at least some reason to think that the “affordable care” part of the act may be working already. The rate of inflation of medical care costs has tumbled in recent years.
At this point I was seeing what Blinder really wanted to say to strongly support Obamacare. But then he adds two more points of concern or worry on his part (and I am assuming that he was not being held hostage by Sara Palin when he wrote them):
  •             If many low risk people stay out of the pool, we have a problem: The insured pool will be less healthy than the total population
  •             So pure self-interest will push firms to drop coverage.
At this point I felt more disoriented than my last night out with JD. Is Alan Blinder against, for, or against Obamacare? Luckily he had not gone beyond his generous article word count when he popped his belief that despite all that other stuff – we need Obamacare to become a humane and efficient country. Thankfully a conclusion. Recall that President Truman always wanted a one-armed economist. I don’t think he would have liked Alan Blinder – who seems more like a multi-headed hydra.
Okay so he flip flops. Who doesn’t? So let’s move on to bigger potatoes. Standing back from the whole article, does Blinder prove or support his conclusions? Let me work on that for the remainder of this piece. So please WAKE UP.
First, he doesn’t make use of one of his key points and that has to do with the influence of the botched rollout on the support and faith people have for government. He said a lot of really nasty things about the rollout. But let’s face it – if they were so negligent in the rollout, are we really so confident that they are going to be able to manage such a new and complicated healthcare program? Can they really educate prospective clients by using people who have not been properly screened for that purpose? Can they really insure that people don’t scam the system and add unnecessarily to the costs? Can they really protect the confidentiality of all that information that goes to so many different government organizations?    
Second, if his two worries are true and low risk people and many firms do not sign up for the program, will we be able to afford it? He says that healthcare costs are already falling but naively attributes that to Obamacare. That is silly. Economists know there are many reasons besides Obamacare for the decline in healthcare costs – including the recession and slow economic growth. A main reason why Obamacare might reduce prices is because they stick it to doctors and other healthcare providers. This is not a political winner and will not likely happen when the plan fully unfolds.  Adding 30-50 million people to healthcare is not going to reduce its costs. Why can’t Blinder spend a paragraph seriously defending these cost reductions?
This thing is getting too long so I better take a nap. Let me end with humane and efficient. Compare the US to many countries and you will conclude that this is a pretty humane and efficient place. Many people do not want insurance and do not want to be coerced into buying it. And while some people will stop going to emergency rooms they will soon find a system wherein they will spend as much or more  time waiting for a private doctor in a nice clean waiting room. Surely as the US healthcare system becomes more like healthcare systems of other countries (ie we can’t afford it) all of us who cannot afford Cadillac plans will find the quality of our care greatly reduced. I seriously doubt the US will make it on the cover of USA today for Obamacare’s great humanitarian contribution.
Now consider efficiency and Obamacare. When did you ever learn that a law composed of thousands and thousands of pages of new regulations that seem to be changing haphazardly over time would lead to the average health practitioner getting more done at a lower cost? Is it possible that there are reasons, perhaps unique to the US, that will keep our healthcare costs as a large percentage of national income even after we impose Obamacare? We in the USA spend more of our income than any other country on American football and JD. We also do most of the drug and device long-term research and development. America is unique in many ways. Maybe we will always spend a large share of our income on healthcare?
But Blinder would rather draw conclusions out of a hat. He can do better than that and we deserve better than that. So I give him another F with the hopes that he will learn from this grade and be more careful with his words in the future.
Note to reader – Alan Blinder is a truly important and gifted economist. I am pretty much a grain of sand on his proverbial beach. As you know I like to sometimes take a humorous approach to some pretty dry issues. I have no personal issue with professor Blinder but I sure do take issue when I think important people take us for granted. High income and status has no monopoly on truth. Larry spouts...

Tuesday, November 12, 2013

Let the Monetary Weaning Begin

Cartoon by Jim Gibson
Janet – hey doc when are you going to get me off this pain medicine? You removed that nasty goiter three months ago and while I cannot leap tall buildings in a single bound, I am back at work as a pole dancer in Peoria. 

Doc – I’d hate to take you off the medicine too soon there is always a chance that you might stub your toe and then – there we go again with all that shrieking and gasping.

Janet -- Okay Doc – you are da man. But I gotta say, you are starting to worry me. My Uncle Charlie told me that drugs can be dangerous and that some people even get hooked on them. My Uncle Pete had his large intestine removed last year and he was off the pain meds by the first Friday night poker game.  How come a mere thyroid-ectomy requires so much pain meds? I am starting to think you are holding out on me. Maybe my Adam’s Apple is rotten to the core? Fess up Doc please.

Janet Yellen might take some of this to heart as the Fed Chief nominee prepares to be grilled in her confirmation hearing. She seems quite intent on helping unemployed persons – but so long as the Fed continues to inject pain medicine into the US national economy some four-plus years after the end of the recession she has to understand what the Fed is doing to the psychology of domestic producers and investors. Every time the Fed announces it will not begin tapering its dose of pain killers it will raise two damaging questions. First, is the economy really so horrible that we can’t even reduce the dosage a tiny bit?

Posing this question raises a cloud of uncertainty that is not good for --- guess what – employment.  It seems that every time the Fed announces it will not begin tapering, the stock market soars. That reaction suggests that more medicine is appreciated by someone. But that doesn’t mean it is good for the patient. As you know, someone hooked on drugs is the last person to recognize what is good and what is bad for them. And the logic is perverse anyway. The government and the Fed perpetuate a myth that the patient is weak and needs more support. The patient appreciates more support. But the truth is that despite unprecedented amounts of Fed policy, the patient is not leaping over tall buildings. Maybe the Fed should understand that the more they tell the patient she is too weak to stand without help, the more the patient believes this is true. It becomes a self-fulfilling prophecy. People wonder why firms have been so slow to return to strong hiring. But why would they want to hire more workers if the Fed tells them the economy is not self-sustaining?

Second, won’t another month or more of medicine have damaging side effects to the economy? Drugs keep the patient going but we all know that drugs can have side-effects. The longer you take drugs the more you raise the chance that these nasty side-effects will occur. Many have already pointed out the bubbles that seem to be forming again in real estate and financial markets. It would be awfully strange and perverse if the solution for the past crisis creates another one with similar characteristics. The message from Washington has to be confusing to the financial markets. On the one hand regulators are telling financial companies to hold more reserves and/or reduce financial leverage and risks. On the other hand the Fed is handing out money like Mars Bars on Halloween. With interest rates held so low – banks and other investors do not want to invest in assets that give no yield – so they are very tempted to buy assets that promise higher returns – and of course more risk.

But the risks associated with a permanently low interest rate environment are broader than these bubbles. China is a great example of a country that has highly unbalanced economic growth. Economic development in China has come mainly through international trade and investment. That sounds pretty good. What could be wrong with that? It’s like saying that since protein creates muscle, you should mostly eat big, juicy ribeye steaks and minimize your portions of vegetables and fruits. It makes sense to have a balanced diet. We all know that. It ALSO makes sense to have a balanced economy. A strong economy capable of withstanding global macroeconomic shocks has balanced growth across sectors. In that balanced country consumers buy more goods and services, firms invest in equipment and research, foreigners want to buy everything for i-phones to mining companies, and the government buys airplanes and tablets for students and teachers.

Current Fed policy is troublesome and needs to be reversed. The USA needs to be weaned or we risk a debilitating addiction to money and low interest rates that just makes us less confident about the future and promises us bubbles and a more unstable economy. If Janet Yellen wants to help the unemployed she needs to distance herself quickly from Bernanke’s risky policies.

Tuesday, November 5, 2013

Japan: A Road Not to be Taken By Guest Blogger Buck Klemkosky

Japan experienced stock market, credit and real estate bubbles in the late 1980s, but with more intensity than the U.S. experienced later. Prior to 1990, the Japanese economy and financial system was considered to be superior to the U.S. as expressed in several books, such as Japan as Number One (1979). Japanese society was considered to be more thrifty and conservative than Western societies. By hindsight Japan was not immune to speculative euphoria and bubbles.

Japanese euphoria was reflected in both stock prices and real estate prices. By the end of 1989, the market value of publicly traded Japanese stocks exceeded those of the U.S. even though the size of their economy was of one-third that of the U.S. Stock valuations were astronomical even compared to the dot.com era in the U.S. While the stock market was soaring, the real action was in the property markets. By the end of 1989, Japanese property was valued four times more than that in the U.S. The grounds of the Imperial Palace in Tokyo were supposedly worth more than all of the real estate in California. Real estate prices in Japan had never declined in the post-WWII period, so investors, including households, corporations and banks, were convinced that property price increases were a certainty.

This increased stock market and real estate wealth eventually fed into the credit markets and the financial system. A massive credit bubble evolved based upon the stock market and real estate bubbles – a nasty combination of corporations, banks and individuals all on a speculative binge. It couldn’t end well and it didn’t.

The Nikkei index peaked at 38,900 in December 1989 and eventually declined more than 80 percent. Property values started to decline in early 1990 and also eventually fell 80 percent. Both have never recovered. The economic consequences of the bursting of the bubbles were catastrophic and long lasting. Banks were technically insolvent and became “zombie” banks. The corporate and household sectors suffered massive losses. Japan has never fully recovered from the collapse of the bubble economy even after two decades. Economic growth has been stagnant and deflation has been a problem. Japan has other issues, such as demographics, but there is no more talk of Japan Number One. In fact, Japan has recently become the third-largest economy in the world after China.

If this all sounds familiar, it should. The U.S. experienced the same phenomena with the stock market, real estate and credit bubbles that collapsed in 2007-2009, but with less intensity and magnitude and also without corporate sector involvement. Japan has been a role model for the U.S. as what not to do when bubbles burst and affect the financial system and real economy. Hopefully Japan’s experience is not a glimpse of the U.S. future after the financial crisis.

Japan has a long-term problem of a declining and aging population and virtually no immigration; the population peaked at about 130 million and is expected to decline to 87 million by 2060, and 40 percent will be over 65 years of age. Since economic growth is a function of population growth and productivity, Japan has to have higher productivity to overcome a declining population just to maintain the same growth as other developed countries. A difficult task. The other major problem has been political leadership; Japan has had 15 prime ministers in the last 20 years. Not a good recipe for making tough economic changes.

Many think, including quite a few Japanese, this may have changed when Shinzo Abe was elected prime minister last year and his political party has taken control of both houses of Parliament, resulting in political stability for several years. He has instituted economic reforms referred to as Abenomics. It may be the last chance Japan has to rid itself of its economic paralysis.

Abenomic economic policy has three main arrows as dubbed by the media. Arrow number one is monetary easing. Because of low or zero economic growth and deflation, Japan has the lowest interest rates in the world, so that tool of monetary policy is not operable. So the Bank of Japan (B of J), like the U.S. Fed, has instigated a massive quantitative easing program. Their goal is to double the monetary base (money supply) in two years. But there are risks associated with this first arrow. The balance sheet of the B of J is already large relative to Gross Domestic Product (GDP); it has doubled in size in 2013 and is the largest relative to GDP among developed countries. At some point, investors may lose confidence in the central bank and then the banking and financial system.

The second arrow is a massive stimulus package. This is nothing new as Japan has had several in the past. They have resulted in recurring government deficits; Japan’s government debt to GDP is 245 percent, one of the highest in the world, especially for a developed country. Again, a risk is bond investors lose confidence in the Japanese economy. Most of the debt is held domestically and denominated in yen, so it will be Japanese investors who may eventually question the credit worthiness of Japanese government debt; some foreign investors already have. No one knows where the tipping point is for the ratio of debt to GDP, but there is one. To alleviate this problem, Japan plans to raise the consumption tax from 5 percent currently to 8 percent in 2014 and possibly 10 percent in 2015.

The third arrow is longer term and involves structural reform of the Japanese economy. This would include industrial revitalization, deregulation, lower trade barriers, new markets for industry and a more global outreach for society. This may be the most difficult of the three arrows to achieve. Japan has world-class multinational corporations and most are doing well, like the auto companies, but some, such as several consumer electronics firms, are faltering. But it is primarily the corporate structure below the large multinationals that needs to be revitalized.

The aim of the three arrows of Abenomics is economic growth. There are signs that it may be working in the short term. Japan has had three quarters of solid economic growth, and consumer confidence has picked up as well as stock and property prices. Like Bernanke and the Fed, the Japanese government and B of J are targeting 2 percent inflation by 2015. With deflation, it pays to delay consumption as goods and services will be cheaper. So a little inflation may help domestic consumption.

Another result of Abenomics is that the yen has depreciated from 78 yen per U.S. dollar to 98 per U.S. dollar. A weaker yen will not only make Japan’s exports more competitive, but imports more expensive, helping foster a little inflation. Recent inflation has been close to 1 percent annually, but most of this is due to higher energy costs due to the weaker yen.

Perhaps Abenomics is the last chance for Japan to reverse more than two decades of stagnant economic growth and deflationary pressures. It may take time and be painful to some in society, but change is needed. Monetary easing and the stimulus may help in the short term, but structural changes of the third arrow are prerequisite to long-term economic growth. Given a declining and aging population, growth in domestic consumption is problematic, especially if base salaries remain stagnant. Exports would help the Japanese economy but slow global economic growth weighs against that. All developed countries would like to export more, including the U.S. but exports and imports are a zero sum game in totality. So the global economy may not be the solution either.

Japan has painted itself into a corner economically. Even though Japan is playing a diminished role in the world economy, it is important to the U.S. to have a strong Japan, given the growth of China, both economically and militarily. If these arrows of economic reform don’t work, especially the third arrow, there may be none left in the quiver. Let’s hope three are enough.