Hot Topics For the End of Summer
We have truly hit the end of summer: the flow of data has ebbed to a lazy trickle, analysts are hanging up their ‘gone fishing’ signs, Wall Street is slow, and the President is on vacation. Even the Federal Reserve Board is taking a break – they had their annual Jackson Hole gathering of world central bankers last week the photos from which conclusively prove that these guys really don’t know how to relax.
So I thought that I would provide you all with a cheat sheet of the current hot topics so you have something to read as you wile away the next two weeks.
The Federal Debt
Last week the administration published its revised estimate of how the Federal Debt was going to grow over the next decade. The headlines in the financial press immediately blasted away with references to the 27% increase from the prior estimate and the ‘horrendous’ $9 trillion that is now the administration’s best guess. I want you all to yawn when you hear that $9 trillion. Ten years from now $9 trillion will not be that big a deal. So relax and enjoy that next drink.
Why should we not panic at the sight of such a large number?
Because debt should always be put in context. Absolute figures are not very helpful. Remember: everything is relative. The simple fact is that our economy is already at $14.5 trillion. Grow it at a conservative rate and throw in a low estimate for inflation and it will be in the $22 to $23 trillion range in ten years. Already that $9 trillion has become more manageable.
Next we should always think of the national debt as a percentage of GDP: that gives us a better handle on how difficult it would be to repay. In ten years time, given the conservative estimates I just mentioned, the debt will be approximately 40% of GDP. That’s lower than many other industrial countries have now, and it’s a level that we have seen here before.
So the debt explosion is not so explosive after all.
Further: the majority of the growth in the debt originates from tax cuts not the fiscal stimulus or the various bail-outs. Don’t forget that taxpayers will most likely get a return on some of the bail-out money: we already hauled in a nice 24% return on our investment in bail-out of Goldman Sachs. The Citicorp investment is doing quite well also. Even all those toxic assets will have some value eventually, minimal yes, but something, so the bail-outs will not hit us as hard as some people think. The stimulus helps get the economy back on track faster and so was a wise investment in ourselves: we all benefit from having the economy recover and avoid depression. The only component of the recurring deficit that turns out to have been a bad investment were those Bush tax cuts: they didn’t stimulate the economy, they were paid for with borrowed money, and most of us received very little because they were skewed towards the wealthy. Those tax cuts could be reversed and most of us wouldn’t notice a thing.
This is not to say that the debt isn’t an issue: it is. The notorious bond market gets the jitters whenever it reads the headlines, so we need to placate it. We do that by keeping our focus on the debt to GDP ratio and not letting it explode into uncharted territory – which appears unlikely – and by undoing those tax cuts. Simple.
Healthcare
The ‘debate’ is vacuous, and it is very hard to separate fact from fiction. I don’t blame anyone if their eyes glaze over. But this reform has to happen. We simply cannot afford to keep going the way we are. So the discussion should be about what kind of reform, not whether we reform at all.
The numbers are simple: we spend twice as much as any other country per person. We get nothing extra for our extra spending. We have a perfect right to spend whatever we like on health care, but we also need to be aware that every penny spent on health is not spent on something else – we have to ration our spending. To the extent that we are wasting money, which we apparently are due to the lack of return on that extra spending, we are undermining our overall ability to generate wealth for the future. And we are giving up ground to our competitors.
So reform we must.
Also bear in mind what I have tried to explain in the past: our system is exactly the one you would design if you wanted to waste money. It doesn’t make sense.
The central issue is that a free market system can never deliver a good bang for the buck in health care because the incentives are always misaligned. There is no way to rid the system of perverse incentives. Doctors and hospitals will always increase prices because it is not possible to introduce the normal market feedback method -competition – that keeps things under wraps in other markets. Doctors don’t compete the way auto companies do. They are not typical businesses. So typical business rules break down in the world of health care. That’s why we need more government intervention to establish better rules to force costs down. As long as we pretend that markets are the way to go in health care the longer we delude ourselves and waste money. Even free market believers should see that the incentive structure can never be fixed.
Wait is that true?
Not exactly. We could force the health care system to behave more like a proper market by establishing rules to force doctors and insurance companies to compete. We do that in some other markets. The problem with that is that the moment we introduce competition many of the same issues that opponents of reform fear most will pop in the so-called market system: profits will drop, services will be eliminated as wasteful, and doctors will earn less. In other words the reform scenario and a ‘pure market’ scenario look a lot alike up until this point.
The reason why reform is superior is that the pure market scenario goes further and takes rationing to an unacceptably high degree. Because a market rations by price it inevitably squeezes out any consumer who ‘wants’ a service, but cannot afford it – this is one reason we have so many people without coverage today. As doctors and insurers seek to protect their profit margins in a ‘pure market’ system they will also eliminate services to marginal customers – they will pay more attention than they do now to credit scoring and other measures of ability to pay. In all likelihood this will increase the number of people being tuned away. Price rationing is a worse form of rationing for a service like health care than any other form of rationing.
In terms of cost, we should all bear in mind the drag that our current system has on wages: American wages are at least 6% lower because employers pay most of the coverage cost and equate health care provision with other forms of employee benefit. As health care cost escalate they eat into the amount of money employers have available to pay wage increases. This drag is a back-door ‘tax’ on workers. It exacerbates the skewed allocation of resources in our economy: the health care industry is not just expensive and inefficient, imposes this hidden tax on the rest of us and contributes to all our other economic problems as a result.
So, the onus is fair and square upon the opponents of reform to justify the continuation of our system. In that regard: one last number, 37th. That’s our rank internationally in terms of our health care system. So the question is this: if we have the ‘best doctors’, the ‘best technology’ and the ‘best facilities’ as the opponents of reform claim we do, why do we have the world’s 37th best system? Something is terribly wrong. Are Americans really satisfied with coming in 37th after all the money we’ve poured into the system?
I am waiting for an answer.
Meanwhile reform is urgent.
Double Dip Recession
The risk of a double dip recession is much higher than most people think. It is probably unlikely, but the risk is growing rather than shrinking.
Recession used to end with a sudden surge in GDP growth and an associated spurt in job creation. the last few however have not been like that.
Why?
Because our economy is very different from a few decades ago. We have far fewer manufacturing jobs, and it was the fire/hire cycle within manufacturing that dictated those sharp turns in fortune. We have outsourced most of those jobs, so we have outsourced the sharp recovery too.
What we are left with is a white collar and service oriented economy where job creation is not as tightly coupled with GDP growth. Worse: businesses tend to continue layoffs well past the point at which the economy has begun to recover: for instance, after the 2001 recession job creation did not get under way until well into 2003, and was anemic even then.
This phenomenon coupled with our need to reduce household debt means that the economy is very vulnerable even though it is now beginning to recover: take away the government stimulus and we would still be declining. In other words the private economy has not yet reached a level that is self-sustaining. I doubt that it will well into 2010 and possibly into 2011. So although the headlines blare ‘recovery’, for most of us it won’t feel much different than it does today. And for those who have lost their jobs it will be a very hard climb back on board. This has all the hallmarks of a jobless recovery.
That is a problem because it exposes us to continued risks.
The longer unemployment lingers close to 10% or more the longer we run the risk of rising loan defaults adding to the strain on our banks. Don’t forget: the banks remain very weak. Their recent improvement is largely an illusion resulting from the assistance they have been getting from the government. Low interest rates, tons of cheap capital, lose accounting regulations, easy money, and the reduction in competition has made banking an simple business right now. But capital is thin and could not withstand another battering. So credit is tight: banks have huge reserves as a result of the help of the Fed’s policies, but they are stashing them rather than using them to make loans.
Add in a run up in losses in commercial real estate and credit cards and we could face another banking crisis.
Meanwhile as the stimulus wears off the private economy will have to stand on its own feet. This means that consumers will have to get back to spending. Without that we will fall back down.
So as long as the banks are fragile and consumers are defensive the chances of a ‘double dip’ grow rather than diminish.
There you have it: three subjects to chew on.
- The Federal Debt.
- Health Care Reform.
- A Double Dip recession.
Hot topics for the end of summer. Or at least food for thought.