Coyote Blog

A while back I wrote:

Is it possible that inflation exists but it shows up mainly in financial assets (stocks, bonds, perhaps real estate) that don't really factor into standard inflation metrics?  Every step the Fed has taken, as well as other western central banks, appears to me to be crafted to pump money into securities markets rather than into main street.  Certainly we have seen a huge inflation in the value of financial assets and real estate over the past several years.

It was an honest question -- I am not an economist.  Business school gives one a pretty good working knowledge of micro but macro is usually outside my ken.  However, I see this is not a new idea and others make the same point.  Saw this chart on the Zero Hedge Twitter feed

I will add that progressives want to use this data to make some sort of fairness / income inequality point about wages vs. rich people's asset holdings, but this chart is not a natural result of unbridled capitalism.  It is the predictable result, even the desired result by its creators, of Fed policy in general and quantitative easing in particular.

This is part 1 of a 2 part series.  Part 2 is here. 

The typical way of talking about income mobility and inequality is to look at the relative income and growth rates of different income quartiles.  Here is a chart used recently by Kevin Drum over at Mother Jones:

As you can see, since the three lines here have their steepest upwards slopes at different times, there are a myriad of possibilities for cherry-picking endpoints to make whatever point you want to make.  I would say this is a pretty healthy picture, with real income growth for everyone, though the general flatness of the middle income brackets since 2007 seems to get the most notice.

A healthy and growing economy should cause all of these quintiles to grow. But income growth and mobility for individuals is about more than just the quintiles.  As a small business owner over the last 20 years, I have had tax returns in all five quintiles -- I have had blowout years when I was "rich" and I have had years when my taxable income would qualify me for food stamps.  In other words, I move between the lines -- and so do a lot of other people.

Young people gaining experience and promotions move from lower to higher quintiles as they age.  New immigrants often come in at the bottom and progress over time.  When people retire, they may fall down a few quintiles.  Marriage might kick someone up to a higher quintile, and divorce may lead to them falling down a few.  There is a constant ebb and flow that is hidden by merely looking at quintiles.

Russ Roberts, who seems to be the token non-socialist at Medium, writes:

but the biggest problem with the pessimistic studies is that they rarely follow the same people to see how they do over time. Instead, they rely on a snapshot at two points in time. So for example, researchers look at the median income of the middle quintile in 1975 and compare that to the median income of the median quintile in 2014, say. When they find little or no change, they conclude that the average American is making no progress.

But the people in the snapshots are not the same people. These snapshots fail to correct for changes in the composition of workers and changes in household structure that distort the measurement of economic progress. There is immigration. There are large changes in the marriage rate over the period being examined. And there is economic mobility as people move up and down the economic ladder as their luck and opportunities fluctuate.

Roberts describes several studies that follow actual people, not quintiles, and finds that the American ideal of income mobility is still alive and well

This first study, from the Pew Charitable Trusts, conducted by Leonard Lopoo and Thomas DeLeire uses the Panel Study of Income Dynamics (PSID) and compares the family incomes of children to the income of their parents.⁴ Parents income is taken from a series of years in the 1960s. Children’s income is taken from a series of years in the early 2000s. As shown in Figure 1, 84% earned more than their parents, corrected for inflation. But 93% of the children in the poorest households, the bottom 20%, surpassed their parents. Only 70% of those raised in the top quintile exceeded their parent’s income.

... Julia Isaacs’s study for the Pew Charitable Trusts finds that children raised in the poorest families made the largest gains as adults relative to children born into richer families.

The children from the poorest families ended up twice as well-off as their parents when they became adults. The children from the poorest families had the largest absolute gains as well. Children raised in the top quintile did no better or worse than their parents once those children became adults.

He has a lot more at the link.

In part 2, I will discuss why public policy is missing the boat, and in some cases doing exactly the wrong thing, to promote income mobility particularly for the poor.

The media will breathlessly promote stories about any weather event in tail of the distribution curve.  I have written many times that this creates a false impression that these events are becoming more common.  Another element of this selection bias is what gets left out.  Does anyone doubt that if we were having a record-heavy tornado season, this would be leading every newscast?  If but if a record-heavy year is newsworthy, shouldn't a record-light year be newsworthy as well?  Apparently not:

source

Which reminds me of this chart Kevin Drum had the other day as "proof" of man-made climate change

I am not going to bother to go to their data source and pick it apart, though my guess is that I could.  But without even looking at the data sources I know this is garbage.  Think about places where there are large natural disasters in the US -- two places that come to mind are California fires and coastal hurricanes.  Do you really think that the total property value in California or on the US coastline has grown only at inflation?  You not only have real estate price increases, but you have the value of new construction.  The combination of these two is WAY over the 2-3% inflation rate.  This effect is magnified by the nature of the metric, which is not total losses but losses over some threshold.  This sort of threshold metric is easy to game, and says nothing for the total losses which would be a better measurement.

By the way, I am wondering how he automatically blames all of these natural disasters on manmade climate change.  Take the most recent, disastrous fires that hit the Redding, California area this year.  That fire started on BLM (federal) land.  When it was small, California State Fire (CalFire) personnel showed up to put it out.  The BLM told them to go away.  The chance to put the fire out when it was small was lost.  How do you blame a fire that was really due to moronic intergovernmental rivalry and bad forest management policy on climate change?

I won't repeat the charts but this post has charts on many extreme weather events and shows that, with the exception of large rainfall events, there is no trend in any of them.

Tyler Cowen asks, "Why isn’t inflation higher?"  I have wondered that for a while, but monetary policy and related topics in macro are one of the areas I admit that I simply do not understand so I don't write about it.  So rather than offering any hypotheses to Cowen's question, I will ask my own:

1. Is it possible that inflation exists but it shows up mainly in financial assets (stocks, bonds, perhaps real estate) that don't really factor into standard inflation metrics?  Every step the Fed has taken, as well as other western central banks, appears to me to be crafted to pump money into securities markets rather than into main street.  Certainly we have seen a huge inflation in the value of financial assets and real estate over the past several years.
2. Expansion of the economy above the rate of productivity improvement should drive inflation, unless there was a lot of excess capacity to soak up.   That may have been partly the case in the US since 2008, but surely that is gone.  Does the still greatly underutilized Chinese and Indian labor force act as excess capacity that prevents inflation from heating up here?  If so, might Trump's trade restrictions interfere with this going forward?

On several occasions, I have wondered why progressives continue to be so supportive of paying too many government workers too much at the cost of reducing the government services they seem so passionate about.  This is something I seen in the public parks world all the time.  Arizona State Parks, for example, has about half of its employees in headquarters buildings rather out in the field serving the public while at the same time paying these headquarters staff very high salaries.  This is despite the fact that the agency has tens of millions of dollars of deferred maintenance it refuses to address.

I see this story repeated over and over in the public parks world -- when forced to choose, government agencies will cut back on maintenance and services to protect total staffing numbers, pay, and benefits.

The New York Times found something similar in the New York Subway:

An examination by The New York Times reveals in stark terms how the needs of the aging, overburdened system have grown while city and state politicians have consistently steered money away from addressing them.

Century-old tunnels and track routes are crumbling, but The Times found that the Metropolitan Transportation Authority’s budget for subway maintenance has barely changed, when adjusted for inflation, from what it was 25 years ago.

Signal problems and car equipment failures occur twice as frequently as a decade ago, but hundreds of mechanic positions have been cut because there is not enough money to pay them — even though the average total compensation for subway managers has grown to nearly $300,000 a year.

Later they go into more detail about payrolls:

Subway workers now make an average of $170,000 annually in salary, overtime and benefits, according to a Times analysis of data compiled by the federal Department of Transportation. That is far more than in any other American transit system; the average in cities like Boston, Chicago, Los Angeles and Washington is about $100,000 in total compensation annually.

The pay for managers is even more extraordinary. The nearly 2,500 people who work in New York subway administration make, on average, $280,000 in salary, overtime and benefits. The average elsewhere is $115,000....

Union rules also drive up costs, including by requiring two M.T.A. employees on every train — one to drive, and one to oversee boarding. Virtually every other subway in the world staffs trains with only one worker; if New York did that, it would save nearly $200 million a year, according to an internal M.T.A. analysis obtained by The Times.

Several M.T.A. officials involved in negotiating recent contracts said that there was one reason they accepted the union’s terms: Mr. Cuomo.

The governor, who is closely aligned with the union and has received $165,000 in campaign contributions from the labor group, once dispatched a top aide to deliver a message, they said.

Pay the union and worry about finding the money later, the aide said, according to two former M.T.A. officials who were in the room.

They do not mention pensions.  Who wants to be there is also a looming unfunded pension crisis here?

I thought folks might be interested in a letter I just wrote to the US Forest Service.  I have left some of it out, but these are the guts of it.  As many of your know, we manage parks and campgrounds under concession contract for public entities.  As such, we typically must get changes to customer fees approved in advance by the agency.  This is a version of a letter we just wrote to a number of US Forest Service offices in California explaining the substantial increases to camping rates that must occur over the coming years to accommodate the new California minimum wage laws.

2017 Fee Proposal & Impact of California Minimum Wage Increases on Camping Rates

The purpose of this letter is to make you aware of the substantial effect that the recent increase in California minimum wages will have on use fees. I will get into details below, but in short the newly-legislated 50% increase in the state minimum wage is likely to increase our costs by about 22%, even ahead of inflation in other categories of expenses. Just to stay at parity and to avoid cuts in service, we (and other California concessionaires) are going to need substantial increases in fees over the next five years. Frankly, this does not make me very happy – our company will have to struggle with public resentment of the new fees without making an extra dollar in profit – but it is the reality we must face together. The only other alternative would be large cuts in service (e.g. bathroom cleaning frequency) which frankly I am not going to accept.

Background on the Minimum Wage Increase

California minimum wages have already risen over the last three years by 25% from $8 to $10 an hour. The new California law, which will apply to most concessionaires, demands the following timetable for minimum hourly wages (smaller companies with fewer employees than we have will have one extra year to comply):

2016: $10.00

2017: $10.50

2018: $11.00

2019: $12.00

2020: $13.00

2021: $14.00

2022: $15.00

Note that given the terms of other portions of labor law, these same sorts of percentage increases must trickle up to all managers and salaried employees in California as well.

Background on Concessionaire Cost Structures

Not surprisingly, as a labor-intensive service business, a substantial portion of concessionaire costs are directly tied to wage rates. The minimum wage increase will increase at least three categories of our costs:

• Wages
• Payroll taxes (which are calculated as a percentage of wages, so will go up by the same percentages as wages go up)
• Workers compensation insurance premiums (which like payroll taxes are calculated as a percentage of wages and go up by the same percentage wages go up)

Looking at our financials for our California permits (we have three large permits in the Inyo NF and one in the Cleveland NF) these three categories make up 44% of our total costs.

Preliminary Estimated Fee Impacts

Let’s look, then, and how much our costs may rise between now and 2022.

For the labor and labor-related charges discussed above, we know that costs will rise 50% between now and 2022. A 50% price increase on 44% of our costs raises our total cost structure by 22% (0.5 * 0.44).

But all of our other costs will also continue to rise during this period by at least the national rate of inflation. It is very possible that these costs will increase faster in the future due to this minimum wage increase – for example, our waste disposal costs will almost certainly go up as the labor costs of waste disposal companies rise. For a starting point, we will assume 3% general inflation in 2016 and 2017 and 4% in the years after that. This would yield a 24% increase in the other 56% of our costs for an impact on our total costs of 13.4% (0.24*0.56). Combining these two effects, we can expect a total cost increase to operate campgrounds in California by 2022 of 35.4%.

Note that though we bid based on trying to earn a profit margin around 9%, our actual profit margin in the USFS campgrounds we operate in California has been between 3% and 7% of revenues (5% in 2013, 7% in 2014, 3% in 2015). There is simply no room in that margin to absorb a 35.4% cost increase. We are going to have to therefore seek fee increases over the next 6 years in the 35% range, or between $6 and $8 on the $18-$23 camping rates that currently obtain. This is about a dollar or year, or two dollars every other year.

Competitor Analysis

We understand that the USFS wants to justify fee increases based on market conditions. One problem we will have is that even though we don’t open until April or May at seasonal locations, we need to get fee approval the previous September or October. We fully expect private operators will have to pursue fee increases of a similar magnitude; however, they may not announce their new higher rates in time for our very early fee-setting process. This makes local competitive analysis misleading.

Fortunately, in California we have another large public campground provider, California State Parks (CSP), that has many of the same public service and land management goals as has the US Forest Service. They therefore make a very good comparison. While rates vary by park, CSP is typically charging $35 a night for a no-hook-up campsite in parks that are very comparable in their natural settings to USFS campgrounds.

We currently charge no more than $23 for a no-hook-up site in the USFS in California (both in the Inyo and Cleveland NF). Even with a $6 fee increase, we would still be offering no-hookup campsites at 17% lower cost than does the State of California today (and presumably even lower in 6 years given that CSP is likely to continue to increase its camping fees).

[Rest of the letter on exact fee recommendations and other contract issues omitted]

I have made this point before, but Tyler Cowen has a great chart from a new study.  The explanation is here, but basically they have defined the bands based on some income break points corrected for family size and inflation over time.

A reader sent me a nice note with this link, saying that I had been right many years ago when I began making this point.  That's good, but I will also confess to be wrong on a related point -- I said 8 years ago that the one good thing about having a Democratic President was that the media would become much more positive suddenly about the economy.  On that, I was wrong.  The media still has a strong bias towards telling everyone that their life is getting ever worse, even when no such thing is true.

If you listened to the media and political candidates, you would quickly come to the conclusion that the quickest way to prosperity and wealth is to have a worthless currency.  Every politician the world over argues for devaluing their own currency vs. other nations, with the logic that this helps domestic manufacturers by making imported competitors more expensive and making their own products less expensive to buy in other countries.  **

While the latter two statements are nominally true, the only way this actually helps an economy is if one ignores everyone except manufacturers in markets dominated by international trade.  What it ignores is that a falling currency makes purchases more expensive for everyone else.  Consumers and service industries and even manufacturers who depend on imported raw materials all suffer from a falling currency.  And this is not even to mention the effect on wealth -- if one's savings are all in assets denominated in the falling currency, one is clearly losing wealth as the currency falls.

Well, for the first time in a really long time, I actually saw an article this week that focuses on some of the problems of having a falling currency.  via zero hedge.

“I’ve never seen it that high. It’s usually $6.99, maybe $8 but that seems like quite a jump.”

Grapefruit isn’t the only produce to soar in price as fresh fruit has increased by 12.4 per cent since December 2014, and fresh vegetables are up 14.4 per cent, according to data from Statistics Canada released Friday. Led by those surging produce prices, Alberta’s annual inflation rate rose last month by 1.5 per cent, year over year.

The high prices are a direct result of adverse weather in the United States and the lower Canadian dollar since most produce is imported, said Jason Wiebe, president of Chongo’s Market at the Crossroads Farmers Market.

“Tomatoes trade the same as the TSX. It’s a commodity, too, and all produce is traded in U.S. dollars. In November, the retail cost of tomatoes on the vine was $1.99 a pound. Now I have to sell the same box at $3.99 pound.

“What’s going to be really interesting going forward is what happens to local growers come summer. With the dollar, they can make one and half or two times as much exporting than selling here.”

And that may only be the beginning of higher food costs, according to ATB chief economist Todd Hirsh.

“Going forward I think we’ll see even higher upward pressure on imported fruits and vegetables. If not for weather conditions, certainly that low Canadian dollar will affect it. Because the numbers we’re talking about today are from December and now in January we’re almost five to six per cent lower on that dollar….If people insist on eating fresh tomatoes and pineapple in January, they’ll be forced to pay for it.”

 

** To my eye, every government in the industrialized world is working as hard as they can to hammer down the value of their own currency.  As a result, a rising currency tends to mean only that the country in question has a central bank that is not working as hard and as fast as other countries to trash their currency.  All of which makes accusations that China is manipulating its currency an enormous joke.  Several trilling dollars in QE here and they are the ones manipulating their currency?

Arnold Kling has a good question in this post on secular stagnation.  For most questions of the sort "would you rather the 1985 version of X for the 1985 (nominal) price or the 2015 version at the 2015 price, I would choose the latter.  TV's?  Cars?  Phones? Computers?  All way better for the price today.  This of course implies that for many of these items, the inflation rate is really negative if we could adequately take into account quality and technology changes.  Services are a different story.  For health care, I would take the 2015 version and price.  I would have to think about my answer for a while in air travel (I think folks overly romanticize their memory of air travel -- I was travelling PeopleExpress to Newark in the early 80's and that really, really sucked.   My seat and meal are worse nowadays but I am more likely to be on time).

So Kling then asks about college education.  These are convenient dates for me since I graduated in 1984.   So would I rather Princeton in 1984 at about $10,000 or Princeton today at $60,000.  I guess education-wise, the liberal arts course catalog at Princeton in 1984 was more closely matched to my interests, and I don't get any sense the faculty today is better or worse in either period but it likely was more politically diverse in 1984.  So academically, I would easily give the nod to 1984.  For the ancillary stuff, though, the change in quality has been substantial.  The dorms, the dining options, the residential college system, the student center -- all the non-academic stuff is way better today.  However, all that stuff is a lot of what is driving up the nominal price -- is it worth it?   Yes, I suppose so if someone else is paying, lol.  Probably not if I am paying my own way through.

People keep talking about reducing Greek debt to a sustainable level, but part of the problem is that there is not such level.  Even at zero.  The problem is that Greece is running a government deficit even before any debt service, so if creditors were to waive all of its debt, it would still need to be borrowing new money tomorrow.  Debt forgiveness is not enough -- what the Greeks need is for Europe to write off all its debt, and then (having lost all their money on the old debt) start lending new money immediately.  Note also that any bailout agreement reached this month will just put everyone back in the exact same place a few months from now.

This situation cannot be expected to change any time soon, for a variety of reasons from demographics (Greece has the oldest population in Europe, and a relatively rich pension system) to ideology (the current pseudo-Marxist government will never implement the reforms needed to turn the economy around, even if they promise to do so under duress).

With structural solutions unlikely, Greece has only the options of charity and inflation. Greece still seems to be hoping for charity, which they make harder by spewing derision at the same folks whom they are begging for alms.  Europe, certainly Germany, is in no mood to be charitable any longer, but may still do so depending on their calculation about which action -- bailout or exit -- has the worse long-term consequences for keeping Portugal, Spain, and Italy both in the Euro and continuing to pay their debts.

Lacking charity, the only thing left is inflation.  Some folks think I am advocating that option.  I am not.  The best possible hope for Greece is to slash its economic regulation, privatize business, and cut back on the public sector -- but that is not going to happen with the current government.  Or maybe any government.

I say inflation is the only option because that is what balances the budget and "solves" debt problems when politicians are unable or unwilling to make any hard choices.  It is sort of the default.  If they can't balance the budget or figure out how to pay off debt, then inflation does it for them by reducing the value of pensions and outstanding debts**.  This is what will happen with a Grexit -- a massive bout of devaluation and inflation what will greatly reduce the value of any IOU, whether it be a pension or a bank deposit.

Eventually, the one good thing that comes from inflation and devaluation is that the country becomes really cheap to outsiders.  Tourists will flock in and olive oil will sell well internationally as the new drachma loses its value, creating value for people holding stronger currencies and potentially forming the basis for some sort of economic revival.  My wife and I decided a few months back to postpone the Greek vacation we wanted this year -- too much turmoil is still possible -- and wait for it to be a bargain in 2016 or 2017.

**Postscript:  This is exactly why the Euro is both immensely seductive and a dangerous trap for countries like Greece.  Seductive, because it could pursue any sort of destructive banana republic fiscal policy it wished and still have a strong currency.  A trap because it can no longer print money and inflate away its debt problems.

I have been predicting for years that the only solution for the Greece problem is for it to exit the Euro, go through a horrible economic crisis and deal with substantial devaluation, and then hopefully move on with a cheaper currency that makes its tourist industry look better and plugs the hole between taxing and spending with inflation.  It appears we are closer than ever to this actually happening.  The Greeks would likely be moving forward now, like Iceland, if they had taken their medicine years ago rather than try to kick the can.  Now it is just going to be worse.

I have been enamored off and on with the idea of a gold standard but Megan McArdle made some powerful points today about how the Greek situation teaches us that a gold standard doesn't necessarily impose discipline on governments.

It's easy to moralize Greece's feckless borrowing, weak tax collection and long history of default, and hey, go ahead; I won't stop you. But whatever the nation's moral failures, what we're witnessing now shows the dangers of trying to cure the problems of weak fiscal discipline with some sort of externally imposed currency regime. Greek creditors and Brussels were not the only people to joyously embrace the belief that the euro would finally force Greece to keep its financial house in order; you hear the same arguments right here at home from American gold bugs. During the ardent height of Ron Paul's popularity, I tried to explain why this doesn't work: "You don't get anything out of a gold standard that you didn't bring with you. If your government is a credible steward of the money supply, you don't need it; and if it isn't, it won't be able to stay on it long anyway."

This goes double for fiscal discipline. Moving to a fixed exchange rate protects bond-holders from one specific sort of risk: the possibility that inflation will erode the real value of your bonds. But that doesn't remove the risk. It just transforms it. Now that the government can't inflate away its debt, you instead face the risk that they are going to run out of money to pay their bills and suddenly default. That's exactly what happened to Argentina, and many other nations on various other currency regimes, from the gold standard to a currency peg. The ability to inflate the currency had gone away, but the currency regime didn't fix any of the underlying institutional problems that previous governments had solved with inflation. So bondholders protected themselves from inflation, and instead took a catastrophic haircut.

Postscript #1:  I had one issue with McArdle's piece when she writes

The only people this will be good for is people who long to vacation on the Greek Islands. If Grexit actually happens, book those plane tickets now, but hold off on the hotel. It will be cheaper in six months. Then try to enjoy it as you remember that those fabulous savings are someone else's whole life evaporating.

Hey, if Grexit occurs, you have no reason to feel guilty about taking advantage of the weak currency and low prices for a Greek vacation.  There is nothing the Greeks need more than for you to do exactly that.   It is the single best thing you could do for the Greek people.

Postscript#2:  Here is why exiting the Euro, devalutation, and inflation are the only way out for Greece at this point. Creditors allow countries to run long-term deficits and keep lending despite rising debt (see: Japan) because of a combination of a) the country can always just print the money they need; b) the country can raise taxes and take the money it needs or c) the country can keep spending flat and grow their way out from the debt.

None of these are available to Greece. They can't print money, at least without running up new debts (excess printing of Euros is automatically added to Greece's debt to the ECB).  They can't raise taxes because their citizens don't pay the taxes that already exist.  And they can't grow their way out because there is zero support for austerity or market-based reforms that would be necessary, and besides a huge portion of Greek deficit spending is for inherently unproductive activities.  At this point Greece's only option is charity, that the other countries of the EU will forgive debt or write them new debt, either to be nice or to avoid bad precedents with other PIGS countries.  But  the EU seems at the end of its charity rope, and besides given zero prospects of any sort of Greek recovery, even after a major write-off of debt the EU would be in the position of still having to send Greece new money for its new debts.

As readers will know, I am frustrated that the Feds continue to fuel a huge financial asset bubble.  While I was wrong, so far, that the Feds would create consumer and industrial price inflation from their massive money printing operation, they have created an enormous price inflation in financial assets.   Every week they pour more newly printed dollars into the hands of financial asset holders, and corporations have joined in the fun by taking advantage of low borrowing rates to buy back record amounts of their own shares.   With both the Fed and publicly-traded corporations taking so many financial assets off the market at the same time investors have new cash to invest, someone has to create some new assets to buy.

Enter:  The $500 million spec home.  I kid you not.

LOL, I am betting the neighbors are not happy

As an upside, I suppose they are creating a future tourist attraction.  Many of the great Gold Coast and Newport mansions of the late 19th century were too expensive for later generations to operate and ended up in the hands of non-profits and governments.

Bloomberg (via Zero Hedge) had this chart on Disney theme park entrance prices:

A few random thoughts:

• This highlights how hard it is to do inflation statistics correctly.  For example, the ticket being sold in 1971 is completely different from the one being sold in 2015.  The 2015 ticket gets one access without additional charge to all the attractions.  The 1971 ticket required purchase of additional ride tickets (the famous, among Disney fans, A-E tickets).  So this is not an apples to apples comparison.  Further, Disney has huge discounts for multi-day tickets.  The first day may cost $105, but adding a fourth day to a three day ticket costs just a trivial few bucks.  Local residents who come often for a single day get special rates as well.  So the inflation rate here grossly overestimates that actual increase in per person, per trip total spending for access to park attractions
• This is a great case in pricing strategy.  Around 1980, the Bass family bought into a large ownership percentage of Disney.  The story I am about to tell is often credited to their influence, but I am not positive.  Never-the-less, someone had a big "aha!" moment at Disney.  They realized that families were taking trips just to visit DisneyWorld.  These trips cost hundreds, even thousands of dollars.  The families were thus paying hundreds of dollars per person to enjoy Disney, of which Disney was reaping... $9.50 a day.  They had a stupendously valuable product (as far as consumers were concerned) but everyone else in the supply chain was grabbing most of the value they created.  So Disney raised prices, on the theory that if a family were paying over a thousand dollars to get and stay there, they would not object to paying an extra $50 at the gate.  And they were right.

This letter to customers from San Francisco bookstore Borderlands is making the rounds.  Apparently, the new "living wage" legislation in San Francisco is killing this store:

In November, San Francisco voters overwhelmingly passed a measure that will increase the minimum wage within the city to $15 per hour by 2018.  Although all of us at Borderlands support the concept of a living wage in [principle] and we believe that it’s possible that the new law will be good for San Francisco – Borderlands Books as it exists is not a financially viable business if subject to that minimum wage.  Consequently we will be closing our doors no later than March 31st.  The cafe will continue to operate until at least the end of this year.

I find the authors surprisingly open to the Progressive assumptions behind this bill, despite the death of their business.  I don't know if this is a pair of hipsters destroyed by their own cause, or if the nods towards Progressivism are merely boiler plate that is required in any San Francisco conversation, like having a picture of Lenin on your wall in Soviet Russia.

Anyway, I found the language here familiar because I spent most of last year writing such letters to angry customer bases.  In our case, fortunately, we had the ability to raise prices so the letters were to defuse customer irritation rather than to announce a closure.  Here is one example I wrote in Minnesota:

Labor and labor-related costs (costs that are calculated as a percentage of wages, like employment taxes) make up nearly 50% of our costs.  The Minnesota minimum wage is set to rise from $7.20 to $9.50 in the next two years, an increase of 31%.  Since wages and wage-related costs are half our expenses, the minimum wage increase raises our total costs by 15.5%. This means that all by itself, without any other inflation in any other category of expenses, the minimum wage increases will drive a $3.10 increase in our camping fees (.155 x $20).  Note that this is straight math.  The moment the state of Minnesota passed their minimum wage increase, this fee increase was going to be required.

One of the problems with these minimum wage increases is that the people behind them, with their hazy assumptions and flawed understanding of economics, typically think that companies will just absorb the increase.   Our net profit margin runs in the 4% range, so it difficult to see how any such retail company can absorb a 15+% cost increase, but it happens all the time.  After some trial and error, the "this is straight math" phrase seems to work the best in communicating the need for price increases.

Things like Obamacare cannot be discussed, it seems, in anything but a political context.  So if you don't like Obamacare, everything that happens has to be bad. But I actually think this is good news, and goes against my fears in advance of Obamacare.  I had been worried that Obamacare would just increase the trends of more and more health care spending being by third-party payers.  And my guess is that this is happening, when you consider how many people have gone from paying cash to having a policy, either a regular policy or expanded Medicaid.

A report out today puts numbers behind what hit many workers when they signed up for health insurance during open enrollment last year: deductible shock.

Premiums for employer-paid insurance are up 3% this year, but deductibles are up nearly 50% since 2009, the report by the Kaiser Family Foundation shows.

The average deductible this year is $1,217, up from $826 five years ago, Nearly 20% of workers overall have to pay at least $2,000 before their insurance kicks in, while workers at firms with 199 or fewer employees are feeling the pain of out-of-pocket costs even more: A third of these employees at small companies pay at least $2,000 deductibles.

“Skin-in-the-game insurance” is becoming the norm,says Kaiser Family Foundation CEO Drew Altman, referring to the higher percentage of health care costs employees have to share.

Honestly, this is good news, sort of.  I don't like the coercion and lack of choice, but the main problem with health care is that the person receiving the benefits is not the person paying the bills, which means there is no incentive to shop or make care tradeoffs.  Higher deductibles mean more people are going to be actively shopping and caring what health services cost, and that is a good thing for prices and health care inflation.

Grade inflation is back in the news, as the Harvard Crimson reports that the median grade at Harvard is an A-.  This is clearly absurd.  It reminds me of some of the old Olympics judging where they had a 10 point scale but everyone scored between 9.7 and 9.9.  The problem is not necessarily that the mean is skewed, but that there is almost no room left to discriminate between high and low performance.

There is one potential way to combat this, and it was invented by colleges themselves.  Consider grading in high school.  My kids go to a very tough-grading private school where A's are actually hard to get.  The school sends (for Arizona) a fairly high percentage of its students to Ivy and Ivy-level schools, but the school produces someone with a perfect 4.0 only once every four or five years.  Compare that to our local public school, that seems to produce dozens of perfect 4.0's every year -- in fact since it adds a point for honors classes, it produces a bunch of 5.0's.

Colleges understand that a 3.7 from Tough-grading High may be better than a 5.0 from We-have-a-great-football-team High.  They solve this by demanding that when high schools provide them with a transcript, it also provide them with data on things like the distribution of grades.

Employers should demand something similar from colleges.  This is a little harder for employers, since colleges seem to be allowed to legally collude on such issues while employers can get sued over it.  But it seems perfectly reasonable that an employer should demand, say, not only the student's grade for each class but also the median and 90th percentile grades given in that same class.  This will allow an employer to see how the school performed relative to the rest of the class, which is really what the employer cares about.  And schools that have too many situations where the student got an A, the median was an A, and the 90th percentile was an A may get punished over time with less interest from the hiring community.

One way to get this going is for an influential institution to start printing transcripts this way.  The right place to start would be a great institution that feels it has held the line more on grade inflation.  My alma mater Princeton claims to be in this camp, and I would love to see them take leadership on this (the campus joke at Princeton during the Hepatitis C outbreak there was that at Harvard it would have been Hepatitis A).

Postcript - An alternate grading system from Harvard Business School:  When I was at HBS, they did not give A's and B's.  We had three grades called category I, II, and III.   By rule, the professor gave the top 15% of the class category I, the bottom 10% category III, and everyone else got a category II.  I actually thought this was a hell of a system.  It discriminated at the top, and provided just enough fear of failure to keep people from slacking.

This is a re-post of an article I wrote in 2012.  I am re-posting it to demonstrate that recent stories about doctor shortages and wait times are absolutely inevitable results of government interventions in the health care economy.

My son is in Freshman econ 101, and so I have been posting him some supply and demand curve examples.  Here is one for health care.  The question at hand:  Does government regulation including Obamacare increase access to health care?  Certainly it increases access to health care insurance, but does it increase access to actual doctors?   We will look at three major interventions.

The first and oldest is the imposition of strong, time-consuming, and costly professional licensing requirements for doctors.  At this point we are not arguing whether this is a good or bad thing, just portraying its inevitable effects on the supply and demand for doctors.

I don't think this requires much discussion. For any given price for doctor services, the quantity of doctor hours available is certainly going to increase as the barriers to entry to the profession are raised.

The second intervention is actually a set of interventions, the range of interventions that have encouraged single-payer low-deductible health insurance and have provided subsidies for this insurance.  These interventions include historic tax preferences for employer-paid employee health insurance, Medicare, Medicaid, the subsidies in Obamacare as well as the rules in Obamacare that discourage high-deductible policies and require that everyone buy insurance rather than pay as they go.  The result is a shift in the demand curve to the right, along with a shift to a more vertical demand curve (meaning people are more price-insensitive, since a third-party is paying).

The result is a substantial rise in prices, as we have seen over the last 30 years as health care prices have risen far faster than inflation

As the government pays more and more of the health care bills, this price rise leads to unsustainably high spending levels, so the government institutes price controls.  Medicare has price controls (the famous "doc fix" is related to these) and Obamacare promises many more.  This leads to huge doctor shortages, queues, waiting lists, etc.  Exactly what we see in other state-run health care systems.  The graph below posits a price cap that forces prices back to the free market rate.

So, is this better access to health care?

I know that Obamacare proponents claim that top-down government operation is going to reap all kinds of savings, thus shifting the supply curve to the right.  Since this has pretty much never happened in the whole history of government operations, I discount the claim.  When pressed for specifics, the ideas typically boil down to price or demand controls.  Price controls we discussed.  Demand controls are of the sort like "you can't get a transplant if you are over 70" or "we won't approve cancer treatments that only promise a year more life."

Most of these do not affect the chart above, since it is for doctor services and most of these cost control ideas are usually doctor intensive - more doctor time to have fewer tests, operations, drugs.  But even if we expanded the viewpoint to be for all health care, it is yet to be demonstrated that the American public will even accept these restrictions.  The very first one out of the box, a proposal to have fewer mamographies for women under a certain age, was abandoned in a firestorm of opposition from women's groups.  In all likelihood, there will be some mish-mash of demand restrictions, determined less by science and by who (users and providers) have the best lobbying organizations.

My longer series of three Forbes articles on this and other economic issues with Obamacare begin here:  Part 1 Information, Part 2 Incentives, Part 3 Rent-Seeking

Update:  Pondering on this, it may be that professional licensing also makes the supply curve steeper.  It depends on how doctors think about sunk cost.

Inflation statistics are always kind of hard to read -- what is driving the rise?  Is it across the board or a glitch in one sectors?  The media tries to deal with it by presenting a second number which is the number without the more volatile food and energy number.  The combination of the two gives a bit more information.

But this simple chart is way better.  It shows inflation by component at the same time while showing how much that component is weighted in the overall metric.  Via zero hedge.

Apparently it is some kind of amazing new insight or quasi-scandal that the Fed seems to care more about inflation than unemployment, at least as measured by the language of its meeting notes.

Call me crazy, but the Fed's job is to manage the currency and money supply, not to manage employment or the broader economy.  I have always assumed that it was understood by all that keeping the value of money stable (ie fighting inflation) was the Fed's priority ahead of other economic issues.  What am I missing here?

One of the real frustrations I have with Obamacare is that I believe we were on the cusp of a revolution in health care costs and payment systems, which the PPACA will likely kill.  As more and more of us adopted high-deductible health insurance plans, there was an increasing transparency in pricing, and new delivery models were emerging to serve this consumer-based, non-third-party payer health niche.

I think this even more as I read about the CMS revising its future health care cost inflation numbers to take into account a flattening of medical price inflation that has been occurring over the last few years.  The Left has hilariously claimed credit for this cost reduction via some kind of time-travelling effect of not-yet-implemented PPACA measures.  But Charles Blahous reads the CMS report more carefully and finds that the PPACA has nothing to do with these inflation reductions, and in fact is if anything slowing the cost reduction progress.

The obvious point that leaps out from this graph is that the chief CMS actuary found that the ACA would increase national health expenditures through 2016. Not content to let the tables speak for themselves on this point, CMS was explicit in the text of its memorandum that the ACA increased the near-term cost projections:

“The estimated effects of the PPACA on overall national health expenditures (NHE) are shown in table 5. In aggregate, we estimate that for calendar years 2010 through 2019, NHE would increase by $311 billion or 0.9 percent, over the updated baseline projection that was released on June 29, 2009. Year by year, the relative increases are largest in 2016, when the coverage expansions would be fully phased in…The increase in total NHE is estimated to occur primarily as a net result of the substantial expansions in coverage under the PPACA…”

...CMS is now projecting slower health care expenditure growth than they were in 2009 and 2010. CMS’s current projection of 2016 health spending totaling 18.4% of GDP is 1 percentage point lower than its June 2009 estimate (19.4%) and 0.9 points lower than its February 2009 estimate (19.3%).

Why did CMS lower its estimates of future health spending? It wasn’t because of the ACA. We know this for a fact because CMS has released a memorandum detailing the reasons for changes in their ten-year outlook since April 2010. Here are the factors CMS cited, and the percentage of the improvement each was responsible for:

1) Medicare/Medicaid/other programs “unrelated to the ACA” (50.7% of improvement).

2) Other factors “unrelated to the ACA” (26.1%).

3) Updated data on historical spending growth (21.8%).

4) Updated macroeconomic assumptions (6.1%).

Now, that adds up to 104.7% of the total improvement. The reason these four factors add to more than 100% is that a fifth factor, the “impact of the ACA,” worked against the improvement. Per CMS, adjusting the April 2010 projections for the subsequent impact of the ACA shows it further increasing spending over ten years (equal to and opposite from 4.7% of the total change).

Via Bloomberg

The health-care law eliminates “substandard policies that don’t provide minimum services,” said Jay Carney, a White House spokesman, in response to the cancellations. The “80-plus percent” of Americans with employer plans or covered by government programs are unaffected.

I chose my policy very carefully, and don't think it is "sub-standard" because it does not include pediatric dental care for two people in their fifties.  This is the worst consumer dis-empowerment that I can remember in my lifetime.

And I totally agree with this

Now an effective levy of several thousand dollars on the small fraction of middle class Americans who buy on the individual market is not history’s great injustice. But neither does it seem like the soundest or most politically stable public policy arrangement. And to dig back into the position where I do strong disagree with Cohn’s perspective, what makes this setup potentially more perverse is that it raises rates most sharply on precisely those Americans who up until now were doing roughly what we should want more health insurance purchasers to do: Economizing, comparison shopping, avoiding paying for coverage they don’t need, and buying a level of insurance that covers them in the event of a true disaster while giving them a reason not to overspend on everyday health expenses.

If we want health inflation to stay low and health care costs to be less of an anchor on advancement, we should want more Americans making $50,000 or $60,000 or $70,000 to spend less upfront on health insurance, rather than using regulatory pressure to induce them to spend more. And seen in that light, the potential problem with Obamacare’s regulation-driven “rate shock” isn’t that it doesn’t let everyone keep their pre-existing plans. It’s that it cancels plans, and raises rates, for people who were doing their part to keep all of our costs low.

With my high deductibles, I am actually out shopping every day on health care prices and I can tell you from my experience that if everyone did so, we would see a reversal of health care inflation.  More here

If a city government cannot bring itself to end something so obviously abusive as pension spiking, what hope is there of any real reforms on tougher matters?  Government employees are increasingly running government in their own favor.

After nearly three hours of contentious debate, Phoenix city leaders were so divided over how to tackle pension “spiking” on Tuesday that they ended up doing nothing at all.

They walked into the City Council chambers prepared to make changes, but after splintering into three ideological factions, voted 5-4 against a plan to combat spiking, generally seen as the artificial inflation of a city employee’s income to boost his or her retirement benefit.

Several high-profile cases have come to light, pushing the effort to eliminate pension boosting to the forefront of the council’s agenda.

Former Phoenix City Manager David Cavazos, who retired last week to lead another city, was able to apply unused sick pay and other perks to spike his pension to an estimated $235,863, the second-largest retirement benefit in city history.

Earlier this month, a subcommittee of council members proposed modest reforms that they said would reduce pension spiking and provide transparency. They said the plan treated existing employees fairly and avoided potential litigation.

But the proposal fell apart Tuesday night, when a group of liberal-leaning council members joined the body’s fiscal conservatives in voting against it, though their rationales were vastly different.

After the motion to approve the proposal failed, the meeting ended. The result, greeted by cheers from employee unions in the crowd

Over the last year, I have learned that those of us who took economics back in the 1980's with textbooks written in the 1960's and 1970's are not very well prepared to understand the modern banking system.  This was a pretty good article that whetted my appetite for understanding what has changed.  A couple of interesting bits from the piece:

One cannot think straight about the future impact of different exit strategies without understanding of the role of bank reserves in today’s financial markets.

• Banking and money creation has not worked for at least two decades in the way that most people learned in school.

The old system was rather simple in the textbooks. The basic assumptions were (i) all credit was provided by banks; (ii) all bank credit (assets) were funded by the issuance, or creation, of depository liabilities (money) subject to a reserve requirement; and (iii) central banks controlled credit/money/inflation by rationing bank reserves. A stable 'money multiplier' was hypothesised to allow central banks to accurately predict the eventual impact of changes in bank reserves on money and credit.

The problem with the old theory of monetary operations is that none of the three assumptions has been true for at least a generation.
Most credit in the US is created by nonbanks; virtually all bank lending is funded by the creation of liabilities that are not subject to reserve requirements,³ and central banks do not ration reserves. In fact they take great pains to provide banks with the amount of reserves they desire. Central banks influence credit not by rationing the quantity of reserves but by altering the interest rate that banks must pay to obtain the quantity of reserves they desire.

• Today, credit creation in general and money creation in particular are no longer tied to the stock of reserves (i.e. the stock of banks’ deposits at the Fed).

This gets to the heart of the question of why over $2 trillion in excess bank deposits built up at the Fed over the last 4 years are not really moving the needle on bank lending  (of course, this is a supply AND demand problem, and part of the issue with flat bank lending is tie to lack of demand as many businesses deleverage).  But in terms of supply, I am increasingly coming to terms with the following statement which seems counter-intuitive to someone who studied banking 30 years ago

One of the unintended consequences of Fed LSAPs has been the withdrawal of high quality liquid collateral such as US Treasuries from the financial markets paid for by crediting commercial bank reserve accounts. As discussed above, the banking system as a whole cannot dispose of these assets (reserves). At the same time, banks are under massive pressure world-wide to deleverage. This can take place either by increasing capital (a bank liability), which is costly to shareholders, or by reducing assets. Thus banks’ massive holdings of reserves at the Fed are ‘deadwood’ as far as the banks and their credit-creation capacity are concerned. They may crowd out credit.

The deadwood problem will get worse if the US tightens regulatory leverage ratios – that is, reduces the maximum ratio permitted between a bank’s total assets and capital.⁶

There is a great irony in the journalistic history of monetary policy. What many are calling central bank “money creation” “helicopter money” or “rolling the printing presses” may – in combination with tighter leverage ratios – lead to a tightening of bank credit and deflationary pressures.  And all this is occurring while the spectre of uncontrolled credit expansion and monetary debasement are being decried countless times by those who have not recognized that yesteryear’s monetary paradigm is defunct.

Interesting.  I hear this from a lot of people in the know about the system.  The author suggests one solution is having the Fed begin to do reverse repos with non-banks, which would drain excess reserves while adding high quality collateral back to the banking system which would allow more lending.  Which appears to be exactly what the Fed is considering.

I am reading this article next to see if I can get a better handle on how all this works.  I will let you know if I find it useful.

The Arizona Republic today reviews a speech given by Yellen in January, 2007 in Phoenix:

It was January 2007 when Yellen, then head of the Federal Reserve Bank of San Francisco, spoke here about financial literacy before transitioning into comments about the economy — comments that now look remarkably unperceptive.

Back then, months before the real-estate and banking crisis took down the economy, Yellen expressed concern that inflation was uncomfortably high while job gains were coming too swiftly.

“If labor markets are as tight as the unemployment rate suggests, then there may be reason for concern about building inflationary pressures,” she said according to my Jan. 18, 2007, article.

Subsequent events showed that inflation was the last thing we had to worry about, while the lack of jobs has emerged as a central drag on the economy. Back then, U.S. unemployment was around 4.5 percent. But after the recession took hold, it more than doubled, peaking at 10 percent in late 2009. At 7.3 percent currently, it remains well above where it should be this far into an economic recovery.

In contrast, core consumer inflation (which excludes food and energy costs) of 1.8 percent today has hardly budged from the 2.2 percent rate that had Yellen all worked up back then.

In another comment during her Phoenix talk that now looks wildly off-base, Yellen, who later was named vice chair of the Fed’s board of governors, said recession risks had receded despite lingering weakness in housing. She cited the Valley as a place where home-price appreciation had come down from unsustainably high rates of increase.

The Great Recession, as we all now know in hindsight, began later that year, triggered by a home-price slide of epic proportions.

I don't want to beat her up too bad for missing the bubble burst, since most everyone did.  They also all missed the last bubble burst, and the one before that, etc.

This is what makes me crazy:  not that these folks were wrong, even consistently brutally wrong, but that they display absolutely no modesty in their actions given that they were so wrong.  They propose policy steps, such as seemingly eternal QE, that are astoundingly risky unless one assumes that they have a very, very good grasp on exactly where the economy is going.  Which they clearly never have had in the past.  If they acted like they had been wrong most of the time, then I would have little to criticize.  But to be consistently wrong and then make huge risky bets as if you have reliable predictive powers is hubris of the worst sort.

Kevin Drum quoted this from James Fallows in a post labelled "threat inflation"

As I think about it this war and others the U.S. has contemplated or entered during my conscious life, I realize how strong is the recurrent pattern of threat inflation. Exactly once in the post-WW II era has the real threat been more ominous than officially portrayed

I thought, "wow, someone from the Coke or the Pepsi party is finally going to call BS on all the apocalyptic forecasts from both parties over the sequester."  But alas, he was just discussing foreign policy.  That is not to say I don't agree with the basic point, that foreign policy prescriptions are often accompanied by exaggerated horror stories of imminent threats -- I just wish they would recognize the same dynamic on the domestic front, whenever the smallest cut in government spending growth rates suddenly mean we are are going to put grandma out on an ice flow to freeze.