Dispatches from District 48
Posts tagged ‘inflation’
Price controls, like those famously instituted by Diocletian, are something like 0 for 162,000 in their success rate at "fixing" inflation.
So of course, Argentina has instituted price controls on supermarkets. Argentina, meet Zimbabwe. Another agricultural powerhouse that will soon see food shortages.
Apparently Swedish unions are demanding a looser monetary policy
Forget Chuck Schumer's cat-out-of-the-bag 'get back to work' comments to Bernanke, now it is union-leaders who are advising the world's central bankers. "There is a not a single reason not to lower rates" exclaims Sweden's trade union confederation to the central bank as he begins negotiations with employers on wage deals for next year. His demands (for lower rates) are "far from excessive" and he adds "should not cause inflation" as Swedish organized labor have "never called for levels that ... could not be supported economically."
Inflation and monetary debasement have always been Progressive favorites -- until, of course, they were not. Consider the plight of the worker in Weimar Germany
By mid-1923 workers were being paid as often as three times a day. Their wives would meet them, take the money and rush to the shops to exchange it for goods. However, by this time, more and more often, shops were empty. Storekeepers could not obtain goods or could not do business fast enough to protect their cash receipts. Farmers refused to bring produce into the city in return for worthless paper. Food riots broke out. Parties of workers marched into the countryside to dig up vegetables and to loot the farms. Businesses started to close down and unemployment suddenly soared. The economy was collapsing.
It was total hell. If a worker's family member could not find something to buy in the morning with the worker's morning pay packet, the money was worthless by dinner time. Not to mention the incredible lost productivity of all those man-hours spent running around trying to find goods on shelves (of which we got a small taste post-Sandy, as people spent hundreds of dollars of their own time waiting in queues because the government would not let gas station owners charge them an extra $20 for scarce gasoline).
I know, I know -- this is Wikipedia. But there is a line there in the quantitative easing article that makes even less sense than other political topics at that site:
It should be noted that mortagage-backed securities such as are being purchased as part of the QE3 program are not based on liquid assets, and their purchase [by the Fed] does not entail inflation risks
This makes zero sense to me. But maybe I am missing something.
First, I don't understand why the fact that the assets purchased with the printed money are liquid or not liquid. If anything, I would have assumed that purchasing less liquid assets would have more inflation risk than the other way around. If one puts more currency into the economy, the more currency-like the asset one pulls off the market, ie the more liquid, the less the inflation risk, I would have thought.
Second, while mortgages may not be liquid, mortgage-backed securities are very liquid. If liquidity of the asset matters here, I am not sure why the underlying asset would matter as much as the asset itself being purchased. I mean, by this metric, treasuries are based on a really, really illiquid asset, simply the full faith and credit of the US government.
Third, printing of money would seem to always have inflation risk, no matter what the government is purchasing with the still-wet dollars. (yeah, I know, it's all digital).
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.
I have been a stock market bear for some months now. I don't really think the US economy is going to double dip on its own, but I felt like Europe and Asia would bring us down. Well, I simply underestimated both the Fed's and the ECB's willingness to goose financial assets. If the Fed and ECB are going to inflate our way out of, uh, whatever it is we are in, then I certainly don't want to be holding bonds, particularly at these absurdly low interest rates. Stocks are not as good of an inflation hedge as some hard assets, but they are a hell of a lot better than most bonds. I'm certainly not going to buy back in the current euphoric highs, but I am giving up on trying to predict that market based on fundamentals. It seems that fundamentals are a suckers game, and you better not be timing the market unless you have an inside line to government policy, because that seems to be what drives the train.
PS- I wish Milton Friedman were still around. QE was as much his idea as anyone else's. I wonder what he would have thought of the results, or of this particular implementation.
European economic problems must be due to the "austerity" (which means, in popular Leftist use, not growing government spending faster than the rate of inflation). I am sure this kind of thing has nothing to do with high unemployment rates. I would certainly be really excited to hire more employees under these conditions:
For most Europeans, almost nothing is more prized than their four to six weeks of guaranteed annual vacation leave. But it was not clear just how sacrosanct that time off was until Thursday, when Europe’s highest court ruled that workers who happened to get sick on vacation were legally entitled to take another [paid] vacation.
“The purpose of entitlement to paid annual leave is to enable the worker to rest and enjoy a period of relaxation and leisure,” the Court of Justice of the European Union, based in Luxembourg, ruled in a case involving department store workers in Spain. “The purpose of entitlement to sick leave is different, since it enables a worker to recover from an illness that has caused him to be unfit for work.
New taxes are frequently sold as protecting police, fire, and education, though these together represent barely 25% of all US government spending. Where does the rest go? It's a giant bait and switch, made worse by the fact that even within these categories, new headcount is more likely to be added in administrative and overhead roles rather than in promised functions such as "teachers". This is the subject of my Forbes column this week:
There is a way to reconcile this: While increases in education spending are sold to the public as a way to improve results in the classroom, in reality most of the new money and headcount are going to anything but increasing the number of teachers.
Let’s start with an example from the city of Phoenix, New York. Why this town? Am I cherry-picking? In fact, I was looking for data on my home town of Phoenix, Arizona. But I have come to discover that while school districts are really good at getting tomorrow’s cafeteria menu on the web, they are a little less diligent in giving equal transparency to their budget and staffing data. But it turns out that Phoenix, New York, which I discovered when I was looking for my home town data, publishes a lovely summary of its budget data, so I will use it as an example that helps make my point.
The city’s budget summary for 2012-2013 is here. Overall, they are proposing a 0.4% increase in spending for next year, which initially seems lean until one understands that they are projecting a 4% decline in enrollment, such that this still represents an increase in spending per pupil faster than inflation. But the interesting part is the mix.
What are the two things politicians are always claiming they need extra money for? Classroom instruction and infrastructure. As you can see in this budget, only two categories of spending go down: classroom instruction and facility maintenance and cleaning. Administrative expenses increase 4% (effectively 8% per pupil) and employee benefits expenses increase just under 1% despite a total decline in staffing. Though I am not very familiar with the program, one irony here is that the fastest growing category is the 8.7% growth (nearly 13% per pupil) in spending with BOCES, a New York initiative that was supposed to reduce administrative costs in public schools. In other words, spending increases are going to everything except the areas which politicians promise.
I don’t think these trends are isolated to this one admittedly random example. The Arizona auditor-general recently did a study on trends in education spending in the state. They found exactly the same tendency to reduce classroom spending to pay for increases in administrative headcounts.
Read it all, as they say.
Apparently the news of the week is that the letter grade "A" is now the most common. Mark Perry has more on college grade inflation.
I am actually a fan of the grading system at Harvard Business School when I was there. 15% of the students in each course get the top grade (category I) -- no more, no less. 10% get the bottom grade (category III) -- again by rule, no more and no less. All the rest are in the middle. It effectively acknowledges that for most folks, the point is to demonstrate you have satisfactorily learned the course material, while still allowing folks to distinguish themselves on both ends. Budding young executives who complain that it is unfair to automatically "fail" the bottom 10% of each course are reminded that this is exactly how many Fortune 500 companies run their HR systems, seeking to constantly weed out the bottom 10%.
Update: The argument usually is that students need high grades to compete with other kids from grade-inflated schools in the marketplace. I just don't think this is true. Colleges themselves deal with this all the time in admissions. When they get a high school transcript, attached to that transcript is a fact sheet about the high school that gives its distribution of grades. That way the recipient can discount the GPA as appropriate. Every company doing hiring should demand the same of colleges.
Here is a personal anecdote. My son Nic's school grades hard. Something like 2 kids over the last 2 decades have graduated with a 4.0. One could argue my son's grades could have been higher at another school, but knowledgeable consumers of high school GPA's know how our school works and we have never felt he somehow was at a loss due to the school's grading policies (but Oh God can type A parents fret about this incessantly among themselves). [edit: took out brag about my son. Nothing more boring than other people bragging on their kids.]
Maybe I am missing something, but "friction-reduced" tires seem to be going in the wrong direction. Hopefully friction-reduced brake pads or inflation-reduced airbags are not next.
What is the difference between this hypothetical family budget and the US Government's budget?
One answer is: eight zeros, because these are essentially the US budget numbers with eight zeros knocked off.
A second answer is: Prisons and the printing press. Because the biggest difference is that in the family budget context, everyone sees these numbers as simply insane, while on the national level at least half of folks think they are just fine. The difference is that the US government can take money from other people at whim and by force, backed by the threat of incarceration. And if that fails, it can print money (actually using bits and bytes rather than the printing press, but that's just a detail) to pass the cost of its extravagance onto other people in the form of inflation.
Update: The chart above probably over-estimates the belt-tightening. If you really wanted a comparable situation to today's federal government, the example would say that the family spent $37,000 last year, proposed to spend 38, 285 next year, but agreed to only spend 37,900 for a $385 "cut", said cut being claimed despite the fact that actual spending will be $900 more than last year.
As I predicted, the various highly touted European debt and currency interventions last month did squat. This is no surprise. The basic plan currently is to have the ECB give essentially 0% loans to banks with the implied provision that they use the money to buy sovereign debt. Eventually there are provisions for austerity, but I wrote that I don't think it's possible these will be effective. It's a bit unclear where this magic money of the ECB is coming from - either they are printing money (which they refuse to own up to because the Germans fear money printing even more than Soviet tanks in the Fulda Gap) or there is some kind of leverage circle-jerk game going where the ECB is effectively leveraging deposits and a few scraps of funding to the moon.
At this point, short of some fiscal austerity which simply is not going to happen, I can't see how the answer is anything but printing and devaluation. Either the ECB prints, spreading the cost of inflation to all counties on the Euro, or Greece/Spain/Italy exit the Euro and then print for themselves.
The exercise last month, as well as the months before that, are essentially mass hypnosis spectacles, engineered to try to get the markets to forget the underlying fundamentals. And the amazing part is it sort of works, from two days to two weeks. It reminds me of nothing so much as the final chapters of Atlas Shrugged where officials do crazy stuff to put off the reckoning even one more day.
Disclosure: I have never, ever been successful at market timing investments or playing individual stocks, so I generally don't. But the last few months I have had fun shorting European banks and financial assets on the happy-hypnosis news days and covering once everyone wakes up. About the only time in my life I have made actual trading profits.
Thought problem: I wish I understood the incentives facing European banks. It seems like right now to be almost a reverse cartel, where the cartel holds tightly because there is a large punishment for cheating. Specifically, any large bank that jumps off the merry-go-round described above likely starts the whole thing collapsing and does in its own balance sheet (along with everyone else's). The problem is that every day they hang on, the stakes get higher and their balance sheets get stuffed with more of this crap. Ironically, everyone would have been better getting off a year ago and taking the reckoning then, and certainly everyone would be better taking the hit now rather than later, but no one is willing to jump off. One added element that makes the game interesting is that the first bank to jump off likely earns the ire of the central bankers, perhaps making that bank the one bank that is not bailed out when everything crashes. It's a little like the bidding game where the highest bidder wins but the two highest bidders have to pay. Anyone want to equate this with a defined economics game please do so in the comments.
Countless regulations and laws in the US that are ostensibly consumer protection turn out to be simple power plays by government officials and well-connected corporations.
We see this yet again in Argentina, where a government takeover of the newsprint business was ostensibly justified based on "unfair" business practices by the previous owners. Of course, the only thing the Argentine government, which recently started prosecuting private economists for disagreeing with government inflation numbers, finds "unfair" is the fact that newsprint is being sold to papers who publish unflattering articles about the government. More here.
The same Argentine legislation defines a new crime right out of Atlas Shrugged that they call economic terrorism, which in practice will likely be interpreted as 1) businesses that do anything that the current rules do not like or 2) businesses that get just too valuable for government officials to resist grabbing them for themselves.
Nice tax refund you have coming .... we think we'll keep it
The [Greek] government has decided to stop tax returns and other obligation payments to enterprises, salary workers and pensioners as it sees the budget deficit soaring to over 10 percent of gross domestic product for 2011.
For all the supposed austerity, the budget situation is worse in Greece. Germany and other countries will soon have to accept they have poured tens of billions of euros down a rathole, and that they will have to do what they should have done over a year ago - let Greece move out of the Euro.
Government workers and pensioners simply will not accept any cuts without rioting in the street. And the banks will all go under with a default on government debt. And no one will pay any more taxes. And Germany is not going to keep funding a 10% of GDP deficit. The only way out seems to be to print money (to pay the debt) and devalue the currency (to effectively reduce fixed pensions and salaries). And the only way to do all that is outside of the Euro. From an economic standpoint, the inflation approach is probably not the best, but it is the politically easiest to implement.
My new column is up at Forbes, and discusses solutions to the European debt crisis. The problem is that there are really only three, and all are bad, so most solutions being proposed either attempt to disguise that they are bad or to disguise that they are not really doing anything. An excerpt:
The default option will almost certainly wipe out a lot of powerful banking and financial interests as well as make it very hard for governments to keep spending money at their historic pace. This will certainly have a bad effect on the larger economy, but we should be careful accepting forecasts of economic catastrophe as most of these come from these same powerful bankers and politicians. Every group, down to the local dog catchers, argue that the world will suffer a calamity if their particular profession is harmed. What we do know is that large banks and financial companies are even more intertwined with the political elite in Europe than they are in the US. We can be pretty certain that, push come to shove, a solution that saves the banks and allows politicians to keep spending will be preferred.
That is why the Europeans will likely end up printing money to pay off the debt. They almost certainly would be doing so already,were it not for Germany’s strong memories of its Weimar inflation years, when exactly this kind of money printing to pay down government debt led to hyperinflation and political instability. But the appeal to politicians of shifting the costs from themselves and banks to the average consumer is simply too great to pass up. If Germany can be convinced, then the European Central Bank will print Euros. If Germany cannot be convinced, then countries will leave the Euro and print Lira and Drachma.
I found this 2009 graph and comment by Paul Krugman (dredged up by Megan McArdle) to be a hilarious call to arms for all his fellow lemmings to follow him over the cliff
[from November 2009]: Why, people ask, would I want to compare us to Belgium and Italy? Both countries are a mess!
Um, guys, that's the point. Belgium is politically weak because of the linguistic divide; Italy is politically weak because it's Italy. If these countries can run up debts of more than 100 percent of GDP without being destroyed by bond vigilantes, so can we.
Today I spent time arguing with a group of folks about global warming and the precautionary principle. The others all argued that a slim chance of a catastrophe justified immediate action. I argued, of course, that they were understating the cost of the intervention, but that is another story.
Its amazing to me that so many on the Left squawk about the precautionary principle in the case of climate, but are ready to continue running up government spending and deficits despite the fact that the disaster of this approach, given the experience in Europe, is no longer even debatable. Its simply math.
Our problem will play out differently than in Europe. Long before interest rates on US securities run up to the 6% or so tipping point, the Fed will be running the printing presses. Don't believe me, well, they already have been.
Savers beware, our path will be devaluation and inflation.
By the way, the speed with which hyperinflation can take hold is astounding. Here is the inflation rate in the Weimar Republic. As with the Fed today, the central bank of the Weimar Republic was buying up government debt with printed currency. Look how fast the inflation took hold:
(source) Imagine a quarterly meeting of the Fed in August of '22. They are probably looking at month-old data, and in July it looks like everything is under control. Boom, three months later, by the next schedule quarterly meeting, inflation is already out of control. Krugman would say not to worry about inflation, they will have plenty of time to act. Coincidently, this is exactly what Italy and France and Spain said about their sovereign debt, but in a flash, the crisis was upon them and so far out of control there is nothing they can do.
One might think a line like about Greek finances was printed just this week
What followed could only be described as a comic progression of populist pandering [and] the spread to the national economy of a series of parasitic labor unions and cabals
But in fact it is describing Greek conditions circa 1944.
A while back I observed that the difference between Greek and US finances is that the US needs to return to a spending level circa 2007, while Greece has no similar default state of relative fiscal sanity it can return to. This article in Finem Respice reinforces this premise by discussing the absolute insanity of Greek fiscal management before and after and even during WWII, which was characterized by all the exact same problems that have driven the current crisis. Good background reading.
Greece, then as now, was dominated by an expensive public sector funded insufficiently by a tax system that did not work. As may happen soon, Greece was not able to borrow, so all they could do was print money and inflation soared. Only one man was able to stop the inflation, and I won't spoil the ending by the humorous way he did so.
What does a statist government do when attaching "unexpected" to all negative economic numbers does not provide the necessary political cover?
Argentina’s government has filed criminal charges against the managers of an economic consulting firm, escalating its persecution of independent economists.
…The government is charging MyS Consultores with “publishing false information about inflation data” to benefit themselves and their clients. The criminal complaint alleges that MyS’s data also lead to speculative behavior in Argentina’s bond market.
…Consumer prices rose 9.7% in May from a year ago, according to the national statistics agency, Indec. But virtually all economists say annual inflation surpasses 20%—one of the world’s highest rates—angering government officials who dismiss inflation as a problem.
…So far this year, the Secretariat has fined at least nine economic research firms 500,000 pesos ($122,000) each. This week, the Secretariat also slapped a second fine on Orlando J Ferreres & Asociados.
“They fine us for saying how much prices have risen,” Mr. Ferreres, director of his eponymous firm, said. “They could seek criminal charges against all of us. We don’t know how far they’re willing to go.”
Mr. Ferreres said the legal actions are part of a strategy to prevent independent economists from publishing potentially negative information during an election year…
Government officials say they hoped the fines would deter economists from “deceiving” the public into making poor financial decisions by publishing inflation estimates that differ considerably from Indec’s consumer price index.
It is sad to see how far Argentina has fallen. In the past it has been one of my favorite countries in the world to visit.
Apparently the Left is still trying to argue that the stimulus (the process of taking money out of private hands to have it spent by government officials instead) was really a super-fabulous idea and only failed because it was too small. Here is Kevin Drum:
But another reason [the stimulus failed] is that at the same time the feds were spending more money, state governments were cutting back. The chart below from CBPP tells the story. They have data for all but six states, and on average for 2012, "those 44 states plan to spend 9.4 percent less than their states spent before the recession, adjusted for inflation." That's not just less than last year, it's less than 2008. That wiped out nearly the entire effect of the federal stimulus pacakge [sic].
I have a different take. A number of states, because they don't own a printing press as does Uncle Sam, actually tried to deal with economic reality and cut their bloated spending, an effort that was largely wiped out by Obama's "stimulus" spending.
The baseline takes state government budgets and grows them by population growth and inflation. In other words, baseline spending in 2007 would be the same real level per capita as in 2002. The Total Revenue line is the actual revenue collections by state governments. Actual collections grew about 4 times faster than population and inflation in this period. And states still did not balance their budgets or pay down debt in this period. Nick Gillespie writes
Had the states kept their outlays constant while allowing for inflation and population growth, they would have been sitting on $2 trillion in reserves when the recession hit. Instead, they were broke heading into the recession and are in even worse position now.
Revenue is IRRELEVANT to fixing state budget problems. No matter how much money is collected, governments will spend all the money and more. The only solution I can see is imposition of statutory, perhaps Constitutional, spending caps in each state.
My column is up at Forbes, and is the fourth in a series on Obamacare. An excerpt:
Its amazing to me how many ways supporters of government health care can find to rationalize the bad incentives of third-party payers systems. Take, for example, the prevelance today of numerous, costly tests that appear to be unnecessary. Obamacare supporters would say that this is the profit motive of doctors trying to get extra income, and therefore a free market failure. I would point the finger at other causes (e.g. defensive medicine), but the motivation does not matter. Let’s suppose the volume of tests is truly due to doctors looking for extra revenue, like an expensive restaurant that always is pushing their desserts. In a free economy, most of us just say no to the expensive dessert. But the medical field is like a big prix fixe menu — the dessert is already paid for, so sure, we will got ahead and take it whether we are hungry or not.
It should be no surprise that while US consumer prices have risen 53% since 1992, health care prices have risen at nearly double that rate, by 98%. Recognize that this is not inevitable. This inflation is not something unique to medical care — it is something unique to how we pay for medical care.
Contrast this inflation rate for health care with price increases in cosmetic surgery, which unlike other care is typically paid out of pocket and is not covered by third party payer systems. Over the same period, prices for cosmetic surgery rose just 21%, half the general rate of inflation and just over one fifth the overall health care rate of inflation.
This is why I call free market health care the road not traveled. There are many ways we could have helped the poor secure basic health coverage (e.g. through vouchers) without destroying the entire industry with third-party payer systems. Part of the problem in the public discourse is that few people alive today can even remember a free market in health care, so its impossible for some even to imagine.
Update: Coincidently, Mark Perry has a post that addresses just the issue I do in my article, that is the positive effects of high-deductible health insurance and out of pocket health expenditures on pricing transparency and reduced costs. The high deductible health plans at GM seem to be having a positive effect on the health care market. A shame they will probably be illegal under Obamacare. Of course, since GM is owned by the government, it can get any special rules that it wants, unlike the rest of us. But that his how things work in the corporate state.
You often hear people say that one of the main reasons for health care inflation is the cost of all the new technology. But can you name any other industries that compete in free markets where technology introductions have caused inflation rates to run at double the general rate of inflation? In fact, don't we generally associate the introduction of technology with reduced costs and increased productivity?
Compare a McDonald's kitchen today with one thirty years ago -- there is a ton of technology in there. Does anyone think that given the price-sensitive markets McDonald's competes in, this technology was introduced to increase prices?
Or look at medical fields like cosmetic surgery or laser eye surgery. Both these fields have seen substantial introductions of new technology, but have seen inflation rates not only below the general health care inflation rate but below the CPI, meaning they have seen declining real prices for decades.
The difference is not technology, but the pricing and incentive system. Cosmetic surgery and laser eye surgery are exceptions in the health care field -- they are generally paid out of pocket rather than by third parties (Overall, third party payers pay about 88% of all health care bills in the US).
The problem with health care is not technology -- the problem is that people don't shop for care with their own money.
Postscript: Thinking some more after I wrote this, I can think of one other industry where introduction of technology has coincided with price inflation well above the CPI -- education. It is interesting, but not surprising to me, that this is the other industry, along with health care, most dominated by third party payer systems and public subsidies of consumers.
This chart in the NY Times is pretty interesting, though I could quibble about the color coding. You have to stare at it a minute to get it - each cell represents a combination of stock purchase and sales dates, with the color representing the average market inflation-adjusted return for that buy and hold period (click to enlarge, or click through to the source link where it is explained in more depth).
Whenever one uses red and green for coloring a chart, the reader is going to assume red is bad and green is good. In this case, the light red represents returns from 0 to 3% above inflation. Is that bad? Maybe. I would say inflation plus 3% is probably lower than people's expectation of stock market returns, but I think a lot of folks would equate red with capital erosion, which is not the case if returns are out-pacing inflation.
This is sort of a good-news-bad-news story. The good news is that there is no 25-year period where returns fall below inflation. The bad news is that the median return of inflation plus 4% is probably less than most folks are planning for -- including a lot of state pension funds that are still counting on returns like 8% for their entire portfolio (something like inflation + 5-6%), which is a blend of stocks and bonds, implying they are hoping for an equity return north of that.
HT: Flowing Data
A while back another entrepreneur/blogger wrote and asked me about investment choices for retirement. My philosophy on retirement seems to be a lot different than that of others, and I think owning one's own company changes some of the dynamics of retirement investing. Note that this advice is not right for everyone, and maybe no one, so read at your own risk. I publish it because the person I wrote suggested I do so, and after weeks of crazy intense work schedules I finally have the time.
A blogger wrote me about his despair at finding appropriate investment vehicles for his retirement savings. With relatively equal chances of 1) a long period of Japan-like slow growth or 2) a high inflationary period triggered by trying to avoid #1, both bonds and equities looked bad, and while real estate may have some value plays when things finally bottom out, neither of us has the time to pursue that. [since our emails, International equities are something I have moved money into, both as a diversification play as well as a way to short the dollar].
As I wrote him in one email
There is still a good chance of returning to normal growth in the middle somewhere, but both those bookends [inflation and stagnation] loom much larger than they might have, say, in my calculations five years ago. I have trouble figuring out what to invest in when both are possibilities. Equities? Great for hedging inflation but suck if there is a lost decade. Bonds would make sense in that case, but their interest will be low and they will be awful if inflation ramps up. If I really knew we would get inflation and devaluation, I would be leveraging like crazy because inflation transfers wealth from creditors to debtors.
As a result, I said that my main investment for my free capital was debt reduction and de-leveraging of my own business. Paying down debt has the advantage of having an absolutely predictable return and it reduces risk. This makes double sense for me as I have put new expansion investments in my business on hold until a variety of government issues from health care to tax rates become clearer. (For example, in health care, because my company is an oddity, with seasonal part time workers mostly on Medicare already, no one can yet tell me what my future costs will be. Estimates range from +0 to +20% of revenues!)
The key to my business, which may be very different from others, is that I make big investments to gain long-term contracts, but once captured, these contracts give my business a fair amount of stability and predictability. Further, in the latest recession, my business has proved to be either counter-cyclical or at least recession-proof to some extent, as 2009 was actually a blow-out record year for us. Given these facts, I am able to put a higher percentage of my net worth into my own business as an investment, without having to diversify as much in case of business trauma. And I prefer this. Given the choice of investing in a company I barely know on the NYSE or mine, which I understand and control, I prefer the latter. Also, returns on capital from buying or investing in private small businesses can be much higher (with higher risk of course) than in traditional equities -- see my whole series on buying a small business.
But here is where I really differ from most people: I take a very different view of retirement. When I worked in grinding corporate jobs (e.g. up until I was about 40) I was very focused on retirement. Now that I am doing something that is not brutally stressful, I hardly think about retirement. The whole concept of retirement now seems weird. I have, after a lot of hard work, gotten my business to the point where I can generally work as hard as I want to -- if I don't work hard, the business does not grow but I have good people such that it doesn't fall apart either. I compete with people who are running businesses in their late 70's who are still having a good time. I can take nice trips when I want to, take the day off if I need to, or whatever. My business actually has an off-season so I can be more relaxed part of the year.
My advice to this particular entrepreneur was to maybe reconsider the paradigm of "retirement." After all, the the long history of the world, retirement is a new concept that is barely 100 years old.
Are you the shuffleboard and golf type? What do you imagine yourself doing after retirement? I think you need some protection against becoming infirm or senile, but if you are healthy and vigorous, are you the type to get bored fast? As an example, nearly all of my 400 employees are retired, but they all got bored and wanted something to do.
Here is an alternative, entrepreneur's way to think about planning for retirement: How do I work really hard building a business that in 10 years will have a position such that it spits out some level of cash without effort on my part and can still grow if I want to spend time on it. I am surrounded in Scottsdale by people who have done exactly this after giving up a corporate job. At some point they took their savings from their 30s and 40s and dumped it into a business where they could still have the lifestyle they wanted. Buying or building the right company is sort of like buying a bond with an attached warrant whose value is related to how hard you want to work.
As I implied earlier, this is not an appropriate approach for every small business. The problem with technology businesses, for example, is that they never seem to mature into that latter predictable-cash-flow-stable-market-share phase. One is always running in place. One lesson I never forgot from my corporate years: In the industrial sector, I often saw people making loads of money selling bushings or some such whose design hadn't changed since 1920. It led me to this strategy: Find a market with barriers to entry, which may well not be very sexy, and spend ten years battering you way in, and then relax behind those walls. (As to sexy, the very first two classes of the first year Harvard Business School strategy course were a sexy cool software business and a boring stable industrial product business. Of course,the boring stable water meters made a fortune, while the software business never made a good return on capital. Beware of sexy businesses -- see: Airlines).
One other paradigm I would challenge is the notion everything you do as an entrepeneur has to be started from scratch. Many entrepreneurs have fun doing this but the prospect of doing a bootstrap startup when you are 70 years old is exhausting. Such entrepreneurs who have had a life of serial startups might consider a new phase in their business career as they get older, when they have saved enough assets to perhaps buy into an existing business rather than starting from scratch. I cannot tell you how many interesting small businesses there are that come up for sale with a guy who has an interesting product and has made some progress but can't manage his way out of a paper bag and thus hits some growth ceiling. I bought just such a core to my current business 8 years ago. These businesses require a lot of due diligence, because they are a real mixed bag, but I bought mine in an asset sale for 3.5 times EBITDA (which is an entirely typical price). Try buying Wall Street equities for 3.5 times EBITDA! If you pick the right business, and you are a good manager, there is not a better investment out there. Again, see my whole series on buying a small business.
Of course this investing-for-retirement is higher risk, because one bets a substantial portion of his net worth on his own business. But for those with confidence in their own ability, I find it a lot more compelling to bet my capital on myself rather than on guys I don't know running the Fortune 500.
Two Americas: Those who use the coersive power of the government to take money for themselves, and those who have to earn it by giving value for money in non-coerced , arms-length transactions.
Via Carpe Diem, which has more thoughts on the trend
Note: I have seen folks defend this type of chart by saying it is just the function of the inflection point of a normal distribution creeping by inflation across a dividing line. But look the $180K+ in 2010 vs. the $150K+ in 2005. By inflation, a $150,000 salary should not have increased to more than $165,000, but we see more than twice as many people making $180K plus today than made $150K plus five years ago.
This post is based on playing around with some analogies to try to understand quantitative easing in my own mind. I can't decide if this approach is helpful or just wanking. I fear it is the latter, but if we banned all banned all intellectual wanking in blogs, my feed reader would be virtually empty.
I haven't really written much about the Fed's latest round of quantitative easing, dubbed QE2. Basically they plan to print some significant fraction (I see different numbers in different articles) of a trillion dollars and use the newly created money to buy government bonds (they don't actually print the money but create it out of thin air in the memory banks of computers). As I understand it, the theory is that this will boost the price (and thus reduce yields) on the government bonds on the balance sheets of private banks. This will in turn have two effects: improve (at least on paper) the balance sheets of banks, hopefully making it more likely to lend; and it will reduce the yield on the bonds on their balance sheets, hopefully making private loans look like a better investment in comparison.
I am not an economist, and so won't get embroiled in issues I don't understand, but it strikes me that even if one accepts the theory of QE, it will be difficult to have any measurable impact as long as Congress and the administration keeps generating new debt at astounding rates.
But what is really happening here is that the dollar is being devalued. This is one of the semantic quirks that make me laugh -- when Argentina or Zimbabwe do this, its called devaluation. When a western nation does it, it is called quantitative easing. Because, uh, we are much smarter or something. But I have to believe that a lot of progressives have hitched their wagon to QE2 out of the hope for some inflation (wow, the revenge of William Jennings Bryant). Because inflation and dollar devaluation would nominally achieve some of the goals they are hoping for, including:
It is impossible to argue that devaluing a currency is a path to wealth generation. It can't be, though progressives, as always, are willing to tolerate a total reduction of wealth as the price for the type of re-distributions discussed above.
But excepting the re-distribution arguments, it strikes me that the only possible argument for this devaluation is that the economy is somehow trapped in a local minima from which the escape energy is too high. This would make QE a bit like annealing in a metal, where metal that is heated up and cooled too fast can be hard and brittle. The only way to get it to be ductile is to re-heat it and then allow it to cool slower.
This is kind of a pretty comparison, but in large part it is probably BS. The economy is way, way, way more complex and multi-variate than crystallization in a metal. Even if we were trapped in a local minima, which by the way it is pretty much impossible to determine, we don't know what kind of energy should be applied to the system to move it out. In fact, if we wanted to use this analogy, it would make far more sense to me to remove barriers to entrepreneurship and wealth creation which likely form a large part of the energy barrier that keeps us in such a local minima. In fact, the annealing analogy would likely point one in the direction of decalcifying markets and increasing labor mobility rather than massive government interventionism. It is much easier for me to argue that the missing energy is entrepreneurship rather than liquidity. Apparently, the German finance minister agrees with me:
The American growth model, on the other hand, is in a deep crisis. The United States lived on borrowed money for too long, inflating its financial sector unnecessarily and neglecting its small and mid-sized industrial companies. "¦I seriously doubt that it makes sense to pump unlimited amounts of money into the markets. There is no lack of liquidity in the US economy, which is why I don't recognize the economic argument behind this measure. "¦The Fed's decisions bring more uncertainty to the global economy. "¦It's inconsistent for the Americans to accuse the Chinese of manipulating exchange rates and then to artificially depress the dollar exchange rate by printing money.
Update: Chinese bond rating agency downgrades US treasuries
The United States has lost its double-A credit rating with Dagong Global Credit Rating Co., Ltd., the first domestic rating agency in China, due to its new round of quantitative easing policy. Dagong Global on Tuesday downgraded the local and foreign currency long-term sovereign credit rating of the US by one level to A+ from previous AA with "negative" outlook.
