By Christopher Briem, on February 23rd, 2012
Just catching up on some things. A few have asked me about an article a couple weeks ago covering some work from Harold on how Pittsburgh’s medicare spending per capita compares to other regions. In summary read: it’s really high.
It just got me thinking. Whenever I see anything like this I wonder about the impact of age demographics. I can’t tell from the PG’s coverage if there is a fuller reference to look at as it does not give a specific cite, but I think it all follows directly from the data in the map at the the Dartmouth Atlas . So this isn’t really intended as a reaction to that article as a general look at what is going on within the elderly population here compared to elsewhere. Still that map there on the Dartmouth Atlast sure appears to me superficially to have a strong correlation to maps of age in the US; at least that big older swath through Appalachia. I can’t begin to say much about what is going on in Texas and the Gulf Coast.
Even just looking at the local elderly population it is not quite the same as the elderly populations elsewhere. I made a graph of how Pittsburgh’s elder population compares to other metropolitan regions. This is what I get for the breakdown of “Older Old” population, I’ll use the population age 85 and over here, as a propoprtion of the population age 65 and over.
So that is a pretty significant range across metro areas. Some have much older elderly populations than others. Hard to imagine that does impact expendtures on health care here compared to elsewhere. That would especially be true of a Medicare served population which is older to begin with. It may be an age factor that is accounted for in the initial benchmarking of this data, I don’t know.
This all would matter in the health care context a lot since at least the economists have worked out that a large chunk of Medicare spending is all tied up in end of life care. So if you have a lot bigger proportion of your population nearing mortality, then you might expect that to show up in the health care costs in aggregate. Since Pittsburgh remains the only large metro area with a natural population decline (more deaths than births) we remain an outlier across a lot these demographics. Just to think about is all.
By Simon Grey, on February 22nd, 2012
In addition Mr. Krugman cites evidence suggesting large percentages of Social Security and Medicare beneficiaries are confused about their use of these government programs. They don’t seem to think they’re getting handouts.
Maybe that’s because they’re in fact not getting handouts. As they were reminded every time they looked at their paycheck stub and saw the Social Security and Medicare tax deductions, they were forced to sacrifice part of their income for these programs through their working lives. The programs are compulsory; there is no opting out of them; the taxes come out of your paycheck whether you like it or not.
Therefore the notion that people who don’t like big government should not get Social Security and Medicare is utter nonsense. What are they supposed to do? Refuse the benefits that they already paid for? You’d have to be rich to do that. But one can see why left-liberals keep bringing up this humbug. People who don’t share their love of big government are labeled inconsistent for doing what by law they are coerced to do, mocked for complaining about a government apparatus from which they can’t escape.
But why do regions that rely on the safety net elect politicians who want to tear it down? I’ve seen three main explanations.
First, there is Thomas Frank’s thesis in his book “What’s the Matter With Kansas?”: working-class Americans are induced to vote against their own interests by the G.O.P.’s exploitation of social issues. And it’s true that, for example, Americans who regularly attend church are much more likely to vote Republican, at any given level of income, than those who don’t.
Alternatively, as I proposed before, they may simply see this as sunk costs to be recovered. They can’t avoid paying taxes, so they might as well try to recover as much as they can. Furthermore, opposing the political program one uses makes sense because political programs tend to be monopolies for the poor. If the government offers medical care for poor people, they are going to have an impossible time trying to refuse it, especially since taxes (both direct and indirect) eat up a decent portion of their budget. In a sense, the only people who can refuse government programs are the sufficiently wealthy because they can afford to bite the bullet on taxes while also avoiding government programs. The poor cannot do this. The only way a poor person can opt out of a suboptimal government program is vote against it. Thus, it should make sense that some poor people oppose the government programs from which they receive benefits because they would much prefer to simply not go through the government to get their benefits.  Join the forum discussion on this post - (1) Posts
By Claus Vistesen, on February 21st, 2012
The ECB and BOE have shown their intent with their recent aggressive balance sheet expansions and the Fed is trying hard to keep the door open for more QE even as the data in the US continues to defy the general global slowdown.
In Asia however sticky inflation in India, a desire to nail property developers to the wall in China and a belief in a post earthquake recovery in Japan have kept the big Asian central banks from providing additional easing. Even in Australia where the economy has been teetering on the brink of a recession for 6 months, the central bank has refrained from any decisive moves.
In three out of the four cases above however things may slowly be about to change.
In India, the central bank recently opened the door for considerable easing in 2012 as headline inflation comes in. The market has already heavily discounted such a move with Indian equities up about 25% since mid December 2011 and some big ticket single names such as Tata Motors up more than 50%.
Quote Bloomberg
Reserve Bank of India Deputy Governor Subir Gokarn said the monetary authority will cut interest rates once it’s confident inflation will keep slowing.“The stance now is that we have reached the peak and any further action will be toward easing,” Gokarn, 52, said in an interview at his office while discussing the rupee, the government’s budget deficit and bond repurchases. The central bank isn’t concerned about the currency’s record monthly advance in January “because in a sense it’s a correction,” following last year’s 16 percent decline, he said. Emerging-markets have stepped up efforts to shield growth from the impact of Europe’s debt crisis, with Brazil, Russia and the Philippines cutting rates in recent months.
The road is not entirely clear for easing by the RBI where two issues may still derail the central bank’s intention to start an easing cycle.
Firstly, the government’s budget deficit continues to increase and while borrowing to invest in infrastructure etc in India is certainly worthwhile, monetary policy may still have to lean against excessively and essentially structural deficit spending by the government. This is particularly the case as supply side constraints may mean that such deficit spending adds substantially to inflation.
Secondly, the INR may be subject to substantial weakening on a resurgence in global volatility. The Fed’s USD swap lines as well as the the ECB’s efforts to backstop the European banking system have so far calmed things down. Nevertheless, should another period of strong and sudden INR weakness ensue, it means the RBI would not be able to reduce the yield difference to the rest of the world in any meaningful way.
In China, the economy is now visibly slowing. Foreign exchange reserve accumulation have ground to a halt and M1 growth is negative on the year. Even if the desire to cool down excessive credit growth and nailing property developers to the wall might still constitute top priorties, the balance is shifting towards easing.
Quote Bloomberg
China is seen making more cuts to banks’ reserve requirements to fuel lending and sustain economic growth as the housing market cools and Europe’s sovereign-debt crisis weighs on exports.The proportion of cash that lenders must set aside will fall half a percentage point from Feb. 24, the central bank said Feb. 18 on its website. Standard Chartered Plc forecasts at least three more reductions this year, while HSBC Holdings Plc (HSBA) sees a minimum of two.
So far, Chinese authorities seem content to use the reserve requirement ratio (RRR) as the main tool to provide easing. This makes sense in a command market economy where the government can be fairly sure to control the supply side of credit through loan quotas. I think however that the calls for no interest rate cuts until mid 2012 may turn out to be wrong if China is about to slow to the extent that our leading indicators show. Property prices have fallen (or failed to rise) for some time now in China and as growth slows further, the authorities may rightfully begin to argue that their near term objectives have been achieved.
Perhaps the most interesting development this week however came in Japan where the BOJ apparently got my memo as they restarted QE.
Quote Bloomberg
Japan’s central bank unexpectedly added 10 trillion yen ($128 billion) to an asset-purchase program and set an inflation goal after an economic slide fueled criticism it has been slower to act than counterparts.An asset fund increased to 30 trillion yen, with a credit lending program staying at 35 trillion yen, the Bank of Japan said in Tokyo today. The BOJ also said that it will target 1 percent inflation “for the time being.”
This decision appears to have gone completely under the radar, but I think it is very significant. Two points are particularly important to emphasize. Firstly, the entire 10 trillion yen added to the asset purchase program has been earmarked to JGBs which signals the BOJ’s willingness (or the MOF’s orders) that budget deficits in Japan are now to be directly monetised to a much higher degree than has earlier been the case. Secondly, the BOJ has now committed itself to an inflation target (1%) and will use balance sheet expansion to reach this goal.
This is textbook QE and should be bearish for the Yen and bullish for the Nikkei, but things may not be so simple of course. Chris Wood adds to the discussion in the latest version of Greed and Fear [1].
The second point is whether the latest news is a signal to short the yen. On the face of it, it should be. But the issue is whether the BoJ Governor Masaaki Shirakawa is going to follow the previous examples of his conduct of unorthodox monetary policy; whereby he raises thequantity of the so-called asset purchase programme but does not exactly accelerate the pace ofthe buying to fulfil the programme. Thus, the Bank of Japan has so far purchased ¥10.3tn of assets since the latest programme was first announced on 28 October 2010, amounting to only 52% of the previous target of ¥20tn set in October 2011.
In other words, how serious is this inflation target and over what horizon does the BOJ intend to reach it? Only time will tell, but given the persistence of deflation in Japan I would argue that any semi-serious adherence to this inflation target would require substantial balance sheet expansion by the BOJ.
As Chris Wood aptly puts it, the move by the BOJ is merely the latest evidence of the bull market in central bank balance sheet expansion and more importantly, relative central bank balance sheet. In a world where export driven growth is seen as everyone as the way out of debt purgatory you need expand and print more than your peers. On this, I also slightly disagree with Chris that Japan does not need a weaker JPY. My own analysis suggest that corporate margins in Japan are very sensitive to changes in the Yen. But that is a discussion for another time. For now, I will agree with Chris that we have seen the beginning of a sea change in Japan, but we need to see the BOJ backing up intentions.
Ultimately though, the most significant piece of news from Asia last week was the indication from both Japan and China that they would stand ready to offer their full support for the euro zone. The idea is simple; China and Japan would use the IMF as conduit to create the only real bazooka (apart from ECB monitisation).
Quote Bloomberg (my emphasis)
Japanese Finance Minister Jun Azumi said his nation and China will work together to help Europe solve its debt crisis through the International Monetary Fund.Europe needs a bigger so-called firewall of added funding to contain the crisis, even as Greece shows some improvement in solving its financial woes, Azumi told reporters in Beijing yesterday after meeting Chinese Vice Premier Wang Qishan. Azumi, who met Chinese Finance Minister Xiu Xuren during his visit, also said he asked China to make its currency more flexible.“We shared the view that Europe needs to make more efforts to create a bigger firewall,” Azumi said. “We also agreed to act together as the IMF will probably ask the U.S., Japan and China” to help boost its lending capacity.
This would indeed be global monetary relief from Asia.
By Simon Grey, on February 20th, 2012
Many liberals like to point out the apparent hypocrisy of the people featured in the article, who rail against big government, demand lower spending, and simultaneously rake in benefits from the federal government that they hate. The central figure in the article, Ki Gulbranson, works hard yet has barely enough money to support his family, even with the earned income tax credit* and reduced-price school lunches for his kids. His conclusion: the country is going bankrupt, but people don’t make enough money to pay more taxes, so we should have smaller government. He would rather go without his current benefits—but he can’t imagine retiring without Medicare and Social Security. [Ed.—the rest of the article is worth reading as well.]
I have no opposition to people pursuing or receiving government benefits if they’ve paid into the system, even if they oppose the offering of those benefits. There are two reasons for this.
First, if you’ve paid taxes, you should be able to recoup them because the government is supposed to act in your interests. Some benefits will be indirect (military spending, e.g.), some are indirect (highway construction, e.g.), and some are direct (welfare, e.g.). The problem with government is that all benefits are part of the same basket; you can’t opt out of paying for any of the benefits. As such, there is little reason to opt out of receiving any benefits because you’ve already paid for them and, as is the case in a democracy, they belong to you (what with it being a government of the people, by the people, for the people and all).
Second, the government does things that incentivize the receipt of direct benefits. Taxation is one example, in that taxation prevents you from taking care of things for yourself. More people would be able to afford their own health care if the government cut health spending and the corresponding taxes. Another example is regulation (which is in many cases not enacted democratically), which also makes many things more expensive. More people could more easily afford the things they need if regulatory compliance costs were reduced.
Now, political principles are indeed wonderful things, as they give us some idea of where we want to go. But we should never mistake political principles for political reality. It would be great if there weren’t any unconstitutional government programs and their corresponding taxes. But that is currently not the case, and our ethical considerations need to account for the various distortions that come at the hands of the government. If the government is going to force you to make bricks, there’s no principled reason to refuse their straw.
* Caveat 1: while I argue that people shouldn’t be considered hypocrites for receiving government benefits that they argue against, they should also be aware that there are costs to qualifying for government benefits, and that they should be prepared to comply with them.
Caveat 2: this ethical analysis only applies to people who have paid taxes. Those who haven’t paid a dime in taxes should not receive a dime in benefits.
By Thomas Knapp, on February 20th, 2012
The US government’s post-9/11 “war on terror” breathed new life into its long, failed “war on drugs.” An American public showing signs of increasing disenchantment with the latter was told that drug money fueled and financed terrorism, and that the “war on drugs” was part and parcel of the war on al Qaeda.
Now this, via Reuters:
Italian police said on Friday they had seized about $6 trillion worth of fake U.S. Treasury bonds and other securities in Switzerland, and arrested eight Italians accused of international fraud and other financial crimes. … Potenza’s prosecutor Giovanni Colangelo said an international network “in many countries” was behind the forgeries. Italian daily Corriere della Sera said on its website that the criminal network was believed to be interested in acquiring plutonium, citing sources at the prosecutors’ office.
I can only think of a limited number of reasons why someone would want plutonium, and all of them except for use in atomic/nuclear weapons would more likely run through legal/”official” channels of securities fraud, theft, etc.
Or, to put it a different way, if the US government didn’t visibly run some serious debt, al Qaeda and so forth couldn’t try to finance its nuclear terror aspirations by faking instruments of that debt.
If heroin cultivation in Afghanistan is a “war on terror” concern, so is an unbalanced US government budget and $15 trillion + in US government debt. But I’d advise against holding your breath while you wait to see if Congress declares “war” on those things.
By Simon Grey, on February 16th, 2012
James Kwak and Larry Mishel, in slightly different ways, make a point I was planning to get to: the rise in safety net spending over the past decade does not reflect an expansion of that safety net. Instead, it reflects two things: rising health care costs, and a terrible economic slump that has put many more people in need.
Basically, the rise in safety net spending is due to increases in qualified recipients, not an expansion of average net benefits. Here’s the LA Times: But now, as the economic rebound picks up a bit of steam, Latinos are scoring bigger job gains than most other demographic groups and proving to be a bright spot in the fledgling recovery.
While they make up only 15% of the country’s workforce, Latinos have racked up half the employment gains posted since the economy began adding jobs in early 2010, Labor Department data showed.
Expanding the labor pool while simultaneously placing restraints on businesses will have the unfortunate consequence of driving down wages and preventing demand for labor from expanding. Tack on a price floor for labor, the high costs of regulatory compliance, plus the ability to easily escape onerous regulations via free trade agreements, and you have a recipe for high unemployment and low wages for those that remain employed.
Anyhow, one immediate step that can be taken by the government is to kick out illegal immigrants, eliminate the guest worker program, and cut down on legal immigration, particularly of the low-skill variety. This would reduce the labor pool, helping the currently unemployed have more opportunities to find employment, and eventually reduce safety net dependence, thus cutting government spending.
Also, given that the government is supposed to act in its citizens’ best interest, it should be a no-brainer to put the labor interest of citizens ahead of the labor interests of non-citizens. Especially since doing so will reduce government spending.
By Simon Grey, on February 14th, 2012
No Child Left Behind requires all students to be proficient in reading and math by 2014. Obama’s action strips away that fundamental requirement for those approved for flexibility, provided they offer a viable plan instead. Under the deal, the states must show they will prepare children for college and careers, set new targets for improving achievement among all students, develop meaningful teacher and principal evaluation systems, reward the best performing schools and focus help on the ones doing the worst. [Emphasis added.]
The reason the college bubble exists is due in large part to the federal government’s actions, predicated on politicians’ assumptions that college is a universal good to be enjoyed by everyone. This is, of course, predicated on several fallacious assumptions, including the belief that a college education increases one’s knowledge, that a college education improves one’s intelligence, that a college education is either evidence of or brings improvement in one’s work ethic, and that there is a general correlative or causal link between a nation’s collective level of education and its economic output. As such, this continued emphasis on college will only lead to higher college costs, and have nothing to show for it.
By Ajay Shah, on January 26th, 2012
The debate
Roughly one decade ago, there was a strong debate in India about how we should tackle the problem of education. There were two
views:
- Intensification
- On one side were those who felt that nothing was fundamentally wrong; all that was needed was more money. So we should just continue building more government schools and hiring more civil servants to act as school teachers, and we’ll be fine.
- Reform
- On the other side were the reformers, who argued that the basic incentives in Indian education were wrong. Putting more money down a dysfunctional system was pointless.
The Intensifiers won this debate. An informal coalition of educationists (i.e. the incumbent education system) and leftists came
together, supported by the World Bank, which pushed for mere enlargement of Indian education, without questioning the foundations.
All of us are involved in this story at many levels. At the simplest, we are the customers of the education establishment. We pay income tax and VAT and a few other taxes. On top of this, we pay the 2% education cess. In return for this, we get certain educational
services. These influence our kids, and they influence all the young people that we encounter in this young country. Trillions of rupees have been spent, and more than a decade has gone by. It is time to assess the performance of this strategy.
Three blocks of evidence are now visible, which tell us that the Intensifiers were wrong. The old strategy, which was invigorated by a
vast rise in spending, was the wrong one.
Evidence #1: OECD PISA results for India
This story is well told in a recent blog post by Lant Pritchett. Bottom line: The first internationally comparable measurement of what children learn has been done. The sample correctly includes urban and rural children; it correctly includes children going to private or public schools; there are no first order mistakes in what was done. It tells us that Indian education policy has failed miserably: the results have come out at the bottom of the world.
Evidence #2: ASER 2011 results
Pratham has been running surveys which measure characteristics of children and schools in rural India (only). Their latest survey results, for 2011 show the following facts.First, rural kids learn less at public school. Here’s a simple example of what the evidence shows. Surveyors ask kids in class III to recognise numbers upto 100. Here are the numbers, for the proportion of kids in class III who cannot recognise numbers upto 100:
In 2008, the failure rate with private schools was roughly 17 per cent. Government schools were much worse at over 30 per cent. A short three years later, conditions had deteriorated sharply in government schools. The failure rate had gone up to 40 per cent. Private schools had also worsened slightly, to a failure rate of 20 per cent. By 2011, a big gap had opened up between the two: private schools are failing to teach 20 per cent of the kids while government schools are failing with a full 40 per cent of their kids.
Parents in India face the choice between sending their children to a government school, which is free and serves a mid-day meal, versus sending them to a private school where they pay fees. Yet, an increasing fraction of parents choose to send their children to a private school, paying tuition fees from their own pockets, while government schools are free. The relationship between a parent and a private school is a transaction between consenting adults. The relationship between a parent and a government school involves all of us, because we are paying for it.
Given the low income of parents in India, their use of private schools is a striking indictment of what the Intensifiers have wrought:
At class II, the fraction of rural children in private school went up from 19 per cent (2007) to 23 per cent (2011). At class VII, this
rose more slowly to levels slightly above 20 per cent.
Evidence #3: CMIE household survey
CMIE has data for the year ended March 2011 about the behaviour of 169,492 households, about their expenditure on school/college fees and tuition fees. Here’s the picture for the quarter ended September 2011; all values as percent of overall expenditure:
| Income class |
School/college fees |
Private tuition fees |
| Rich – I |
4.79 |
0.66 |
| Rich – II |
3.79 |
0.51 |
| High Middle Income – I |
3.54 |
0.63 |
| High Middle Income – II |
3.12 |
0.65 |
| High Middle Income – III |
2.44 |
0.68 |
| Middle Income – I |
1.93 |
0.59 |
| Middle Income – II |
1.62 |
0.45 |
| Lower Middle Income – I |
1.38 |
0.49 |
| Lower Middle Income – II |
1.05 |
0.60 |
| Poor – I |
0.76 |
0.58 |
| Poor – II |
1.13 |
0.28 |
| Overall |
2.10 |
0.57 |
If parents chose to stay within public sector schools, their expenditure on fees would have been zero. The table shows that across
all income groups of India, there is movement towards private provision of education, both by paying fees at schools and by paying
for private tuition classes. These two elements add up to 2.67 per cent of overall expenses of households. (The CMIE household survey separately measures expenses on books, journals, stationary, additional professional education, education overseas, hobby classes and other education expenses. This helps us gain confidence in the extent to which the two fields in the table above narrowly pin down the feature of interest).
These decisions of well intentioned parents are the strongest indictment of education policy in India. The product being given out
by the Intensifiers is such a terrible one, the parents of India are walking away from it even though it is free and the alternative is
not and the parents are poor.
Implications
For more than a decade, the Intensifiers have controlled Indian education policy. They have said: Leave education to the education
establishment, do nothing radical, just give us more money, we will deliver results. Now we know that they were wrong. They took the money, but failed to deliver the results.
Kapil Sibal has said that his ministry should not be held responsible for the stream of bad news that is coming out. This seems to me to be dodging accountability. His ministry is responsible for Sarva Shiksha Abhiyaan, for the Right To Education Act, for blocking OECD PISA from being done in India, etc. The bureaucratic consensus of his ministry represents the education establishment.
This brings us to accountability. If a contractor took money from you, and failed to deliver on building your house, you would sack
him. (You would also take him to court, to recover the money that was paid to him, for services not delivered). In similar fashion,
education is too important to be left to the educationists. We need to start over.
What is to be done
- We need to start over in the field of education, with a fresh management team, one that is not a part of the status quo, one that is rooted in the worlds of incentives, public policy and public administration.
- The flow of public money into the status quo needs to go down sharply. There is no reason to put money into something that fails to deliver the goods. First we must prove that a mechanism delivers results, and only after that should we put money into
it. This is the common sense that a housewife would apply. She would not spent gigabucks on promises from people who have failed to deliver.
- OECD PISA measurement needs to take place every year at every district.
- The education cess was always a mistake and needs to go. Public expenditures on education should always have come out of general tax revenues; there is no need to have a cess.
- Civil servant teachers, who have tenured (permanent) have no incentive to teach well, regardless of their qualifications or high income. We can’t sack them, but what we need to do on a massive scale is to stop recruiting them. The existing stock can be reallocated to other civil servant functions where staff is in short supply. Through this, it would become possible to whittle away at the accumulated stock over the coming 20 years.
By Doug Gentry, on January 13th, 2012
In honor of the first week in our Healthcare Economics class, and the beginning of a 6 week session on healthcare via OLLI, here is an interesting report from The New York Times.
National health spending rose a slight 3.9 percent in 2010, as Americans delayed hospital care, doctor’s visits and prescription drug purchases for the second year in a row, the Obama administration reported Monday.
The recession, which lasted from December 2007 to June 2009, reined in the growth of health spending as many people lost jobs, income and health insurance, the government said in a report, published in the journal Health Affairs.
 from The New York Times There are a couple of takeaways from this news.
First, the reduction in spending on healthcare could mean a welcome, albeit temporary relief to those governments and organizations that pay for healthcare….BUT…no real relief for state and local agencies which provide/finance healthcare for poor people. Recessions, of course, result in greater numbers of people qualifying for government-supported care.
The other point is a reminder that some portion of healthcare services are discretionary. When healthcare spending was growing by 10 percent or more each year in the 1980s, that growth probably wasn’t driven by an increase in the need for services. Likewise the slower growth over the last several years is probably not due to the population getting healthier and needing fewer services. Instead, people moderated their demand for healthcare. They put off diagnostic tests, or did not follow through on treatments or prescriptions. Going in the other direction, hospitals routinely see increases in elective surgeries near the end of a calendar year, as people have already met insurance deductibles, and decide to seek care before those deductibles are reset in the new year.
Is this good news? Not necessarily. To the extent the people put off truly necessary tests and treatments, those delays may cost us more in the long run. To some extent, though, tough economic times force us to be more cautious about discretionary spending, and there may be very little impact on long run health status. There is the old saying that if you get a cold, it will take 7 days to go away, but if you see a doctor you’ll be cured in a week! One important element of effective healthcare reform is to introduce that sense of caution in our population. It is a delicate balance – not wanting to interfere with early testing and early, cost-effective treatment, but also discouraging care that has less impact on long term health.
Prices for medical care services and supplies also stayed roughly on par with general inflation during this last year, which is a change from the decades of the 1980s and 1990s where the medical care component of the consumer price index routinely outstripped regular price increases.
I wouldn’t have to polish my crystal ball very much to predict that spending increases for healthcare will pick up speed as the economy recovers. This remains the single most important issue in our nation’s federal deficit struggles.
By The Gold Report, on January 11th, 2012
  What do investors need to be watching out for in 2012? More Eurozone drama? Record gold highs? A hard landing in China? The U.S. Global Investors team addressed these questions with Endgame: The End of the Debt Supercycle author John Mauldin in a Jan. 5 Outlook 2012 webinar. The Streetwise Reports editors highlight some of the expert insights.
John Mauldin: Instead of doing an annual forecast, I’m going to look out about five years, which may be five times more foolish. What I want to do rather than try and figure out where the stock market is going to be at the end of 2012 or what gold is going to do, is look at the choices we have around the world.
In most cases, political events don’t change the economic world all that much. It’ll probably annoy partisans on both sides, but if Clinton had lost to George Bush senior the first time, we would have still had a bull market. We were already in recovery. Yes, we would have had different Supreme Court Justices, but that’s not the economic world. We were set on a path. If Gore had beaten Bush 2, economically I don’t think much would have changed. We still would have had the end of a bull market and a recession in 2001. We would have had a housing bubble. Greenspan would have probably been reappointed either way. We would have had a credit crisis because we were in the process of building up debt that started in the ’50s. Europe was building its debt up. Japan was building its debt up. That is the reality.
Now the private sector is deleveraging, but sovereign debt is in a bubble. The air is coming out. My view is that the wheels are going to fall off Europe this year. I have been researching the Mayan codes and I have determined that the ancient Mayans were not astrologers; they were economists. They weren’t predicting the end of the world; they were simply predicting the end of Europe. That is a humorous way of saying this is the year Europe is going to have to make some very difficult choices. Greece gets to choose what kind of depression it wants, hard and fast or slow and long. It can’t avoid depression completely. It has borrowed too much money. The government is too big. It has come to the end of the ability to raise money at low rates. Italy and Spain are well on that path along with the rest of Europe. So, they have to make a decision, a political decision that is going to have major economic consequences.
Does Europe want to be a political union that looks more like the United States, where the individual entities have to run balanced budgets and can’t print their own money and have some kind of fiscal controls or they go back to a two-tiered Europe with multiple currencies. One way or another, this is the year that Europe is running out of road to kick the can.
Fortunately, in the U.S. we are not there yet. We have some room to make a decision. That decision is going to be made in 2012 because by 2013 we are going to have to decide how we deal with the deficits and debt. After 2014, the bond markets will start to raise rates. Total U.S. debt is continuing to grow because governments are growing debt faster than private citizens are decreasing debt. The bond markets are starting to rebel long before you would think they would for a country that’s the world reserve currency. The key is whether debt is excessive relative to income. If you can make your debt service, people will still lend you money. When they don’t think you can, they will stop. That’s when you have a crisis. It’s a debt super cycle. And, when you reach the end, you have to deal with the debt. You can pay it down. You can default on it. You can print the money, extend it out with lower rates or financial repression, which are all other ways to look at default. But, nonetheless, that debt is there.
The problem we are facing in the U.S. is that gross domestic product (GDP) is consumption plus investment plus government spending plus net exports. If we decrease government spending over time, we decrease GDP. That’s the problem that Greece is going through right now. It has to decrease government spending by 4.5%, thus shrinking the economy. But it can’t increase government spending without increasing debt or taking taxes away, which decreases consumption. Nothing the government does will make things better. The U.S. is on the same path. We can become Greece by continuing to borrow or be proactive and say we are going to get our deficits under control over a period of five or six years. The economy is still going to be slower than we would like and unemployment higher than we would like. That’s just the rules. We’re at the end game. We are at the end of the debt super cycle and that’s what happens.
Printing money doesn’t increase the GDP in actual real terms, but it makes everyone holding gold happy because the value of natural resources goes up. That is why I buy gold every month. I take those coins, I put them in a vault and I hope I never need them. I quite frankly hope gold goes back to $300/ounce (oz) because that means the economy is in wonderful shape. I’m actually afraid that gold is going to go up in value, which means we are not getting our act together.
That leads to questions about fault. Did the banks do things they shouldn’t have? Yes. Were they the cause of it? No. Was Greenspan the cause of the bubble? No. He was part of the cause. I mean, we did a lot of things as a country that weren’t good choices. Should we have allowed our banks to go to 30 and 40 to 1 leverage? No. Should we have repealed Glass-Steagall? No. The problem is that real median household income hasn’t moved for 15 years because real private GDP hasn’t changed. The only thing that has grown is government spending.
John Derrick: In 2011, the European financial crisis moved from the periphery to the core. Central bank policies were big drivers of the decline. The European Central Bank and China raised rates early in the year and again in July as fears of a China slowdown grew. That early tightening to fend off inflation had a big impact on the course of events throughout the year. The other big events were the U.S. credit downgrade in August and currency intervention, particularly in the Japanese yen.
Frank Holmes: There is a huge amount of borrowing around the world in Japanese yen because it is so inexpensive. That includes investing in commodities, resources and emerging markets. And, every time we see this huge signal move by the yen, you get this rippling effect that takes about six weeks to resolve itself with commodities being sold down. Therefore, a lot of fund managers borrowing in Japanese yen are long energy stocks, resource stocks and emerging markets, which leads to a lot of selling.
JD: The second half of last year was very volatile, but the market ended essentially flat. In fact, much of the volatility was concentrated in the last month, which made for a very difficult psychological environment, as the market has been somewhat schizophrenic with weekly rallies and selloffs.
Spikes in the yen caused market selloffs. This hit commodities especially hard. So the secret for 2012 is to use the volatility. Buy on the volatility spikes. Unfortunately, what most people do is just the opposite. Another thing to look for in 2012 is a positive fourth year of the presidential election cycle as the government tries to implement policies that will get them reelected.
Brian Hicks: There has been a lot of concern about money supply growth in the emerging markets, particularly in China, which reduced bank reserve requirements last year. A reacceleration of global money supply can be particularly constructive for commodities going forward as there has been a high correlation between money supply growth and commodities.
If you were to take all the global money and back that by gold, the price of gold could go to $10,000/oz. If you just use half of the global money supply, gold would trade at about $5,000/oz, up from approximately $1,600/oz right now. The more U.S. dollars in circulation, the higher the price of gold. This has been the main factor increasing the price of gold since 1998 and will continue to be the case in the years to come. Gold has a lot of running room to go.
Another driver for the price of gold has been federal deficits. Government spending is way above revenues. We hit a point in 2000 where spending as a percentage of GDP greatly exceeded taxes as a percentage of GDP. This could be a point of no return and could potentially drive the price of gold even higher. There has been a large bifurcation between the price of gold and gold equities, particularly in the last couple of years as risk aversion has prompted many investors to buy the bullion as opposed to gold equities. This is creating opportunity. We feel like there’s going to be a catch up in gold equities, many of which are trading at very low multiples to cash flows and earnings. Stocks such as Newmont Mining Corp. (NEM:NYSE) look like value stocks now paying high dividend yields and trading at sub 10-times price to earnings ratios. This could really present an attractive opportunity in 2012.
JD: Just a comment on all the takeovers. We were seeing 6% premiums on takeovers in ‘06. Now we are talking 60+ premiums. That’s another reflection of how undervalued the stocks are relative to commodities.
BH: That’s a great point. We have seen tremendous value creation based on mergers and acquisitions.
Shifting gears a little bit, crude oil and refined product inventories ended the year at the lowest level on record (about 685 million barrels). That’s 6% below the prior year. It’s particularly interesting when you consider some of the geopolitical factors that have arisen with Iran talking about blocking off the Strait of Hormuz. This is a primary factor behind oil price supports despite the tenuous economic environment. Many investors don’t realize that Russia is very important for non-OPEC (Organization of Petroleum Exporting Countries) supply, a key factor in containing oil price spikes. Russia is increasing production while other non-OPEC production in Mexico or in the North Sea have been declining significantly, which has helped to bolster OPEC’s market share. It has also limited the ability of oil markets to increase production out of the Middle East due to the inability to invest in those troubled areas. In fact, Russian production has been quite steady since 2006, increasing anywhere from 100 to 400,000 barrels per day (bpd), mid-single digit growth. But, forecasters predict in 2012 we will see flat production growth, which is troubling given the fact that we continue to see demand increase in other areas of the world, mainly out of China. This will be a driving factor going forward for crude oil prices.
Evan Smith: Oil supply threats include geopolitical problems at a time when oil supply and spare capacity at OPEC is rather low—a little over 2 million bpd. Nearly 40% of global supply is under autocratic rule. Iran has threatened to disrupt the supply of crude oil and products through the Strait of Hormuz where about a third of global oil supply passes. So, any disruption, even temporarily, would cause a severe spike in oil prices. We think oil prices could support $100/barrel. One of the things we like in 2012 is higher exposure to master limited partnerships partly because of their steady cash flows. They are becoming a growth business now. The capital expenditures here in the United States have grown from $3.5 billion (B) in 2005 to nearly $16B this year. This is partly because of the growth in many of the shale plays, which require increased infrastructure. We think this is an excellent investment opportunity. We also see a big opportunity for the global oil services. We can see that capital expenditures have been rising. We expect them to rise from about $500B to nearly $.5 trillion this year, an increase of 15%. So, we see tremendous opportunity for some of the oil services contractors and equipment providers. Another key driver is the impressive amount of money that has been invested in North America. Just over the last three years nearly $129B in mergers, acquisitions and joint ventures has occurred. Global companies are coming to North America to invest in these shale plays because the economics are so attractive due to improved technology. They want to learn that technology and take it home. So, we think there is continued opportunity for investors in the resource play here in North America.
Shifting gears, one of the base metals we will target is copper. It is our favorite base metal. The demand side is holding up relatively well compared to some of the other base metals. Even in China, which is the largest market for copper growth, the build out of the grid is really a key driver. That is holding up quite well. On the other side of the supply/demand equation, supply has been a problem. Through most of the boom in copper prices, mine output has lagged forecasts. Causes included weather, labor strikes and just poor grade. The bottom line is that supply has not kept up with demand. We have not solved that problem so we think 2012 should be a relatively good year for copper prices.
Another theme we like is the agricultural space. Global population continues to grow. The emerging middle class continues to consume more grains, principally through the production of more meat as people consume more protein in their diets. There has been a huge surge in the need for the production of grains, yet no more land is being created. One of the key ways we’re seeing increased yields out of croplands is through higher applications of fertilizers. That has created a fairly tight situation for potash, specifically. But, other fertilizers such as nitrogen and phosphate are also benefiting from this trend.
FH: I would just add that the world’s population has doubled from the ’70s when we had rising commodities. There’s a very different factor and China and India have a global footprint that they didn’t have.
Xian Liang: China remains the biggest driver of world demand for energy due to a rising middle class, but it is in a very early stage when it comes to discretionary spending. Take for example passenger cars. Despite a tremendous growth in auto consumption in the last decade, only 18% of Chinese households own a car. Car ownership in China is just one-tenth of U.S. levels or the same level it was in the U.S. in 1914. Air travel remains at the U.S. equivalent of the 1950s. This illustrates a great growth potential going forward. Urbanization is one of the most significant trends driving consumption. In 2011, the number of urban residents in China exceeded rural residents for the first time in Chinese history. But, China won’t stop at this 50% urbanization rate if the historical trajectory of its richer neighbor, South Korea, is any guide. We could have another 30% of growth by the year 2013. South Korea outgrew its urbanization rates in a 40-year time span. And, if China continues to urbanize, there will be about 200 million new urban households in China, which creates enormous demand for consumer staples, durable goods and housing.
China’s government policies signal the trend will continue. China raised reserve requirement ratios 12 times since January 2010. We view that as an early signal for the next easing cycle. The last time China eased reserve ratios in October 2008, that triggered a big market rally in Chinese stocks. This should bode well for stocks. We don’t think the Chinese auto boom is over. Actually, in the last couple of days, officials in China hinted that new measures may be introduced to support auto and home appliance sales.
Outside of China, we see government policies remaining very positive in southeast Asia, especially in Indonesia and Thailand. The money supply in the past two years has not deteriorated in these two countries, in fact, it is growing at a healthy 16% year over year. This is part of the reason why we remain positive on southeast Asia. Indonesia is rich in natural resources, but it doesn’t depend as much on exports. In fact two-thirds of its GDP is driven by domestic consumption, which is how it managed to escape a recession in 2008 and 2009. Favorable demographics is a factor. It is a very young country. More than 45% of the population is under 24 years old and 2 million people a year are joining the work force. Second, urbanization is creating new consumer demand. Just like China, Indonesia’s household debt is low. Total mortgage loans outstanding account for only 3% of GDP. Consumer credit is still at a very early state. I see tremendous growth potential going forward.
FH: The money supply is growing very rapidly in the entire region. I think it’s not just a China story. It’s a whole emerging market. And, I like to characterize it as the American dream trade as all these countries want the American dream. They all want a house. They want a car. They want all the lifestyle that we have.
John Derrick joined U.S. Global Investors Inc. in January 1999 as an investment analyst for the U.S. Global Investors money market and tax free funds. In March 2004, he was promoted from portfolio manager to director of research and now manages the day-to-day operations of the investment team. Prior to joining U.S. Global Investors, Derrick worked at Fidelity Investments. He has appeared on CNBC and Bloomberg TV and has also been a guest on Marketwatch Radio and NPR. Derrick has been featured in stories for BusinessWeek, The New York Times, the Associated Press and USA Today. A graduate of The University of Texas at Arlington, Derrick earned a Bachelor of Arts in finance. He sits on the board of directors for the CFA Society of San Antonio.
Brian Hicks joined U.S. Global Investors Inc. in 2004 as a co-manager of the company’s Global Resources Fund (PSPFX). He is responsible for portfolio allocation, stock selection and research coverage for the energy and basic materials sectors. Prior to joining U.S. Global Investors, Hicks was an associate oil and gas analyst for A.G. Edwards Inc. He also worked previously as an institutional equity/options trader and liaison to the foreign equity desk at Charles Schwab & Co., and at Invesco Funds Group, Inc. as an industry research and product development analyst. Hicks holds a Master of Science degree in finance, and a bachelor’s in business administration from the University of Colorado.
Frank Holmes is CEO and chief investment officer at U.S. Global Investors Inc., which manages a diversified family of mutual funds and hedge funds specializing in natural resources, emerging markets and infrastructure. In 2006 Mining Journal, a leading publication for the global resources industry, chose him as mining fund manager of the year. Holmes coauthored The Goldwatcher: Demystifying Gold Investing (2008). A regular contributor to investor-education websites and speaker at investment conferences, he writes articles for investment-focused publications and appears on television as a business commentator.
Xian Liang is an Asia research analyst at U.S. Global Investors Inc. and a Shanghai native.
John Mauldin is the author of New York Times Best Sellers list four times. They include Bull’s Eye Investing: Targeting Real Returns in a Smoke and Mirrors Market, Just One Thing: Twelve of the World’s Best Investors Reveal the One Strategy You Can’t Overlook and Endgame: The End of the Debt Supercycle and How it Changes Everything. He also edits the free weekly e-letter Outside the Box. Mauldin also offers The Mauldin Circle, a free service that connects accredited investors to an exclusive network of money managers and alternative investment opportunities. He is a frequent contributor to publications including The Financial Times and The Daily Reckoning, as well as a regular guest on CNBC, Yahoo Tech Ticker and Bloomberg TV. Mauldin is the President of Millennium Wave Advisors, an investment advisory firm registered with multiple states. He is also a registered representative of Millennium Wave Securities, a FINRA-registered broker-dealer.
Evan Smith joined U.S. Global Investors Inc. in 2004 as co-portfolio manager of the Global Resources Fund (PSPFX). Previously, he was a trader with Koch Capital Markets in Houston where he executed quantitative long-short equities strategies. He was also an equities research analyst with Sanders Morris Harris in Houston where he followed energy companies in the oil and gas, coal mining and pipeline sectors. In addition, he was with the Valuation Services Group of Arthur Andersen LLP. Smith holds a Bachelor of Science degree in mechanical engineering from the University of Texas in Austin.
|
|
Most Popular Posts