Category Archives: Jack Heidel

The Economic Damage Caused by Very Low Interest Rates

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As is well known, the Federal Reserve’s main tool in responding to the Financial Crisis in 2007 – 2009 has been quantitative easing (to lower long term interest rates) and direct reduction of the Federal Funds Rate (to lower short term interest rates). These measures definitely limited the severity of the Great Recession resulting from the Financial Crisis.  But the recession ended in June 2009, more than seven years ago.
Capture37In the meantime the continuation of such low interest rates is having many detrimental effects such as:

  • Pension funds, both public and private, have become greatly underfunded,  creating crises especially for state and local governments with defined contribution plans.
  • Retirement plans for millions of seniors have been upset by erosion of savings.
  • Inequality has increased as affluent stock owners benefit from the rapid increase of asset prices as investors reach for yield.
  • An immense misallocation of capital towards bond issuers at the expense of small business is taking place.
  • Federal debt is soaring as low interest rates make it much easier for Congress to ignore large budget deficits.
  • The next recession, when it inevitably arrives, will leave the Fed in a bind. The only tools remaining are a new round of quantitative easing (additional bond purchases) and even lower (i.e. negative) interest rates.
  • The Fed’s dual mandate of low unemployment (currently 4.9%) and price stability (low inflation) is being met but is accompanied by anemic GDP growth averaging only 2% since the end of the Great Recession. Such slow economic growth is largely responsible for the populist revolt in the 2016 presidential race.

Conclusion. Monetary policy can only accomplish so much. It is critical for the Fed to wind down its $4.5 trillion balance sheet as its bond holdings mature and to keep raising short term interest rates.  This will force Congress to step up to the plate with the changes in fiscal policy which are needed to stimulate economic growth.

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How to Solve the Student Debt Problem: Grow the Economy Faster!

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Based on a post I wrote last fall, “Solving the Student Debt Problem,” and a recent Op Ed by the economics journalist, Robert Samuelson, “Good News on the College Debt Front,” here is where I think we are on this serious problem:

  • The unemployment rate is very low for college graduates, about 2.5%. We should strongly encourage post-secondary education for all.
  • Since 1996 outstanding student loans have risen from $200 billion to $1.3 trillion.
  • Counting both community colleges, four year colleges and universities, 56% of college students borrow money to pay for college costs.
  • For undergraduates who attended two and four year colleges, more than half of loans were less than $20,000. Only 10% exceeded $40,000.
  • The highest default rates occur at community colleges (23% in 2012) and at for-profit colleges (18%). Hurt worst are low-income and minority students who never graduated but have unpaid debts.
  • The Federal Reserve Bank of New York has found a close correlation between subsidized loan and Pell Grant limits and the rapid increase of college tuition costs.

It seems clear that the way to address this problem is to focus on where it is worst: for the low-income and minority students who attend community colleges and for-profit colleges.
Capture36In other words:

  • Place a strict lid on the total amount of subsidized loans available for undergraduates, say $25,000 to $30,000 per person.
  • Use the savings achieved in doing this to increase the size of Pell grants for the lowest income students who need help the most.
  • Overall faster economic growth will help college graduates and dropouts alike find better paying jobs and make it easier for them to pay back their college debts.
  • On an individual basis, urge all students, but especially low-income and minority students, to avoid debt as much as possible in the first place!

Conclusion: Careful analysis of the student debt problem shows that there are very useful steps to take which will not cost the federal government more money.

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Is Single-Payer Health Care a Good Idea?

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My last two posts, here and here, have discussed major intrinsic problems with the Affordable Care Act.  It has been set up in an actuarially unsound manner and the cost of insurance coverage through the exchanges is growing very fast.
CaptureThe rapidly rising cost of American health care, public and private, is in fact one of our country’s biggest problems.  It is an affordability issue for millions of American households.  Furthermore the rapidly rising cost of the entitlement programs of Medicare and Medicaid is the fundamental driver of our exploding national debt problem.
As I see it there are two different routes we can take to solve this problem.  One way is to move towards a true free-market approach where healthcare consumers (all of us!) have more “skin in the game” in the sense that we move away from third party payment for routine care.  It is quite interesting that this is already starting to happen under Obamacare!
The other way of getting costs under control is to adopt a single-payer system, like much of the rest of the developed world.  But this would necessarily involve stringent cost controls and severe rationing and would be a lot more difficult than just enrolling everyone in Medicare. For example:

  • American doctors and nurses are very well paid. The average family physician in the U.S. earns $207,000, double the rate for general practitioners in Great Britain, which has a single-payer system. Are we going to arbitrarily chop doctor salaries in half in order to control costs?
  • The State of Vermont recently backed away from implementing its own single-payer system because the needed tax increases would have more than doubled Vermont’s annual budget. Colorado will vote in November on a petition-supported single-payer proposal, ColoradoCare, which would be paid for by a $26 billion annual state tax increase, and is therefore unlikely to pass. For a state to implement its own single-payer system at least requires budget honesty, since all states are required to balance their budgets. There is no such requirement for our federal government and so a single-payer system would be financed just like Medicare, with deficit spending. Bad idea!

Conclusion. American healthcare needs radical reform but adopting a single-payer system is not the best way to do it.

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How to Improve Obamacare and Lower It’s Costs

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I have been making the case for some time now that the rapidly increasing costs of U.S. health care, especially for the entitlement programs of Medicare and Medicaid, is the fundamental cause of our exploding national debt, and therefore these costs must be curtailed.  The only way to fix this problem is for Americans to have more “skin in the game” regarding these costs.
Capture10My last post, “The Inherent Instability of Obamacare,” discusses the separate but related problem that the Affordable Care Act is actuarially unsound because it misprices the basic risks involved in health insurance.  This is why costs on the exchanges are going up so fast which, in turn, leads to fewer enrollees.
A good way to address this double whammy of problems is to use a plan developed (mostly) by the American Enterprise Institute in December, 2015.  The main features are:

  • ACA Mandates, for both individuals and employers, would be abolished.
  • Retain tax preferences for employer-paid premiums, with an upper limit comparable to the cost of catastrophic health insurance.
  • Provide refundable tax credits to households without access to employer coverage, gradually replacing subsidies provided by ACA exchanges.
  • Persons with pre-existing conditions would have continuous coverage protection.
  • Medicare would migrate to a defined contribution, refundable tax credit model as above, with eligibility gradually rising to age 67.
  • Medicaid would be financed with block grants to the states and would supplement the refundable tax credit model.
  • Health Savings Accounts, to accompany high deductible plans, would be encouraged with a one-time federal tax credit matching enrollee contributions.
  • Health Care for Veterans would be integrated into mainstream care.

Summary. Abolishing the mandates means that coverage levels and price would be actuarially determined in the market place. Equal tax credits for insurance and help in setting up health savings accounts ensure fairness and widespread accessibility.  The overall free market model will guarantee both low cost and the greatest possible degree of flexibility, innovation and quality of care.

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The Inherent Instability of Obamacare

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The recent announcement by Aetna Insurance Company that it will exit the health insurance market in most of the states where it now operates raises a fundamental question about the stability of the Affordable Care Act. As shown by the following map  from yesterday’s New York Times, it appears that at least five states with 17% of the American population will have only one health insurer to choose from next year.
Capture33As the Wall Street Journal’s Greg Ip points out in a recent article, “the problem isn’t technical or temporary, it is intrinsic to how the law was written”  Specifically:

  • Insurance is supposed to price risk but the ACA changed this. Insurers can no longer charge or exclude coverage for pre-existing conditions, charge men and women different rates, or charge older customers more than three times as much as the young.
  • For example, a 64-year-old consumes six times as much health care as the average 21-year-old. Adhering to the 3-to-1 maximum ratio, the insurer would have to greatly overcharge the 21-year-old than his actual cost and/or greatly undercharge the 64-year-old.
  • The rational response for unsound pricing is for young and healthy customers to stay away and sick, older customers to flock to the exchanges. ACA mechanisms to prevent this type of behavior aren’t working very well.Capture32
  • One example of this is that the ACA exchanges, which provide income-based subsidies for those without employer provided health insurance, are mainly attracting those people just slightly above the poverty line who get the biggest subsidies (see chart).

I have pointed out many times that the cost of health care, especially for the entitlement programs of Medicare and Medicaid, is the fundamental driver of our exploding national debt and therefore must be curtailed.  But now, in addition to the cost problem, we are discovering that the ACA also has a fundamental access problem as well. Big changes are clearly needed in the ACA.  More details later!

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Rising Prosperity around the World

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My last post responds to a reader who is pessimistic about the future of our country and in fact of the whole world.  He thinks that the environment is deteriorating, that rapid economic growth is unsustainable and that there is too much income inequality between high and low wage earners.
My response to him is to refer to the recent book, “The Rational Optimist: how prosperity evolves” by Matt Ridley.  Mr. Ridley persuasively argues that not only has the human race made huge strides in recent times but that this progress is intrinsic to evolved human nature and is likely to continue indefinitely:

  • Since 1800 the population of the world has multiplied six times, yet average life expectancy has more than doubled and real income has risen more than nine times.
  • Between 1955 and 2005, the average human on earth earned nearly three times as much money (adjusted for inflation), ate one-third more calories of food, and could expect to live one-third longer, all this while world population doubled.
  • The rich have got richer but the poor have done even better. For example, the Chinese are ten times as rich, one-third as fecund, and 28 years longer-lived than fifty years ago. (Also see the above chart).
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  • The spread of IQ scores has been shrinking steadily – because the low scores have been catching up with the high ones. This is known as the Flynn effect.
  • The four most basic human needs – food, clothing, fuel and shelter – have grown markedly cheaper during the past two centuries.
  • The most notorious robber barons of the late 19th century: Cornelius Vanderbilt, John D. Rockefeller, and Andrew Carnegie, got rich by making things cheaper.
  • Exchange and specialization, not self-sufficiency, is the route to prosperity.

Conclusion. As long as human beings are free to engage in exchange (trade) and specialization (acquisition of skills), prosperity will continue to evolve and human life will become better and better.

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Optimism or Pessimism for the Future: Which Is More Justified?

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Comments from a blog reader:

I also am concerned about consumption and waste/pollution – plastic in oceans getting into the food chain, CO2 affecting climate with animals not adapting quickly enough so that we are in the 6th great extinction. Is there a non-debt based economy, or conservation/conserve (vs consumption encouraged) economy that we can transition to?

I am a financial conservative, but have lost faith in the business community and financial sector because of the obscene multiples of pay for upper management vs worker pay. Government is not efficient but there needs to be a counter weight to multinationals and the concentration of wealth. Service and products lose value when they are given to people so a monetary incentive is needed, but the current capitalist model trajectory is not sustainable.

This is why I disagree with your desire to replicate post WWII production increases and growth. The context has changed since we do not have to rebuild from the destruction and disruption of WWII. The continued push for people to consume and take on debt makes one a slave to debt.                                                                                                                             

My response to these thoughtful comments will be divided into two parts. First of all I refer to the book, “The Rational Optimist: how prosperity evolves” by Matt Ridley. Mr. Ridley makes a powerful argument that life all over the world is getting better all the time. The two evolved habits of exchange and specialization, starting thousands of years ago, have created a collective brain that sets human living standards on a rising trend.
Capture31For example, referring to the first paragraph above:

  • Emissions from U.S. air pollutants such as carbon monoxide, nitrogen oxides and sulphur dioxide have been cut in half since 1980.
  • Species extinctions are at most 2.7% per century.
  • Suppose that temperatures rise by the IPCC’s most likely scenario of 3 degrees C by 2100. This means that the sea level will rise by one foot, the Greenland ice cap will melt by 1%, fresh water will increase because of more evaporation, and in a warmer, wetter world habitat lost to cultivation will shrink from 11.6% today to 5% in 2100.
  • A revenue neutral carbon tax is by far the best way to sort out the optimal response to global warming.

Conclusion: The environment is likely to be much improved by 2100. The world will also be much more prosperous in 2100 as I will discuss in my next post.

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The Democrats Are Half Right (and Half Wrong!) on the Economy

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In my opinion both of the two main presidential candidates have overall poor economic plans.  But at least several major Democratic figures such as Hillary Clinton, the NYT columnist Thomas Friedman, and the economist Larry Summers do understand the importance of economic growth.
In particular, says Mr. Summers, “What is unfortunate is that many (progressives), in their eagerness to focus on fairness, neglect the single most important determinant of almost every aspect of economic performance – the rate of growth of total income, as reflected in the gross domestic product.”
Furthermore,

  • More growth means more employment. For each 1 point increase in adult male employment, the employment of young black men rises by 7%.
  • More growth reduces the need for desperation monetary policies that risk future financial stability.
  • If U.S. growth continues to have a 2% ceiling, it is doubtful if we will achieve any of our major national objectives. If we can boost growth to 3%, interest rates will normalize, middle-class wages will rise faster than inflation, debt burdens will continue to melt away and the power of the American example will be greatly enhanced.
  • The question is not whether business success is desirable. The question is how it can be achieved.

All of the above is very positive on the part of Mr. Summers. But then he adds, “What is needed is more demand for the product of business.  This is the core of the case for policy approaches to raising public investment and increasing workers’ purchasing power.”  In other words Mr. Summers is ignoring that:

  • Our national debt is huge and growing way too fast.
  • Wages are now increasing fairly rapidly which increases demand by itself.

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  • Investment in new business structures, equipment and intellectual property has now fallen for three quarters in a row.

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Conclusion. The way to achieve the faster rate of growth which Mr. Summers (and almost everyone else) wants is not more public investment but rather more private investment. The House Republicans have a plan to accomplish exactly this.

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Why We Should Be Deeply Worried about Our National Debt

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My last post is highly critical of the economist and New York Times columnist, Paul Krugman, for encouraging massive new deficit spending to stimulate our under-performing economy.
Debt and the slow growth of our economy are the two main topics of this blog which I have now been writing for almost four years.  How to speed up growth is a complicated and highly charged political issue about which reasonable and well informed people can differ.  However avoiding excessive debt is to me a moral issue whose resolution should not be that difficult, at least in a conceptual sense.
Capture2 I have often used the above chart from the Congressional Budget Office to illustrate our debt problem because it clarifies the problem so vividly.  Here are its main features:

  • Our public debt (on which we pay interest), now about $13 trillion, is 75% of GDP, the highest since right after the end of WWII. And it is projected to keep getting steadily worse under current policy.
  • Note the decline in the debt from the end of WWII until about 1980. This doesn’t mean that the debt was actually paid off but rather that it shrank as a percentage of GDP as the economy grew fairly rapidly during this time period.
  • From 1980 – 2008 the debt level fluctuated and increased somewhat but did not get badly out of control.
  • Debt shot up rapidly with the Great Recession and has been continuing to grow ever since.
  • The current GDP of our economy is about $19 trillion. At a current growth rate of 2.1%, this adds $400 billion of GDP per year. This means that a $400 billion deficit for 2016 would stabilize the public debt at 75% of GDP. But our 2016-2017 deficit is projected to be almost $600 billion (and rising). This is not good enough!

Conclusion. In order to begin to shrink the size of the public debt, it is imperative that annual spending deficits be reduced to well below $400 billion per year. This will be difficult for our political process to achieve but it is the only way to avoid a new and much worse financial crisis in the relatively near future.

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Paul Krugman’s Great Crime: Stealing from Our Nation’s Future

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New York Times columnist Paul Krugman is perhaps the most ardent Keynesian economist in the U.S. today. Let’s agree that Mr. Krugman is a very intelligent and articulate fellow.  He is a Nobel Prize winner and undoubtedly has made important contributions to economics. But he has the absolutely nutty idea that extreme deficit spending not only doesn’t hurt our economy but can actually be beneficial.  His column, “Time To Borrow”  in yesterday’s NYT is a perfect example of this dangerous idea.
Capture31Here is the essence of his thinking:

  • Our national debt of $19 trillion is just a big scary number. Actually just our public debt alone of $13 trillion (on which we pay interest) is 75% of GDP, the highest since the end of WWII, and is projected (by the CBO) to steadily become much worse.  
  • Federal interest payments are only 1.3% of GDP, low by historical standards. Just lock in repayment with 30-year inflation protected bonds, yielding .64% interest. Okay, suppose we can lock in very low interest payments on our current debt and therefore just borrow away oblivious to total debt for the next 30 years. In 2046 I expect to be gone but my children and grandchildren will still be around. Why should they be stuck with paying off or refinancing our own extravagant debt at likely much higher interest rates?
  • There are pressing infrastructure problems all over the country which need fixing now. For example, in Florida, green slime infests beaches because of failure to upgrade an 80 year old dike. The answer is to let Florida voters decide if they want to issue bonds for this project and pay them off with state tax revenue. Nebraska, for example, has decided to raise its state gas tax by 6 cents/gallon in order to pay for infrastructure upgrades.

 

Conclusion. The U.S. is currently in a huge fiscal bind with massive debt and continuing large annual deficits. It is extremely reckless to continue even current deficit spending, let alone increasing it, for anything less than a true national emergency.  Infrastructure repair, for example, is an important but routine need which should be paid for out of current tax revenue.

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