Minus 87.4%

About 1½ weeks ago, a friend of mine told me he had invested in an American subprime lender and asked me what I thought about it. He said he knew they had problems, but he wanted to take advantage of their currently low stock prices and so receive high returns once the market turns around. My reply was that while his strategy was a good one under some circumstances, he had gone into the sector far too early. I told him it won't turn around until sometime next year-or even later. Until then the risk is too high and the chance of a near future turnaround is too low for investing in them.

He took my advice and sold his shares at a small loss. But he can be glad he took my advice as shares of most subprime lenders have fallen dramatically since-far more than the overall stock averages.

The case of American Home Mortgage serves as an illustration of just how high the risk is. Its shares fell a full 87.4% today (This from a level more than 70% lower than in December 2006), after news that it can no longer fund its home loans. This means that there is a very high risk that the company will go bankrupt or is forced to some other solution which would basically wipe out shareholder value. By now, the stock is a mere lottery ticket given the high risk of failure-and the potentially extremely high returns in the unlikely event that shareholder value will somehow be preserved. I still think the worst has yet to come, so I still wouldn't recommend anyone to buy stocks of subprime lenders unless it is one of particularly sound business practices compared to others-or unless you want a substitute for regular lottery tickets.

Flat Tax Reaches New Low

Bulgaria introduces a flat tax of just 10%. Suddenly Estonia, Slovakia and even Hong Kong are looking bad. Prediction: just as Estonia and Hong Kong have for long enjoyed high growth and just as Slovakia's growth sharply accelerated after it introduced a flat tax (Now at 9%), Bulgaria will see a sharp acceleration in growth next year.

Sign of the Times

Yesterday my micro wave oven crashed, so I had to buy a new one today ( Having the old one fixed would have probably cost me more). I had several brands to choose from, including Whirlpool from America, LG from South Korea, Matsui from Japan plus two others who I can't remember. Ultimately, I chose the Matsui oven because it was the cheapest.

Anyway, I noticed something interesting. Regardless of whether the brand was American or Japanese or Korean or of unknown origin, they all had the "Made in China" text on them (Or "Made in P.R.C.", but that is China)

The Insanity of Farm Subsidies

I've reported repeatedely about the insanity of farm subsidies. Now Johan Norberg has an interesting post about how these farm subsidies just keep getting more and more insane:

"First they paid farmers to farm.

Then they paid farmers not to farm.

Then they took another step by paying non-farmers not to farm.

And just when you thought they´d run out of ideas, here comes the logical conclusion: Agricultural subsidies for the dead. Washington Post reports that deceased farmers in the US get $157 million a year. That makes a decent wage per working hour."

Kerrynomics

John Kerry, Massachusetts Senator and former Democratic Presidential Candidate, famous for voting against proposals just before he votes for them and insulting troops just before flattering them, now tries to demonstrates that he understand economics better than he holds on to his political views. He fails-before he succeeds (if he ever manages to do that...that is one flip-flop Kerry is unlikely to succeed with...).

Anyway, George Borjas here quotes him saying this:

"In order for America to remain truly competitive in a global economy, we must invest in our workforce to stimulate small business growth. Small businesses create two-thirds of all new jobs in this country, and the vast majority of them are paying their new workers higher than the minimum wage.

It's no secret that good wages result in increased productivity, ultimately improving a firm's bottom line and economic development in their community. In fact, the last time Congress raised the minimum wage, our country experienced the strongest economic growth in decades. We saw lower unemployment, lower poverty rates, and lower inflation.

Small businesses get it. By raising the minimum wage, we're creating a prosperous future for our small businesses, their workers and their families."

To which Borjas comment:

"(1) If a $5.85 minimum wage creates a more "prosperous future for our small businesses" than a $5.15 minimum wage, isn't it a little irresponsible to stop there? Let's go for the $10.00 minimum wage? Or a $15 one? Or...

(2) No matter how disappointed one is with the Bush administration, all it takes is a little googling of John Kerry's latest nonsense to appreciate that things could be worse."

Indeed. With regard to point number one, you could go further , asking P.J. O` Rourke's question: "And if minimum wage laws work, why fool around? Why not make it a thousand an hour?"

Bullish & Bearish In U.S. GDP Report

The second quarter GDP numbers came in at 3.4%, within my expected range of 3-3.2% give or take a few tenths of a percentage points. Looking at the details, the main reason why it came in at the high end of that range was that government spending increased more than expected. As a result, government demand rose to its highest share of GDP since the first quarter of 1993. Also, Net exports was somewhat higher than expected but on the other inventories increased lower than expected.

More interesting was the revision. As I predicted yesterday, it did indeed downwardly revise growth in 2004-2006. 2004 was revised down to 3.6% from 3.9%, 2005 to 3.1% from 3.2% and 2006 to 2.9% from 3.3%. Inflation was on the other hand upwardly revised, but not by as much as the downward revision to real growth, so nominal growth was also downwardly revised. The related measures of GNP (GDP plus net factor income) and national income (In principle GNP minus capital consumption, but in practice it also includes a statistical discrepancy as its data come from other sources).

But the most interesting aspect of the revision was the change of distribution within national income. This revision implies a somewhat more bullish outlook for private consumption than I outlined yesterday, but it also implies a much more bearish outlook for business investments.

The bullish news from the revision was that disposable income was upwardly revised even as consumer spending was downwardly revised. As a result, the savings rate was actually +0.6% instead of the -1% to -1.5% one could have expected from the unrevised April and May numbers. While there was a small upward revision to compensation of labor, the main reason for the upward revision of personal income was much higher dividend income. That the savings rate is positive rather than negative, if only slightly, means that consumer spending now seems less vulnerable to falling house prices.

The really bearish news was the downward revision to corporate profits. And with dividend payments upwardly revised, that of course also implies that retained earnings was even more downwardly revised. As a result of the downward revision to profits and upward revision of dividend payments, retained earnings in the first quarter of 2007 fell to their lowest level since 2003 (except for the special case of Q4 2004 when Microsoft's special dividend depressed the number) in nominal dollars. You have to go back all the way to the recession year of 2001 to find retained earnings at a lower share of national income. Including dividends, corporate profits aren't fully as weak. But even including dividends, domestic corporate profits were at their lowest share of national income since 2004 (except for the third quarter of 2005, when Katrina related damages depressed it). And I expect profits for the second quarter to be even lower.

The decline in profitability and the weaker cash flow implies that it seems unlikely that corporate executives will really find it profitable to increase investments significantly, especially with the weakness in domestic demand. For this reason, it seems likely that the decline in investment goods demand implied by the durable goods report yesterday was not an anomaly, and that business investments will be stagnant or even negative.

All in all, the report does not significantly strengthen or weaken the bearish case as the more bullish outlook for consumer spending is cancelled out by the more bearish outlook for business investments. Ultimately though, as business investments is what builds the productive capacity, the supply side of the economy, the more bearish case for investments is more important than the more bullish case for consumption-particularly in the long term.

U.S. Economy Weakening Again

There have been a lot of economic reports today, which I will return to soon, but the big number for the week is tomorrow's U.S. GDP report. This report will also include revisions of GDP for 2004-2006. The GDP revision for 2004-2006 is likely to slightly -but only slightly- downwardly revise real GDP growth, just like the 2005 and 2006 revisions did.

As for Q2 2007, I basically agree with the average Wall Street forecast of 3-3.2% at annualized rate ( give or take a few tenths of a percentage points) compared to the previous quarter. Personal consumption will likely increase about 1.5% (The decline in June retail sales means however that it could be lower), which is enough to add roughly 1%:point in growth. Meanwhile, both inventories and net exports will each add slightly less than 1%:point. In dollar terms, the trade deficit is likely to be assumed stay roughly unchanged compared to the first quarter, but as import prices (primarily oil prices) rose sharply, this will still mean that net exports will add slightly less than a percentage point to GDP given the prevailing -and illegitimate, but never mind that now- volume methodology. Meanwhile, business investments -particularly private nonresidential construction- will likely add some to GDP, but this will likely largely be cancelled out by continued falling residential investments, so the total net addition from fixed investments will probably be small. Also, increased government spending will likely add a few tenths of a percentage points. If we add this up, we come up with the number of 3% or slightly more than that.

This will represent a significant acceleration in growth from the 0.7% rate of the first quarter, although the terms of trade factor means that the real improvement is not as big as the headline volume number would suggest. Moreover, growth will likely decelerate significantly again in the third quarter. It is way too early to give any exact forecast, but it seems unlikely that growth will exceed 1% and there is a significant possibility of negative growth.

The reason I believe this is that there are a number of strong factors pushing down the economy.

First and foremost, the subprime mess just keeps getting worse and shows signs of spreading to the junk bond sector and to other mortgage borrowers. This implies first of all that residential investments will continue to fall. The sharp decline in new home sales confirms this, as it shows that builders are finding it increasingly difficult to sell newly built homes. Secondly, falling house prices implies that despite higher stock prices, consumers will find it increasingly difficult to expand or even just continue with their negative savings rate. That in turn means that real personal consumption will at most increase (or decrease) at the same rate as real disposable income, and likely be even weaker than real disposable income. Thirdly, higher yield spreads on junk bonds means that M & A activities and business investments will be restrained, as is illustrated by the difficulties for private equity firms to raise the capital needed to buy Chrysler from Daimler. The loose monetary conditions that supported the stock market rally may thus be about to dissipate, which would end the rally and reinforce the effect from lower house prices.

Another factor which will certainly drag down the U.S. economy is the continued sharp increases in oil prices. The sharp increase in oil prices means that real disposable income is likely to be stagnant at most, and it could even turn negative. That also implies for the above mentioned reasons that real personal spending is likely to be stagnant or negative for the third quarter.

Furthermore, business investments aren't likely to increase particularly much, if anything at all. Durable goods orders excluding aircraft and defense orders, a proxy for future business investment spending fell again in June. While tomorrow's GDP release isn't going to say anything about corporate profits, the earnings reports from Wall Street suggest that profits for domestic companies fell as a general theme of the earnings reports was that earnings on average increased only because of higher foreign profits. While absolute profit level remain high, the fact that they are declining and the aforementioned higher junk bond yield means that business investments are likely to be stagnant or negative.

And if final sales are weak, inventories are likely to fall back again.

Somewhat counteracting the above mentioned forces are strong foreign growth and the weak dollar, both of which should imply that net exports at least according to the volume methodology will contribute to growth. The higher oil price means that the dollar trade deficit may fall only slightly or not at all and so this boost will largely be just a statistical illusion. The aforementioned boost in earnings from foreign subsidiaries will likely support U.S. incomes, but not to any significant extent.

All in all, increased net exports and net factor income from the weak dollar and global economy and the stock market rally that is to some extent a result from higher net factor income will provide some support to the U.S. economy. But will it really be enough to counteract the fallout from the subprime mess, the soaring oil prices and the weak domestic profits? That is possible, but it looks increasingly unlikely.

Two Great Mises.org Articles

While most of my readers have presumably already read them, to those that haven't I would like to recommend two great mises.org articles.

First, Lew Rockwell describes the hell that China was during its communist era. While the Chinese government can still be oppressive in some non-economic areas and is far from consistently laissez faire in economics, it is clear that there has been a dramatic improvement in particularly the economic aspects and to a lesser extent also the non-economic aspects since Deng Xiaopings capitalist reformation.

Second, Robert Blumen has an interesting review of Peter Schiff's book. While the book is not flawless, it does seem interesting (I haven't read it myself yet, so I can't review it yet).

The Problem With Ad Hoc Tax Cuts

The Swedish centre-right government wants to increase employment. And it realizes that this is done most effectively by reducing taxes. So far, so good, in other words. The problem is that it remains unwilling to significantly reduce government spending. And to the extent the burden of spending for structural and cyclical reasons falls, it seems committed to using this to run large surpluses and pay off the government debt.

And so, it is not willing to commit to any significant across the board tax cuts. But how then will they be able to increase employment through tax cuts? Well, radical libertarian turned centrist technocrat finance minister Anders Borg probably thinks he is a real brilliant economist by coming up with the idea of targeted tax cuts to specific sectors. Labor cost sensitivity is higher in some sectors compared to others, mainly due to the fact that some are more labor intensive than others and the related fact that some products and services can more easily be done by consumers themselves or within the unofficial sectors. For example, you can cut your own hair or have a friend or relative do it, but you could hardly build your own car. And so, Borg probably thinks he is really smart by targeting the tax cuts to just specific sectors.

And well, targeted tax cuts to these sectors are indeed likely to generate more jobs than across the board tax cuts of a similar amount. The problem is that while it may "work" in that sense, this solution will have negative side effects that wouldn't have appeared with across the board tax cuts. First of all, it will lower productivity as it in effect means extra punitive taxation of more capital intensive sectors. And while consumers may not be able to build cars themselves, they can always substitute Swedish cars with foreign cars.

And secondly, this new special rules will create lots of extra bureaucracy, red tape and complications for small businesses. As is highlighted in this Dagens Industri-article, just about all organizations reject the proposal on precisely the massive amount of extra red tape for businesses. For example car mechanics will get tax relief when they fix cars-but not when they fix buses- Cafes will get tax relief except when they sell bread and so on.

It is time for the Swedish government to show that they really are different from the Social Democrats-and implement more broad based tax cuts financed by real spending cuts-something which would be unequivocally good and make the pick-up in Swedish growth more sustainable.

Very Funny

BBC Business News reports on the increased trade surplus in Japan with the headline "Cars drive Japan's trade surplus", alluding to how increased car exports was one of the factors behind the increase.

The key factor behind the increase is of course the extremely undervalued yen. The surplus is likely to continue increase albeit at perhaps a slower rate due to higher oil prices and a weaker U.S. economy.

Subprime Mess Getting Worse

Nouriel Roubini has as usual a good wrap up of the bearish news on the subprime sector, with lots of useful links.
An especially interesting link is this columns by Bill Gross on how yield spreads are rising in other sectors as well as a result from the subprime (Try to ignore the socialist-egalitarian nonsense in the first half of the column and focus on the latter parts about yield spreads).

Another interesting story, not included in the Roubini post, is this story about how a leading subprime lender believes there will be no recovery in the housing market before 2009.

Japanese Deflation Underestimated?

The "Alpha-Sources" blog notes that inflation in Japan and the United States are measured with different methodologies, with the U.S. applying to a much higher extent "hedonic adjustment" and substitution adjustments. As the anonymous blogger and the authors of the study he(?) quotes thinks the U.S. methodology is the correct, they argue that this means that price deflation in Japan have been even higher than previously thought, which also means that real growth have been higher. I would be more inclined to think the Japanese methodology is better and that inflation in the U.S. has been higher and real growth lower.

But regardless of whether Japanese deflation or U.S. inflation have been underestimated, two things are clear: First, relative inflation in the U.S. has clearly been higher and relative growth lower compared to Japan. Second, this implies that the real depreciation of the yen has been even more dramatic than I reported before and that the case for believing that the yen is extremely undervalued is even stronger

P.J. O Rourke On Minimum Wages

Like everyone else, I have been basically forced to switch from VHS to DVD format with regards to new movies, but since I've got dozens of old VHS tapes with a lot of stuff I want to keep I have a dual VHS/DVD format VCR. Anyway though, I have in many cases not been so good in writing down what I have on what VHS cassette so I have now started a project to look through them all, a project which will likely take some time before it's finished since again we're talking about dozens of 4-hour tapes.

In one of the tapes I recently looked through I saw a really great old clip from 60 minutes. Next week, America will see its first increase the minimum wage for a decade. Because the real value of it is still relatively low both in historical terms and compared to other countries, I don't think it will do much damage. But it will certainly do even less good, and the net effect, while small, will certainly be negative. The clip in question featured a short duel with first an opponent holding a monologue against the increase and then a supporter holding a monologue in favor of the increase.Libertarian-conservative humorist P.J. O'Rourke had been chosen to argue against an increase and now deceased left-liberal Molly Ivins had been chosen to argue for it. Ivins had no real strong arguments and simply argued against O'Rourke's arguments below that "free market fundamentalism is as dead as the dodo. We had this debate a 100 years ago, and the good guys won". The only thing resembling a factual argument was denying O'Rourke's argument that wage increases means fewer jobs with this line "if this were true, how come we have so many CEO:s around? Their salaries have sky-rocketed". A rather pathetic argument as it of course overlooks that pay increases driven by rising marginal productivity will not be empirically associated with the same change in employment as pay increases mandanted by government (or union) decree. O'Rourke on the other hand was really good arguing:

"Why is Congress even debating the minimum wage? Where does the constitution say that government sets the price of delivering pizza? And if government knows the best price of everything, then how come the B-1 bomber cost so much? And if minimum wage laws work, why fool around? Why not make it a thousand an hour? Molly, if workers are more expensive fewer workers are hired. I wish this weren't so. I also wish I could wear the same size jeans I wore in College. Free market value isn't good or bad, it's a measurement. Laws won't fix it. We can pass a law saying a foot has ten inches*. I put a tape around my waist-same size jeans I wore in College! But the gut is still there. Raise the minimum wage, pay goes up a little, prices goes up and poor people are back where they started. But liberals feel good, which is of course the whole point of government. If we want to help the working poor, we should cut sales taxes, cut gas taxes, cut farm subsidies that keep food prices high. And get rid of all the nonsense regulations, such as minimum wage laws, that just keeps poor people from starting businesses and getting richer".

*=To those used to the metric system of measurement it should be pointed out that a foot currently has twelve inches.

Why High Oil Prices Are More Sustainable Now

The Economist has an interesting story of why this year's increase in oil prices is likely to prove more sustainable than last year's. Last year, the then peak of $78 per barrel was mainly driven by the fear facto-the fear of a regional war in the Middle East and/or another Katrina-style Hurricane that would disrupt Mexican gulf oil production.

But this year, it is increased underlying demand from primarily China and India which has helped push up oil prices. Another factor -which The Economist does not mention- that makes this year's increase more sustainable is the weak dollar. While the dollar price of oil may be only 3-4% lower than last year's , the oil price in terms of yuans, euros or pounds is still 10% or more below last year's peak.

New Argument Against Legalizing Cannabis

The news that 8 of Gordon Brown's Cabinet ministers have smoked marijuana has made Tim Worstall withdraw his support for legalizing cannabis:

"Clearly I'll have to change my view on the matter. It would appear that just a few tokes on a joint can indeed turn you into a talentless drone with no moral values whatsoever."

China Overheats

Both second quarter GDP growth and June industrial production and consumer price index for China came in way above analysts expectations. Real GDP growth in the second quarter was 11.9%, with growth likely being especially strong in June as industrial production growth rose to 19.4%. Meanwhile consumer price inflation accelerated to 4.4% with particularly food prices rising fast.

All regular readers of this blog of course knows what I think needs to be done: accelerate the pace of yuan appreciation and preferably stop cold foreign exchange intervention. This would help solve virtually all of their problems: it would ease trade tensions and reduce the excessive trade surpluses and it would also reduce money supply growth which in turn would reduce the problems of overinvestments and rising consumer price inflation. I am somewhat puzzled as to why they don't take such an obviously appropriate action.

Robert Schiller's Liquidity Nonsense

Via Mark Thoma's Economist's view, I see this piece by Robert Schiller where he suggests that the term liquidity is more or less tautological with bubbly markets. Schiller sometimes writes good stuff, but this time he is dead wrong.

He writes:
"Traditionally, "awash with liquidity" would suggest that the world's central banks are expanding the money supply too much, causing too much money chasing too few goods.

But if that were the problem, one would cause all prices - including, say, clothing and haircuts - to rise.

That is what the US Federal Reserve Chairman Arthur Burns meant when he said that the United States was "awash with liquidity" in 1971, a period when the concern was general inflation.

But the recent popular use of the term "awash with liquidity" dates to 2005, a time when many central banks were tightening monetary policy.

In the US, the Fed was sharply raising rates. Central banks worldwide clearly have been behaving quite responsibly with regard to general inflation since 2005. According to the IMF, world inflation, as measured by consumer price indices, has generally been declining since 2005, and has picked up only slightly in 2007.

So it is something of a puzzle why people started using the term so much in 2005. If central banks are tightening and long-term rates aren't rising, one needs some explanation."

The fallacy should be obvious here. He is trying to disprove the existence of high money supply growth by invoking the false and disproven Friedmanite mechanical link between money supply and consumer prices. Even setting aside that official CPI likely underestimate true consumer price inflation due to so-called hedonic adjustment and similar things and the fact that consumer price inflation is likely to accelerate sharply as soon as last year's brief oil price peak is removed from the 12-month comparison, the non-existence of high consumer price inflation does not disprove the non-existence of high money supply growth. Instead it disproves the mechanical
Friedmanite link between these two things. Money supply statistics is not something derived from indirect indicators and are available directly. And these money supply statistics show that in virtually all mayor economies except Japan, money supply growth are at double digit levels. The United States and the Euro area with their "mere" 10% money supply growth have actually relatively slow money supply growth compared to other mayor economies except for Japan.

What makes Shiller's piece even more nonsensical is that the link between money supply growth and financial bubbles are generally the greatest when consumer price inflation is modest. When the receivers of new money uses them to bid up asset prices rather than consumer prices, this will mean that financial markets will be "awash with liquidity" due to monetary factors. Thus, not only do the monetary explanation of financial bubbles not presuppose consumer price inflation, but it is in fact only applicable to the extent new money aren't used to bid up consumer prices to any mayor extent.

Increased Wall Street-America Decoupling

Swedish neoconservative blogger Dick Erixon is as clueless as usual when claiming that America is in a cyclical boom, only to be puzzled as to why Americans aren't upbeat about the economy. That may have something to do with the fact that America is not in a cyclical boom. While not yet a recession, it is certainly a cyclical slowdown with year over year growth being just 1.9%, significantly below the historical average and most other countries.

Just about the only fact he got right was that Wall Street is at record highs (or at least the Dow and the S & P 500, NASDAQ is still nearly 50% below its March 2000 peak). Yet as I've explained before,
Wall Street and the U.S. economy is increasingly decoupled.

We have gotten more confirmation of this trend this week. First, in many earnings reports (which BTW have been surprisingly weak so far. While they are still likely on average the beat official estimates, they seem to be doing so with a smaller margin than usual) it is reported that revenue and earnings growth is concentrated to its foreign operations. Case in point is Coca Cola, which saw domestic sales volumes drop 2%, while its non-U.S. sales volumes rose 9%.

We also saw another explanation to why stocks have been rising so fast despite stagnant earnings growth, besides the rapid money supply growth I reported about a few days ago. The Treasury International Capital Data reported that foreign net acquisition of U.S. stocks rose to a record $41.8 billion in May, after being $27.4 billion in April, after being roughly $10 billion per month the 10 months before that. It is also far higher than the roughly $10 billion monthly acquisition of foreign stocks by U.S. residents. Why foreigners have started to show such an interest in U.S. stocks is not clear, but presumably it reflects at least partly the fact that the weak dollar and the boom in other stock markets have caused the relative weight of the U.S. market many fund managers portfolio to decline, which means that they'll have to buy more U.S. stocks to achieve their desired level of diversification.

This reflects a global trend where both operations and ownership of companies are increasingly globalized . This, as I've discussed before, is a factor which have helped reduce cyclical fluctuations in the economy. It also means that local stock markets will to a lesser and lesser extent follow the movements of the local economy.

Myths & Fact About The American Health Care System

Since the release of Michael Moore's "sicko" movie, the U.S. health care system and its alleged failure have been widely debated. But while the U.S. health care system is far from perfect, it is much better than Michael Moore would have you believe. Furthermore, the real shortcomings that it does have are not the effect of its free market elements, but to various regulations and factors unrelated to the health care system.

This will not be a direct review of "sicko", a movie which I haven't seen. But it will of course be a indirect attack on the movie's thesis. For a listing of the lies present in the movie, see this review.

Myth: "The U.S. has a purely free market health care system"

Fact: The U.S. health care system is indeed more market driven than in most other countries, but nearly half of all health care costs is paid for by the government. Already in 2004 roughly 45% of health care costs were government funded a proportion which has likely increased since then due to Bush's Medicare expansion.

Furthermore, the system is burdened with heavy regulations, which contributes to raising its costs, as The Economist recently reported in an interesting article.

Myth: "The U.S. health care system leaves 45 million (or whatever number is claimed)without health insurance"

Even setting aside that a significant proportion of these uninsured are illegal immigrants, which in Sweden is completely excluded from the health care system, this is only true in the sense that nearly 9 million in Sweden is without health insurance. Everyone in America over the age of 65 is covered by the Medicare program and low income earners below the age of 65 can get their health care paid by the Medicaid program. And besides, one can always simply go to an emergency room and demand care there since federal law prohibits hospitals from denying people care there, a possibility which has created some problems in the border regions to Mexico since illegal immigrants have been very good at taking advantage of this (more about this in the link in the beginning of this paragraph).
And if you are unable to pay, government will have to compensate the hospitals.

Myth: "Market mechanisms are responsible for the high costs of the American health care system"

Fact: That the U.S. health care system has a very high cost level is one of the few criticisms of it which is basically true. Regardless of how you calculate, U.S. health care costs are higher than anywhere else in the world. It should however be pointed out that many -including reportedly Michael Moore- exaggerate just how much more expensive it is by comparing the cost in PPP-adjusted dollars per capita. Since the U.S. is still the third richest country (After Luxembourg and Norway) in the world according to that method of comparison and because a higher average income will for various reasons drive up the cost in PPP-adjusted dollars this kind of comparison will exaggerate the relative extra cost, while greatly underestimating it in dirt poor Cuba.

Health care costs in the U.S. are roughly 15% of GDP compared to roughly 10% in countries like France, Canada and Cuba. What is then the cause of these higher costs?
Well, in part it is actually (see below) the case that U.S. health care quality is higher, and quality costs. And as is also described below, an unhealthier lifestyle among many Americans also contributes to pushing up costs.

Moreover, as discussed above various regulations have contributed to pushing up costs (see aforementioned The Economist article) and furthermore American doctors and nurses has much higher pay relative to the rest of the population than in most other countries.

And it is also the case that the American health care system in practice function as an Atlas which carries the world's medical research costs on its shoulders. In Sweden, Canada and most other countries, the government health system purchases medicine for very low prices which doesn't cover the research costs needed to produce it. Drug companies still reluctantly agrees to this since the prices they receive still give them a small profit given the completion of the research needed to produce it and because they can in the United States charge prices which covers not only cost of production but also the cost of research and more. This factors means that real health care costs are overestimated in the United States while being underestimated in the favorite countries of Michael Moore and other socialists.

If the United States were to act as other countries and pay the same low prices for medicin -something which many leading Democrats have advocated- as other countries this would of course contribute to a significant short term reduction in U.S. health care costs. The problem is that this would mean that new research would be unprofitable and so few or no new medicines would appear which in the long run would raise health care costs everywhere.

Myth: "Despite its higher costs, the World Health Organizations ranking show that the American health care system ranks only number 37 in quality".

Fact: No, it doesn't show that at all. The ranking is actually only to a small extent a ranking of health care quality. If you check its details it measures mostly other things. What is being measured is mostly things like a population's health level (why this is not a good indicator of health care quality see below) and to what extent financing and treatment is in accordance with the WHO:s socialist ideals. That socialist systems are better in accordance with socialist ideals is hardly surprising and is definitely not a valid indicator of health care quality. The only one of their indicators which measures quality is "level of responsiveness" which is based on patient satisfaction and how quickly and efficient the system works. And in this category the American health care system is....number one!

Myth: "The somewhat shorter life expectancy and somewhat greater health problems of the United States shows that its health care system doesn't work as well"

Fact: No, it doesn't show that at all. These indicators vary mainly due to other factors, primarily different life style factors. Sweden's and Denmark's health care systems -and the economic system in general- are basically the same, yet life expectancy is a few years higher in Sweden. The difference is caused by the fact that Danes have a less healthy life style than Swedes. Hong Kong has a very high life expectancy and low level of health problems "despite" having a health care system largely privately financed like in the U.S. And as Michael Moore himself is a perfect illustration of, the United States have a higher proportion of people who are fat and/or for other ways live a unhealthy lifestyle. This will both contribute to raising the cost of the system and worsening these health indicators.

Ayn Rand & Israel

Jerusalem Post has an interesting feature which discusses Ayn Rand and her relation to Israel. Both in terms of why she and other objectivists supported Israel despite the fact that during her lifetime, it was relatively socialist (after her death, it has become a lot more capitalist, although it still has an extensive welfare state), and also the level of support and familiarity that her ideas enjoy in Israeli universities and society.

Liquidity Driven Stock Rally

This Associated Press story captures the background of the irrational stock rally yesterday very well. While the conventional explanation of the rally was that it was due to Rio Tinto's bid for Alcan and the better than expected Wal Mart sales, that it is only the pretext for it. While it is certainly understandable that the stocks of Alcan and Wal Mart would rise, it makes no sense at all for other stocks to rise on these news. Why would stocks that aren't affected by the news rise in value? Why would for example Alcoa, who due to Rio Tinto's bid will lose the bidding war for Alcan or will be forced to pay an extremely high price in order to get it rise by 7%? And why would Motorola rise despite having issued an earnings warning?

And this trend of sharply rising stock prices despite mediocre news isn't just something that happened yesterday. Stocks have become much more expensive the latest year as they have increased more than 20% even though earnings are up only about 5%.

But as the story points out, what really drives the market is liquidity, which is to say rapid monetary expansion which at this stage mainly bids up asset prices. This is because the newly created money is generated by the debt creation that finances M & A activities. The M3 money supply measure is of course discontinued now, but if we look at the broadest still available money supply measure, the MZM (Money at Zero Maturity, which is M2 minus small time deposits plus institutional MMMF:s) it is increasing at a rate of more than 10% in America. As the article points out, what ignited the acceleration in monetary growth was the decision by the Fed last August to hold interest rates unchanged for the indefinite future.

The Fed, it seems, is again trying to re-inflate a new bubble.

UPDATE: Given that one of the pretexts used for the rally was stronger than expected sales at Wal Mart, one would have expected (assuming the pretext had any truth in it) stocks to sell off today when it was reported that overall retail sales were much weaker than expected. Yet stocks have in fact risen even further today. I rest my case....

Merkel Rebuffs Sarkozy's Populist Statism

German chancellor Angela Merkel attacks Nicolas Sarkozy over his calls for increased political influence over the ECB to force it to pursue an even more inflationary monetary policy, his plans to increase the budget deficit and his calls for more protectionist EU trade policies. It is good that at least some EU leaders are relatively sensible.

Sarkozy's performance so far underlines that he was merely a lesser evil than Royal and certainly not a positive character in any absolute sense.

Today's numbers from Eurostat, which showed that year over year growth in the Euro area was upwardly revised from 3.0% to 3.1%, while France's was downwardly revised from 2.0% to 1.9% again illustrates the failure of French statist policies. Well worth noting is that the 3.1% number includes France, which is 20% of the Euro area economy. Excluding France, growth was 3.4%.

Sub-Prime Mess Revives

As I reported yesterday, the most recent dollar decline was due to reports indicating increasing weakness in the housing and retail sectors. More specifically that meant earnings warnings from D.R. Horton, Home Depot, Sears and several other companies in these sectors, as well as downgrades from both Standard & Poors and Moody's on the credit rating of sub-prime mortgage debt backed bonds.

Relatively bullish signals from other sectors have made some people to dismiss the risk of a recession, but this clearly serves as a reminder that the damage from the sub-prime mess is far from over and could yet drag down the aggregate U.S. economy into a recession. Nouriel Roubini has a great overview of the situation which I recommend.

Michael Moore: Big Fat Liar

David Gratzer has an interesting column on NRO documenting some of the numerous factual errors of Michael Moore in his "sicko"-movie.

Dollar Reaches New Lows

Reports indicating weakness in housing and retail sales in the U.S. today sent the U.S. dollar to a new all-time low against the euro and multi-year lows against many other currencies including the Swedish krona, the U.K. pound, the Australian dollar and the Chinese yuan. It even fell against the yen, although in a longer perspective, the yen has been even weaker than the U.S. dollar.

With interest rates movements going against the dollar and with rising oil prices likely to prevent reductions in the trade deficit, look for the dollar to fall further against most currencies, but not that dramatically though. I expect it to test the 1.40 level against the euro fairly soon. At that point, however, further appreciation is likely to be limited due to discontent from Sarkozy and other EU leaders that complain that the euro is too strong. Also, if the euro rise too much against the dollar and the yen, it could further delay future rate hikes from the ECB. And as the increase in interest rates is the driving factor behind the strength of the euro, a dramatic appreciation in the euro could prove to be another case of self-preventing prophecies.

Global Warming Reality Check

Argentina and Chile experience record cold this winter, with southern Argentina (in the southern hemisphere, the winter is in June-August and the weather gets colder the further to the south you go) experiencing temperatures of -22 degrees celsius (-8 degress fahrenheit). Buenos Aires now experience snow for the first time in 89 years and at least three people have frozen to death (they're not as well prepared to handle cold as us Nordics).

Sarkozy The Supply-Sider

President Sarkozy new economic plan contains both good and bad news. The good news is that he wants to cut taxes by €11 billion per year, a much needed relief for the over-taxed French economy. The bad news is that he doesn't want to finance these cuts by spending cuts. Instead he wants to increase the deficit further. France already has a 2.5% of GDP government deficit-very high considering the current cyclical boom and Sarkozy's unfinanced tax cuts is likely to push the structural deficit even higher.

Sarkozy hopes this will increase growth, yet theoretical net effect of such a policy is ambiguous as the improvement in incentives from the tax cuts is counteracted by the "crowding out" effect of deficits as well as the income effect on work efforts. And as the theoretical effect is ambiguous, the likely actual net effect is likely to be small in either direction.

Combined with his attacks on the ECB for pursuing a "too tight" (i.e. insufficiently inflationary) monetary policy, a clear picture emerges of Sarkozy as a supply-sider. Supply-siders are basically Keynesians with their love for budget deficits and a "accommodative" (i.e. inflationary) monetary policy. Only unlike left-liberal Keynesians like Paul Krugman, they wishes to achieve the deficits by reducing taxes rather than increasing spending and they also generally use free market rhetoric and some free market policies (apart from tax cuts usually also deregulation and free trade). Sarkozy fits this description perfectly, although being a French politician he also uses some statist rhetoric and favors a certain degree of protectionism.

Oil Prices To Rise Significantly?

According to this story, oil prices look likely to rise in the coming few years as demand increases and supply looks tight. Meanwhile, the increased ethanol production that have helped push up food prices look unlikely to make much of a difference. "In its report, the IEA argued that biofuel production would hit 1.8 million barrels by 2012, more than double 2006 levels. However, while supplies of the green fuel are set to surge, it is likely to remain marginal with just a 2% slice of the overall energy market."

Republican-Democratic Budget Fight

Three weeks ago, I told you about the possibility of a budget fight between the White House and Congress, or more correctly between the White House and Congressional Democrats. The absolute numbers that is being contested doesn't make that much of a difference, -$23 billion out of a $2.9 trillion budget- , but as this story reports, both Republicans and Democrats have a interest in creating a fight. Republicans in order silence criticism from libertarians and small government conservatives that they have increased spending too much. Democrats in order to convince core supporters that their election victory made a victory. This could possibly mean a repeat of the 1995 partial shutdown of the federal government.

Mosquitos Benefit From Bursted Housing Bubble

Via Mike Shedlock I see that the bursted housing bubble have created an unexpected side effect: an increase in the number of mosquitos as they can lay their eggs in abandoned swimming pools.

"A glut of vacant, unsold homes with swimming pools is contributing to a glut of mosquitoes in the West.

An untended pool means stagnant water, a breeding ground for mosquitoes to lay eggs that can produce thousands of mosquitoes in a couple of weeks. "They become these little backyard swamps," says John Townsend, who runs the mosquito-control office in Arizona's Maricopa County. "Mosquitoes move in and breed up a storm."

Luis Navarro, a mosquito-control officer in Maricopa County, says mortgage foreclosures have brought him more business this year.

Some owners don't drain pools when they move out, and pools that were drained collect rainwater, he says. Even a properly treated pool can become a haven for mosquito larvae in the heat as chemicals break down faster, allowing the growth of algae and mosquito food sources such as zooplankton."

Icelandic Economy Starts To Melt

Exactly a year ago, I wrote on this blog on the imbalances of the Icelandic economy. I pointed out that Iceland pursues very sound microeconomic policies with low tax rates, low unemployment benefits and a deregulated labor market and also have a budget surplus. Iceland differs from other Nordic countries in being relatively low tax in most areas.

However, Iceland's macroeconomics isn't very sound. Iceland with its mere 300,000 inhabitants is simply far too small to be an independent currency area without causing significant economic distortions. And so when e American company Alcoa invested in an Aluminum plant called Fjarðaál, this caused the Icelandic krona to massively appreciate (when a currency zone is so small as Iceland, transactions that in bigger currency areas would have almost no effects can cause massive distortions of the exchange rate), making it absurdly overvalued, contributing in turn to a massive current account deficit and a generally overheating economy.

Now Iceland have formally fallen into a recession, with GDP being down 0.9% (3.6% at an annual rate) compared to the previous quarter and 0.1% compared to the same quarter in 2006.

Domestic demand was in fact down as much as 10%, with only a rapid decline in the trade deficit preventing a even larger decline in real GDP. Arguably, the cyclical boom in the rest of Europe have limited the extent of the cyclical decline.

Ultimately, this recession is sound for Iceland as it helps limit the unsustainable imbalances of excessive inflation and current account imbalances.

The question is how to prevent these problems from happening again. The obvious solution would be for Iceland to adopt the euro as currency. The trouble with that is however that in order to formally join the euro zone, Iceland would have to join the EU. And that would entail quite large costs in membership fees and loss of rights for its important fishing businesses.

A better solution would really be to unilaterally impose the euro as currency (Something which both Montenegro and Kosovo have done). While this would imply the loss of seignorage revenues to the ECB, it would nevertheless be cheaper than the alternatives of either joining the EU or suffering more of these kinds of crisis.

Peter Schiff vs. Donald Luskin

Donald Luskin has posted a youtube video of a debate on CNBC between him and Peter Schiff, as well as comments from himself, Schiff and some of Luskin's readers. Both Luskin and Schiff can broadly be described as libertarians, but their view of the U.S. economy could hardly be more different.

Donald Luskin is one of the most bullish analysts around, while Peter Schiff is the by far most bearish analyst I know of. He is in fact so bearish that he makes me look like a bull in comparison!

The debate was somewhat pitted against Schiff. Not only did he have to argue against Luskin, but also against another guest called Jim Awad whom I hadn't heard of before and who also was bullish. Moreover, the two news anchors also argued the bullish case.

The big problem with the debate was that both sides used the invalid argument that if something has increased in price in the past they will do so in the future too. The 4 bulls tried to use the more of 20% increase in the S & P 500 the latest year as evidence for their case, while Schiff used the weaker development since 1999 and the stronger development in non-U.S. market. While strong price movements in some directions can sometimes be a indicator of a trend which may go on for a while more, it might also not be the last move in a trend. And from a fundamental point of view, stocks will be less worthy of a buy if they rise in price (and vice versa).

Peter Schiff was wrong to argue that the United States is a burden on the rest of the world, and that the rest of the world wouldn't suffer if the U.S. fell into a deep recession. Nevertheless, while expressed in a misleading way, this argument also contained the valid point that countries that today intervene in the currency markets by accumulating massive amounts of dollar assets would gain by ceasing to do so (see here my analysis of how much and why China would gain. This analysis also applies to other countries accumulating foreign exchange reserves), while the U.S. would lose if they did so.

Schiff is thus right that the sooner the rest of the world realize that it is isn't in their best interest to subsidize the U.S. economy through these interventions, the more bullish will the case for non-U.S. stocks be relative to U.S. stocks.

Donald Luskin's personal attack on Schiff for promoting himself and his book was hardly fair, especially since 1) There's nothing wrong with doing that 2) I have a hard time believing that he didn't hope to attract some people to his firm Trend Macro Analytics by sitting in a room with his firm's name clearly visible in the background. And he is just being childish when he publishes a reader letter criticizing a misspelling of a single word in Schiff's online follow-up letter.

Schiff (in the online follow-up letter) makes a good point with regards to the effects of the inability of people like Luskin to see the negative effects of Fed inflating on the U.S. economy:

"The main problem with guys like you is that you purport to advocate free market capitalism, yet you have little understanding of basic economic principles. As a result, when our phony economy comes crashing down the public will look to the left for solutions. It is a real shame as more government will only make our situation worse. The mindless cheerleading of phony conservatives like you has done more to hurt the causes of liberty, limited government and free market capitalism then anything from the left."

On the other hand, Luskin was the funnier of the two in the debate. Here is his explanation of why the stock market rallied on Monday:

"If you need any better explanation for why stocks were up so much today. Pick up a copy of the New York Times, go to the opinion pages, look at Paul Krugman's column - he's got this end-of-the-world column about how the subprime mess is going to drag the whole economy down. He even quotes Bill Gross saying the same thing. If there was ever a buy signal, we got it. You want to buy 'em with both hands here my friend."

Incentives Work-Even When It's Discomforting To Politicians

The Swedish government reduce the subsidies to the still voluntary unemployment insurance (although it plans to make it compulsory later)-both in the form of higher fees and lower benefits. The results? Not, unexpectedly for anyone who understands economics, an increasing numbers of Swedes have decided to stay out.

Interestingly though, the Swedish government is surprised as it budgeted for more than 1 billion kronor more in fee revenues than what they know appear to actually receive.

The fact that they didn't appear to expect that higher prices and less benefits from the unemployment insurance would lead to lower demand is just another reason why I'm now starting to think I shouldn't have credited Finance Minister Anders Borg with being a competent economist. Apparently, he and the other at his department seems increasingly incompetent.

Sure Thing Prediction

Next week, the earnings season for U.S. companies begin. I hereby officially put myself on record predicting that on average be "better than expected", just like they've always been "better than expected", regardless of whether the absolute change is very week, mediocre or very strong.

More On Zimbabwe

Via Jeffrey Tucker I see this story about hyperinflation in Zimbabwe and the pathetic, hypocritical and futile attempt by Mugabe to fight it by price controls rather than by ending the massive money printing. Needless to say, it led to shortages, despite direct coercive measures from Mugabe thugs:

"Bread and other essentials all but vanished from shops and supermarkets in Harare yesterday after President Mugabe ordered a 50 per cent cut in prices.

Price inspectors and police, sometimes armed, descended on supermarkets in the Zimbabwean capital to enforce price controls. Their intervention followed the order issued by Mr Mugabe last week in an attempt to get to grips with rampant inflation.

The result was chaos. Bags of sugar burst open in struggles between shoppers who had streamed into supermarkets. Computerised checkouts jammed, unable to cope with the rapid price changes. There was further confusion when officials forced their way into storerooms and declared stock items to be “illegal hoarding,” and ordered all goods to be moved on to supermarket floors.

At one store where the manager tried to restrict sales to two of each item, one worker was seriously injured in the mayhem. Annual inflation reached 4,500 per cent in May, the result of nearly three decades of economic policies devoid of prudence or forethought.

Economists estimate that the real figure is closer to 10,000 per cent. Prices are more than doubling every month as suppliers and retailers struggle to keep up with the decline of the currency, which at lunchtime yesterday traded at Z$260,000 to £1.

With hard currency earnings now almost negligible, the central bank buys foreign currency at black market prices from finance houses and prints mountains of increasingly worthless currency to pay them.

Mr Mugabe, however, asserts that inflation is the fault of “profiteering” by retailers in league with the British Government to oust him."

But apparently, life in Zimbabwe is not equally bad for all people. Mugabe cronies are able to take advantage of the situation in their own way, as desperate women will sell sex to them. A telling quote from one of them as one would-be customer says there is not enough of her bottom: "What do you expect on one meal a day?"

Misleading Leftist Attack On Ron Paul

Blogger "cactus" of Angry Bear attacks Ron Paul for supposedly being a hypocrite. He quotes a story from Houston Chronicle which says this:

"U.S. Rep. Ron Paul of Lake Jackson, the Libertarian-leaning contender for the Republican presidential nomination, long has waged war on the widespread federal spending he views as outside constitutional boundaries.

But the congressman, who often votes against spending bills, including funds for the Iraq war, leads the Houston-area delegation in the number of earmarks, or special funding requests, that he is seeking for his district. He is trying to nab public money for 65 projects, such as marketing wild shrimp and renovating the old movie theater in Edna that closed in 1977 — neither of which is envisioned in the Constitution as an essential government function."

That certainly appears bad and when I first read it, I thought "Et tu, Ron Paul?". But, if you read the rest of the story it really isn't as bad as it first appears:

"The way it works in Paul's office is that local groups and officials from his district make pitches to him for federal funding. The congressman passes along those recommendations to the Appropriations Committee as earmark requests. Paul said he tries to treat everyone equally and rejects few requests. He said it would be unfair "for me to close the door and say this is a bunch of junk."

But in the end, Paul said, he would likely vote against the spending bills even if they included earmarks he sought."

So, Paul does not vote for pork barrel spending for his own district since he always vote against the spending bills even if all of the earmarks are approved. But he does make sure that if there are to be any spending it should to some extent be in his district rather than in the rest of the country.

Arguably, Paul shouldn't open himself for these kinds of attacks by approving these requests. It would be more straightforward to refuse to deal with the composition of spending bills he oppose. But as he always vote against the bills, it is not a case of Paul abandoning his opposition to unconstitutional spending.

The Anti-Michael Moore

Via Robert Bidinotto I see this 24-minute documentary & website attacking Michael Moore and other advocates of Canadian socialized medicine. That should make it clear that despite the shortcomings of the U.S. system, the kind of reforms desired by Michael Moore wouldn't improve it.

Slovenia Gets Euro Boost?

6 months ago, Slovenia became the 13th country to officially adopt the euro as currency.

Now we can see that first quarter growth rose to 7.2%. That is the highest number since Slovenia gained independence from Yugoslavia, and the highest number of all EU countries except the flat tax havens of Slovakia and the Baltic countries.

Note also the increase in year over year growth from 5.5% in the fourth quarter to 7.2% in the first quarter. This implies that growth expressed in the American way (compared to the previous quarter in annualized terms) was likely 12% or more.

Was there a causal connection between Slovenia's adoption of the euro and the sharp acceleration in growth? Probably to a certain extent as monetary unification tends to increase trade. Moreover, the pick-up in inflation also indicates that lower interest rates and the following higher monetary expansion could have provided some boost.

One argument against this is that the increase in growth was much bigger than the one experienced by other countries adopting the euro. That does indeed mean that some other factor could have been involved, although it should be said that the expected theoretical boost to Slovenia is higher than for most other countries given Slovenia's small size ( With its mere 2 million people, only Luxembourg is smaller among current euro zone members) and its not particularly stable monetary history. So, the euro probably explains most of the increase.