In answer to my question about economic issues…. by guestblogger Robert Arvanitis

In an earlier post, I asked several questions about economic issues that confuse me.  Robert Arvanitis wrote a comprehensive reply, but then couldn’t get the Word Press comment system to accept it.  Because it is so comprehensive and informative, I’m putting it up here as an independent post.  All that I ask of the rest of you is that you don’t let its length and depth dissuade you from chiming in with your own two cents (or, with inflation, four cents) on the subject.  There’s a lot to be said here.

And now . . . Robert Arvanitis:

Why, if the economy is contracting and the labor market is flat-lined, has the stock market gone up?

Will the stock market stay up (long-term and short-term predictions, please)?

In normal times, the stock market is a reflection of true economic activity; stocks typically trade at multiples of earnings from 10 to 14 times. So the yield is the inverse of that — if you pay $10 for $1 yield, that’s a 10% return. Likewise if you invest $14 to get $1 then that’s like a 7% return. That’s the norm, 7-10% for “risky” equities in contrast to the “safe” bond yields of 3-4% or “really safe” bank accounts at 2-3%.

Alas, we are not in a yield-trading market. Rather, we are seeing the impact of inflation caused by printing of money at the Fed. Our GDP, the value of everything we produce, is like $16 trillion. But if we suddenly doubled our money supply, then the GDP would be, nominally, $32 trillion. Same loaves of bread and haircuts, but now “worth” twice as many dollars. Kinda like the story of the boy who sold his dog for a million dollars. Dad asks how he got so much money. Boy replies “No, I got two, $500,000 cats…”

Same with our stock market. Right now up to 14,000 on the Dow, but that’s not any more loaves of bread that the 10,000 Dow of just a few years ago.

Bad news — wealth effect makes people falsely confident, so they go spend and do other stupid things. Good news — at least it’s something of a hedge against inflation. You can still get the same number of (now more expensive) loaves of bread when you’re hungry.

The IRS says that families will be paying $20,000 for health insurance. It also says that the top penalty for failing to buy insurance is less than $3,000. Medical insurance companies can no longer turn away people with pre-existing conditions. This means that people can avoid the $20,000 fee, pay the small penalty, and buy “insurance” only at the time they need it. (Or, more accurately, buy “cost shifting” when they need it.) Can the insurance companies stay solvent under these circumstances?

If insurance companies cannot stay in business with this non-insurance fee structure imposed upon them from above, how will they change? Most are diversified. Will they simply abandon health insurance? They cannot refuse to pay onerous fees, because payments are forced upon them by law.

Will the death of insurance companies create a medical black market, where people pay cash for services? In a way, this wouldn’t be so bad, because it would do away with the moral hazard that comes from both huge insurance companies and government interference. With those huge systems, people have no incentive to shop around for better or more affordable treatment.

Take a step back. We must separate the various functions. First is health care provision. Doctors, nurses, drugs, hospitals, equipment… That is a service sector that will rise with demand and shrink with price-controls. Obamacare = less service, fewer doctors, worse outcomes.

Second is true insurance. You have a one in a hundred risk of losing 100,000 (car crash, home fire, serious illness). Being rationally risk averse you’ll gladly pay $1,000 (expected value of 1% times 100,000) as a premium. Heck, you’ll even pay like $1,500, just to be safe. That extra $500 pays for agents, and underwriters, and insurers’ capital, and all the rest.

Third is what we have today — redistribution masquerading as insurance. Young/healthy should pay a fair premium of like $4,000. Old/ill should properly pay $20,000. But Obamacare, to hide redistribution, says everyone will pay $12,000 each, the average of the high and the low. Insurers wouldn’t care how they get paid, EXCEPT the young/healthy aren’t stupid. They won’t pay $12,000 for insurance worth (to them!) a mere $4,000. Hence the unconstitutional (shut up Roberts!) mandate.

(Side note — this use of phony insurance to hide redistribution is just the latest iteration of the continuing fraud. It starts with “tax Peter to pay Paul.” Steps then include high rates with unfair deductions, borrowing to tax the unborn, inflation to rob lenders and the poor, unfunded mandates, and finally scams like Social Security and Obamacare. Details on request.)

Ok, that’s the real economics. Now the politics. Even with all the arm-twisting, and bribing, and parliamentary cheats, and brief supermajority, Obamacare could NOT pass with anything close to the necessary punitive taxes needed to get the young/healthy. That’s why the penalty is so foolishly low.

But to the left, that’s a feature, not a bug. It’s OK if insurers get squeezed out of health insurance. They’re just capitalist parasites anyway, and we’re one day closer to single-payer, that is, a government-monopoly on when you die.

Obama’s Consumer Financial Protection Bureau is forcing banks to give unsecured, low-interest home loans again. These loans, and the machinations into which the financial industry entered in order to protect itself from the downside risk of such loans, triggered the 2008 recession. What will happen this time around? Will banks go out of business? Will they come up with some grand new scheme? I assume that, if they do the latter, it will implode. The last time, it took around two decades before the Ponzi scheme collapsed. How long will it take this time?

We have a problem that banks got “too big to fail” because of government distortions of the credit markets. The Fed taught markets that serious losses get “socialized” (fall on taxpayers, not the true failures).

We also have a problem that government misallocated credit via the “Community Reinvestment Act.”

So what does government do? Makes an utterly irrelevant move into more controls. Plus an additional misdirection of credit.

We do not learn from our mistakes. We simply make new and more subtle errors.

It’s like this. A hippo gets into the bathtub. Water overflows everywhere. Hippos declares an emergency and nationalizes all the towels…v

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  • David Foster

    One thing to remember is that: people who manage large amounts of money (that is not their own) need to constantly worry about keeping their jobs.
    Let’s say James keeps 70% of his fund’s money in money market funds and short-duration bonds, with only 30% in equities….and Sandra, who is running a fund of the same category, puts 45% in equities and 45% in long-duration bonds (higher yields but also more exposed to price declines in event of increased inflation.) After a year, James has generated a return of 3% for his investors, but Sandra’s number comes in at 7%.
    James is now worried about getting fired. He knows that if he follows a Sandra strategy, he is increasing the risk to his investors due to either (a)a sharp decline in stock prices, or (b)a rapid increase in inflation. But investors are migrating away from his fund, his management is not happy, and he figures maybe things will work out if he follows a Sandra strategy and tries to react very quickly if/when things turn to the downside….


    Feds aren’t using “real” money. QE 4 starting pumping [read: pimping and printing $85 billion …pause, take a breath…per month beginning Dec. 2012 into government bonds.  A brief comment on insurance (Medicare supplemental). Premiums are rising and in the past two years, Ive seen a 40% increase. Enough of an increase that I changed from one plan to another to decrease payments.  The change in no way really protects me within a policy year, since insurance companies can “adjust” rates to any change in Medicare rules and regs. along with age. I spent sometime with an insurance agent recently and asked, “what percentage of clients are asking questions” – the answer came back: Out of 100, eighty-seven have their head in the sand. 
    Robert Arvanitis:
    Banks paying 2-3%? It’s fractional here on the east coast and less than 1/2% and the depositor must keep a minimum of $2,000. If the minimum deposit drops below said amount, one is charged monthly. Imagine, a penalty for keeping your money in a bank. The days of wine and roses and free toasters … kaput! Zimbabwe dollars here we come!
    Obama called for a “level playing field” and he’s going to bulldoze the entire economy to get it. Note: XL Pipeline is on hold for another six months (minimum). What the hell…unemployment is up, gas is up, food is up and Obama’s mantra is UP YOURS!

  • David Foster

    Re Book’s post of a couple weeks ago on robots…I increasingly see robotics being used as an excuse for Obama’s lame economy. I haven’t heard much in the way of coherent arguments, though, as to why today’s robotics technology would really be a breakpoint from the vast productivity improvements which have already been going on over the last 2+ centuries.
    An article on robotics and the economy which is better than most, HERE….although there are still some problems with the analysis, some of which I point out in comments there.

  • nathan

    Please allow me to register a slight exception to your stock market theory.  Yes, today’s stock values, like all asset prices, are not worth as much because of inflation.  And if the Dow Jones Industrial Average was expressed in dollars, the number of ounces of gold needed to buy the Dow has fallen over the past three years.
    At current market prices it is difficult to find new stocks to buy.  But, if you look at a stock as a bond-like investment with a growing coupon, and keep track of the yield you are now getting on your original cost, the results can be dramatic.  
    I keep a spreadsheet with detailed records of what I paid for a stock, estimates of what the underlying company will earn in the coming 12 months – or, in some cases, its free cash flow or expected increase in intrinsic value when those figures give a truer economic picture – to arrive at my yield on original cost (YOC).  My average YOC is 17 percent, ranging from 7.5 to 35 percent.
    If the managements of these companies do a reasonable job of reinvesting cash back into their business, I will eventually benefit, even if inflation gets worse.  If a company repurchases shares, that also works for me.  Dividends are the worst outcome because I must pay tax (outside of a retirement account) before reinvesting them.
    Even now you can find a handful of quality companies, that may be held for the long-term, with a starting YOC of slightly over 10 percent.  But these stocks are disappearing fast as investors figure out that “look-through earnings” – what Warren Buffett calls a shareholder’s proportionate share of the underlying company’s profits – is one of the last areas that can escape taxes, at least until a stock is sold.
    It is important to maintain discipline when you buy, and to be vigilant for a time when stock prices reach ridiculously overvalued levels.

  • Danny Lemieux

    Two other factors to consider – yes, inflation increases prices and devalues the currency. However, many companies are global. Their international sales are in currencies that don’t devalue against the dollar and may, in fact, appreciate against the dollar. This would be reflected in their stock prices. Walmart, for example, is engaged in a major push into China. A Chinese friend recently told me that every major Chinese city now has a Walmart and that they are very popular.
    Second, there is always money to be made in any market. There are companies doing well in the U.S., Europe and Japan, even though our respective economies are in the tank.
    Third, markets are NOT efficient: a significant part of a stock’s price reflects consumer and institutional biases, which can be founded on very ephemeral assumptions. Thus, every time our government announced a new “stimulus”, there tends to be an irrational exuberance about the economy’s future.


    Picking up where Danny began…”Their international sales are in currencies that don’t devalue against the dollar and may, in fact, appreciate against the dollar. This would be reflected in their stock prices.”

    Early in the 4th century, Emperor Diocletian issued an infamous decree to control spiraling wages and prices in the rapidly deteriorating Roman Empire.As part of his edict, Diocletian commanded that any merchant or customer caught violating the new price structures would be put to death.

    S&P finally downgraded the US one notch in August 2011, the SEC and Justice Department announced that S&P was under investigation, just two weeks later.
    Egan-Jones, a smaller rating agency, has been even more aggressive, downgrading the US credit rating three times in 18 months. And while the federal government may not have imposed Diocletian’s death penalty, they are just as willing to squash dissent.
    Egan-Jones is banned for the next 18 months from rating US government debt.
    My question for brighter heads than mine: What currency, if any is real. Europe is on an austerity-lite diet, Japan’s population is contracting and every few months there’s the “swindle of century” in a headline from money managers from here to there. Wallstreet and Washington make the Gambino family look like small potatoes. Anyone asking why Germany, Switzerland … want to take physical possession of gold stored in the U.S. by 2020.

  • JKB

    Not really an answer but an observation that I’ve been pondering.  
    During the Great Depression, after the initial wipeout, productivity in companies went up even as the weren’t hiring. A lot of innovations that were incorporated to make the remaining employees more productive.  It really is the only way a company could survive.  
    I believe we are in a similar situation today.  Unemployment is high but companies are making higher profits on higher productivity.  Some claim this comes from working the remaining employees harder but that isn’t accurate.  The remaining employees are using technology front-loaded by innovation before the collapse.  As well as, unskilled labor is getting replaced by automation.  
    Now here is something that worries me.  We had a world war that used up and forced improvement in the stagnant labor.  Plus, we had the post-war period where few countries could supply the needs to rebuild or to race against the Cold War.  So, what cataclysm awaits us?  What crisis will push past the increase in productivity to need more production using more labor?  Of course, now the threshold for taking on new human labor is much higher with the government mandates as well as government taking a larger bite out of the pie: labor (wages/benefits/obamacare), capital (ROI), government (direct taxes, employer portion of payroll taxes, worker insurance, etc.), that productivity is divided among.

  • JKB

    A burger flipping robot that turns out 340 gourmet burgers and hour without human involvement.  In fact, it doesn’t slice the tomato until it is ready to put on the burger
    And check out this pizza kiosk.  3 minutes, no human involvement.  I assume a human must load the vacuum packed bags of ingredients every once in a while.


    Momma Mia – I want one for my kitchen!

  • Ymarsakar

    I suspect that while some will suffer, many of the companies with rising stocks are technology based, such as Green energy, internet semi monopolies backed by Democrat politicians, and so forth.
    This economy is not an equal well of depression and recession. Some people are making a lot more money than they would ever have under a Republican admin.