Galen's Log

Hedging against inflation

A timely post from Coyote Blog, as this is a question I've been mulling over for the past couple of weeks.  I'm not really a gold bug, and stocks are still to volatile for my taste.  I've given some thought to purchase some non developed land for future use or sale. 

The myth of economy of scale in outpatient medicine

Bigger is not always better.  Many large medical groups have failed following expansion for reasons that may not obviously be apparent.  After all,larger organizations should benefit in many important areas such as more efficient marketing, lower borrowing cost, and lower purchasing costs for bulk medical supplies.  Consolidated medical groups may also hold varying degrees of a monopoly in certain services, allowing them to charge above market rates (to a small extent) for certain services.

Not all large medical organizations are doomed to fail, but groups that undergo expansion may lose sight of the fact that financial viability is dependent on physician productivity, which under our current system has a definite ceiling.  MOM commenter Allan remarks:

...Everyone else (except the drug companies -- hmm) has the same capacity limit as your barber. While your doctor is paid about an order of magnitude more than your barber, he can only service one client at a time and there are only so many hours in a day. So don't look for doctors to be cruising the halls of Congress lobbying to protect their rent seeking value transfer...

This means that I can only see so many patients during office hours.  Given our very rigid fee for service system, there is a maximal amount of income that I can bring in, regardless of my efforts.  Quality improvement is largely wasted in generating extra revenue, as I can only charge the same as my mediocre competitors.  More so the opposite, given that extra quality will likely translate into extra time, reducing my revenue further.

Really, this is a prescription for substandard medical care, though that is a topic for another post.

Relating to expansion, as the numbers of physicians in a group goes up, the ratio of employee to physicians will increase at a greater rate.  The number of patients seen remains the same, given that many fields (especially primary care) have an under supply of physicians and there are enough patients for them to remain full even without the added value of one stop multispecialty care.  Your least expensive employee will cost a minimum of 40k per year in salary and benefits.  Larger groups will need administrators, mid-level managers, vice president, etc. who are typically reimbursed in much greater figures.  Soon the administrative burden becomes enough to offset the competitive advantages above.  Physicians seeking jobs will often notice that the largest organizations are rarely the best paying ones.

Outpatient groups will often rely on ancillary services (phlebotomy/lab work, radiology) with a captive audience so to speak, but staffing and cost of support may turn that into a double edged sword.  Especially when Medicare changes it's mind on short notice on how those services should be reimbursed.

 

The 500 billion dollar black box

I finally had a chance to sit down and look at the 2010 fiscal year budget summary for the Department of Health and Human Services, being somewhat curious about how they planned on spending 630 billion dollars.  After a considerable amount of swearing, I calmed down enough to write a post about it.

The short answer is I have no &#@** idea on what exactly they plan to with most of it.  Maybe the soon to be rapidly growing number of HHS employees don't know either.  If you add up the figures given, it comes out to about 65 billion, two thirds being a Medicaid supplement which will be handed out to the states. Here's how some of the other expenditures break down:

    Indian Health Service                                4 billion

    NIH cancer research                                  6 billion

    FDA                                                          1 billion

    Head Start/child programs                         4.2 billion

    HILEAP (energy subsidy for low income)      3.2 billion

    Under served area health/recruiting            400 million

    Autism support                                          211 million

Other areas mentioned but no dollar amount specified:  health IT development, HIV/AIDS prevention and treatment, teen pregnancy prevention. 

The budget makes a number of nebulous statements about Medicare, such as "strengthening program integrity and expanding the research agenda" as well as "encouraging high quality and efficient care, and reducing excessive Medicare payments".  Sounds great.  How will that be done exactly, and for how much money?

We can account for 10% of the total budgeted.  This is being sold as a reserve fund for over 10 years.  Forgive me, but I think that a year with a 1.8 trillion dollar deficit is hardly the best time to be setting up a reserve fund.  Why pay interest on money you don't plan on using right away?  You can't even make a stimulus argument as most of the spending isn't front loaded.  What's the rest of the money to be used for?

Let's consider this section for a minute

Makes a down Payment on health Care

Reform.

The Budget establishes a reserve fund

of more than $630 billion over 10 years to finance

fundamental reform of our health care system

that will bring down costs and expand coverage.

The reserve is funded half by new revenue and

half by savings proposals that promote efficiency

and accountability, align incentives toward

quality, and encourage shared responsibility. In

addition, the Budget calls for an effort beyond

this down payment, to put the Nation on a path

to health insurance coverage for all Americans.

Ah, a possible answer to our question.  It eludes to the creation of a Universal Health plan, securing partial funding for it, and spells out the need for additional, unspecified funds at some point in the future.  Fortunately, with a wave of the bureaucratic magic wand, half of the initially needed resources will materialize from "savings proposals that promote efficiency and accountability, align incentives towards quality, and encourage shared responsibility."  I'm not sure what the hell that means (I can guess), but it's going to get us 315 billion.

Tell you what.  You put in to place these wondrous programs that will conjure 300 billion without placing a crippling regulatory burden costing billions in forced compliance on the rest of the health care system and you can spend it anyway you want without a peep of complaint from me.  Until then, I'm going to assume your budgeted items will be paid for almost entirely from tax dollars or deficit spending. 

More disturbing is the lack of details concerning the remaining 500 billion dollar plan.  Can I sell you my car hiding under the canopy?  15 thousand will starting paying for it, but I won't tell you what kind of car it is, or what the final price will be.  It's an awesome car, though, trust me...

Does anyone else find this troubling?  If we want a program of Universal coverage, then let's come up with a specific program and debate it on its merits.  Giving the government an open tab for 500 billion with no specific instructions or benchmarks to start an improvement in our health care system isn't quite the best way to go about it.

Putting my personal libertarian bias aside for a second, it's still clear we simply don't have the money to do this.  Looking 10 years in the future, we don't even have the money to honor our current commitments to Medicare and Medicaid.  It's building a lovely garden and patio while your house is in flames.  Since the start of this financial crisis, our government has been throwing money around with no regard to fiscal sanity.  500 billion real is quite a bit of money, or seemed to be many eons ago.  I hope we haven't become so deconditioned that we let this pass without discussion.

A dark and stormy night...

Scene One:

An unseasonable midnight thunderstorm rages over Washington DC.  The unmarked motorcade pulls into an abandoned warehouse.  Secret Service agents scan the perimeter, but the area is deserted.  Two familiar figures emerge for a black Lincoln Towncar.

President Obama:  Look, I still don't see the need for all this secrecy.  You're doing critical work here!

Ben Bernanke:  It's too soon.  We're continuing to build on the Bush administrations work.  Experiment One Nine Two Nine will give us great insights into the workings of the Great Depression, but it is a fearsome beast, and would be misunderstood by the public.  Only when the experiment is completed and the subject put down can we release our findings...

Ben presses a loose stone on a bare cinder block wall.  A hidden staircase reveals itself, and the pair descend into the Federal Reserve Laboratory.  After passing though a series of checkpoints, including voice and retinal scans, they enter the Central Control Station.

Assistant:  Good evening sir.  Would you care to look at the latest data?

Obama stops to stare at the large containment field.  Within the shimmering blue walls prowls a chimeric creature, constantly changing color and form.  Snarls and cries of pain echo through the lab as the monster tests the boundary field.

Obama:  Er...isn't a little bigger than last time?

Bernanke:  (looking up from his clipboard)  Hmm?  Oh, I suppose it is.  (looking back down again)  Fascinating!  Robbins, how's our little fellow doing?

Assistant:  Ravenous sir! He ate through our entire supply of subprimes, and is starting in on the Alt-A's.

Obama:  Are you sure this thing can hold it?

Assistant:  Don't worry Mr. President.  That Hank Paulson fellow was just here to check on the containment field and placed the TARP upgrade before he left on vacation.  Said there should be no risk at all.

Bernanke:  It's a pity we'll have to dispose of this beautiful creature  before...

Suddenly a bolt of lightning strikes the warehouse above.  Lights dim, then darkness ensues.  Electricity arcs from overloaded instrument and displays, filling the lab with acrid smoke. 

Researchers stumble to their feet, coughing.  Dim emergency lighting filters through the smoke.

Bernanke:  Robbins, report!

Robbins: (Peering at one of the few remaining functional terminals)  Ummm...bad news sir.  The main generator is off line, and the backup is producing...MY GOD....THE CONTAINMENT FIELD...

Bernanke stares with horror at the field.  Its steady, pulsating blue light is now weak and flickering.

Robbins:  Sir?...  SIR! .... ORDERS?

Bernanke stands dumbfounded as Experiment One Nine Two Nine tears at the diminishing walls of its prison.  Beads of cold sweat stand out on his rapidly paling complexion.  His mouth moves, but no words come out.

He comes to a bit after a hearty slap in the face from Robbins.

Bernanke:  Get those interest rates down!  We need the field back up.

Robbins:  Dialing down sir.

The field strengthens a bit, then starts flickering again.

Bernanke:  Money supply!  More money!!

The field continues to weaken.

Robbins:  I've doubled the supply sir.  It's not holding.

Sensing its freedom is at hand, One Nine Two Nine wheels to the back of its cage, then lunges forward at full gallop.  Unable to bear its overwhelming force, the field fails completely.  Free from his prison at last One Nine Two Nine tears through hapless lab workers, seeking an exit.

Robbins and Bernanke:  NOOOOOOO!!!!!!!!

Screams echo through the corridors as the beast smashes through a makeshift barricade, then makes it into the stairwell.  Sirens blare, and blast doors close, but it is too late.  The beast is loose.

Obama:  (consoling a sobbing Bernanke) Don't worry.  It won't get far.

Bernanke:  (gibbering)  no no no...you don't understand...

Obama:  (picking up his cellphone)  Get Geithner on the horn right now...

At the sound of Geithners name, Bernanke starts wailing, then curls himself into a fetal position.

Through the morning haze, observers make out a line of bloody, clawed footprints.  Footprints headed north, to New York....

Random thoughts

I'm recovering after a week of night shifts, though still a bit nocturnal.  A few bits of news caught my eye.

First, Wednesday's treasury auction was fairly weak, with a 50% reduction in foreign demand.  The Fed bought treasuries and yields went up, which I'm pretty sure was not their intention.  Even further, the Bank of England actually had a failed auction.  All in all, not a good sign in funding deficit spending.

When able, the evil entrepreneur will exploit the needy.  Fortunately, the ever watchful superhero G-Man is ready to smack his ass back down before he may do any damage.  Thank goodness!  He might have handed out some antibiotics or something, undera reprehensible fixed rate plan.  Now back to the news, where we can continue with our report about the lack of health care in the uninsured.

How much debt can we write off if we give Timothy Geithner to China?  Note to Timmy...that may happen anyway given your current efforts, but let's not speed it along, OK?

Maxed Out Mama reports that noted Great Depression researcher Ben Bernanke's efforts to recreate the 1930's in his Washington DC lab are proving wildly successful.

 

The many legs of Aimee Mullins

A wonderful video of Aimee Mullins that redefines what can be called a disability.

Crisis management

The health care system needs to start thinking about contingency plans for a sudden loss of Medicare and Medicaid dollars. 

We've discussed that recent moves by the Fed as well as a tightening trade balance will likely continue to dry up foreign sources of deficit financing.  Without adequate domestic purchases, we're looking at further monitization of debt and/or significant spending cuts.  Either would have similar outcomes, be it federal payments not keeping up with inflation, or simply diminished payment.

If we look at Medicare's past efforts at cost containment, the first intervention to watch for would be an increase in punitive programs under the guise of quality improvement.  These will be difficult to counter, as arguing the opposing argument would be a PR nightmare.  Who's against improved quality?  This would be a double punch for hospitals, both in complying with an increased regulatory burden, as well as that the programs will be designed for hospitals to fail.  These are cost cutting measures.  Truly it would be a win-win for Medicare.  If hospitals comply, the government can take credit for quality improvement.  If not, Medicare can wave a scolding finger and keep their money. 

Here's another fun graph from the Kaiser Family Foundation:

As we can see, Medicare and Medicaid payments fail to cover the cost of services and are effectively being subsidized by 3rd party payers.  From Paul Levy:

On the cost front, the president for now seems to be confusing underlying costs with how much the government chooses to pay. His budget proposal apparently would reduce Medicare payments to doctors and hospitals as a way of building a savings account for greater access. Reductions in appropriations might reduce costs to the federal government, but they do not reduce the underlying costs of care. With 50% of American hospitals operating at a deficit right now, it is hard to imagine how a reduction in federal payments for Medicare patients deals with the cost problem. Costs remaining uncompensated by the federal government would simply be spread to other patients.

Who's going to be left to spread the cost to?  Given the rising unemployment, loss of health care coverage, and increasing charity care, a loss of federal funding couldn't come at a worse time. 

One foreseeable consequence would be further splitting of the hospital system.  Institutions that do not accept payment from HHS or CMS are not bound by EMTLA, and not obligated to provide care to patients that can't pay.  Could large third party payers follow a Kaiser model and set up their own hospitals, particularly if fees are raised to cover federal shortfalls?

A quick glance back at the KFF chart, shows that this would be a knock out blow for our current system, suggesting a two tiered outcome as the government would be forced to step in and take over a number of hospitals to prevent a public health disaster.  Somewhat ironic that the government could end up spending dramatically more money trying to cut costs, no?  Is this where we want to go?

Hyperinflation part II

RG gives a very thoughtful response, worthy of a post of its own instead of hiding in the comments section.

Yes, we have been dependent on foreigners to fund our debt, unlike Japan. But also, unlike Japan, foreigners have a need to purchase US dollars: to obtain the necessary currency to purchase oil. That creates a built-in demand for dollars. As the price of oil denominated in US dollars increases, so too does the demand for dollars used to purchase that oil.

There is only one major currency that is not generally weakening as the US Dollar weakens: the Euro. As the Euro further strengthens, it will put tremendous pressures on their export sectors, which will cause increased unemployment, expanding social services costs and ultimately causing higher deficits tending to counterbalance the strengthening Euro. The BOE has begun quantative easing and it’s likely the BOJ will do so again if necessary as it’s experiment 2001-2006 was generally seen as sucessful. So if England, Japan and the US are (or soon will be) printing money and Europe’s exports are crashing, what currency will be regarded as a safe haven? This is one of the negative externalities of globalism.

There is an assumption that should deflation turn to inflation, the Fed would not halt quantitative easing soon enough because, in the past, there has been considerable lag between loose money and its inflationary effects. With quicker access to reliable data sets and smaller inventories associated with JIT delivery systems, why is this expected to be so now?

The basket-case Argentina, in its worst year 2002, never even came close to hyperinflation. It peaked out at somewhere between 30-40% per year, but most of that came in April 2002. Zimbabwe is a catastrophe not because of printing money, but because Mugabe chased away most of the competent and productive people.

My point is that hyperinflation is actually pretty rare and is more often associated with highly corrupt and or incompetent governments than just printing money. All fiat currencies involve creating money out of nothing and paradoxically this has lead to more price stability than was seen during periods of gold-backed currency use. Now the latter period was certainly more inflationary in agregate; but it was also more stable, without the wide inflationary and deflationary spikes seen here in the 19th century.

While I would actually prefer an inflationary regime, my strong hunch is that the Fed will keep a close eye on the charts and halt QE before serious inflation is reignited. How all this fits in with the unemployment rate, price of oil, federal budget deficit, domestic political climate, etc. when that day comes is anyone’s guess. There are too many interlinked variables to assert with any certainty that a significantly expanded monetary base will cause hyperflation.

Comments:

RG is quite correct in that hyperinflation has a strict definition , and should be seen as a separate entity from its informal use (what we would consider debilitating inflation).  Considering the formal definition of cumulative inflation rate over three years approaching 100% or greater than 50% per month, than I would agree that unless the Fed is completely incompetent, we're unlikely to see anything close to those sorts of numbers.  On the other hand, quite a bit of damage can be with low double digit inflation, especially for the newly wiped-out boomers and those on a fixed income.  Concerning Argentina, they were able to avoid hyperinflation, but paid quite a high price in doing so.

The Fed certainly has tools to mop up excess from the money supply, but I think it would be hard pressed to act appropriately if there is a massive sell off of foreign holdings.  Black Swan (commenter at Mish's site) lays out the possible scenario:

We hear from the St. Louis Fed that all this money that's being created out of thin air (trillions of dollars) has not found its way into the economy, and thus, there is no inflation. The Fed claims that when the economy heats up again, and this credit finds its way back into the system, that the excess dollars will get mopped up with the expirations of short term notes and other magical methods known only to the brilliant bankers and economic professors who run the Fed. This is how the Fed intends to stop inflation dead in its tracks. We hear from Denninger that we will have an economic collapse and continued deflation. In other words, the conventional wisdom is that there will be no inflation until the economy is growing again, and that the Fed can stop it if or when that inflation emerges. The conventional wisdom, however, may not be all that wise.  
 
While the Fed and many others are saying that US inflation will only take place through the front door of a recovering economy, there are many more foreign dollar debt holders out there who could bring about US inflation through the back door of panic selling their USD debt, and then using the proceeds of those debt sales to buy up the world's commodities as well as some bargain basement priced US real estate. Foreign entities will dump the dollar before its value evaporates, and that will increase the money supply within the US economy. There would be nothing the Fed could do about it. I'm not sure this wasn't the Fed's plan from the beginning. After all, who really runs the Fed?

It is ironic that just after Chinese Premier Wen warned the US not to devalue China's two trillion in USD investments, the Fed announced that it will buy its own country's long bonds. That announcement resulted in an instant USD devaluation against other currencies and PMs. There are many sovereign wealth funds and foreign investors sitting on trillions of dollars who can't be very happy with having to watch their USD debt investments devalued by the Fed and the Treasury. Exchanging those dollars for commodities and US assets will drive up the prices of both. Import prices will also rise. Even with Americans losing jobs and being paid less for the jobs they still have, the cost of living in the US would still rise for them. The PM buyers on this site have already figured this out. They are preparing for the US dollar's homecoming.  

Note PM=precious metals

Fortunately, a massive, coordinated sell off is unlikely unless the Fed does something truly stupid.  Otherwise the risk of devaluing their assets should be enough to enough to convince foreign entities to hold tight.  And, as RG points out, world wide recession/depression provides broad incentives for devaluation of currency across the board, particularly in exporting nations.  In a race to the bottom, rrelative strength of currency is probably a more important driver than absolute value.

Given our current and prospective debt levels, the government has a strong incentive to promote inflationary policies.  The trick is if they'll be able to do so without upsetting the apple cart.

 

The road to hyperinflation?

RG, commenting on this Maxed Out Mama post, asks a fair question:

The big question which none of the doomsayers will answer is this: If Japan's central bank employed quantitative easing from 2001-2006 with no Weimar-style inflation, why must quantitative easing cause run-away inflation in the U.S.?

I don't think anyone thinks there will be immediate hyperinflation.  Indeed, most markers are pointing in the opposite direction, which was one of Bernake's rationals for quantitative easing.  Before we get too complacent, let's take a look at the following graph:

 

We haven't seen a major response to this surge in the money supply yet because A)the banks are sitting on most of it and B)it's been accompanied by a massive destruction of credit.  It does, however, set the stage for inflation down the road.

Getting back to RG's question, why would quantitative easing be worse for the US?  About 64% of foreign exchange reserves are held in US dollars.  70% of China's 2 trillion reserve are in USD denominated assets.  Once the government starts making moves to undermine strength of the dollar (like Q.E.) the logical choice would be to dump USD holdings while they still have some value.  Sure, they'd be shooting themselves in the foot in the process, but if the US wants to keep revving up the printing presses, all bets are off.

This ties in to the issue of large deficit spending.  Japan was able to have a buyer for their deficit (I believe most of it is public held, not externally held like the US).  We've been dependent on foreign sources to fund our debt.  Q.E. makes our debt less attractive to foreign buyers, meaning if domestic purchases don't step up, the government will either have to cut spending (which they've shown neither the desire or ability to do so) or print more money to cover the shortfall.

In our case, Q.E. begets more Q.E., increasing the risk of hyperinflation. 

Comments, anyone?

Update: I'm not the only one with concerns.

Weekend links

I'm working nights this week, but I thought I'd post some insights into the current financial crisis:

Rolling Stone (of all places) for the story of AIG's Joseph Cassano, a name that will live in infamy.

A Crisis of Credit.  A great, though simplified, 11 minute video for those who haven't seen it yet.  My only complaint is it vastly understates the role of the Fed and GSE's (Fannie and Freddie) in suppling large amounts of cheap money to banks and buying up toxic assets.

For a better look at the Fed's role, look at Meltdown by Thomas Woods Jr, though non-Austrians may find the von Mises cheerleading a bit distracting.

And please don't follow this link.  Really, don't.  Aaaugghh!  My eyes!