In certain extreme demographic strata, for instance, the rate of obesity and diabetes is so high that health coverage amounts to providing arsonists with fire insurance. Likewise, it has long been demonstrated that the incidence of a variety of surgical procedures per 100,000 population is a function of the number of surgeons in the catchment area. In truth, employer-provided health insurance is one of the great deformations of our times, and is no more an honest form of free market insurance than Social Security pensions. Instead, it is a form of tax-subsidized cost pooling in which overutilization, overpricing, and free-riding is endemic.
Were the problem of employer health insurance contained within the mainly middle-class population (about 170 million) covered by such plans there would be serious economic efficiency and equity costs, but these would not be the worst blemishes on the free market: workers would transfer some of their income to doctors and hospitals unnecessarily and health-care resources in general would be drastically overconsumed. But the insuperable problem is the massive spillover on innocent citizens: rampant health-care inflation means that much of the non-employer-plan population is eventually priced out of the health-care system, including the poor, the retired, the self-employed, and those with preexisting conditions.
Once again, therefore, one market disturbance by the state begat another. Already by the mid-1960s the poor and elderly were being squeezed, and so Lyndon Johnson succeeded in dramatically updating the New Deal via Medicare and Medicaid. The obvious and well-intended purpose was to effectively supplement the incomes of non-working populations being priced out of the health-care market, but what LBJ inadvertently delivered was the greatest victory for crony capitalism ever imagined.
The giant misfire is that the Johnson plans did not deliver cash to people in need; it delivered the bodies of the poor and elderly to health-care providers and equipped them with pre-paid medical cards requiring minimal out-of-pocket cost sharing. It was the worst of all possible worlds, especially with respect to the larger Medicare program because it put the entire retired population into a cost-averaged pool and laid the expense off on the payroll tax and general revenues (for Part B). Needless to say, use of health-care services thereby became utterly divorced from financing their costs, and in the process two great deformations of the state quickly emerged.
Since there was no means test on Medicare, the entire retired population became a potent political force against any patient cost-sharing measures that might have helped contain the explosion of costs owing to the third-party (i.e., taxpayer) payment system. Thus, Part B premiums for physician’s services were initially set at 50 percent of costs and long ago eroded to under 25 percent, raising Medicare outlays by $100 billion annually at current cost levels. Likewise, every serious attempt to raise deductibles or co-pays in Medicare has been buried by the AARP (American Association of Retired Persons) and the other retirement lobbies.
More importantly, Medicare and Medicaid were built on a misbegotten combination of socialism for the beneficiaries and capitalism for the providers. While both programs attempt to regulate providers through utilization controls and reimbursement caps, this cumbersome and bulky bureaucratic machinery fights on an inherently uneven battlefield; that is, the K Street– and PAC-dominated milieu of Washington where virtually every medical specialty, supplier, and type of institutional medical care facility has organized representation.
The proof that Medicare and Medicaid function in the realm of crony capitalism, not market capitalism, is in the pudding. By the time these programs were up and running in 1970, combined Medicare-Medicaid costs (including the state matching share of Medicaid) were $15 billion, or 1 percent of GDP. Thirty years later, the cost had escalated to $375 billion and 5 percent of GDP. Today the combined cost exceeds $1 trillion and will reach $2.4 trillion, or 10.5 percent, of GDP by 2022.
It goes without saying that the medical needs of the elderly and the poor did not escalate by a factor of 9 percent of GDP over the last fifty years. What happened was that the state created massive insurance pools for an uninsurable service, and then invited the medical profession to morph into Washington’s greatest crony capitalist lobby. The American Medical Association, for instance, fell on its sword in opposition to Medicare in 1965, but in 2010 it sold its soul in support of Obamacare in exchange for a more doc-friendly control régime, the very thing which will cause the cost of Obamacare to explode in the years ahead.
In fact, Obamacare is the endgame of the seventy years ago carve out (from income taxation) for employer health plans. The combination of giant employer-based health cost pools and the even larger ones run by Medicare and Medicaid have not only driven health inflation skyward, but have also generated a noxious system of price discrimination that would be wholly unnatural on the free market. The so-called big buyers, consisting of large plans and managed-care operations, have extracted ever larger “discounts” (25 to 75 percent) from “rack rates” (i.e., sticker prices) for their plan participants, thereby forcing rack rates higher and higher for everyone else including small employer plans and individual insurance buyers.
Accordingly, the Obama health exchanges came about essentially because another component of the population was flushed out of the system. The self-employed and workers in part-time jobs and small businesses became the third wave of citizens needing state intervention to compensate for the original employer-paid insurance distortion. Their claims arose for the same reason as Medicare and Medicaid; namely, part-time and self-employed America was priced out of the crony capitalist health-care system in the same manner as the elderly and the poor. Yet with eligibility for state-run health exchanges under Obamacare reaching up to $90,000 per family, the cost explosion from still more health-cost averaging of pre-paid plans subsidized by the public purse is virtually unimaginable.
What is clear already, however, is that the crony-capitalist-driven health-care system is devouring the American economy, and the figures which prove it could not be more dispositive. In 1960, national health expenditures amounted to $150 per capita and hardly 5 percent of GDP. By 2000 the figures had grown to $5,000 per capita and 13.8 percent of GDP. Today it is nearly $9,000 per capita and more than 18 percent of GDP.
To be sure, these trends are widely known to the policy wonks, and widely lamented, too. But the backstory is far less noted and is the reason that the Keynesian state in America is headed for inexorable insolvency: namely, as the free market economy continues to fail owing to the burdens of debt, money printing, and fiscal profligacy, more and more of the population will be flushed into the state-funded pools of Medicare, Medicaid, and the Obamacare health exchanges.
As the fiscal crunch intensifies, the crony capitalist gangs which fed on these pools will resist controls and cost containment with a vast mobilization of lobbying power and campaign lucre. It is the ensuing hand-to-hand combat in the corridors of Washington which will further paralyze the fiscal process; and it is the asymmetrical nature of the contest which will ultimately break the state.
SUNDOWN AND THE ENDGAME OF CENTRAL BANKING
Under a régime of sound money the prospect of fiscal deficits of $20 trillion would be unthinkable, nor would the free market be barnacled with crony capitalist coalitions which fatten on the public purse and regulatory powers of the state. Indeed, the potent purgative of free market interest rates would have kept the old prudential fiscal culture alive and provided politicians with the shield they need to impose limits, make trade-offs, and balance the fiscal accounts.
In fact, what elected officials desperately needed over the last several decades were intervals of double-digit interest rate flare-ups, even rates which reached 20 percent. High interest rate episodes are the market signal to politicians that vivify the true cost of deficit finance and thereby give them the reason to say no to tax cuts and spending increases financed with red ink.
Herein lies the real evil of the Greenspan-Bernanke régime of financial repression and wealth effects levitation: it de
stroyed free market interest rates in the name of monetary central planning and thereby unshackled democratic politicians from the ancient fiscal disciplines. But monetary central planning couldn’t work in the long run, while the low administered price of debt turned the nation’s budget into a fiscal doomsday machine.
As has been seen, the gold dollar was the true embodiment of sound finance and it was steadily strangled between 1914 and 1971. But even then there was a second-best alternative embodied in the worldview of the Federal Reserve Act framers of 1913. It was something called “mobilization of the discount rate” and was an embodiment of the injunctions of the great English banking theorist Walter Bagehot. While he is usually quoted with respect to his advice that central banks should print money freely in a financial crisis, the qualifying clauses were the more important; namely, that the central bank should lend only against good collateral at a penalty rate of interest.
In a narrow sense, Morgan Stanley could have never brought its $100 billion of junk collateral to the Fed window in late September 2008 under the Bagehot rules. But in the larger sense, had the post-Volcker Fed adopted a mobilized discount rate policy rather than financial repression, the Morgan Stanley garbage heap could never have been created or accumulated: it was an artificial product of low interest rates and the Fed-enabled carry trade. And it was only one case, a symptom, of the financial and fiscal deformations that had spread across the entire system by the time of the BlackBerry Panic. The growing piles of federal debt and the rising heaps of Wall Street–created junk securities arose from the same profoundly misbegotten central bank policy.
Under a mobilized discount rate policy, the deformations of both Wall Street and fiscal policy would not exist. There would have been no monetary central planners to enable them and no monetary politburo to provide puts and other assurances that the nightmare of high interest rates would not be visited upon the leveraged speculators on Wall Street and the fiscal libertines on both ends of Pennsylvania Avenue.
Indeed, under a mobilized discount rate régime there would be no need for an open market committee (FOMC) at the Fed at all. Eligible banks with good collateral would come to the Fed window as a last resort, but would always prefer to obtain overnight funding needs in the interbank market to avoid paying the Bagehot penalty; that is, 200 or 300 basis points above the market. Consequently, in times of credit stress the interbank market rates for short-term funding would flare up sharply, and the Fed’s discount rate would soar higher. Continuously resetting higher and higher, it would provide a profound warning to speculators that there will be no mercy on the days of financial reckoning: Greed and recklessness would be laid low.
Accordingly, the job of the Fed would be to do what J. P. Morgan’s young men did night after night in the great financier’s library during the panic of 1907. They did not pontificate on their intentions for the GDP and the Russell 2000 in the manner of Greenspan and Bernanke but, instead, put on their green eyeshades and examined the nitty-gritty of the balance sheets of supplicants for emergency loans who came to the Morgan Library at Madison Avenue and Thirty-sixth Street. As seen, solvent institutions got liquidity injections; insolvent ones met their maker.
Ironically, Pierpont Morgan’s top green eyeshade was Benjamin Strong, who went on to become the first great US central banker as president of the New York Fed in the 1920s. Had Strong stuck to his 1907 role as collateral examiner, the Fed-enabled financial bubbles of the later 1920s would not have happened, nor would there have been the Great Crash of 1929 and its aftermath. Likewise, had Alan Greenspan rejected the perfidious implications of the Humphrey-Hawkins Act and simply declared that sound money under a mobilized discount rate was the surest route to low inflation and full employment, the financial calamities of the present era could have been avoided.
Needless to say, today’s wanna-be masters of the universe who populate the monetary politburo would have been cut down to size; their job would have been that of penurious, flinty-eyed bank examiners, who would scour the collateral of supplicants for Fed discount window loans one application at a time. They would have no dog in the stock market hunt. Nor would they care about the latest swiggle in the GDP reports or tick in the unemployment rate. Most assuredly, these humble bank examiners would never pretend to manage the rise of national wealth or the rate at which the people on the free market create new output, savings, investment, and consumption.
Under a mobilized discount rate the cardinal rule of sound finance would have been respected; to wit, no man can borrow unless another man first saves. Accordingly, the free market interest rate would become the honest balancing wheel, undistorted by central bank bond buying and cash injections into the money market. With the freedom to soar when the demand for credit sharply exceeds the supply of savings, free market interest rates would automatically check creation of new credit in the banking system and rehypothecated credit in the shadow banking system.
The reason is straightforward: in a financialized economy, the marginal demand for credit consists of funding for the carry trades in one form or another. Yet this is the very perversion which permits the politicians to carry on with deficits without tears. When the Fed drives overnight money to zero and promises to keep it there through long-dated points on the calendar, it creates a false demand for government bonds.
Much of this false demand is financed in the repo market where fast money traders are happy to harvest the spread on the Fed-managed yield curve. They buy ten-year treasuries at a yield of 180 basis points (1.8 percent) and fund 98 percent of their position with 10-basis-point overnight borrowings—all the while sleeping peacefully because Bernanke has promised that short-term rates will not rise until 2015. This amounts to robbing a bank without criminal liability. Not surprisingly, the banks themselves have gone in for this kind of legalized larceny. Since Bernanke slashed deposit rates to essentially zero, bank holdings of government and agency bonds have nearly doubled, rising from $1.2 trillion to $2 trillion.
Here lies the Great Deformation. Over the last several decades the implicit choice has always been between a régime of free market interest rates and a mobilized discount rate versus a régime of financial repression and unchecked private and public debt creation. The former route would have limited the Fed to the role of “bankers’ bank,” providing emergency discount loans at market-driven interest rates plus a penalty. The latter route, explicitly chosen by Greenspan and carried to an absurd extreme by the Bernanke Fed, has turned the Fed into a destroyer of honest financial markets, an enabler of financial speculation on a scale never before imagined, and a reallocator of society’s income and wealth to the 1 percent.
But worst of all, it has transformed the nation’s central bank into the handmaiden of fiscal calamity. Today the US Treasury can borrow money from ninety days out to five years, thereby encompassing most of its issuance, at rates between 10 basis points and 80 basis points. Washington’s mega-deficits are thus being funded with essentially free money. The Fed’s utterly foolish interest rate repression has stripped the politicians buck naked in the face of the free lunch propensities of the democracy and the raids and plunderings of crony capitalists in a political system where money rules.
Needless to say, the Fed has painted itself and the nation into a dead-end corner. Sundown comes because the Fed dares not let interest rates rise by even a smidgeon, let alone “normalize” or ever again approach something like an honest price for money and debt on the free market. If it did, the vast army of fast-money speculators who have rented Treasury bonds and notes on 98 percent repo would sell in a heartbeat, causing the price of government debt to fall sharply. Then the slower-footed bond fund managers would be forced to liquidate in the face of retail investor redemptions and eventually even banks and insurance companies would panic, selling into a bidless market for government debt and everything tied to it.
Standing at the edge of a financial abyss, the Fed is thus hostage to its own four-decade excursion in money printing and
macroeconomic management. It cannot stop buying government debt because it is being front run by a herd of speculators which will turn on a dime unless it keeps buying and pegging the price of Treasury notes and bonds. At the end of 2012, its policy was to buy government and GSE debt outright at a rate of $1 trillion per year, which means that its balance sheet would be $6 trillion by the end of Obama’s second term.
THE GLOBAL MONETARY BUBBLE
It won’t get that far, however, because there are powerful countervailing forces gathering momentum; namely, a global beggar-thy-neighbor currency depreciation war that will dwarf the conflagrations of the 1930s. As indicated earlier, the Fed has been the lead ship in a convoy of monetary roach motels since the 1970s. Not surprisingly, Bernanke’s balance sheet expansion spree during the BlackBerry Panic spread like wildfire.
The top eight central banks, including the ECB, Bank of Japan, and the People’s Printing Press of China, had combined balance sheet footings of $5 trillion before the financial storm erupted in 2007. Now they total $15 trillion and are expanding at explosive rates. Following in the footsteps of the Fed’s 4X increase in its balance sheet and the embarrassingly blatant spree of money printing by the Bank of England, the practice of buying unwanted sovereign debt has become universal.
The ECB’s $1.2 trillion so-called LTRO money-printing operation during late 2011 and 2012 was merely a thinly disguised backdoor means of financing the debt of Spain, Italy, Greece, and others that genuine investors did not want to buy at current interest rates. And the announcement by Japan’s new LDP government in late 2012 that the Bank of Japan should print money at whatever rate it may take to bring inflation back to life in a bankrupt economy simply carried the money-printing régime to a new extreme.
The Great Deformation Page 96
