Fundmastery Blog

Kurt Brouwer November 2nd, 2009

What happens when we enter high inflation?

My experience with inflation dates back to the 1970s and early 1980s.  Inflation averaged almost 8% for the entire decade of the ’70s, but it cranked up into double digits in 1979.  Let’s head back to those days of yesteryear — the early 1980s — and compare some key indicators to the situation back then.

Here is a good chart showing key interest rates plus inflation and unemployment, then and now:

Source: Carpe Diem

I suspect you could win some bets with some of these statistics.  How many folks remember that home mortgage rates hit 18% back then?  Or, another statistic that is not shown in the chart is that home mortgages rates averaged 12% from 1979 through 1985?

Is inflation an immediate problem?

Inflation is not a huge problem now as it was throughout the 1970s and early 1980s.  For example, inflation is now running in the Fed’s sweet spot of 1-2%.  However, given all the monetary stimulus and government spending we have seen, inflation is definitely a threat, but one that has not really manifested itself yet. I do not expect us to get back to the inflationary climate we saw in the 1970s, but none of us knows what lies ahead.

If you believe inflation is on the way, you also need to figure out where in the inflationary process we are.  If, like the early 1970s, you think inflation is underway and the Federal Reserve will not attack it for quite a while, then inflation hedges make some sense.  However, if you think the Fed might be planning to raise interest rates soon in order to counteract inflation, then inflation hedges could be a problem.  Here’s why.

If inflation went quite a bit higher, the Fed would eventually be forced to raise short-term interest rates.  Long-term interest rates would certainly go up and that would be bad for those holding long-term bonds.  Once interest rates begin moving up, then economic activity would probably slow down, bringing us into recession and that would hurt most other assets such as real estate and stocks.

For example, in 1979, the Federal Reserve (under Chairman Paul Volcker) decided to really attack inflation by raising the Fed Funds rate (short-term interest rates).  As you saw in the chart above, interest rates on home mortgages went way up.  As rates went up, economic activity fell off and we entered a recession.  In that environment, most assets fell (real estate, stocks, bonds).  Gold prices lagged the decline in other assets, but they also fell.

Gold  in 1980 — from darling to dog in two years

In fact, gold hit a high point in 1980 of $875 per ounce, but it fell as low as $463 within a few months.  Gold prices went back up into the $700 range, but by 1982, gold prices had fallen to a low of $298 per ounce.  That’s right.  From a high of $875, the price of gold fell to around $300 within a couple of years. Beginning in 1982, inflation fell quickly from the double digit level, but gold prices fell much more quickly as gold had a 60% price decline.

Now, gold is hitting new prices highs due, in my opinion, largely to the weakness of the U.S. dollar.  There are other factors at work in the price of gold, but for U.S. investors the dominant issue at work is the falling dollar.  The point here is that you need to make sure you are buying gold — or any other asset — for good, solid, long-term reasons.  A little further on I’ll give you my thoughts on the best way to buy gold.

What should I do about inflation?

If you believe high inflation is coming our way, how do you protect your portfolio? This piece from the Wall Street Journal covers some solutions and we add a few more ways to protect your portfolio from the ravages of high inflation.

However, be careful out there, because it is not as easy or straightforward as some would have you think.  The key takeaway I have for you is that you should seek investments that you believe are undervalued and likely to go up in value.  That’s how you keep your portfolio growing:

Inflation-Protection Strategies Offer Investors No Guarantees (Wall Street Journal, October 5, 2020, Jeff D. Opdyke)

Worried investors have been looking for insurance in the form of assets such as mutual funds and exchange-traded funds focused on gold, commodities and Treasury inflation-protected securities, or TIPS. In the past year, interest in TIPS funds in particular has been running at record levels, with some weeks recording more than $400 million in sales.

But many of these investments have never been tested during a bout of meaningful inflation. The last time inflation ramped up significantly was three decades ago. Yet TIPS have been around only since the late 1990s, and commodity funds are of even more recent vintage, as are the gold funds that invest in bullion or track the metal’s market price.

This is a really important point.  Wall Street is great at coming up with new and complex investment opportunities.  However, the track record on Wall Street innovations is not good.

Be cautious with new or untested investments

I think of it just like new operating systems for a computer.  I never rush to upgrade my computer with the latest, groovy operating system because I know there will be bugs.  I wait a few years usually before upgrading so that the bugs will largely be fixed before I make the switch.

I view innovations from Wall Street with even more skepticism than I do new operating systems for my computer.  In general, if it is new — and complex — and it’s from Wall Street, I pass.

As an example, consider commodity-oriented exchange-traded funds (ETFs).  They are new and relatively untested, so be cautious.  One critical issue with commodity mutual funds or ETFs is whether or not they actually hold commodities or just a basket of futures contracts for a given commodity.  With precious metals, it is possible to actually hold a commodity such as gold.  However, some commodities such as agricultural products or even oil or gas are less likely to be owned directly by a given fund.  In many cases then, an ETF or mutual fund just holds future contracts or notes redeemable by a bank.

There are some mutual funds such as Pimco Commodity Real Return Fund (PCRDX) that seek to benefit from investments in commodity-related securities.  Here’s how Pimco describes the investment strategy:

PIMCO manages CommodityRealReturn Strategy by combining a position in commodity-linked derivative instruments backed primarily by a portfolio of inflation-indexed securities…Other fixed income instruments may also be used tactically in the portfolio. The commodity-linked derivatives capture the price return of the commodity futures market, while our active management of the fixed income assets seeks to add incremental return above those markets, along with additional inflation hedging…

This type of fund can give you exposure to commodity-related investments, but it is no walk in the park.  We use this fund a bit, but we do so knowing it can be very volatile.  For example, in 2008, it fell over 43%.

Tracking error

Commodity mutual funds or ETFs have the potential to go up in value due to inflation, but they are inherently volatile.  And, as we saw above, they often also invest in futures contracts and other so-called derivatives that can lead to unintended consequences as shown by this piece from MarketWatch.  It illustrates the point with examples of commodity or precious metals ETFs that had results wildly divergent from the actual commodity or metal they are tracking:

…The United States Natural Gas Fund (UNG) , for example, has tumbled 50% this year while natural gas prices are down about 12%…

Natural gas prices go down so you expect the fund to go down, but a loss of 50%? Ouch.

…PowerShares DB Oil Fund’s flexible strategy helps it navigate market conditions…Since the fund’s inception in early 2007, it has gained about 16% while oil prices have risen about 40%…

Nothing wrong with a gain of 16% since 2007, but that return significantly lags the actual increase in oil prices.  As long as you understand what a commodity or precious metal mutual fund or ETF does, then that’s fine.  I suspect many investors in UNG are a bit mystified though.

If you are interested in investing in precious metals, I would simply just own them directly.  That is, buy some gold coins or silver coins and hold them in a safe deposit box.  If you do go that route, you have the coins and there is no muss or fuss. As a second best choice, I would buy an ETF such as the SPDR Gold Trust (GLD), which, by its prospectus, actually buys and holds gold at its custodian in London.

Other ETFs or mutual funds investing in precious metals or commodities may simply be putting together a basket of futures contracts on the commodity in question.  That’s fine if you have faith in the ETF or fund provider, but how exactly those contracts will perform in volatile markets is a bit of a question mark.

The Wall Street Journal continues:

…Though long heralded as a hedge against inflation, gold hasn’t always gone along for the ride when U.S. consumer prices are rising. Consider data from Morningstar Inc.’s Ibbotson Associates research and consulting unit: The correlation of spot gold prices to an Ibbotson-tracked inflation benchmark is just 0.096. (Correlation is perfect at 1; the closer to 0, the less the correlation.)

Certainly, gold has done well in some inflationary periods, like the late 1970s, when the metal spiked above $800 an ounce. Still, investors would do better to view gold as an international currency that hedges against weakening paper currencies, particularly the dollar. For instance, the U.S. dollar index, tracking the greenback’s performance against a basket of currencies, has slipped more than 13% since March, when the index hit its peak so far for this year. Gold prices, meanwhile, are up more about 14% so far this year.

…But there’s another issue: What does your gold fund own?

Exchange-traded funds such as SPDR Gold Shares and related trust products such as Canada’s Central GoldTrust own physical bullion, held in secure bank vaults and regularly audited.

Others don’t own physical gold and instead seek gold exposure through derivatives. PowerShares DB Gold, for instance, tracks an index of gold-futures contracts…

In mutual funds or ETFs that invest through futures contracts on gold or silver, there are a number of risks.  The obvious one is that spot prices for a given precious metal and futures contracts for that metal have very different prices as we saw from the examples above.  In a rising market, the fund would often underperform spot prices.  That can be very disappointing if you bought a fund and the precious metal followed the trajectory you anticipated, yet the fund lagged far behind.

So, there is the issue of the internal structure and strategy of the fund or ETF.  But, there are also other issues.  The Wall Street Journal continues:

…Many commodity-based securities are exchange-traded notes, or ETNs, which pose a different risk. Unlike ETFs, which generally own a pool of hard assets or securities, ETNs own nothing. They are promissory notes issued by a bank, meaning they’re unsecured debt; the return you earn is calculated based on the movement of an underlying commodity index.

“You’re loaning money to a bank, and the bank pays you the return of the underlying index,” Morningstar’s Mr. Burns says…

Hmmm.  Loaning money to a bank.  What could go wrong?

Going beyond precious metals or commodity funds, here are some thoughts on different asset classes of funds and how they might fare during inflationary times:

Money market mutual funds: One very good investment in times of high inflation is cash in a money market funds.  Assuming interest rates go up due to inflation, the return on the money market fund should go up too.  In a money market fund, interest rates are variable, so your money will begin earning higher interest as soon as rates go up.

Short-term & intermediate-term bond funds:  If you have some fixed income investments, as a first step for an inflation conscious investor, I would shorten the maturity of any bonds or bond funds you own and use short-term and intermediate-term bond funds primarily.  You could also put some assets in a fund that invests in Treasury Inflation Protection securities as mentioned above.

U.S. stock mutual funds: Stocks can do quite well in a moderate inflationary environment, in particular stocks of companies that have pricing power.  However, if inflation really takes off, eventually the Federal Reserve would have to raise interest rates and that would result in a recession in all likelihood.  Recessions are not generally good for stocks.

International stock mutual funds:  The points made above about U.S. stock funds apply generally to international stock funds too.  In addition, there is the currency issues.  That is, most international funds hold stocks in currencies other than the U.S. dollar.  As such, if inflation has a negative impact on the dollar, then those funds should benefit.  The flip side is true also though.  That is, if the dollar strengthens, then most international funds would suffer a bit due to their non-dollar exposure.  Right now, international stock funds are benefiting from higher share prices plus currency gains from the falling dollar.

Real estate mutual funds:  Real estate has been struggling for a couple of years now.  Residential real estate started falling first and now commercial real estate is taking a big hit.  Assuming you are a long-term investor and assuming you are worried about inflation, real estate funds are worth a look.  It may be premature at this point because real estate is still weak, but historically real estate has done pretty well during inflationary times.  I would wait a bit on this though.

In closing, I’ll make a couple of points.  First, there is no guarantee that we will go through a high inflationary period.  There is pretty solid evidence that inflation will be moving up at some point, but that does not mean we will get back to the type of inflation we saw in the 1970s.  Also, as you know, disinflation, not to mention, deflation, is still a possibility although probably a much lower one than inflation.  But, if the economy fails to re-ignite, we could drift into another recession in a year or two and that would mean most inflation-centric investments might suffer.

When it comes to investing, I believe a diversified portfolio works best because the future is not knowable.  That is, do not bet all your assets on one specific scenario such as high inflation.  You can certainly do things to lessen the impact of inflation on your portfolio, but do not put all your assets in one narrow strategy.

Disclosure:  Kurt Brouwer owns shares of Pimco Commodity RealReturn Fund (PCRDX)

• ETF , Economy , Energy , Geopolitics , Investing , Money , Mutual Funds , Personal Finance , debt , inflation
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Kurt Brouwer October 28th, 2009

‘Life should  NOT  be a journey to the grave with the intention
of  arriving safely in an attractive and well preserved  body,
but rather  to skid in sideways - Chardonnay in one  hand -

chocolate in  the other - body thoroughly used up,  totally worn out and
screaming ‘WOO  HOO, What a  Ride’ 

 

I’m not sure who actually wrote this, but it does contain a very different perspective on planning for retirement, doesn’t it?  My only quibble has to do with the wine selection.  I always thought chocolate went best with a nice, full-bodied red.

Most of us do not have the perspective of the author of this pithy paragraph though.  In fact, one of the key concerns — perhaps the key concern — people have about retirement is whether or not they will run out of money.

In answer to that question, the answer is almost certainly no.  That is, you won’t run out of money.

Here’s why. Think of your gas tank in your car.  If you were on a long trip and the circumstances were that you were getting low on gas and no gas stations were available, what would you do?  Would you keep driving at high speed knowing that would burn gas quickly or would you cut back to the most efficient speed in order to conserve?  Answer: you’d conserve.

The same is true of conserving your assets in retirement.  If things looked tight, you would cut expenses and reconsider assumptions you had made long before a shortage would come about.  You would make changes, consider new options and, in a variety of ways, you would think outside the box.

Retiring outside the box

As an example of thinking or even retiring outside the box, I was chatting with a client who complained that his retirement expenses were unsustainable given his steady income and savings.

I was kidding a bit, but I said, “You could always move to Guatemala.”

The thinking behind that statement is that many American and Canadian retirees have moved south of the border to expatriate enclaves in Mexico, Guatemala, Costa Rica, Panama and Nicaragua.  Living expenses are generally much, much lower in those places.  The client laughed and told me he had given some thought to living half the year in Mexico.

In other words, though you may think you’re going to retire and maintain all your present circumstances, that may not be the case either because you want a change or because you need to change.

You can have (almost) any thing you want, but not everything you want

In other words, there are definite tradeoffs in planning for retirement.  If your primary goal is just to have the money for a simple, comfortable retirement, then that’s probably fine.  But, if you begin adding on requirements, you may impinge on your primary goal.

Let’s say you are about to retire and you want to figure out how much you can spend each year during retirement.  Before getting into formulas or related concepts such as inflation, in my view, the key question is this:

What do you want?

When I ask that question, people generally have a pretty clearcut plan on certain issues such as:

• I want to leave $_____ to my kids or my church or my charity while providing for a comfortable retirement
• I’m mainly concerned about retirement income and if there is anything left over, it will go to our kids
• I am worried that our retirement needs could become a burden to our children
• I don’t want to leave any money to anyone; so I want to write my last check on my deathbed

The details may vary, but your retirement goal should be clearly stated.  For most people, the primary concern is providing for their own retirement expenses.  Beyond that, they either want to pass on some of their wealth or they don’t.

Once that issue is addressed, the next issue is how much can you spend on yourself — on your lifestyle — during retirement?  The viability of a retirement spending plan rests on three primary components — your spending, your steady income and your savings.

All three of these have to be considered together in order to come up with a coherent answer to the question, will you run out of money in retirement?  Obviously, we cannot know the future, so we are speaking in terms of probabilities, but it is useful to go through this type of analysis:

I. Spending during retirement: Let’s say you are on the cusp of retiring.  First, congratulations are in order.  You made it.  Next, let’s take a look at how you figure out what you’ll spend during retirement.  The best place to start is to figure out how much you spend now.  I know that sounds obvious, but many people don’t really know what they are spending.

We use a Microsoft Excel worksheet to help people go through this exercise so they don’t miss any major spending categories.  One of the biggest spending black holes is your home.  People spend a lot of money on upkeep and maintenance, insurance, property taxes, principal and interest payments and home improvements.  It’s easy to miss something.

Your home: Are you planning to stay where you are?  If so, home expenses may not change much, until you pay off your mortgage.  If you plan to downsize your home, will you buy a condo or rent.  For many retirees, renting is hard to imagine as they have owned a home for decades, but renting makes economic sense for many.

Your state or city?  If you are planning to move, are you considering another state.  If so, the cost of living in that state is important as are all the various taxes (income tax, sales tax, property tax).  There are places around the country — and around the world — where your money may go a lot further than it does where you live now.  Or, you may be considering a move to be close to family or even to bring about a lifestyle change.  A change such as this complicates things, but that’s OK.

Other easy items to miss are expenses that come once a year (such as many types of insurance) or expenses that occur irregularly, such as replacing a car or a furnace or a roof. Once you have a good handle on how much your spend now, you can estimate what you will spend in retirement.  In order to look forward in terms of spending, you have to make some decisions:

There are rules of thumb for adjusting your working level of income to see how much you will need in retirement, but I have not found them terribly useful.  I think it’s much better to track your current spending and then go through and make adjustments to deal with your contemplated lifestyle changes during retirement.

One of the best ways to estimate retirement expenses is to talk with those who are already retired.  This is not a huge revelation, but I have found that many folks are reluctant to ask family members or friends or others about what life in retirement is like or to find out how their spending compares to spending before they retired.  Most retired folks that I know are happy to help others and share their knowledge.  So, if you have questions, just ask.

II. Steady Income: Figuring this out is generally the most straightforward part of the process.

Social Security: Most people will have Social Security income during retirement and the Social Security administration sends out a specific statement for your personal Social Security benefit at retirement.  The only big decision for Social Security is whether or not to take it immediately or to wait until full retirement age.  This chart from the Social Security administration illustrates how your initial monthly benefit can change depending on your age when you start taking Social Security.

Source: Social Security Administration

As you can see, assuming a retiree has a full benefit of $1,000 per month at age 66, the actual benefit could be higher or lower depending on what age the retiree actually elects to start taking the benefit.  Many articles I have seen recommend waiting until age 66 to get the full benefit.   That may not necessarily be the best choice for many people because you have to give up four years of Social Security benefits to get the higher amount.  The reason it may not make sense for you to wait until full retirement age is that the crossover point could be about 12 years.  That is, it takes 12 years at the higher benefit amount to make up the amount you missed by not taking benefits at 62.

For example, using the numbers in the chart above, at age 62, you would get $750 per month for four years for a total of $36,000.  On the other hand, if you wait until age 66 for full benefits, you would get an extra $3,000 per year ($250 per month).  Without getting too fancy, in actual dollars it would take 12 years to make up the money you missed by waiting.

If you plan to work until 66, it probably makes sense to wait to take benefits until that age.  However, many people may want to take benefits at 62 just to bring in some income.  That method will give you more money until the crossover point is reached in about 12 years.

Many folks will have some part-time or full-time employment income during the early years of retirement and that could impact your decision on when to take Social Security benefits among other things.  For more on this issue, you can go to the Social SecurityAdministration’s Retirement Benefit site.

Other pension benefits:  If you are lucky enough to have an outside pension plan from your employer, then that is an additional source of income during retirement.  In addition to the pension income, you may also be eligible for additional benefits such as retiree health insurance.  One very important question to consider with an outside pension is whether to take the monthly income option or to take a lump sum distribution, assuming that option is available to you.  If you are at all concerned about the level of funding for your pension, taking a lump sum may make sense.

III.  What assets do you have?

This refers to your investments, whether IRAs, 401(k)s or personal savings or investments.  We typically include retirement assets if you have them in an account in your name.  We include monthly pension income above under Steady Income.  Looking at your assets means you would also potentially include other assets such as your home or a business or anything else you have that is valuable.  You may want to remain in your home now, but it is still a resource if you have some equity in it.

If there is a gap between your spending (Section I) and your steady outside income (Section II), then your portfolio has to be tapped to make up the difference, if you cannot cut expenses that is.

People often ask what is a reasonable return for retirement assets and that is hard to forecast because returns vary dramatically from year to year and from one type of asset to another.  If you have your investments in a diversified portfolio, then you could consider historical rates of return, that is the long-term average return for each type of investment.  We look at those historical returns and then make adjustments according to our view of conditions in the future.

What kind of spending assumption should I make?

What we often do is look at a 4-5% withdrawal rate from your portfolio.  That is, if someone has a long-term portfolio, then he or she should be able to withdraw 4% per year from that portfolio without drawing it down to zero over the course of a normal retirement.  The way the math works on this is to assume a return from a diversified portfolio of say 8%.  Then, from that 8% return, deduct your inflation assumption.  Say, that’s 3% and the remainder, 5%.  Assume some income taxes, albeit at a fairly low rate, and 4% is left that can be spent without dipping into your principal on an inflation-adjusted basis.  In this scenario, you would be able to pull out 4% per year and also to keep your principal intact even with the ravages of 3% inflation.

However, you may not be as concerned with inflation as you get older depending on your initial goal.  For example, if you plan to write your last check when you check out, then keeping your principal intact will not matter much to you.  Or, if your primary concern is your own retirement span and whatever is left over, if anything, could go to your children or a charity, then again keeping up with inflation may not concern you too much.

In these cases, you could spend quite a bit more than 4% because you don’t mind dipping into principal and because you don’t care if the portfolio value does not keep pace with inflation.

Another alternative we have seen is that retired folks take out more than 4% in years when investment returns are good, but they cut way back on withdrawals from the portfolio in down years.  That can work if you are disciplined.

Living longer & margin for error

One point to bear in mind also is longevity.  The good news is that life expectancy is going up and people are living much longer.  Initially, most recipients of Social Security did not last all that far beyond 65.  Now, people are routinely living well into their 80s or 90s.  That is one reason why Social Security funding is a problem.  But, it is also a problem we need to consider as part of a retirement plan.  How long are you planning to live?  Or, what life expectancy would you like to assume.  A reasonably healthy couple, each of whom are at age 65, will likely be around for quite a while, and one member of the couple could easily live 20 years or more.  Therefore, retirement planning needs to account for a potentially long life span.

I believe you also need to have a cushion in your planning to account for the possibility of getting lower investment returns or other factors such as higher inflation or a long, long life.

Summing it all up

When you begin thinking about these issues, the temptation is to go right to one of the retirement calculators you can find online (see here or here or here for examples).  That’s fine.  Do it.

But then, you actually have to sit down and do your own personal math.  Track your expenses.  Make adjustments based on what you hear from retired family or friends.  Add in your steady income from Social Security or other sources.  And, finally, make a conservative assumption of what you can take from your portfolio to make up any difference between spending and steady income.

As you can see, this is a very personal decision as your goals could be quite different from those of family members or friends.  If your situation is complicated or if you want a more rigorous retirement analysis, you would need to go to your CPA or financial advisor for help.

Have fun and if you have an interesting tale let me know.

• Investing , Money , Personal Finance , income taxes , inflation
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Kurt Brouwer October 12th, 2009

As we have noted before, Congress has a tendency to underestimate the costs of a program it is considering.  In yet another example of this, this chart demonstrates that Medicare costs have been significantly underestimated by Congress at the time of enactment:

Source: Carpe Diem

Medicare: What will it really cost?

The ironic part about the current discussions of healthcare reform costs is that proponents of the plan initially said — and some are continuing to say — that healthcare reform would save money.  Unfortunately for them, the Congressional Budget Office (CBO) pointed out that the legislation before the House of Representatives (H.R. 3200) would actually add significantly to the deficit by as much as $1 trillion over the next 10 years.

That news caused many in Congress to gulp hard, yet the CBO estimate is almost certainly low if history is a guide.  I thought it would be useful to look at how far off previous estimates from Congress on Medicare costs have been  in the past.

When Medicare was passed, various future estimates of costs were made by Congress.  Those estimates were wildly off base, so much so that it is doubtful that Medicare would have passed, had there been an accurate cost estimate.  The chart above shows that the actual costs for Medicare programs run from a minimum of 200% over budget up to 1700% over budget.

Lyndon Johnson & Medicare cost estimates

There is an interesting interview on National Public Radio [emphasis added] which presents evidence that President Johnson deliberately underestimated the cost of Medicare to get it passed.  The interview is with James Morone, co-author of the Heart of Power: Health and Politics in the White House.   In it, the show’s host, Renee Montagne, asks the author about comments President Johnson made about the original cost estimates for Medicare.

Democrats Could Learn From LBJ’s Medicare Push (National Public Radio/Morning Edition, August 26, 2020, Renee Montagne)

[NPR-Montagne]: There are tapes of Johnson showing a different side of how he worked [Medicare's passage].

[James Morone, co-author of The Heart of Power: Health and Politics in the Oval Office]: Johnson maneuvered every step of the way getting this bill through Congress, and one of the things he did — and this is a little dicey in today’s climate — was suppress the costs. So this young kid gets elected from Massachusetts, Ted Kennedy, in 1962, and Johnson is explaining to him [over the phone] how you get a health bill through. And what he tells him is don’t let them get the costs projected too far out because it will scare other people:

“A health program yesterday runs $300 million, but the fools had to go to projecting it down the road five or six years, and when you project it the first year, it runs $900 million. Now I don’t know whether I would approve $900 million second year or not. I might approve 450 or 500. But the first thing Dick Russell comes running in saying, ‘My God, you’ve got a billion-dollar program for next year on health, therefore I’m against any of it now.’ Do you follow me?”

[JM]: We believe, after looking at the evidence, my co-author [David Blumenthal] and I, that if the true cost of Medicare had been known — if Johnson hadn’t basically hidden them — the program would never have passed. America’s second-most beloved program would never have happened, if we had had genuine cost estimates…

That is an amazing piece of history and it seems authentic as it is based on tapes LBJ made of his various conversations.  Most people don’t realize this, but the various pieces of healthcare reform legislation now before Congress use an interesting technique of which LBJ might approve.  Taxes and fines and Medicare cuts would start right away, but spending on the program would be delayed until 2013 or so.  So, the 10-year estimate only has 6 or 7 years of actual expenditures built in.  Nice.

Can we trust Congress?

For a variety of reasons, estimating costs of government-run health insurance reform seems to be quite difficult, even assuming our leaders are trying to do so fairly and honestly.  So, I would not take current estimates of the cost of health insurance reform as being cast in stone.  In fact, I would assume they are very low as Congressional estimates for Medicare have always been in the past.

• Economy , Geopolitics , Money , Personal Finance , deficit , healthcare
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Kurt Brouwer October 9th, 2009

We frequently are told by politicians that the only solution to our budget deficits at the Federal, state and local levels is to raise taxes.  I might buy this argument if those same politicians had made efforts to cut government spending that is not needed or is wasteful.  Unfortunately, those types of efforts get short shrift except when it is time to campaign.

From the Foundry blog, here are 10 examples of eggregious government waste:

50 Examples of Government Waste. (Foundry, October 6, 2020, Brian A. Riedl)

…Reducing wasteful spending is not easy. Even the most useless programs are passionately supported by the armies of recipients, administrators, and lobbyists that benefit from their existence. Identifying inefficiencies and abuses is much easier than devising a system to fix them. Many lawmakers focus more on bringing home earmarks than on performing the less exciting task of government oversight. Exasperated taxpayers see the cost of government rise with no end in sight.

Of course, eliminating waste cannot balance the budget. Lawmakers must also rein in spending by reforming Social Security and Medicare and by eliminating government activities that are no longer affordable. Yet government waste is the low-hanging fruit that lawmakers must clean up in order to build credibility with the public for larger reforms…

I have not cherrypicked these items, just took the first 10 from the Foundry’s list and added three bonus items from further down the list: [emphasis in the original]:

1. The federal government made at least $72 billion in improper payments in 2008.[1]

Okey dokey.  Has anyone thought of asking for these improper payments back?

2. Washington spends $92 billion on corporate welfare (excluding TARP) versus $71 billion on homeland security.[2]

We should be able to get to bipartisan agreement on this one.  Some don’t like waste, some don’t like welfare and some don’t like corporations.  It’s a match made in heaven.

3. Washington spends $25 billion annually maintaining unused or vacant federal properties.[3]

D’uh…Why not sell these properties?  We’d save $25 billion a year in maintenance savings alone plus the value of the properties, which are undoubtedly worth something.

4. Government auditors spent the past five years examining all federal programs and found that 22 percent of them-costing taxpayers a total of $123 billion annually-fail to show any positive impact on the populations they serve.[4]

Unfortunately, lawmakers do not seem to feel that positive impact from government spending is critical.  Witness the Cash for Clunkers program and many others.  Nonetheless, this is definitely low hanging fruit.  But still, $123 billion for programs that show no positive impact?

5. The Congressional Budget Office published a “Budget Options” series identifying more than $100 billion in potential spending cuts.[5]

This report from the CBO contains hundreds of recommendations to cut spending.  Again, we’re talking $100 billion per year.  $100 billion here and $100 billion there.  After a while, it adds up to real money.

6. Examples from multiple Government Accountability Office (GAO) reports of wasteful duplication include 342 economic development programs; 130 programs serving the disabled; 130 programs serving at-risk youth; 90 early childhood development programs; 75 programs funding international education, cultural, and training exchange activities; and 72 safe water programs.[6]

Do we really need 342 Federal economic development programs?

7. Washington will spend $2.6 million training Chinese prostitutes to drink more responsibly on the job.[7]

We previously said all we had to say on this one here: In this era of budgetary constraint and fiscal rectitude, we are pleased to report that our political leaders and bureaucratic chieftains have really gotten the message.  Otherwise, they would fund all kinds of crazy things.  Oops.

U.S. Will Pay $2.6 Million to Train Chinese Prostitutes to Drink Responsibly on the Job (CNS News, May 12, 2020, Edwin Mora)

The National Institute of Alcohol Abuse and Alcoholism (NIAA), a part of the National Institutes of Health (NIH), will pay $2.6 million in U.S. tax dollars to train Chinese prostitutes to drink responsibly on the job.

Dr. Xiaoming Li, the researcher conducting the program, is director of the Prevention Research Center at Wayne State University School of Medicine in Detroit.

The grant, made last November, refers to prostitutes as ”female sex workers”–or FSW–and their handlers as “gatekeepers.”

“Previous studies in Asia and Africa and our own data from FSWs [female sex workers] in China suggest that the social norms and institutional policy within commercial sex venues as well as agents overseeing the FSWs (i.e., the ‘gatekeepers’, defined as persons who manage the establishments and/or sex workers) are potentially of great importance in influencing alcohol use and sexual behavior among establishment-based FSWs,” says the NIH grant abstract submitted by Dr. Li…

This study certainly seems essential doesn’t it?  After all, what could be more important to people in Detroit, home of Wayne State University, than that Chinese prostitutes drink responsibly?  And, since this ’study’ is funded by the Federal government, it’s not as though we have any problems closer to home, right?

8. A GAO audit classified nearly half of all purchases on government credit cards as improper, fraudulent, or embezzled. Examples of taxpayer-funded purchases include gambling, mortgage payments, liquor, lingerie, iPods, Xboxes, jewelry, Internet dating services, and Hawaiian vacations. In one extraordinary example, the Postal Service spent $13,500 on one dinner at a Ruth’s Chris Steakhouse, including “over 200 appetizers and over $3,000 of alcohol, including more than 40 bottles of wine costing more than $50 each and brand-name liquor such as Courvoisier, Belvedere and Johnny Walker Gold.” The 81 guests consumed an average of $167 worth of food and drink apiece.[8]

It has been found over and over again that government employees abuse credit cards to the point where they really should be given out sparingly.  No doubt there are plenty of responsible bureaucrats who do not abuse cards, but nearly half of all purchases are either improper, fraudulent or embezzled?  C’mon.  Cut up the cards.

9. Federal agencies are delinquent on nearly 20 percent of employee travel charge cards, costing taxpayers hundreds of millions of dollars annually.[9]

Apparently, Federal employee not only abuse credit cards, but their agencies are also frequently delinquent in paying the bill.  From the link for this item #9, we read:

The most stunning revelation concerns not how the cards are used but rather how long it takes the government to pay its bill — and what those delays are costing taxpayers.

According to the most recent data from the Office of Management and Budget, in January 2009, governmentwide delinquency rate for centrally billed card accounts — those paid by an agency rather than an employee — was 19.23 percent. The average delinquency rate for individually billed cards was 6.25 percent, data showed.

A card is considered delinquent if a bill is outstanding for more than 60 days.

“A private travel agency would be out of business running this kind of operation,” said Scott Amey, POGO’s general counsel. “This report summarizes problems with individual transactions and, more important, with government agencies that aren’t safeguarding taxpayer dollars.”…

10. The Securities and Exchange Commission spent $3.9 million rearranging desks and offices at its Washington, D.C., headquarters.[10]

Now, in all fairness, the SEC has been given some new responsibilities, but that is still a lot of dough for a pretty modest task.

And, here are three bonus items:

12.  Over half of all farm subsidies go to commercial farms, which report average household incomes of $200,000.[12]

I have never understood this farm subsidy concept in which we pay well-to-do folks not to do something.  What does it take to kill off something as silly as this?

13.  Health care fraud is estimated to cost taxpayers more than $60 billion annually.[13]

Much has been made of this as a source of ‘found’ money to help pay the cost of health insurance reform.  OK, fine.  Why not just fix this problem first, if it’s so easy.  See this post, Why Not Fix Medicare First? for more on this issue.

And, finally, the Pentagon’s procurement group should be summarily fired. Of course, Congress shares some of the blame for this one because Congressional leaders have frequently put great pressure on the Pentagon to allow wasteful cost overruns.

14.  GAO audit found that 95 Pentagon weapons systems suffered from a combined $295 billion in cost overruns.[14]

This should also be a Congressional ‘no brainer’ because some in Congress don’t like waste and some don’t like the Pentagon.  I don’t want to undercut our military men and women at all.  They do a difficult and often dangerous job and I would like to make sure they have adequate resources.  Yet, cost overruns on big projects do no one any good.

It looks to me as though savings in just these 13 items would be in the hundreds of billions per year.

That’s enough to give insurance tax credits or vouchers to all those who do not have health insurance, with some spare change left over.  No need to do more deficit spending or to raise taxes.  Just cut the waste and do it first.  What’s not to like?

• Blogging , Business , Geopolitics , Money , debt , deficit , income taxes
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Kurt Brouwer October 5th, 2009

As you know, the dollar has been falling against the Euro and other currencies lately. But, it is sometimes hard to put that in an actual historic perspective. Also, it’s hard to understand why the dollar is falling. With this post, the goal is to give you answers on both questions — How far has the dollar fallen? And why is it falling? And, we also want to discuss what is likely to be ahead for the declining dollar.

Declining the dollar

Do you remember hearing that the Euro fell to historic lows versus the dollar in 2001? In fact, the Euro fell steadily versus the dollar for the first five years of its existence, beginning in January 1999. It did not get back to even until mid-November, 2003. At the low point for the Euro you could have bought one for 84 cents. Now, it takes a $1.46 to buy one Euro.

Here is a chart showing the fluctuations of the Euro versus the dollar since inception in 1999. This shows how many dollars it takes to buy one Euro. When the blue line is heading down, the dollar is getting stronger. When the line heads up, the dollar is getting weaker.

U.S. Dollar / Euro

Source: St. Louis Federal Reserve Bank

The gray bars in the charts indicates the relatively brief recession we experienced in 2001 and the longer recession we are experiencing now. You might notice that the 2001 recession coincided with the low point for the Euro (or conversely, the strongest point for the dollar during this time period). Why? The very strong dollar and the recession went hand in hand because the Federal Reserve raised interest rates beginning in 1999 and that led to the recession. Higher rates cause the dollar to strengthen, but they also inevitably slow down the economy. On the other hand, lower interest rates are positive for the economy, but often not for the dollar.

After the 2001 recession ended, our economy strengthened for years and the dollar fell, more or less continuously during that economic upturn. Coincidence? No. Here is a chart showing the Federal Funds target rate.

Federal Funds Rate

Source: St. Louis Federal Reserve Bank

As you can see from this chart, the Federal Reserve began raising interest rates (blue line going up) to slow down the technology bubble in 1999. By comparing this chart to the first one, you can see that when U.S. interest rates went up, the dollar rose versus the Euro. When the economy fell into recession in 2001 (the first area in gray), the Fed began slashing interest rates and the Euro finally began strengthening versus the dollar. The Fed began raising rates again in 2004 due to inflation concerns and the Euro stabilized versus the dollar until the Fed stopped raising rates in 2006. At that point, the Euro began climbing and the process accelerated when U.S interest rates were cut significantly in 2007 as the economy began to weaken.

Flight to the dollar during financial panic

During the financial panic at the end of 2008 and early in 2009, the dollar strengthened considerably.  This chart is the same data as in chart number one, the dollar versus the Euro, but for the period of 2008 and so far in 2009.  I also took off the recession bar.  Remember that the blue line going down means the dollar is strengthening versus the Euro, while the blue line going up means the dollar is weakening.

Source: St. Louis Federal Reserve Bank

The flight to the dollar during the panic began in the Summer of 2008 and ended in early 2009.  As the panic subsided, other considerations such as interest rates took hold again and the dollar again began to weaken against the Euro.  At the low point, it took nearly $1.60 to buy one Euro.  Then, during the depths of the financial panic, it took only $1.25 to buy one Euro, but now that same Euro would cost $1.46 or so.

What’s Next?

The big difficulty we face now is that the economy is weak and the Fed likes to have low interest rates to help the economy begin to grow again.  Low interest rates are helpful to overall economic activity, but, as you have seen, lower rates generally hurt the dollar.  If we wanted to help out the weak dollar, the response would ideally be to raise interest rates.  However, due to serious weakness in the economy, the Fed is hampered in its ability to respond to this situation and I believe it will opt to keep very low interest rates in order to promote economic growth.

You may hear various members of the Federal Reserve or politicians or pundits decrying the weak dollar.  However, for decades, our government’s philosophy during recessions has been to publicly espouse a strong dollar while, at the same time, cutting interest rates to strengthen the economy and give unemployment a boost.  This has traditionally been done despite the fact that lower interest rates generally lead to a weaker dollar.  I don’t see anything in the cards that appears to have changed that policy.   Therefore, I expect continued pressure on the dollar as the Fed seeks to get economic activity going again.

• Economy , Geopolitics , Investing , Money , debt , deficit
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