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First, Let’s Lower the Bar
November 12, 2010
By John Mauldin

Health-Care Realities
The Chinese Renminbi is Going Down, Not Up
First, Let’s Lower the Bar
They Need to Borrow How Much? Really?
Irish Eyes Are Not Smiling
La Jolla, New York and a Forbes Cruise

China’s currency is rising ever so slowly against the dollar. But is that hurting China? We will look at a very interesting chart and some research. And then we’ll gain some more insight into why the employment numbers seemed to surprise. I guess if you lower the bar, it’s easier to jump over. I also deal with the pushback from last week’s Outside the Box! And Ireland is on my radar. There is a lot to cover, so let’s jump in.

I start this week’s letter on a flight from Cleveland (where I was at the Cleveland Clinic meeting with my good friend and doctor Mike Roizen (of Oprah and the various “YOU” books with Mehmet Oz) on some non-health-related business, and we talked last night about the state of health care. Mike keeps pointing out that much of our health-care cost comes from chronic diseases that are either directly or partially lifestyle choices. And he is right. The data shows it. Smoking, overeating, lack of exercise – all contribute to our health-care bills. And health care was on my mind.

Now, a little mea culpa. I get letters from readers who start their missive out with something like, “I know you probably won’t read this, but…” Well, I can’t say I read every letter, but someone does and I get and read as many as I can. And my rule is that I get all the negative ones, and any letters that show particular thoughtfulness and give me suggested reading or just good suggestions. I do pay attention to you. It takes some time, I admit, but I think it is important.

And the feedback I got on last week’s Outside the Box on health care was definitely running much more on the negative side. And as it turns out, for good reason. There were just simply some factual errors in the piece that made it more partisan than it sounded when I first read it. And many readers justifiably took me to task for that.

What attracted me to the piece to begin with was the central fact that the incentives within the health-care bill give businesses significant monetary reasons to do things that are not in what I think of as the best interests of the economy or labor. Businesses will be able to save a great deal of money by canceling their employer-paid insurance plans and simply paying the fine and offering their employees some kind of cash payment to buy managed-care programs. Go to Friday’s USA Today. Read the story on Medicare-managed health care, about the shortage of specialty doctors and the denial of benefits that I think of as routine in my more or less plain-vanilla health insurance plan. I don’t think people are going to be happy.

Second, there is the incentive to hire part-time employees over full-time, and thereby not have to provide insurance. This is already an issue I see every week with my own kids, as getting full-time jobs even in relatively OK Texas is an issue. As a nation, we are already witnessing a disconcerting and still-rising level of part-time employment. Do we really want to encourage more of that?

If there is one thing we know in economics (and there are admittedly distressingly few of them), it is that people respond to incentives, whether intended or unintended. I don’t think the writers of the health-care bill intended to increase part-time employees, keep payrolls under 50 employees, or encourage businesses to dump their health insurance or move to outsourcing, etc. But if you are a business person facing budget and sales shortfalls, rising prices, and fierce competition (is there any other kind?), saving $2-3,000 per employee is going to be tempting. When two part-time employees cost $3-6000 a year less than one full-time? What do you choose when the boss is breathing down your neck about expenses? The recent employment data tells me that already businesses are opting for more part-time workers. It doesn’t work for every business, but it will for a lot of them. I hope that is not going to be the case, but I want policies that encourage and reward good corporate behavior.

For many people who read the letter, the factual errors obscured the main points. Frankly, I understand. I often have that reaction in reading other material myself. But Outside the Box is not “other material.” I put this out there, and with the core standards we have in place, I should not have been as tone deaf. I WILL be better. And in a few weeks, we will have a new website with reader forums and feedback (targeting December – this is a major project and they always take more time than I would like).

Two things I did take away from the feedback. First, most of my readers are amazingly civil in an era where simple civility on the internet is not the norm. And second, this is an extremely emotional issue. Most of us have stories about people who have been hurt by not having access to health care. And it is a lot more complex, with more moving parts, than any issue we face as a nation.

I spent some time with Newt Gingrich this Wednesday. He seems to me surprisingly upbeat about the potential for solutions to the health-care issue. He points out that there are some amazing medical advances just around the corner. A cure for Alzheimer’s would save, according to Newt, about $20 trillion over the coming decades. Cancer? Heart disease? My friend Pat Cox suggests we are on the edge of a tsunami of medical breakthroughs.

But we have been seemingly on the edge for a long time. As I wrote a few weeks ago:

Let’s look down the road. I think we will at best be in a Muddle Through Economy for the next two years. Unemployment is going to be above 8%, best-case, in 2012. If the Bush tax cuts are not extended, in my opinion it is almost a lock that we go into recession next year, unemployment goes to 12%, and underemployment gets even worse. That is not a good climate for Obama and the Democrats in 2012. It is especially bad when you look at the number of Democratic Senate seats up for re-election that are in conservative states. The Republicans could take a serious majority in the Senate.

And then what? Right now Republicans are running on promises that they will not cut Medicare and Social Security, but are going to reduce spending and get us closer to a balanced budget. But everyone knows that the only way to get the budget into some reasonable semblance of balance will be to either cut Medicare benefits or increase taxes.”

Read the rest of this entry »

Positives

1) UoM confidence rises to 5 month high
2) Initial Jobless Claims 4 week avg falls to lowest since Sept ’08
3) NFIB small business optimism index rises almost 3 pts to best since May
4) Wholesale Inventories jump more than expected, good for GDP
5) Global criticism of Fed’s money printing exercise

Negatives

1) Consumer 1 yr inflation expectations rise to 3%, most since June
2) 30 yr bond auction very weak, yield rises to 5 month high, 10 yr yield at two month high, avg 30 yr mortgage rate rises to one month high, has Fed lost QE2 war before it really began?
3) Chinese stocks slammed on inflation and rate hike fears
4) PIG debt blowing out, Spain and Italy also see rise in yields, pressure for Ireland to tap EFSF grows
5) From equity contrarian view, individual investor’s most bullish since Jan ’07
6) Wholesale Inventories rising, unwanted inventory?
7) CSCO disappoints, co specific or not?

In 1914, John Alexander Smith, Professor of Moral Philosophy at Oxford, addressed the first session of his two-year lecture course as follows:

“Gentlemen, you are now about to embark on a course of studies that (will) form a noble adventure…Let me make this clear to you. ..nothing that you will learn in the course of your studies will be of the slightest possible use to you in after life – save only this – that if you work hard and intelligently, you should be able to detect when a man is talking rot, and that, in my view, is the main, if not the sole purpose of education.”

That quote reminds me of the famous Joan Robinson line: “The purpose of studying economics is not to acquire a set of ready-made answers to economic questions, but to learn how to avoid being deceived by economists.”

California is a strong brand, the state of new beginnings, dreams and movie stars, of surfers and a wonderful climate. But the Golden State is bankrupt and the city of Los Angeles is running out of cash. Public services are being cut and unemployment keeps rising. At the same time, optimism, entrepreneurship and the belief in the power of America are stronger than ever.

In Los Angeles, we meet five people who are going through a transformation in their lives during this crisis. Justin and Christine lost their jobs and are now living in a van with their two young sons. Charles has gotten out of prison after fourteen years. Mizuko prepares her children for the future by making them at ease in virtual reality. Laura has taken advantage of the crisis by buying land cheaply and starting an urban farm and artists collective Fallen Fruit maps the abundant free ‘public fruit’ available in the city. Who are the pioneers who are reinventing the new America and how do they see the future?

The 1st look at Nov UoM confidence was slightly better than expected at 69.3 vs the consensus of 69. It’s up from 67.7 in Oct and the best reading in 5 months but remains below the best figure of the year, 76 back in June. Most of the gain was in Current Conditions which rose by 3.1 pts to 79.7 with the Economic Outlook up by less than 1 pt to 62.7. The survey captures the strong market rally of late, Fed action, the elections and the improving level of initial claims. The most interesting aspect of the report was the jump in one year inflation expectations which went from 2.7% to 3%, the most since June. This squares with the weekly news of late from companies that are raising prices to help offset the rise in their commodity costs. One of the most high profile consumer costs of them all in terms of what’s seen everyday, gasoline, is up to an average of $2.88 per gallon as of last night according to AAA. That’s a 6 month high.

By now you’ve heard about the $63 million Warhol, the $69 million Modigliani and the $43 million Roy Lichtenstein paintings that sold in the past two weeks. You probably didn’t know that a Chinese vase sold for £53 million (that’s more than $75 million) yesterday in a provincial English town.

Either way, it wasn’t hard for you to conclude that the art market is back in a big way.  The two-week agenda-setting New York sales that just concluded did $1.25 billion in turnover. That’s not as much as the height of the art bubble in 2007-2008 but back around the run-up levels of 2006. (For more charts see artmarketmonitor.com)

We’re all adults here, so I don’t have to explain to you that there’s nothing immoral or offensive about works of art trading on a regular basis for eight and nine figure sums. But since that is a common reaction to big numbers in the art world, let’s remind ourselves — and everyone else — that no wealth is created or destroyed by the art market.

The art market is a simple distribution and exchange machine. When a Chinese billionaire pays someone $75 million  for a dusty old piece of bric-a-brac, as just happened in the UK, the recipients are free to use that money to build a school or hospital, support their favorite charity or simply pay some taxes.

The big knock on the art market is the obscenity of the sums but in these fiscally strapped times we should be rooting for more of these transactions because each triggers a capital gains tax payment. With the three important estates being sold at Christie’s this week, there would also be a fair amount of death duty coming to the government if Congress could ever sort out the appalling situation surrounding estate taxes.

So the question about the art market isn’t whether it is a sign of decadence but a financial one. Why are buyers so eager to trade cash for objects? There the answer is relatively easy to see.

The low interest rates being used to heal the world economy after the debt crisis have created a thriving art market as a by-product. Blue-chip art is no different from gold. It’s equally useless and almost as universally valued. So with gold making new highs at $1400, it should surprise no one that art prices for recognized and fairly fungible artists like Andy Warhol are back at the levels (or beyond) of the art boom of 2007-2008.

Art is like real estate, highly sensitive to interest rates. Unlike real estate, there’s very little leverage in the system. You buy art with cash. What leverage there was in the system got squeezed out over the last two years of pain.

It used to be that your money was trapped in the art because transactions were few and most owners hoped to donate their art to a museum where they’d realize the value in a tax break and ego boost. But the first decade of the new century has seen the emergence of a deeper, broader, faster and more frenetic art market where buyers can find sellers faster and better than ever before.

Plunking $20 million into a Matisse is no longer a means to decorate your fabulous house, acquire a trophy of your success or show off your worldly sophistication  and taste, though it still accomplishes all of those. Buying that Matisse is now a half-decent store of value.

Let’s take an interesting example from last week. This painting (left) by Matisse was purchased in London at the height of the height of the credit bubble in June of 2007. The buyer paid £11 million or $22 million at the exchange rate of the time.

In the old days of the art market, you would be stuck with a work like that for a generation. Sales are said to be driven by work that’s “fresh to the market,” which is auction-house speak for a once-in-a-lifetime opportunity (so make sure you’re money-market account is topped off.)

These days, a good painting is a good painting no matter when it is sold. With many new buyers coming into the market, especially new money from China that’s hoovering up everything in sight even without the Yuan having had to appreciate, there’s always someone to sell your quality work on to.

That’s what happened with the Matisse. Whoever bought it 2007 needed to get their money out in 2010. We know this because they took a risk in putting the work back on the market. Sotheby’s estimated it far below the original selling price the auction house achieved in London. The market maker was signaling the sellers expectations: make me an offer!

The painting could have easily sold for $12 million which would have been quite a loss for the buyer who paid more than $20m three and a half years ago. That’s how we know he was in a desperate bind or at least valued cash over the painting at whatever level he could acquire it.

Risk, however, can get rewarded. When the hammer sounded at the end of the bidding at Sotheby’s, the seller was getting $18.5 million. Then came the currency play. Because the pound has dropped so far since 2007, that $18.5 million works out to slightly more than £11 million. Not only did the owner who briefly held the Matisse get out alive, he or she made a small profit.

Shortly after the buyer acquired the Matisse in 2007, the S&P hit a double top of 1550 in July and October. Had the same $20 million gone into an index fund, it would be worth $15.4 million today even with the same reflation-backed Fed boost.

This is an isolated example. But it does illustrate the temptation to use art to store value in a chaotic economy. The majority of buyers these last two weeks are not thinking of the art as a safety deposit box. But it can’t ever be totally out of mind.

If things go South again, especially here in the US, art offers one final advantage. It’s portable wealth that’s not subject to currency controls. If you’re very rich, you can ship your art to Switzerland, London or Singapore to be stored in a state-of-the-art facility and not have to worry about the Feds tracking it as funds.

Believe it or not, that’s where the majority of art ends up these days, sitting in storage waiting for the right time and place to be shown or sold.

Since so many of you have asked: These funds are getting mangled on expectations of — All Aboard! Munis and California joining Ireland on the default train.

Even the general Muni funds have lots of California Exposure

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PIMCO Municipal Income Fund II

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PIMCO California Municipal Income Fund II

Nuveen Municipal Value Fund

Chinese stocks and the rest of Asia did not respond well (Shanghai index down 5.2%) to the 4.4% rise in Chinese CPI and the faster than expected loan growth in Oct as it spurred fears that the PBOC will quickly respond with another interest rate hike. While most of the rise in CPI was due to food prices, the nominal per capita income of the Chinese people is only $3,700 so inflation must be tamed there. Positively today, bond yields in Ireland, Portugal and Greece are lower after the G20 said any new, permanent EU bank bailout vehicle would only come alive in mid ’13 and there would be no change in terms for existing debt, only for new, incrementally issued debt. The euro is bouncing in response even though Q3 GDP for the Euro zone was a touch below expectations as growth in Germany, France, Italy and the Netherlands missed the mark. Greece’s GDP q/o/q contracted for a 9th straight quarter but not as much as expected.

Gordon Long has an interesting graphic on what he describes as the New Economic Cycle.

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Quite fascinating . . .

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Source:
We’ll Need The Courage Of Our Forefathers
The New Economic Cycle
Gordon T. Long
The Automatic Earth, November 8 2010
http://theautomaticearth.blogspot.com/2010/11/november-8-2010-well-need-courage-of.html

Hat tip Druce

http://www.slideshare.net/padday/the-real-life-social-network-v2