Recent articles on the specter of stagflation are right on. What is not made explicit is the cause of stagflation: the Federal Reserve. Since its creation in 1913 when the federal government nationalized our money supply, we have allowed the hand of politicians inside the cookie jar of easy money. As expected, they can’t stop eating.
The root cause of stagflation has been known for over a hundred years. As the Fed creates money out of thin air to finance politicians’ expenditures, prices must increase (inflation). Printing of money also causes a reduction of the interest rate below its natural level. The natural rate of interest is not controlled by the Fed but is controlled by the proportion of income consumers save versus what they spend. The more they save, the lower the natural interest rate, the higher the level of investment, the higher the productivity of labor and the higher the level of economic prosperity. But an interest rate artificially below what real savings rate supports gives investors, entrepreneurs, businesses, banks and homeowners the wrong economic signal: projects that would not have been profitable and would not have been started now become viable, at least for a while. But the inevitable correction necessary to liquidate all of these malinvestments always come because the distorted capital structure in the economy is not supported by real savings. Instead, the capital structure is supported by nothing, by thin air, by paper money. As this paper money flows from the Fed to the central government to banks to businesses and finally to consumers in the form of higher wages and as consumers save at their natural rate rather than the higher rate implied by the artificially low interest, they spend more on consumer goods and less on savings. As the economy grapples with an amount of consumer savings that is insufficient to support the total investment in capital to which business and entrepreneurs are committed, like a pyramid scheme, those now unprofitable capital projects on the bubble collapse (it could be investments in the stock market, businesses, dotcoms, mortgages, whatever) and are liquidated (recession).
If at the same time that the bubble bursts the Fed accelerates the money printing machine, as it is doing now and as it did back in the 70’s, we get a recession caused by manipulation of the interest rate with inflation caused by printing money (stagflation). Boom and bust cycles and inflation are not inevitable characteristics of capitalism free from government intervention. But these cycles are the predictable consequence of the actions of the Federal Reserve. Politicians cannot fix the mess they got us into by printing more money and lowering interest rates because that was the cause of the mess to begin with!
The only way to manage our politicians’ addiction to the cookie jar of paper money is to smash their jar once and for all: dismantle the Federal Reserve, privatize our money supply and bring back the gold standard. Until politicians can figure out how to create gold out of thin air, the gold standard is the only way to force stability on our supply of money and the only way to stop them from causing inflation and recessions. Plus, it is the only way to keep politicians at the federal level honest: with their ability to get their hands in the cookie jar gone, they would be forced to increase taxes rather than print money in order to finance federal expenditures, just like state and local governments are forced to tax to spend. This was one of two critical elements of the vision for sound money of our Founding Fathers (the other one was to severely restrict the ability of the federal government to impose taxes on individuals). Thomas Jefferson fought hard and eventually succeeded in closing down Alexander Hamilton’s federal reserve/central bank scheme. Jefferson knew that giving the power to create money to the federal government would be the beginning of the end of the American experiment. Jefferson was and still is right. I mean, if we all intuitively know that printing money is wrong for private individuals, what in the world makes us think that it is right for the Fed to counterfeit at such monumental levels?
Wednesday, February 27, 2008
Saturday, February 23, 2008
Why health insurance does not work
The object of insurance is to cover a large loss to the policy holder triggered by an event that is outside one's control. The probability of the loss caused by this uncontrolled risk and the cost associated with it must be calculable in a large group of random policy holders so that in exchange for an affordable premium, the insurance company can pay for the loss and make a profit.
Sickness combines both controllable risks and uncontrollable risks born by the policy holder. Breast cancer, for example, occurs at predictable rates in large groups of females and is beyond the control of the policy holder; therefore, it can be insured against. But routine diagnostic tests, for example, follow patterns that are influenced, at least in part, by the individual choice of the policy holder and are hence a type of risk controlled by the policy holder. The more that diagnostic tests are covered by insurance, the more that the insurance contract encourages their use and the higher the costs to the insurance company. This is the phenomenon of “moral hazard” in which the actions of the policy holder change the value of the insurance contract. Facing this type of uninsurable risk, insurance companies react by increasing premiums, copays and deductibles. There comes a point in which premiums, deductibles and copays become so large relative to the protection offered, that the covered group faces “adverse selection” and becomes non-random as healthier policy holders chose to drop out and only high cost individuals remain insured.
The only sensible system to cover risks controlled by the patient is in an environment in which fee for service dominates the market, similar to the car maintenance model. This is, of course, what we had in the US prior to the hospital and physician sponsored Blue Cross and Blue Shield and HMO plans of the 1920’s and 1930’s. These plans were the first ones to introduce first dollar coverage for risks controlled by the policy holder and, while they may have attempted to manage the business consequences of moral hazard and adverse selection, they did not understand the negative economic and political consequences that their business model would cause decades later. These consequences (enumerated below) were exacerbated by two factors. One, the prevalence of employer provided health benefits resulting from the wage and price controls imposed by the US government during WWII and the tax code which forced employers to compete for qualified personnel not via wages but via tax deductible benefits such as group health insurance. Two, the introduction of Medicare and Medicaid, modeled after Otto von Bismarck’s Health Insurance Act scheme implemented in Germany in the 1880’s. Bismarck’s plan was the first one to ever attempt compulsory social insurance. Lenin and Stalin in Russia, Mussolini in Italy, Franco in Spain, Hirohito in Japan, Hitler in Germany, Castro in Cuba, Peron in Argentina and FDR in the US, have all followed Bismarck’s model: welfare payments mandated by the state and paid for through taxation, government debt and inflationary monetary policy.
The economic consequence to the manner in which private health insurance and socialized welfare medicine are structured in the US is obvious to everyone: over utilization, high costs, high taxes, poor outcomes, rationing, price controls, adverse selection, large pools of uninsured, etc. The cause and effect mechanisms that result in these problems all stem from a pricing structure that is not the result of the free exchange between patients and providers, but the result of government intervention. Without the clear guide of prices, patients, hospitals, insurance companies and physicians cannot rationally plan their actions. The details of these mechanisms are beyond the scope of this article, but some of them are explored by this author here and here. The political consequence of this structure in the healthcare market is that industry, welfare, professional associations and business interest groups continually call for more government regulations and more medical socialism and that politicians of both parties effectively respond to those calls. Practically nobody is seriously challenging the flawed assumptions of the existing healthcare model. If anything, in the hopes that more government intervention will help save the current system, movement towards medical socialism has accelerated in the past two decades.
A sensible step towards reform away from medical socialism would be the deregulation of the private health insurance industry and allow individuals and families to deduct individual policy premiums from their income tax. Such a deregulated environment would encourage individuals to take responsibility for their controllable risks, would bring back a fee for service environment for a small but significant portion of the healthcare market and would allow insurance companies to:
Sickness combines both controllable risks and uncontrollable risks born by the policy holder. Breast cancer, for example, occurs at predictable rates in large groups of females and is beyond the control of the policy holder; therefore, it can be insured against. But routine diagnostic tests, for example, follow patterns that are influenced, at least in part, by the individual choice of the policy holder and are hence a type of risk controlled by the policy holder. The more that diagnostic tests are covered by insurance, the more that the insurance contract encourages their use and the higher the costs to the insurance company. This is the phenomenon of “moral hazard” in which the actions of the policy holder change the value of the insurance contract. Facing this type of uninsurable risk, insurance companies react by increasing premiums, copays and deductibles. There comes a point in which premiums, deductibles and copays become so large relative to the protection offered, that the covered group faces “adverse selection” and becomes non-random as healthier policy holders chose to drop out and only high cost individuals remain insured.
The only sensible system to cover risks controlled by the patient is in an environment in which fee for service dominates the market, similar to the car maintenance model. This is, of course, what we had in the US prior to the hospital and physician sponsored Blue Cross and Blue Shield and HMO plans of the 1920’s and 1930’s. These plans were the first ones to introduce first dollar coverage for risks controlled by the policy holder and, while they may have attempted to manage the business consequences of moral hazard and adverse selection, they did not understand the negative economic and political consequences that their business model would cause decades later. These consequences (enumerated below) were exacerbated by two factors. One, the prevalence of employer provided health benefits resulting from the wage and price controls imposed by the US government during WWII and the tax code which forced employers to compete for qualified personnel not via wages but via tax deductible benefits such as group health insurance. Two, the introduction of Medicare and Medicaid, modeled after Otto von Bismarck’s Health Insurance Act scheme implemented in Germany in the 1880’s. Bismarck’s plan was the first one to ever attempt compulsory social insurance. Lenin and Stalin in Russia, Mussolini in Italy, Franco in Spain, Hirohito in Japan, Hitler in Germany, Castro in Cuba, Peron in Argentina and FDR in the US, have all followed Bismarck’s model: welfare payments mandated by the state and paid for through taxation, government debt and inflationary monetary policy.
The economic consequence to the manner in which private health insurance and socialized welfare medicine are structured in the US is obvious to everyone: over utilization, high costs, high taxes, poor outcomes, rationing, price controls, adverse selection, large pools of uninsured, etc. The cause and effect mechanisms that result in these problems all stem from a pricing structure that is not the result of the free exchange between patients and providers, but the result of government intervention. Without the clear guide of prices, patients, hospitals, insurance companies and physicians cannot rationally plan their actions. The details of these mechanisms are beyond the scope of this article, but some of them are explored by this author here and here. The political consequence of this structure in the healthcare market is that industry, welfare, professional associations and business interest groups continually call for more government regulations and more medical socialism and that politicians of both parties effectively respond to those calls. Practically nobody is seriously challenging the flawed assumptions of the existing healthcare model. If anything, in the hopes that more government intervention will help save the current system, movement towards medical socialism has accelerated in the past two decades.
A sensible step towards reform away from medical socialism would be the deregulation of the private health insurance industry and allow individuals and families to deduct individual policy premiums from their income tax. Such a deregulated environment would encourage individuals to take responsibility for their controllable risks, would bring back a fee for service environment for a small but significant portion of the healthcare market and would allow insurance companies to:
- Insure primarily against uncontrollable risks
- Not insure against controllable risks, which result in moral hazard and adverse selection
- Underwrite individual policies, the practice of determining how much coverage the policy holder should receive and determining the premium
- Move away from community rating, the practice of charging the same premium to healthy people and to sick people
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