It's been sixty-three years since I last sat in a classroom as a student. For an additional fifty-five years, I was a teacher; in the absence of any correspondence to the contrary, I believe I am still listed on the faculty of two medical schools. Socratic teaching is now nearly universal, but I only got a smattering of it as a student. I hated it then, and I grumble about it, still.
Just about the only thing I remember about my experience in fourth grade is the following question by the teacher: "Argentina grows wheat. Now, class, what does Argentina grow?" I refused to answer such a question.
It would be another ten years before I had a chance to read some Socratic dialogues, finally recognizing that many of the questions Socrates asked of his students were sarcastic, and even a few of his answers were mocking. After all, Socrates was judged a rebel and executed for promoting subversive thoughts among young and therefore impressionable students. The dialogues are not demonstrations of how to teach a class, they are semi-theatrical depictions of Plato's recollections of Socrates, heavily edited for the purpose of defending his reputation. The main modern criticism of Socrates is not that he made students squirm, but that he relied so exclusively on logic and reasoning. The truth of his teaching was based on plausibility, not testing and proof. Such pontification today would be viewed with skepticism; at most, it would be described as relying too heavily upon secondary sources, because there could certainly be no reference to primary ones. How would I know what Argentina grows? Or, for that matter, how do you know? One really has to pity that poor tormented teacher.
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Method
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One has less sympathy with current medical school faculties of New York City, who have largely taken up a denatured version of what they imagine was the Socratic Method, and which their students openly refer to as teaching by coercion. One swaggering professor ended his dialogue with one of my classmates, who in fact later won the Nobel Prize in Medicine, with the finale, "You won't forget that, will you?" To which the future Nobel laureate replied, "Sir, I won't forget you." And another somewhat less distinguished classmate was cringed beside the locked door of the examination room, studying notes right up to the last moment before a final exam. "Well, Levy," boomed the same professor, "Do you know everything about Rheumatic Fever?" To which was made the immortal response, "Sir, no one knows everything about rheumatic fever." By the time they get to be seniors, medical students are famously independent-minded, and they can give back as good as they get. So, one pities that professor less than that fourth-grade teacher, but questions the methodology more. One other mocking description the irreverent medical students give of it is: "Well, what am I thinking, today?"
Let's change the scene to cable television, to a continuous live presentation of current history called C-Span. Once a week, some famous teacher from anywhere in the country is depicted giving a real college seminar. One can easily imagine the editor of this program, with essentially unlimited budget, seeking out the best teachers in the best educational system in the world. On the evening in question, one charmingly pert young lady was performing on a topic I now do not recollect; it was, however, perfect Socratic dialogue. No matter how preposterous the answer, no student was ever wrong about anything. Encouraging smiles urged the student to try again, or stand aside for a classmate eager to recite. Like Molly Bloom, the teacher's responses were, "Yes, yes, yes".
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Socratic Diagram
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Within a few minutes, two seemingly unrelated mysteries got clarified somewhat. A possible explanation of the self-assurance of the "x" generation began to suggest itself. Those children of silent, withdrawn parents had been encouraged to believe their spontaneous instincts were oracular, as a way of encouraging the shy to assert themselves. Ten or twelve years of Socratic, "Yes, yes, yes" had half-convinced a sizable minority that their views were those of unsullied vestals, clearly to be preferred to those who relied on that famously undependable source, experience. It can take four or five years to recover. And watching TV another mystery seemed to expose some of its roots. For some years I have marveled at the manner of academics in charge of a meeting of peers. Ever since Thomas Jefferson presided over the unruly Senate at Sixth Street in Philadelphia, the Parliamentary rules have been strict: the chairman only votes to break a tie, and absolutely never engages in partisan debate. Yet repeatedly one watches these lovely people, often close friends, riding rough-shod over colleagues in a debate. Suddenly while watching TV focus on the best of them, some glimmering of understanding begins to emerge. The teacher states the proposition, asks the question of the audience, and hunts for someone to give the right answer. If the question is amended, it is referred to a committee which will think about it. If someone voices the right answer, it is cheered as having closed the topic to further discussion. Very few votes are ever taken.
It's impossible to crawl inside the heads of people, even your friends, and pick out their motives. But now, the Socratic skeptics at least have some idea where all this is coming from.
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Joseph Wharton
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I grew up in Pittsburgh, where they kept the street lights on all day for several days each year. So I'm well aware of environmental issues, and the dangers of neglecting them. At one time, the forks of Ohio were world famous for their beauty and now look at them. Furthermore, I know the story of Joseph Wharton, after whom the Pine Barrens were named because he owned them. Mr. Wharton wanted to pierce the Pine Barrens with drill holes down to the so-called Cohansy aquifer of the purest water known to man. Wharton planned to pipe the water over to Philadelphia, but even then there was enough public outcry to stop it. No doubt we ought to have experts thoroughly examine the matter before we permit the destruction of that neighborhood jewel.
But the Alaska Wildlife Preserve and the fate of the grizzly bears, now really, should that really be a concern of the New Jersey legislature? Really, give me a break. We have plenty of local concerns that the New Jersey Legislature might actually do something about. Like sending a doctor to the legislature to speak for the interest of the patients, amidst all of the confusion of rather vague healthcare reform. The plan seems to be to put the uninsured into Medicaid, the most rickety, underfunded program in American medicine. When those people discover what Medicaid is like, there's going to be an uproar of some kind. That will probably lead to hasty re-adjustments, and someone has to speak out about the effect on patients, from the program or the reaction to the program, or both. For that, I'm your man.
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Notions of Immortality
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When we are children, we have childish notions of immortality. Perhaps we still nourish them for lack of replacement, busying our thoughts with premature death, instead. Most of us forget the dreams of robbing candy stores or marrying a princess, and never bother to replace them. After all, everyone has to die, don't they?
So put it this way: we now have semi-realistic plans to end our lives with a thirty-year paid vacation, but what can be said about a fifty-year paid vacation, or even a hundred? Life itself is degraded by seventy years of loafing, as those who could afford it will tell you. All notions of purpose to life eventually disappear. No longer defining ourselves as soldiers and housewives; we're just cats, dogs and lice. And all our yesteryears have lighted fools the way to welcome death. As that day approaches, it will be marked by waves of awesome but fruitless literature. The Calvinist worship of work gets the last laugh of the comedy.
Subsequent generations of would-be hedonists have certainly given Calvin a hard time. Harder, in a way, than dunkings and pillories. Perhaps harder even than burning at the stake, because Calvinists had the audacity to get rich and comfortable by their effrontery. Perhaps poor and comfortable is better, and comfortable is the real goal, as Quakers were executed for advising. Once you get over the ambition to be King, what else is there?
The Affordable Care Act was announced as mandating health insurance for everyone, but about thirty million people were specifically excluded. The healthcare problems of seven million prison inmates, eight million unemployable, and eleven million illegal immigrants were too specialized to be included in a program which hoped to be one-size fits all. Quite properly, such special outliers would be better handled by special programs designed for their special needs.
The Affordable Care Act (ACA) is now central to Administration attention, and Medicare may be deemed too hot to handle in an election campaign. Nevertheless, we elected here to discuss Medicare but not the ACA. Retirement, childhood, and how to unify complete the list--pretty much all that's left surrounding, but excluding the ACA, election or no election. That emphasizes what had been evaded or neglected, and avoids direct confrontation with the ACA, preparing for the day when that big gorilla is either confirmed or abandoned. It's obviously too expensive, and it remains to be seen whether it can be fixed, or must be abandoned. In our alternative scheme, all of the lifetime healthcare would be financially connected to a single lifetime Health Savings Account, one account per person, but the delivery systems would remain semi-autonomous. ACA could surely live in peace with the HRSAs, and could even peacefully adopt the HSA approach. That would save money, but the questions left are whether it would save enough to be worth the trouble, and whether politics will allow it. Like the European Union, it's surely easier to describe than to accomplish.
Retirement as a Medical Issue. The news is precarious for retirement funding. We begin with the far end of life, where most health cost and all retirement cost concentrates. While retirement is parallel in time to Medicare, we begin to recognize increased longevity as an outcome of better health. If one is to help pay for the other, they must, in the Medicare case, draw their funds from the same pool. That's Medicare, which most people don't want to change, but is the first thing which must change. Because unchanged it costs too much to leave anything for retirement.
Although the Industrial Revolution brought many lifestyle improvements in the past two centuries, it also brought turmoil. The idea of leisure time may once have been a reward for the upper 1%, but actually, most of the population never dreamed of any leisure time. The novels of the "Lost Generation" after the first World War often revolved around the discovery of unfamiliar leisure pursuits by members of social classes newly learning about such things. The moral, then and now, seems to be that leisure is no bed of roses.
We must assign a reasonable definition to a "decent" retirement, provide for a marginal one, and leave the rest to our own sources of wealth.
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The cultural response seems to be that leisure was best reserved for retirement, although the younger generation sometimes rebelled, wanting some of it sooner. In any event, Medicare surely extended retirement longevity. (Overextended it, if you believe it will be impossible to pay for.) After all, retirement is a continuous cost, while illness is episodic. There are ways of calculating costs which depict retirement as five times as expensive as healthcare. But Medicare cost averages thirteen thousand dollars a year and rising. That's a pretty meager retirement, and when you discover Medicare is 50% borrowed, you question how many people could retire on $26,000 a year per person, on public sector revenues. If you see retirement as a couple of old folks, you wonder where they would get $52,000 a year, for thirty years. Add Medicare to retirement, and you begin to get absolutely impossible numbers. There seems no possible way to handle this except to provide for subsistence retirement, plus Medicare, and let everyone find some way to get whatever extra he needs, or defines as "decent". And that defines retirement cost as equal to medical costs when both costs could rise appreciably. The Health Savings Account method of accomplishing this is to put retirement at the end of the financial line, funded by the residuals of the other pearls on the string. You keep what's left. Another way is to retire later, or best of all, find some remunerative way to fill your time and use your experience.
Medicare As a Financial Issue. Medicare is about half paid-for, half borrowed, but it's really totally under water. According to Mrs. Sibelius, about half of Medicare expenditures are supported by the general fund or general taxation. The general fund is in deficit, however, providing some fairness to the description of Medicare as a fund borrowed from the Chinese, although China and Japan combined only purchase 13% of ten-year Treasury bonds. In the event of Medicare default, the main creditor victims will be U.S. citizens. The purchasers may change, but the deficit looks to be permanent. Until deficits are paid off, it will remain true that Medicare provides a dollar of care for fifty cents. That sounds wonderful until it suddenly sounds terrible. Medicare is bleeding money. If you want to know how brutal our government can get, read the section later on, about the Diagnosis Related Groups.
About half of the Medicare deficit is paid as you go, about another half is borrowed; only a quarter of the budget is current revenue from the beneficiary age group.
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An accountant might say, Medicare's cash revenue is roughly divided between premiums paid by the beneficiaries, and pre-paid as a payroll tax of 3% on workers not yet old enough for benefits. (About half of this wage tax comes directly from the employee, another half from the employer. We skip over the technicalities that some parts of the program are tied to one fund, other parts to another, and also some are subject to higher income tax). About a quarter of Medicare is paid in advance on a "pay-as-you-go" basis, which is to say some people pay current costs of other people -- they are definitely not saved in anticipation of the contributors becoming beneficiaries, as the term "Trust Fund" implies.
A second quarter is indeed paid and spent by current beneficiaries as Medicare premiums. That is, about half of the deficit is paying as you go, another half is borrowed from foreigners; only half of the deficit is matched by current revenue from the beneficiary age group. Nevertheless, the payers of pay-as-you-go are about thirty years younger than the spenders of it. If we put the youngsters' cash to work for thirty years, what interest rate would it take to grow one dollar into three? The answer is about five to seven percent. For quicker understanding, a few unfamiliar tools are needed:
First and Last Years of Life Re-Insurance By far the best proposal for refinancing Medicare, however, is to anticipate the way science is going to re-design costs. In the long, long, run, there should be very little medical cost left, except for the first and last years of life. We have no idea how long it will take, but that's the direction things are almost sure to be going.
So, phase in a restructuring of funding for both children and elderly first, and then add in the rest of a lifespan, step by step. That way, you first fund an obligation you are always sure to have. Be sure to do it in such a way that maximizes the investment income at compound interest. This might be a project under construction for decades, but its first step would be to begin funding for the Last Four Years of Life, which happens to be an early proposal in refinancing Medicare. Since the reader may be unprepared for the topic, it is considered in a free-standing way, in the next section.
Pay at the time, or pre-pay in advance?> At first, it might seem frugal to have people pay for what they spend; let them pay for what it costs, when you know who ran up the cost. But in the case of birth and death, it's going to be 100%, and the amount of it is a lottery. By far the more important issue is the compound interest you earn by paying in advance. Using the rule of thumb that money at 7% will double in ten years, a life expectancy of 90 should double 9 times from birth to death. That is, a dollar at birth is worth $512 at death.
What's more, 50% of Medicare is reported to be spent in the last four years of someone's life. That's likely to represent terminal care, but it doesn't matter. If you prepay those four years, the rest of Medicare has its cost cut in half. In those two simple statements is found the nut of paying for half of Medicare for $100 -- ninety years from now. It's up to actuaries and accountants to find the "sweet spot", of the most revenue enhancement for the shortest time of investment.
“There is no barrier for U.S. Treasury yields going below zero. Zero has no meaning, besides being a certain level.”
–Former Fed Chair ALAN GREENSPAN in August 2019
“I am not a fan of low interest rates, as a great believer in the importance of savings in the economy. Subsidies to debtors and penalties for savers, I think in the long term harms the economy.”
–Credit Suisse CEO TIDJANE THIAM
“It is hard to imagine a more stupid or dangerous way of making decisions than by putting those decisions in the hands of people who pay no price for being wrong.”
–DR. THOMAS SOWELL, former Forbes columnist and acclaimed author
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INTRODUCTION
For over 30 years, I have read every Barron’s Roundtable edition interviewing many of the world’s foremost money managers. Past and current members have included Peter Lynch, Mario Gabelli (still a participant), Bill Gross and, though not nearly as well known, one of the best stock pickers extant, Meryl Witmer. Accordingly, it was with great pleasure that I discovered a former member of the esteemed cohort is also an EVA reader.
He had emailed me about our “A Blast From A Bubble Past” EVA back in June that discussed the raging mania in the IPO (Initial Public Offering) market. He was most complimentary about that chapter of our “Bubble 3.0” series and he particularly enjoyed the vignette about our tennis ball-swallowing dog who turned up his big, wet nose at a Beyond Meat burger patty.
Then, in July, I asked him what he thought about the next chapter, “The Post Retirement Society” and especially my rant against the bizarre phenomenon of negative-yielding bonds. While his comments were generally positive, he did make a case that bonds an investor has to pay to hold aren’t totally deranged. His point was that if enough people are really worried about another monstrous deflationary bust along the lines of 2008, then it isn’t completely illogical to pay the German government a small amount each year to hold a genuinely risk-free security. He’s far from alone.
On that score, do you know what the fastest growing asset class is this year? That would be bonds with negative yields. In fact, 30% of the planet’s securities now “sport” negative interest rates. Further, with each passing week there seems to be another trillion added to the total which now amounts to around $17 trillion. As a result, 95% of the planet’s investment grade bond yields are made in America. Essentially, the rest of the world has gone yield-free, at least on high-quality debt. And this is before the upcoming grand finale by European Central Bank chief Mario Draghi next month. Mr. Draghi, who is stepping down at the end of this year, has made it disturbingly abundantly clear that he intends to go out with a big bang of monetary pyrotechnics. This has the very real potential of forcing eurozone yields even deeper into the red.
This week’s edition of our Guest EVA is, once again, courtesy of my long-time friend and investment newsletter legend John Mauldin. As many EVA readers are aware, his weekly “Thoughts from the Frontline” is free and yet it frequently contains financial insights every bit as profound as those available from high-cost sources. (You can subscribe via this link.) John also does his own version of a guest newsletter which he calls “Over My Shoulder”. His most recent, written by Thorsten Polleit of the Mises Institute, is dedicated to what the author refers to as “The Disaster of Negative Interest Policy”.
As he points out, one of the reasons why negative yields have been spreading like a highly contagious virus on a cruise ship is that they allow debt-addicted governments to finance their enormous obligations at either basically zero or, astoundingly, sub-zero. As he writes, “running into debt becomes a profitable business, and financially ailing states and banks can reduce their debt burden at the expense of creditors”.
In Denmark today, it is possible to take out a mortgage that pays the borrower each month! As Mr. Polleit also notes: “If anyone can suddenly get a loan with a negative interest rate, then it is to be expected that credit demand will get out of hand.” And a bit later: “The low interest rate policy facilitates a spectacular inflation of prices in the asset markets; a gigantic speculation bubble is pumped up.” One certainly doesn’t have to look any further than the crypto currencies or new-issue US stocks to witness this effect.
He also astutely articulates the deleterious impact negative yields have on savings and investment decisions. As these pages have frequently observed, hundreds of millions of Baby Boomers worldwide are waking up to the terrifying reality of not being able to earn an adequate return on their portfolios. This causes them to spend less and save more – an economic irony John Maynard Keynes coined as the Paradox of Thrift – which is pretty much the opposite of what the central banks are trying to achieve.
As always, there are winners and losers from misguided policies. A glittering star this year has been gold which is now up 20% and gold mining stocks are up an even more impressive 42%. It wasn’t long ago the miners were even more out of favor than energy issues are now. Evergreen was one of the few touting them at the start of the year as beneficiaries of negative yields. US bonds, of course, have also produced outstanding gains this year with the 10-year T-note having posted a total return of 11.5%.
Yet, frankly, the list of losers is considerably longer, particularly once artificially inflated asset prices begin to crack, as many have started to do. Moreover, the truly “Fearmaggedon” scenario would be a global recession with central banks already in max stimulus mode—and then some. Not to worry, though; according to Ned Davis Research the probability of a global recession is only 96%. Now, don’t you feel better?
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THE DISASTER OF NEGATIVE INTEREST POLICY
By Thorsten Polleit
Those who had hoped that things could not get worse with the monetary policy of the European Central Bank (ECB) have been proven wrong. At its last meeting on 25 July 2019, the Governing Council of the ECB kept interest rates unchanged: the main refinancing rate was kept at 0.00% and the deposit rate at -0.40%. At the same time, however, ECB President Mario Draghi has prepared the ground to lower interest rates even further in the coming months. What is the reasoning behind that?
According to the ECB Governing Council, inflation is too low, and the euro area economy is too weak. It was precisely this assessment that signaled to the markets to expect a rate cut in the near future. It has now become very likely that the deposit rate will be lowered by 0.2 percentage points to -0.60% at the next ECB meeting in September; and the main refinancing rate could drop to -0.20%. The continued path into the negative interest world, however, has quite dramatic consequences.
The Essence of the Interest Rate
This becomes clear when considering what the interest rate stands for. In short, it represents the value discount that a later satisfaction of a want suffers compared to an earlier satisfaction of the same want (under otherwise identical circumstances). The “pure” or “originary” interest rate is positive — always and everywhere. It cannot disappear, it cannot go to zero, let alone fall below the zero line; the logic of human action informs us that the pure interest rate cannot be thought away from human actions and values.
However, there is the “new negative interest rate theory,” saying that the “new natural interest rate” — or: the “social pure interest rate” — has become negative. And while this theory is wrong, it has already found its way into monetary policymaking; presumably because it is highly attractive to the state and those groups closely associated with it because if the central bank forces interest rates into negative territory, running into debt becomes a profitable business, and financially ailing states and banks can reduce their debt burden at the expense of creditors.
The fact that many market interest rates in the euro area are now in the negative range is by no means an evidence of the validity of the “negative interest rate theory.” Market interest rates are manipulated to the core. They are dictated by central banks — and not just the short-term, but also the long-term interest rates: The monetary authorities buy debt securities, thereby increasing their prices and lowering their returns. That is why many interest rates have become negative; it is not a “natural” development; it has been orchestrated by the ECB.
Negative Interest for All
Is it conceivable that in the euro area consumer-, home construction-, and corporate loans will soon be offered at a negative interest rate? Yes, it is possible, indeed. To illustrate how this could occur, we assume that euro commercial banks get credit from the ECB for minus 2% per annum: Banks borrow 100 euros, and after one year, they pay 98 euros back. So the banks easily reap a profit of 2 euros. However, the ECB will let the banks only borrow at negative interest rates under the condition that they lend the money.
To stick with our example: A bank borrows 100 euro for one year at minus 2% per year from the ECB. It lends the money to consumers at, say, minus 1% (giving them €100 and getting €99 back after one year). Overall, the bank makes a profit of 1 euro: It earns 2 euros by borrowing from the ECB while losing 1 euro in the lending business. A twisted world, and it does not bode well for the prosperity of the economies.
The Way into the Planned Economy
If anyone can suddenly get a loan with a negative interest rate, then it is to be expected that the credit demand will get out of hand. To prevent this from happening, the ECB will have to resort to credit rationing: It determines in advance how many new loans it wishes to hand out, and then allocates this amount of credit. The credit market no longer decides who gets what and when and on what terms and conditions; those decisions are made by the ECB.
According to which criteria should loans be allocated? Should anyone who asks for credit get something? Should employment-intensive economic sectors be favored? Should the new loans only go to ‘the industries of the future’? Should weakening industries be supported with additional credit? Or should Southern Europe get more than Northern Europe? These questions already indicate that the planned economy is established through a policy of negative interest rates.
More than ever it will be the ECB that reigns over credit: It will effectively determine what will be financed and produced and where and when; it will determine who will be in a position to buy and consume on credit. As a central planning authority, the ECB — or the groups that greatly influence its decisions — determines everything: which industries will be promoted or suppressed; which economies are allowed to grow stronger than others; which national commercial banks are allowed to survive and which are not. Welcome to the planned economy in the Eurozone!
Speculative Bubbles
But that is not enough. The process toward ever lower interest rates drives asset price inflation: Stocks, houses, and land — everything becomes more expensive. Because the lower the interest rate, the higher the present value of future payments and thus the market prices of assets. The low interest rate policy facilitates a spectacular inflation of prices in the asset markets; a gigantic speculation bubble is pumped up.
This initially offers investors high returns. At the same time, however, the future yield prospects worsen. This can be explained as follows: Zero interest rates make investors bid up the prices of stocks and houses until the expected future returns of these assets are close to the zero interest rate set by the central bank. In the extreme case, when the central bank sets negative interest rates, expected market yields can even fall below zero.
Once central bank policy has succeeded in pushing all returns to or below zero, the free market economy is about to end. Without a positive return in sight, saving and investing stops: Because acting man has a positive originary interest rate, it no longer pays off to save and invest. The division of labor economics comes to a shrieking halt. Replacement and expansion investments will no longer take place. Capital consumption begins, and the modern economy falls back into a primitive subsistence economy.
The End of the Free Society
The monetary policy of zero and negative interest rates — if it is consistently thought through — leads to the demise of (what little is left of) the free society as we know it in the Western world. The destructive effects of a negative interest rate policy are not immediately obvious to most people, because the path toward negative interest rates may be accompanied by an artificial economic upturn that gives the impression that the economy looks good, even though it effectively lives off its substance.
Only gradually, the damage becomes visible. Economic growth is dwindling; political conflicts over income distribution are increasing; the state becomes more and more powerful; the degree of freedom for citizens and businesses decreases; and at some point, asset prices collapse and the bubble bursts as economic performance becomes increasingly impaired: Companies make less profit, jobs are lost, and consumers must rein in their demand.
All this leads to economic impoverishment and, most likely, eventually to political chaos. The negative interest rate policy proverbially cuts off the branch on which the welfare democracy of the Western world is sitting. The harmful consequences of a negative interest rate policy are already clearly visible today. If central banks are not prevented from pushing interest rates to zero or into negative territory, this will turn out to be one of the greatest tragedies of our time.
Originally the "lower counties" of Pennsylvania, and thus one of three Quaker colonies founded by William Penn, Delaware has developed its own set of traditions and history.
Start in Philadelphia, take two days to tour around Delaware Bay. Down the New Jersey side to Cape May, ferry over to Lewes, tour up to Dover and New Castle, visit Winterthur, Longwood Gardens, Brandywine Battlefield and art museum, then back to Philadelphia. Try it!
Millions of eye patients have been asked to read the passage from Franklin's autobiography, "I walked up Market Street, etc." which is commonly printed on eye-test cards. Here's your chance to do it.
In 1751, the Pennsylvania Hospital at 8th and Spruce was 'way out in the country. Now it is in the center of a city, but the area still remains dominated by medical institutions.
Grievances provoking the American Revolutionary War left many Philadelphians unprovoked. Loyalists often fled to Canada, especially Kingston, Ontario. Decades later the flow of dissidents reversed, Canadian anti-royalists taking refuge south of the border.