The latest surprising discovery in the 2500 pages of ObamaCare is how the rules will explicitly kill jobs. When you read the reason for this job killing, the nominal cause is a rule concerning the mechanism to provide a subsidy for people enrolling in a policy from one of the ObamaCare “exchanges”.

But one wonders if this effect, which could have been avoided,  derives from a government lust to create more dependencies on itself.

Read the analysis and explanation in Wall Street Journal, 25 APRIL 11: How Health Reform Punishes Work, by DANIEL P. KESSLER.

In this excerpt, the deadly “minimum” is revealed:

This new entitlement—which the chief actuary of the Centers for Medicare and Medicaid Services estimates will cost more than $100 billion per year once it is fully implemented—will damage the country’s long-term fiscal outlook. It also will introduce far-reaching negative effects on rewards to work and bizarre new inequities into American life.

The health law establishes insurance exchanges—regulated marketplaces in which individuals and small businesses can shop for coverage—and minimum standards for the insurance policies that can be offered. Because the policies will be so costly, there’s a subsidy for buyers that phases out as family income rises. This sounds reasonable—but the subsidies required to make a “qualifying” insurance policy affordable are so large that their phaseout creates chaos.

 

Economist Herb Stein famously said: “If something cannot continue forever, it will stop.” We now see many socio-economic systems in USA that cannot continue as they are forever, and which seem to be close to the point at which they could easily move into damaging and chaotic states. Let’s take a look at some of our favorites: But first, we need to roughly define a “Tipping Point”.

What’s a Tipping Point?

Every system has limits, including social systems. For every system there is some generalized boundary of system behavior and its use of resources that constrains system operation. When a system reaches its boundaries, some form of dramatic behavior can ensue. As systems approach these boundaries, they may cross their “tipping point.”

The “tipping point” is the state of the system at which catastrophic and usually unpredictable results emerge. For a simple, physical example, consider a sand pile. If you add sand by dripping handfuls on a flat plate, eventually you will have a cone and then it eventually takes only one more grain of sand to cause the whole pile to collapse. For socio-economic systems, people’s behaviors will change as the tipping point is neared. What will happen when these systems get close to their limits? We will make this general question more specific in several current socio-economic systems.

The Banking System Tipped

We have already seen a painful example of a system that tipped over its boundary: Banking. When people and corporations are unable to pay their debts (induced in large scale by government easy-borrowing policies), they default. Defaults vaporize money (the amount owed and not paid back), promoting deflation and breed wide distrust by lenders and leading to a freeze in economic transactions. Then government succumbs to the urge to stop the crisis by “bailing out” the biggest debtors. These government payments (effectively making money materialize) thus relieve the borrowers of the consequences of the risks they freely chose to take. Bailouts are examples of “moral hazard”, which is a condition in which risk-takers expect no unpleasant consequences since they expect to be indemnified by other People’s Money (OPM).

Systems Near Their Tipping Point

We have compiled a series of some of the more obvious social systems near their tipping points. We present them in tabular form, describing the system, a natural tipping point, and give some examples of what could happen once the tipping point is reached. This is the heart of the matter, and will affect almost everyone. We give a number for each system described, starting with Banking.

Financial

Demographic

Health Care System

State and Local Government

Foreign Affairs

The Biggest System: For How Long Can Government Itself Continue to Function so Incompetently?

People choose their governments for pretty basic reasons, such as maintenance of a legal system, operation of courts and enforcement of contracts, construction of shared infrastructures, protection from foreign invasions. Governments have naturally massively expanded beyond these basic roles, but one expects that whatever they do should at least be done reasonably well, even if not really in their charter. We are starting to see that governments have become so big they cannot successfully solve the problems they were elected to solve, let alone efficiently operate in their vast regulatory systems.

Government failures to competently manage recovery from natural disasters set off alarms, because one expects government to at least get that function right. Such management is one of the few things governments are actually required and expected to provide the tax payers.

Since the attacks of Sept. 11, 2001 (a failure of our expensive intelligence bureaucracy) the world has seen these catastrophic events and others:

• Tsunami in the Indian Ocean,
• Hurricane Katrina,
• Global flu pandemic,
• Global financial crisis
• Earthquake in Haiti,
• Oil spill in the Gulf of Mexico,
• Devastating floods in Australia and New Zealand.
• Earthquake in New Zealand
• Japanese earthquake, tsunami and nuclear crisis.

It seems that despite national governments having an uncontroversial mission to help its citizens recover from disasters, every government has been incompetent in trying to do so. This government incompetence seems evident even with the Japanese in their current crisis-the same Japanese who have the most disciplined society in the world, and who were famously meticulous in their preparations for earthquakes and tsunamis. Has government size reached a tipping point where it collapses under its own bureaucratic weight and becomes generally incompetent?

In many socio-economic systems in USA, this fear seems born out.

Want to hear a real laugher? Despite the current disharmony in politics, there’s one policy on which all of Washington agrees. Republicans and Democrats, House and Senate, president and Congress all agree that after last fall’s financial crisis, the federal government has to regulate the financial industry more closely to protect our economy from risk of systemic financial collapse.

Here’s the joke. As boom- and bust-prone as high finance always has been and remains, the greatest systemic risk to our economy is not Wall Street. It’s the growing federal debt (and weakening dollar) being enacted by those Washington politicians — the ones who want to protect us from Wall Street.

The piece was written by Tony Blankley and you can read it here.

Our financial situation is breathtakingly unsustainable. You really need to pay attention to preserve and grow your capital.

]]> http://www.rocketcap.com/the-largest-systemic-risk-to-usa-economy-our-federal-debt/feed/ 0 http://www.rocketcap.com/defeat-the-debt/ http://www.rocketcap.com/defeat-the-debt/#comments Wed, 07 Oct 2009 00:00:32 +0000 admin http://www.rocketcap.com/?p=1629 A truly excellent web site that focuses on our national debt and how to reduce it is this one:

www.defeatthedebt.com

Almost every page of the health care bill HR3200 from the House of Representatives has at least one statement that can alter your life. When those 1017 pages interact, they will produce effects not imagined by the bureaucrats and politicians who wrote this thing. The odds those unpredictable Black Swans are good for you are nil. They will hurt you.

As an example, consider this from the New York Times of 1 OCT 09 in regard to the current Medicare:

Medicare is putting in place a new policy that may sharply curtail the use of the cancer drug Avastin as a treatment for eye diseases.

But the way the bureaucratic gears mesh in this case, the move could end up costing Medicare itself hundreds of millions of dollars a year, and individual patients thousands of dollars.

What happened is that Medicare added a new reimbursement category for doctors to use for very small doses of an existing expensive drug. As the Times writes:

But Medicare has now introduced a special reimbursement code just for the smaller doses of Avastin. And starting Thursday, the reimbursement of Avastin dropped to about $7.20 for the dose typically used in the eye.

That would mean eye doctors — who purchase Avastin and then are reimbursed when using it on patients — would lose money administering the drug.

The new policy would give eye doctors a financial incentive to switch to Lucentis, for which they would be fully reimbursed even though that drug is significantly more expensive.

If doctors do shift to Lucentis, “this will have a huge economic impact on Medicare, in the range of hundreds of millions of dollars,” said Dr. David W. Parke II, chief executive of the American Academy of Ophthalmology. “Members view this as a bureaucratic decision that is maybe necessary, based on statutes, but highly short-sighted.”

This illustrates the obscenity the Congress is creating by rushing to a new, vast bureaucratic system with enormous perverse incentives and deep complexities that can only make life worse for everyone.

Read Full Article

Domestic discretionary spending amounted to $485 billion last year. With a deficit last year of $459 billion, we would have had to abolish virtually every single domestic program to have achieved budget balance. That means every penny spent on housing, education, agriculture, highway construction and maintenance, border patrols, air traffic control, the FBI, and every other thing one can think of outside of national defense, Social Security and Medicare.

This means that it is impossible to get control of spending without cutting entitlement programs. Many Republicans agree, but they never make any serious effort to do so. On the contrary, they defend entitlements when Democrats suggest cutting them. The Republican National Committee has run television ads opposing cuts in Medicare because Obama proposed using such cuts to fund health reform. Many demonstrators at right-wing tea parties were seen carrying signs demanding that the government keep its hands off Medicare.

This reality is actually old and well-known. But it’s wise to review this stark fact from time to time if you care about your long term financial future and appreciate the enormous impact in our economy by the federal government.

ObamaCare Instructional Video

Naturally, the first thing a rational approach requires of us  is get some facts about the proposed systems and consider the implications, then revise beliefs.

We have found an excellent summary of comparative performance statistics for US, Canadian and British health care systems. When you read the following data, ask yourself this question:

Where would I prefer to be really sick?

Source: The Gartman Letter, May 2009

“Canada is a wonderful place to have a nasty gash on one’s forehead stitched, or to break one’s nose in a game of pick-up baseball; but have cancer, or need eye surgery, or want an MRI, and the business of medicine in Canada and/or the UK breaks down badly in favour of medical care here in the US. For example… and we wish to thank The Investor’s Business Daily for the data noted here this morning…

“… here in the US men and women survived cancer at an average of just a bit better than 65%. In England only 46% survive. In the US, 93% of those diagnosed with diabetes receive treatment within six months; in Canada only 43% do, and in the UK only 15% do! For those seniors needing a hip replacement and getting one within six months, 15% get it done in the UK; 43% get it done in Canada … and in the US 90% do! For those waiting to see a medical specialist, 23% of those in the US get in within four weeks, while 57% in Canada have not yet done so, and in the UK 60% are still waiting after four weeks.

“When it comes to proper medical equipment, in the US there are 71 MRI or CT scanners available per million people. In Canada there are but 18, and in the UK there are only 14! Ah, but the best figure of all is this: 11.7% of those ‘seniors’ in the US with ‘low incomes’ say they are in excellent health, which in and of itself sounds rather low … rather disconcerting … and an indictment of the system itself, doesn’t it? But in Canada only 5.8% do!

“Yessiree bob, ya’ jus’ gotta’ luv that collectivized, socialized medical care! Let’s all go break a collective arm and enjoy the benefits of socialized medicine in the Commonwealth! (Canada) … but heaven help you if you’ve got something really, really wrong. If that’s the case, you’ll be running south to the border faster than you can reach a specialist anywhere in Canada; of that we are certain.”

We believe those socialist systems get exactly the results one should expect from the government–those same folks who in USA bring us Medicare and the Postal Service.

Well, lots of fellow Americans have thought about it…and they are now called Medical Tourists. I believe the future for the American health care system will be substantially improved by the Indian system, which, by providing options to Americans for health care, will force competitive reaction in USA and reduce demand (a good thing).

Many Indian doctors are well trained in USA medical schools, speak good English, and use effective medical instruments/devices and procedures. Not only that, the Indians seem to have a very pragmatic attitude about keeping patients first (see article below)…quite different in practice from USA where government regulations, subsidies and bizarre insurance practices act against patient interests and drive costs up, all in the name of providing quality service.

The Medical Tourism concept probably arose in USA when Americans, desperate for various experimental cancer treatments went to get them in Mexico. Then the American mainstream media  noticed large numbers of Canadians traveling to USA border states to get medical care that the Canadian system would not provide or would delay so long as to be deadly. Now, Americans are increasing their medical tourism by going to Asia.

Aside from the substantially reduced prices in Asia (e.g., Thailand for cosmetic surgery), Asia will naturally become a major destination for Americans seeking high quality, low cost medical care. I believe there is another reason:  delays and rationing are almost certain in future USA health care system. These will result quite naturally from a stark reality: when upwards of 40M new people gain access to the medical system by government fiat, the demand for service will spike, but the capacity (doctors, nurses, rooms, machines,…) required to deliver those new services can grow only slowly. The math guarantees delay and rationing. Even absent new demand, the inevitable increase in government control of health care alone will ensure reduced quality of service. Thus, in this scenario, many Americans will seek relief overseas, with India a prime destination. Of course, this travel will serve those who remain in USA for treatment by reducing total demand.

The investment opportunity may well lie with firms that can organize and vet such medical tourism flows. Possibly a combination of travel agency and health care evaluator? Comments please!

The article below from the Economist gives a nice description of the Indian situation now.

Lessons from a frugal innovator
Apr 16th 2009 | BANGALORE
From The Economist print edition

http://www.economist.com/business/displaystory.cfm?story_id=13496367

The rich world’s bloated health-care systems can learn from India’s entrepreneurs

Tom Pietrasik

ENTER the main cardiac operating-room at Bangalore’s Wockhardt hospital on a typical morning, and you will find a patient on the operating table with a screen hanging between his head and chest. On a recent visit the table was occupied by a middle-aged Indian man whose serene look suggested that he was ready for the operation to come. Asked how he was, he smiled and answered in Kannada that he felt fine. Only when you stand on a stool to look over the screen do you realise that his chest cavity has already been cut open.

As the patient was chatting away, Vivek Jawali and his team had nearly completed his complex heart bypass. Because such “beating heart” surgery causes little pain and does not require general anaesthesia or blood thinners, patients are back on their feet much faster than usual. This approach, pioneered by Wockhardt, an Indian hospital chain, has proved so safe and successful that medical tourists come to Bangalore from all over the world.
This is just one of many innovations in health care that have been devised in India. Its entrepreneurs are channelling the country’s rich technological and medical talent towards frugal approaches that have much to teach the rich world’s bloated health-care systems. Dr Jawali is feted today as a pioneer, but he remembers how Western colleagues ridiculed him for years for advocating his inventive “awake surgery”. He thinks that snub reflects an innate cultural advantage enjoyed by India.

Unlike the hidebound health systems of the rich world, he says, “in our country’s patient-centric health system you must innovate.” This does not mean adopting every fancy new piece of equipment. Over the years he has rejected surgical robots and “keyhole surgery” kit because the costs did not justify the benefits. Instead, he has looked for tools and techniques that spare resources and improve outcomes.

Shivinder Singh, head of Fortis, a rival hospital chain based in New Delhi, says that most of the new, expensive imaging machines are only a little better than older models. Meanwhile, vast markets for poorer patients go unserved. “We got out of this arms race a few years ago,” he says. Fortis now promises only that its scanners are “world class”, not the newest.

Mr Singh is not alone in thinking that many firms in the rich world are looking at innovation the wrong way. Paul Yock, head of the bio-design laboratory at Stanford University, which develops medical devices, argues that medical-technology giants have “looked at need, but been blind to cost.” Amid growing concern about runaway health spending, he thinks the industry can find inspiration in India.

Poverty, geography and poor infrastructure mean that India faces perhaps the world’s heaviest disease burden, ranging from infectious diseases, the traditional scourge of the poor, to diseases of affluence such as diabetes and hypertension. The public sector has been overwhelmed, which is not surprising considering how little India’s government spends on health as a share of national income (see chart). Accordingly, nearly four-fifths of all health services are supplied by private firms and charities-a higher share than in any other big country.
In the past that was more a reflection of the state’s failure than the dynamism of entrepreneurs, but this is changing fast. Technopak Healthcare, a consulting firm, expects spending on health care in India to grow from $40 billion in 2008 to $323 billion in 2023. In part, that is the result of the growing affluence of India’s emerging middle classes. Another cause is the nascent boom in health insurance, now offered both by private firms and, in some cases, by the state. In addition, the government has recently liberalised the industry, easing restrictions on lending and foreign investment in health care, encouraging public-private partnerships and offering tax breaks for health investments in smaller cities and rural areas.

Cheaper and smarter
This has attracted a wave of investment from some of India’s biggest corporate groups, including Ranbaxy (the generic-drugs pioneer behind Fortis) and Reliance (one of India’s biggest conglomerates). The happy collision of need and greed has produced a cauldron of innovation, as Indian entrepreneurs have devised new business models. Some just set out to do things cheaply, but others are more radical, and have helped India leapfrog the rich world.

For years India’s private-health providers, such as Apollo Hospitals, focused on the affluent upper classes, but they are now racing down the pyramid. Vishal Bali, Wockhardt’s boss, plans to take advantage of tax breaks to build hospitals in small and medium-sized cities (which, in India, means those with up to 3m inhabitants). Prathap Reddy, Apollo’s founder, plans to do the same. He thinks he can cut costs in half for patients: a quarter saved through lower overheads, and another quarter by eliminating travel to bigger cities.

Columbia Asia, a privately held American firm with over a dozen hospitals across Asia, is also making a big push into India. Rick Evans, its boss, says his investors left America to escape over-regulation and the political power of the medical lobby. His model involves building no-frills hospitals using standardised designs, connected like spokes to a hub that can handle more complex ailments. His firm offers modestly priced services to those earning $10,000-20,000 a year within wealthy cities, thereby going after customers overlooked by fancier chains. Its small hospital on the fringes of Bangalore lacks a marble foyer and expensive imaging machines-but it does have fully integrated health information-technology (HIT) systems, including electronic health records (EHRs).

New competitors are also emerging. A recent report from Monitor, a consultancy, points to LifeSpring Hospitals, a chain of small maternity hospitals around Hyderabad. This for-profit outfit offers normal deliveries attended by private doctors for just $40 in its general ward, and Caesarean sections for about $140-as little as one-fifth of the price at the big private hospitals. It has cut costs with a basic approach: it has no canteens and outsources laboratory tests and pharmacy services.

It also achieves economies of scale by attracting large numbers of patients using marketing. Monitor estimates that its operating theatres accommodate 22-27 procedures a week, compared with four to six in other private clinics. LifeSpring’s doctors perform four times as many operations a month as their counterparts do elsewhere-and, crucially, get better results as a result of high volumes and specialisation. Cheap and cheerful really can mean better.

But there is more to India’s approach than cutting costs. Its health-care providers also make better use of HIT. According to a recent study in the Journal of the American Medical Association, fewer than 20% of doctors’ surgeries in America use HIT. In contrast, according to Technopak, nearly 60% of Indian hospitals do so. And instead of grafting technology onto existing, inefficient processes, as often happens in America, Indian providers build their model around it. Apollo’s integrated approach to HIT has enabled the chain to increase efficiency while cutting medical errors and labour. EHRs and drug records zip between hospitals, clinics and pharmacies, and its systems also handle patient registration and billing. Apollo is already selling its expertise to American hospitals.

Eye on the prize
A casual visitor to Madurai, a vibrant medieval-temple town in southern India, would not think it was a hotbed of innovation. And yet that is exactly what you will find at Aravind, the world’s biggest eye-hospital chain, based in the town. There are perhaps 12m blind people in India, with most cases arising from treatable or preventable causes such as cataracts. Rather than rely on government handouts or charity, Aravind’s founders use a tiered pricing structure that charges wealthier patients more (for example, for fancy meals or air-conditioned rooms), letting the firm cross-subsidise free care for the poorest.

Aravind also benefits from its scale. Its staff screen over 2.7m patients a year via clinics in remote areas, referring 285,000 of them for surgery at its hospitals. International experts vouch that the care is good, not least because Aravind’s doctors perform so many more operations than they would in the West that they become expert. Furthermore, the staff are rotated to deal with both paying and non-paying patients so there is no difference in quality. Monitor’s new report argues that Aravind’s model does not just depend on pricing, scale, technology or process, but on a clever combination of all of them.

C.K. Prahalad and other management gurus trumpet examples like Aravind, but do the rich countries accept that they could learn from India? Unsurprisingly, some reject the notion that America’s model is broken. William Tauzin, head of America’s pharmaceutical lobby, warns that regulatory efforts to cut costs could stifle life-saving innovation. Sandra Peterson of Bayer, a German drugs and devices giant, stoutly defends the industry’s record. She argues that overall cost increases mask how medical devices, “like cars or personal computers, give better value for the money over time.” Diabetes monitors and pacemakers have improved dramatically in the past 20 years and have fallen in price-but costs have gone up because they are now being used by more patients.

But those examples are exceptions. Many studies show that America’s spending on health care is soaring, yet its medical outcomes remain mediocre. Mark McClellen of the Brookings Institution, an American think-tank, says that a big problem is the overuse of technology. Whether or not a scan is needed, the system usually pays if a doctor orders it-and the scan might help defend the doctor against a malpractice claim. “The root cause is not greed, but tremendous technological progress imposed upon a fractured health system,” says Thomas Lee of Partners Community HealthCare, a health provider in Boston.

Dr McClellen, a former head of America’s Food and Drug Administration, points out that other innovative industries often sell new products at a loss, and recoup their investments later. In genuinely competitive industries, innovators are rarely rewarded with the “cost plus” reimbursements demanded by medical-device makers for their gold-plated gizmos.

That is why Stanford’s Dr Yock wants to turn innovation upside down. He has extended his bio-design programme to India, in part to instil an understanding of the benefits of frugality in his students. He believes that India’s combination of poverty and outstanding medical and engineering talents will produce a world-class medical-devices industry. Tim Brown, the head of Ideo, a design consultancy, agrees. In the past, he notes, health bosses thought all devices had to be Rolls-Royces or Ferraris. But cost matters, too. Pointing to another recent example of India’s frugal engineering, he says: “In health care, as in life, there is need for both Ferraris and Tata Nanos.”

Jack is silent. The robber, frustrated says again “Your money or your life!” Finally, Jack says: “Wait a second, I’m thinking about it!”

Dear reader, you and I will probably face this situation and the Leviathan US Government will be demanding. Consider this astounding fact, cited by Kent Smetters, Wharton insurance and risk management professor, and a former deputy assistant Treasury secretary and economist for the Congressional Budget Office (my emphasis added; quote taken from an interview is given below.):

“Medicare is tough for two reasons. One, the shortfall in Medicare is six to seven times larger than in Social Security. Social Security is a major problem; Medicare is a crisis. You add both of those… shortfalls together and you’re getting something that’s … between $80 and $120 trillion in total present value shortfalls. … People can’t even imagine how big that number is. If you took the total value of the United States, except for the people (all the land, houses, buildings, everything that’s non-perishable, your washer and dryer, cars, and so forth), it has about a value of about $50 trillion. So we’re talking about a shortfall of twice the value of the value of the U.S. except for the people. Now, the value of the people is about three times that. We’re just talking about biblically large shortfalls. We’ve never seen this type of problem.”

Keep in mind that this problem is not a matter of political interpretation. It is real. The scale of the shortfall is so gigantic that precision is irrelevant. Worse, and (here is my point) all attempted remedies will deeply affect everyone, but in ways we cannot know now.

Yes, taxes will rise and benefits will drop. But then what? What will that do to economic life? How will expectations for increased cost or rationing of health care affect people’s behavior? The specific consequences are impossible to predict or even model now. So we must recognize the Leviathan has created, by pandering to generations of us voters who loved it, a breeding ground for vast numbers of Black Swan Events, and not the good kind.

The interview below gives the horrifying details.

A Thought for Tax Day: The Real Fiscal Crisis Is Yet to Come
Published : April 15, 2009 in Knowledge@Wharton

For taxpayers in America, today is the deadline to pay their federal income taxes for 2008. With that chore behind them, they might now like to think about their future taxes — the ones that will pay for the $787 billion stimulus package, the $2 trillion commitment to prop up collapsing financial firms, and other programs that promise to deepen our $11 trillion national debt. Of course, that doesn’t count the $80 trillion to $100 trillion shortfall in funding for Medicare and Social Security. According to Wharton insurance and risk management professor Kent Smetters, a former deputy assistant Treasury secretary and economist for the Congressional Budget Office, most Americans should not be worrying about having to pay higher taxes. Why? Because even the biggest tax hikes will not raise enough money to pay off the debt and meet coming obligations. Accomplishing the latter would require politicians to do something they fear even more than raising taxes: Cut back on Medicare and Social Security benefits. Smetters described the coming crisis in an interview with Knowledge@Wharton.

An edited transcript of the interview follows:

Knowledge@Wharton: Assuming China continues to invest in our Treasury bonds, when do we have to start backfilling the deep debt hole that we’ve dug for ourselves, not even counting the much bigger shortfall for Medicare and Social Security that’s heading our way?

Kent Smetters: [China is] very nervous right now and… they’ve thought about floating an international reserve that’s no longer U.S. based. But even given the assumption that under the Safe Haven hypothesis [that United States Treasury bonds are the safest investments], U.S. debt is still viewed as the safe place [for investors] to go. And we continue to get the ability to float debt at these very low rates, which is almost a topic unto itself because these rates are so unbelievably low. But we face a very… significant short-term problem… because all this [U.S. government] debt is going to crowd out lots of private investment, and [the stimulus package it is funding] assumes that the government can do a better job at picking… the winners and [losers with its] investments.

Economists don’t have a hard and fast rule that says, “Here’s your maximum debt ceiling. And here is the most that you can go.” But given where we are in terms of paper debt — we’re adding another $2.1 trillion just this coming fiscal year and we’re going to be close to $11 trillion to $12 trillion in total, and on top of that … Social Security and Medicare — we really do face a very dire situation right now. The U.S. economy has never faced this type of challenge in the past, even in World War II when our paper debt was high. We just never faced the type of fiscal challenges that we face right now.

Knowledge@Wharton: Do we have to dig ourselves out of the national debt before we can address Social Security or Medicare?

Smetters: No. In fact, ideally, it would be in some ways just the opposite. Social Security and Medicare are much bigger problems, and the longer that we delay those, the more those problems [will] snowball. In particular, every year that we delay reform on either of those programs it adds about another $2 trillion to the present value shortfalls of both programs. So just a one-year cost of delay is about the size of the record deficit that we’re going to have this year….

Knowledge@Wharton: So, whatever we do for Social Security, the bottom line is that it has to cost a lot less than it does now.

Smetters: Yes. You can certainly raise some tax revenue in some places. People have talked about increasing the maximum taxable wage cap [currently $106,800]…. That’s not going to… help a lot in present value, because those people will eventually collect more benefits. They’re not going to collect as much… as they paid into the system, but it’s still not going to be super-effective…. People have [also] talked about taxing fringe benefits like health care and so forth. But the fact of the matter is that these benefits are growing faster than inflation. We have to bring Social Security benefit growth rate closer to [the rate of] inflation for it to be a sustainable system. And that’s the easy problem.

Medicare is the tough one.

Knowledge@Wharton: Medicare is tougher, why? Because … people [are reluctant] to give up benefits that have to do with their health care?

Smetters: Medicare is tough for two reasons. One, the shortfall in Medicare is six to seven times larger than in Social Security. Social Security is a major problem; Medicare is a crisis. You add both of those… shortfalls together and you’re getting something that’s … between $80 and $120 trillion in total present value shortfalls. … People can’t even imagine how big that number is. If you took the total value of the United States, except for the people (all the land, houses, buildings, everything that’s non-perishable, your washer and dryer, cars, and so forth), it has about a value of about $50 trillion. So we’re talking about a shortfall of twice the value of the value of the U.S. except for the people. Now, the value of the people is about three times that. We’re just talking about biblically large shortfalls. We’ve never seen this type of problem.

Eighty percent of that is driven by Medicare. And a lot of that is because of the way Medicare benefits are provided. It’s not a dollar benefit, it’s an “in kind” benefit. That is, they pay for operations. And so how do you scale that back? A dollar benefit like Social Security is easier to scale back. An operation, what do you do there? Do you say, “Okay, we’ll pay for half of it and you pay for the other half of it?” People have talked about this, but it’s more likely that we’ll move to some type of rationing system unless we take kind of a long [term] approach and get people to save for their future medical costs.

Knowledge@Wharton: The Obama administration asserts that reforming health care overall for all Americans the best way to address Medicare. Do you agree?

Smetters: It will address some of it. It is interesting that the Obama team is starting to lean more toward the [Hillary] Clinton proposal, [raised] during the [Democratic primary] campaign, for… mandatory coverage. There’s nothing I’ve seen so far, however, that will fundamentally address the core issue, and that is that medical care costs are simply going up. Increasing access is great for various social reasons, but it’s not going to have a big impact on increasing costs unless we actually start making some hard choices. Some of those hard choices are going to be very unpopular, especially when you start to ration care. You basically say, “You’ve hit a certain age [after which] we’re no longer going to do those triple bypasses,” or something like that. And that’s obviously a tough choice. I hope we don’t get to that.

But the second approach is more of a long term approach, where you have to make people sensitive to how much… they spend on health care. That’s the core problem: People always want the very best, even if the marginal benefit is much less than the marginal costs, because they don’t bear the cost. In Medicare, the government bears the cost. And so people don’t have any type of trade off between spending and benefits. They always want the very best. And… the innovators always come up with the better pill even though its efficacy may be just marginally better than the generic drug; or the better operation, even though its efficacy will be just marginally better than the cheaper operation.

Knowledge@Wharton: Is there a way to bring more sensitivity about marginal benefits and marginal costs?

Smetters: There are only really two things you can do. The first is you say, “Well, people still aren’t sensitized to cost and benefits. We’ll keep on paying for it.” And in that case the government then has to say, “You know what, we’ll keep on paying but for only some stuff.” And now the government is the one in charge of deciding who gets what. The second approach is to actually make people directly sensitized to it. And you do that with things like health savings accounts in which people have to pre-fund some of their future medical care. They have to pay out the first several dollars of that care, and the government’s only a back stop on a catastrophic case.

The problem with the health savings accounts, people say, is there’s an equity issue — some people can’t accumulate a large savings account. And so then how do you address that issue? Whatever you do to address that issue de-links people from being sensitized to benefits and cost. So there’s no silver bullet here. Ultimately, the best package is some type of hybrid where you have people being sensitized to health care costs for routine care. For catastrophic care you probably have a government back stop, but more of minimal back stop than we now have. It’s not always wise to pay for the best device that’s out there. It’s really about taking into account cost benefits.

Medicare, by the way, will claim that it take costs and benefits into account. But in effect they do not. They will approve almost anything that has some type of marginal benefit and not really think very hard about the costs.

Knowledge@Wharton: How does the government go about preparing people for this? Given the psychology that you just discussed, how does the government go about preparing people for those difficult choices?

Smetters: That’s an interesting question because elected officials really have no incentive to do that. The chance of them being around 20 to 30 years or even 10 years from now is pretty low. So they have an incentive to always keep things going along. History has shown that it takes a crisis before you get any type of reform. And obviously that [last minute] reform is never the best possible reform. So, we could talk about what things the government will do. But we know the government won’t.

It’s going to require a lot more action by citizen groups. The Peter G. Peterson Foundation, for example, tries to educate people about some of these fiscal problems. Certainly there are some “blue dog” Democrats and some Republicans who want to talk about this issue. But for the most part this is an issue that [causes] you to lose re-election. So, trying to have a sustainable, reasonable conversation is difficult. And it’s only becoming more difficult as the baby boomers start to age even more and they become even more sensitive to this issue.

Knowledge@Wharton: So then what does the result of the crisis — when the crisis arrives, what does it look like in terms of taxes? If we have to raise them to some extent, along with cutting back benefits, what does the tax bill look like for Americans?

Smetters: We currently have a present value shortfall that’s twice the value of the entire country, except for the human beings. So, obviously, we can’t tax our way out. So the real issue is, what type of hit are we going to give do to benefits? You’re going to see benefits reduced, especially for higher income earners. We got a hint of that in Medicare Part D, the newest part of Medicare that gave us our prescription drug bill. They explicitly have some means testing in there, which basically says higher income people get a smaller benefit. Social Security benefits are now taxed. And in fact, they’ve been taxed since 1983. But it’s taxed on a progressive basis. Higher income workers get more of their benefits taxed. I think you’ll start to see a lot of more of that.

And so what will happen is Medicare and Social Security will become more of a flat system, [with] fewer benefits to higher income people even though they paid in more. But on the [revenue] side, I don’t see a lot of room for continuously increasing taxes. We’ll see, I think, more taxes on higher income individuals. And that will have long run implications because they’re also the ones who create jobs and invest and innovate. We already have the second highest corporate income tax rate in the world, even after you net in things like expensing and so forth. So for us to remain competitive, I just don’t see how… we can really do a lot on the tax side. But I do think we will see taxes go up. The thing I fear the most — and I think it is the most likely outcome — is that the government will print a lot of debt to pay off a lot of these shortfalls. And then the international markets, in particular the fixed income markets, will figure it out.

They will realize the government is basically monetizing that debt through higher inflation. And if you have an inflation rate that’s 25, 3% more per year than the historic average, you can really eat away a lot of debt just through the law of compounding. And so the market should figure that out and adjust the interest rates accordingly. That’s one reason why I believe that 30 year yields right now on Treasury [bonds], especially to non inflation protected Treasuries, is really too low. I believe Treasuries are in a bubble right now because everybody’s flocked to the safety. And there’s just no way that those low yields of 3.5% are going to cover the inflation rate over the next 30 years.

Knowledge@Wharton: Why doesn’t the rate respond to the reality of what’s going on in the market?

Smetters: In theory it should. I think what you have is a flight to safety going on right now, where people are basically saying, “Where else do I hold my money? And I’m nervous about the markets.” It’s obvious that people are worried about even corporate fixed income, given the very high yield that those are earning right now. So people are panicked. And so they’re moving toward was viewed as historically safe, and that’s U.S. Treasuries. The irony is that a whole herd of people moving into one security because they’re scared creates a problem for those people because prices of those securities get bid up. You’re going to have a lot of people holding long duration, fixed income, government securities who are going to see pretty significant price declines over the next decade.

Knowledge@Wharton: And it’s not just China that is holding those bonds. It’s also American retirees or future retirees.

Smetters: Sure.

Knowledge@Wharton: What is it that’s keeping the Chinese government in that market?

Smetters: China, Japan and the UK have over half of our debt…. Traditionally the view was that U.S. debt is safe and there were some regulations, especially for Japanese pension funds, requiring investments in safe areas, and U.S. Treasuries qualified because of their safe reputation. China is starting to question that now, as are other investors. The question becomes, when does it kind of snap? What we know from fixed income markets and foreign exchange markets internationally is that things don’t just gradually change. Investor sentiment suddenly snaps and people start to panic. We saw that in Asia and Latin. One reason U.S. may face a different situation is that, in the case of previous crises such as in , South Korea or Thailand or Argentina, it was easy just to yank your money and put it elsewhere. When you yank your money from the U.S., you are not 100% clear about where you put it. And so that may create more of a gradual scenario for the U.S..

But, you know, we’re seeing growth in the BRIC countries [Brazil, Russia, India and China]. It would not be surprising that you could see — not an Asian style currency crisis or anything of that magnitude — but certainly our own currency crisis in which investors would suddenly get nervous and start to pull out of U.S. Treasuries. We could see yields increase quite a bit, and rates and prices decline.

Knowledge@Wharton: Would it mean an absence of cash for the government to do what it does?

Smetters: It would mean that they would have to pay much higher interest rates to float the same debt. That just makes it more difficult for them to continue to roll over the debt. One reason why the Treasury can get away with holding so much debt is that at current yields, it’s pretty cheap for them. Japan during the 1990′s was facing yields of close to 0%. It’s shocking that they, in some sense, weren’t floating even more debt than they were. And they were floating quite a bit.

But the real lesson is not so much the cost of debt, because what Japan did during the 1990′s showed us is that the Japanese government was able to float debt for dirt cheap. The real problem is that they diverted a lot of investments away from new, nimble financial institutions [and propped] up the very inefficient, old school finance institutions. We’re basically doing the same thing in the United States. We’re trying to prop up institutions that were too large to begin with, AIG and lots of the investment banks. They were just too big to begin with. That’s why corporate risk management was never possible, because… they were just too big, too unwieldy to think about corporate risk management very seriously.

Somewhat ironically, [the major banks] actually lost more money buying some of the safer [subprime-based] collateralized debt obligations, than they did with their investments in hedge funds, which bought some of the higher risk stuff… These old institutions, these investment banks and large insurers like AIG, they’re just old, inefficient and too large. And we’re trying to prop them up. We’re trying to keep them alive. And that’s exactly what Japan did and that’s why Japan had a recession that lasted a good decade. I see that scenario playing out over the next five years in the United States. Unless we’re willing to allow for a good train wreck, to have some pain in the short run, we’re going to have this train wreck screech out over many, many years. And, as a result, we won’t clear the tracks very quickly.

I’ve said it before and I’ll say it again: The one nice thing about a good train wreck is you clear the tracks quickly and you start over — but we just refuse to let that happen. That’s what Japan did.

Knowledge@Wharton: Would clearing the tracks quickly mean allowing some pain to occur sooner rather than later?

Smetters: Yes. There are a couple of dimensions. One is what’s going on in the subprime market and the banking market. There, clearing the tracks quickly basically means creating the most transparent fiscal institution possible. And [procedure for doing] that is called bankruptcy. Everybody says we want to clean up the balance sheets of these institutions y quickly, and we want to do it in a cheap and efficient way. Well there’s a process already out there, it’s called bankruptcy. That’s exact what it does. It cleans it up very quickly. And in terms of the entitlement programs [Medicare and Social Security], there’s no real equivalency of bankruptcy per se, rather we need to have this long discussion about exactly how we’re going to scale back benefits — because we can’t raise taxes enough.

Social Security is the easier problem. Again, it’s a cash benefit and all you need to do is slow the benefit growth to something closer to inflation toward, closer toward inflation. And that in particular means hitting higher income people a little bit harder in terms of their eventual benefits. I wouldn’t tax them a lot more, but I would certainly decrease their benefits. Do that and you can pretty much fix Social Security.

Medicare is much harder, obviously because it’s a much bigger problem and because of the nature of its benefits. So again, there your choices are, either have people pay for a lot of it themselves and therefore be sensitized to this tradeoff between benefits and costs, or the government takes a much more draconian approach and basically says, “We’ll still pay for it, but now we’re just going to start rationing who we pay for and what we pay.”

Knowledge@Wharton: Thanks very much.