This is the second installment of my three part series about inflation. Last month, I spoke generally about the basics of inflation. I mentioned that inflation is the gradual increase of prices over time. It leads to an erosion of wealth, since your dollars will buy smaller and smaller amounts of goods and services. This month, I will talk about the main theories about why inflation occurs.
Economists have several different views about the causes of inflation. I will be covering the ideas that fall in the Keynesian and Monetarist schools of thought. Keynesian economics is attributed to John Maynard Keynes. He was an economist in the early 1900's who had a major influence on modern economic thought and theory. Keynes believed that the supply of money in the system does not directly affect inflation, but that inflation is driven by other pressures in the economy. He was a proponent of government intervention into markets to smooth the effects of business cycles. He has several different theories about the cause of inflation.
The first is the so called "demand-pull inflation." As citizens and governments buy more goods and demand more goods, the price of those goods goes up. This causes the government to increase spending when the economy is sagging in hopes of "inflating" economic activity. Demand-pull proponents tend to see fiscal policy, government spending, as the solution to controlling inflation.
"Cost-push" is another inflation theory. This theory assumes that as the price of an input increases, a firm will raise the final price of the good to cover costs. An example is a beet farm. If the cost of fertilizer goes up, the farmer will raise the final price of beets. While the previous theory called for an increase in demand to push inflation, this one deals with a decrease in supply causing prices to go up. When those two forces work together, prices can sky rocket. We experienced something similar to this here in Georgia after Hurricane Katrina hit the Gulf Coast, our number one supplier of gasoline. Expecting shortages, people bought as much gas as possible and hoarded it (demand went up). These two complimentary forces shot prices up as high at $10+ a gallon in some areas.
The final Keynesian theory is called "built-in" inflation. This theory is similar to cost-push, but is much more cyclical. Workers demand more money in wages, therefore firms raise the price of the goods they sell to cover the increases. As more firms do this, workers can no longer afford the goods they normally buy (since the prices are all going up), so they demand more wage money. As you can see, this is a never ending cycle; workers think they are getting richer, but price increases negate their raises.
The last major theory about the causes of inflation is attributed to the "monetarist" point of view. Monetarists believe that monetary policy (actions by the Federal Reserve) is the most effective way to fight inflation The monetarist theory suggests that inflation is caused by the easing of credit, which in turn increases the amount of money in the economy. The more money there is available, the easier it should be to obtain credit. However, the increase in money also leads to increases in inflation. In the 1950's, Milton Friedman became the main opponent to Keynesianism and the main advocate of monetarism, influencing individuals such as Federal Reserve Chairman Ben Bernanke. Currently, the American Federal Reserve follows a modified form of monetarism.
Economists have been debating the cause of inflation for decades (and longer!). These are the most prevalent theories from the last 100 years or so, but it is surely only a matter of time until the next new theory comes around. Like many other things in science and academic fields, there is a continual search for evidence that clearly points to one cause over the others.
Next month, I will be wrapping up this series with a few ideas about the impact inflation has in a practical sense on an investor's portfolio. I will also include some strategies that are used to mitigate the effects of inflation.
Monday, March 15, 2010
Inflation 2 (March, 2010)
Monday, February 15, 2010
Inflation 1 (February, 2010)
We all can agree that health care has been a very hot topic over the past year. In the forefront of discussion is Medicare, which has somehow become the “poster child” for public health care in the United States. Because Medicare will affect all of us one day, it is important that everyone understand the benefits available, the rules for enrollment, and the financial concerns with the program.
First, I’d like to start out with a general overview of Medicare. The Social Security Act of 1965 created Medicare to provide insurance for people over 65. There were originally two parts to Medicare, Part A and Part B. Part A provides hospital and skilled nursing care coverage and is paid for by the government as long as the insured has 40 or more quarters of Medicare-covered employment. It is financed mostly by the Medicare tax of 2.9% split between employer and employee. There is a deductible of $1,100 per year.
Part B covers physicians and other out-of-hospital expenses. The insured person contributes to the cost through a monthly premium, currently $96.40 with a deductible of $155 per year. If you receive over a certain level of income or if you miss your initial enrollment period (discussed later), your premium may be higher. Medicare pays for only 80% of approved charges which often differ from actual charges. For this reason, some doctors refuse to accept Medicare, and this will only worsen if Medicare cuts reimbursement rates as proposed. Medicare Advantage plans are private plans that can help supplement Medicare benefits for an additional premium and are referred to as Part C.
In 2006, Part D, a prescription drug discount plan, became effective. This part has received a lot of attention lately as Congress and the White House have expressed plans to plug the large “doughnut hole.” The “doughnut hole” refers to a gap in coverage for drug costs between $2,830 and $4,550. After a $310 deductible, Medicare pays 75% of drug costs up to $2,830, then nothing until over $4,550, at which point it pays 95%.
So now that you know the gist of what benefits Medicare provides, let’s look at the rules for enrolling in the program. When an individual turns 65, he or she is eligible for Medicare. These days, many seniors are choosing to work past 65 and keep employer health benefits, which can limit your access to Medicare if you are not careful. So here are the rules for enrollment: If you are enrolled in Social Security, you are automatically entitled to Part A and B and a Medicare card will be mailed to you about 3 months before your 65th birthday. If you aren’t receiving Social Security, you can enroll up to 3 months before your 65th birthday and no later than 3 months after. If you fail to enroll during this initial enrollment period, you will have to wait until the general enrollment period which is January through March and coverage will not begin until July 1st. Additionally, the cost of Part B may go up 10% for each 12 month-period that you could have had Part B but didn’t take it and this rate increase is permanent.
There are a few common trap seniors fall into when in comes to Medicare enrollment. One is not checking to see whether their company’s plan requires them to sign up for Medicare Part B upon turning 65. Secondly, some people receiving retiree medical benefits are unaware that the eight-month deadline applies to them. One last trap involves Cobra, a federal law that allows workers to temporarily stay enrolled in an employer’s health plan. If you miss your initial enrollment period, you will have to wait until July of the year you enroll for coverage. Some retirees have chosen to go with Cobra during the gap in coverage only to find out that the Cobra coverage is considered secondary to Medicare. Be sure to research the facts when it comes time for you to consider enrolling in Medicare.
I can’t discuss Medicare without acknowledging the severe financial strain it has on the government. Medicare spending accounts for a large portion of federal spending, trailing behind only Social Security and defense. Program spending is projected to grow around 8% annually. The Medicare Hospital Insurance Trust Fund is projected to be depleted by 2017. The Medicare Report shows that the HI Trust Fund could be brought into actuarial balance over the next 75 years by changes equivalent to an immediate 134 percent increase in the payroll tax (from a rate of 2.9 percent to 6.78 percent), or an immediate 53 percent reduction in program outlays, or some combination of the two. Larger changes would be required to make the program solvent beyond the 75-year horizon.
That being said, the new Senate health care bill proposes a Medicare cut of $500 billion. What will Medicare cut, because clearly, something has to give? The first place to cut would be fraud, which is estimated to be around $60 billion a year. One has to be skeptical on this point. If eliminating fraud was so easy, why hasn’t it been done before now? Even after eliminating fraud, a lot of cuts still need to be made and they have to come from somewhere.
In conclusion, Medicare is a very beneficial program for senior citizens, but it does have many pressing concerns that endanger its sustainability in the future. In fact, Medicare is in even worse shape than Social Security which is also on a bad track. Until the issues with Medicare are resolved, I think it is best that the government focus on Medicare’s shortcomings before instituting yet another public option.
Friday, January 15, 2010
Need to Know: Medicare (January, 2010)
We all can agree that health care has been a very hot topic over the past year. In the forefront of discussion is Medicare, which has somehow become the “poster child” for public health care in the United States. Because Medicare will affect all of us one day, it is important that everyone understand the benefits available, the rules for enrollment, and the financial concerns with the program.
First, I’d like to start out with a general overview of Medicare. The Social Security Act of 1965 created Medicare to provide insurance for people over 65. There were originally two parts to Medicare, Part A and Part B. Part A provides hospital and skilled nursing care coverage and is paid for by the government as long as the insured has 40 or more quarters of Medicare-covered employment. It is financed mostly by the Medicare tax of 2.9% split between employer and employee. There is a deductible of $1,100 per year.
Part B covers physicians and other out-of-hospital expenses. The insured person contributes to the cost through a monthly premium, currently $96.40 with a deductible of $155 per year. If you receive over a certain level of income or if you miss your initial enrollment period (discussed later), your premium may be higher. Medicare pays for only 80% of approved charges which often differ from actual charges. For this reason, some doctors refuse to accept Medicare, and this will only worsen if Medicare cuts reimbursement rates as proposed. Medicare Advantage plans are private plans that can help supplement Medicare benefits for an additional premium and are referred to as Part C.
In 2006, Part D, a prescription drug discount plan, became effective. This part has received a lot of attention lately as Congress and the White House have expressed plans to plug the large “doughnut hole.” The “doughnut hole” refers to a gap in coverage for drug costs between $2,830 and $4,550. After a $310 deductible, Medicare pays 75% of drug costs up to $2,830, then nothing until over $4,550, at which point it pays 95%.
So now that you know the gist of what benefits Medicare provides, let’s look at the rules for enrolling in the program. When an individual turns 65, he or she is eligible for Medicare. These days, many seniors are choosing to work past 65 and keep employer health benefits, which can limit your access to Medicare if you are not careful. So here are the rules for enrollment: If you are enrolled in Social Security, you are automatically entitled to Part A and B and a Medicare card will be mailed to you about 3 months before your 65th birthday. If you aren’t receiving Social Security, you can enroll up to 3 months before your 65th birthday and no later than 3 months after. If you fail to enroll during this initial enrollment period, you will have to wait until the general enrollment period which is January through March and coverage will not begin until July 1st. Additionally, the cost of Part B may go up 10% for each 12 month-period that you could have had Part B but didn’t take it and this rate increase is permanent.
There are a few common trap seniors fall into when in comes to Medicare enrollment. One is not checking to see whether their company’s plan requires them to sign up for Medicare Part B upon turning 65. Secondly, some people receiving retiree medical benefits are unaware that the eight-month deadline applies to them. One last trap involves Cobra, a federal law that allows workers to temporarily stay enrolled in an employer’s health plan. If you miss your initial enrollment period, you will have to wait until July of the year you enroll for coverage. Some retirees have chosen to go with Cobra during the gap in coverage only to find out that the Cobra coverage is considered secondary to Medicare. Be sure to research the facts when it comes time for you to consider enrolling in Medicare.
I can’t discuss Medicare without acknowledging the severe financial strain it has on the government. Medicare spending accounts for a large portion of federal spending, trailing behind only Social Security and defense. Program spending is projected to grow around 8% annually. The Medicare Hospital Insurance Trust Fund is projected to be depleted by 2017. The Medicare Report shows that the HI Trust Fund could be brought into actuarial balance over the next 75 years by changes equivalent to an immediate 134 percent increase in the payroll tax (from a rate of 2.9 percent to 6.78 percent), or an immediate 53 percent reduction in program outlays, or some combination of the two. Larger changes would be required to make the program solvent beyond the 75-year horizon.
That being said, the new Senate health care bill proposes a Medicare cut of $500 billion. What will Medicare cut, because clearly, something has to give? The first place to cut would be fraud, which is estimated to be around $60 billion a year. One has to be skeptical on this point. If eliminating fraud was so easy, why hasn’t it been done before now? Even after eliminating fraud, a lot of cuts still need to be made and they have to come from somewhere.
In conclusion, Medicare is a very beneficial program for senior citizens, but it does have many pressing concerns that endanger its sustainability in the future. In fact, Medicare is in even worse shape than Social Security which is also on a bad track. Until the issues with Medicare are resolved, I think it is best that the government focus on Medicare’s shortcomings before instituting yet another public option.
Tuesday, December 15, 2009
Will Santa's Sleigh be Light This Year? (December, 2009)
The stock market opened 2009 very poorly, but the economy has been showing signs of life over the past months. As you can imagine, the retail industry has been holding its breath this Holiday Season. Consumer spending makes up about 70% of the U.S. economy, so December is a particularly informative time about the state of the economy. With only a week to go until Christmas, this year’s numbers have been mixed.
Consumer sentiment has been at record lows throughout the year. With unemployment reading over 10%, Americans have been worrying about their own homes, jobs, and the prospects of a “jobless recovery.” This uncertainty understandably causes people to spend less. When home values and retirement accounts decline, consumers also tend to cut back. A recent CNN poll found that 49% of people will be spending less than last year, and 39% will be spending the same as last year, with the remaining 12% spending more. Charities are also being hit, with 51% of respondents saying that they will be giving less this year, as well. In an effort to save, many families are focusing on spending time together and less on presents this year.
The news might not all be bad, though. The retail numbers in November were better than expected with sales growing by 1.3%. Bargain hunters are pushing sales with 42% of shoppers expecting to buy from discount stores. After holding back for several months, many shoppers are finally releasing some of their pent-up demand. It also seems that this year shoppers are procrastinating more than in the past. According to the National Retail Federation, on average, people had finished 46.7% of their holiday shopping by the second week of December, the lowest since 2004. Retailers are looking forward to a big push by these last minute shoppers this weekend, with December 19th being the busiest shopping day of the year, traditionally.
The official results will come out at the beginning of next year, and it is too early to tell if shoppers will be keeping a tight grip on their wallets this holiday season. This new era of frugality can be good for consumers if the habits they start this year carry over into the future. One positive is that the number of shoppers buying gifts on credit cards (with money they pontentially don’t have) has gone down slightly since last year. As we all know, overextension of credit is a main contributor to the mess our economy is trying to get out of. Let’s all hope our country as a whole and consumers individually have learned lessons from the past couple of years and that our economy will continue to recover throughout 2010.
Wednesday, November 18, 2009
Gobble 'til You Wobble
Thanksgiving is a wonderful day to spend time with family and friends, relax while watching the Macy's parade or football, and last but not least, enjoy really good food. In light of the holiday season, we would each like to share one of our favorite Thanksgiving recipes. I am sure you all have your own traditions, but if you get the urge to try something new, here are a few Alder suggestions. Ingredients:
Ingredients:
Thursday, October 15, 2009
Underwater Atlanta (October, 2009)
When meteorologists announced a flood watch in the metro Atlanta area on September 21st, I don’t think any of us could have imagined the havoc this flood would wreak. Over just a few short days, we received nearly 20 inches of rain. Water reached the roofs of many houses and submerged many neighborhoods in several feet of water. Sweetwater Creek, which runs just west of the city and is a large tributary to the Chattahoochee River, crested over 8 feet higher than the previous record. It was shocking to see that within a couple hours, the flood watch turned into a disaster area with people stranded at home or work, cars washed away, roads and schools closed and houses damaged beyond repair. When I left for work that morning, there was no water in my backyard. By 3:30 in the afternoon, I could only see the tips of my 3 foot picket fence. I was very fortunate that the water never came close to reaching my house. As I sat glued to the TV that Monday worried about all the people affected, one of the first things that came to my mind was “Wow…I bet most of these homeowners don’t have flood insurance.”
Shortly after the major flooding began, the phone lines were jammed with homeowners panicking and inquiring about their homeowner’s coverage. To their dismay, they were told that standard homeowner’s policies will not cover losses from flooding. There are many different forms of homeowners insurance, but the most common form provides Open Perils coverage on the structure and Broad Form coverage on the contents.
Open Perils coverage means all threats are covered unless they are specifically excluded. This is the most comprehensive form of coverage. Broad Form covers a limited list of named threats. Some of the threats specifically excluded are earth movement, war, neglect, nuclear hazard, ordinance of law and perhaps most importantly, water damage caused by any water that enters the home from outside. Not only does this exclude damage from floods but it also excludes coverage for sewer back-ups since the water entered from outside the structure. It makes no difference whether the water entered above or below ground. The exception from this is if the water entered as the result of some other damage. An example of this would be if a tree fell on your house, put a hole in the roof allowing the rain to come in. Homeowners can insure against some of the excluded threats through endorsements or riders that expand the coverage. Flood insurance can be purchased separately for an additional premium.
While flood insurance is definitely a necessity for some homeowners, it does have some limitations. In order for flood losses to be covered, two or more acres of normally dry land or two or more adjacent properties must be partially or completely flooded. The maximum coverage limit for a residential property is $250,000 for the structure and $100,000 for the contents. Basement improvements such as finished walls, floors, ceilings or personal belongings are not covered. The national average premium for flood insurance is $540 but for those who of us who live in a flood zone, the numbers are dramatically higher (mine is $1300) and FEMA has just announced that rates will soon go up between 8-10%. Flood insurance should be considered by every homeowner. For those living in low to moderate flood risk areas, premiums are only a couple hundred dollars a year which would definitely be worth it if a flood ever hits your area. Just like any other insurance, it is a risk tolerance decision.
Only those who live in a flood zone and receive financing from a federally regulated lending institution are required to carry flood insurance. Flood zones are determined by the Federal Emergency Management Agency (FEMA) based on the 100 year flood standard which means that the flood elevation has a 1% chance of being equaled or exceeded each year. Over a 30 year mortgage, the estimated chance of a flood is about 26% in these areas. According to the U.S. Geological Survey, the recent flood in metro Atlanta was a 500 year flood with only a .2% chance of occurrence in any given year. That being said, the majority of homeowners choose to forgo flood insurance under the assumption that flooding will never affect their home. The truth is, about 25% of all flood insurance claims come from low to moderate flood risk areas.
So why do homeowners policies exclude flooding? When a flood occurs, several homes are generally affected and the losses can be too catastrophic for the private insurance industry. Flood insurance is fraught with adverse selection, meaning the majority of those who buy flood insurance do so because they live in areas at high risk for flooding. For this reason, the government has stepped in and since 1968, the National Flood Insurance Program has made federally backed flood insurance available to property owners who live in eligible communities. Eligible communities are those that pledge to adopt and enforce land use control measures that guide development away from flood prone areas. Many people mistakenly believe that only those who live in flood prone areas are eligible for federally backed flood insurance. The truth is that anyone living in an eligible community can purchase flood insurance.
With the estimated damage in the Atlanta area around 500 million dollars, tragically, many homeowners will find that their home will be a total loss. Times like these remind us all why insurance is so important, even if you don’t think a certain situation will ever happen to you. I guarantee most of these homeowners didn’t think so either.
Wednesday, September 30, 2009
Market Update (September, 2009)
I think we all should take a moment for a collective sigh of relief: We have averted a possible financial catastrophe in 2009. The economy is finally showing signs of improvement while the stock market continues to shrug off less than positive news and climb higher. Though September is typically the worst month of the year for the stock market on a historical basis, there is no denying the many examples of a recovering economy. While many areas of the economy are still hurting, I wanted to take this opportunity to highlight a few areas of business that suggest a rebound may be underway.
The Housing Market: As the original catalyst of this recession, there will be no general recovery without a recovery in the housing market. So it is quite comforting that sales of existing homes in the United States in July rose 3.2%, which was more than forecast. This marked the sixth straight month of increasing home sales, thus reinforcing the view that the housing market is steadying. Compared to July of 2008, sales in the same month this year were up 13%. These are very encouraging statistics that suggest the housing market has bottomed out and is slowly improving. Though August numbers will not come out for a couple of weeks, low borrowing costs and declines in prices will continue to entice buyers into the market.
Manufacturing Sector: Companies in the manufacturing sector are major employers of the middle class, and an economic recovery will hinge on the middle class trusting their job security and therefore spending again. Fortunately, across various areas of manufacturing such as factory expansions and car sales, there have been encouraging signs of a turnaround. Last month, the manufacturing sector grew for the first time in 19 months. As of now, the manufacturing index sits at 52.9, a number which exceeded forecasts and is the highest level since June of 2007. A score of 50 is the dividing line between expansion and contraction, which means that factories have finally crossed into an expansionary phase. The manufacturing sector is the backbone of an economy, so this is certainly uplifting news.
The cash-for-clunkers incentive will not exist to help September’s numbers, and the manufacturing index is likely to show a slight dip this month as a natural reaction. However manufacturing sectors have been improving around the world, not just in this country. China’s factories expanded more in August than in any of the previous 16 months, which means the country expects other large nations such as ours to have the means to import their products. In addition, European manufacturing shrunk by the least amount in over a year, which suggests stabilization as well. In a world with a highly globalized economy, improvements in other countries are likely to positively impact the United States too.
Mergers and Acquisitions: While individual mergers and acquisitions may seem somewhat unimportant to the broader economy, the frequency of these arrangements is actually a great predictor of an economic recovery. There has been a recent flurry of M&A announcements such as the Walt Disney Company purchasing Marvel Entertainment for $4 billion a few days ago. These deals are signs of economic health since they show the purchasing company’s confidence that the investment will prove profitable as the consumer returns to stores. Acquisitions also demonstrate the acquiring company’s ability to pay as well as value in the company being purchased. The M&A market has been barren for almost a year, so these large deals may signal a bottom for this market.
Of course we are all familiar with the bank mergers as well since many of us have witnessed the name of our bank change. While no one likes to see his or her bank fall into the arms of another due to financial woes, the vast majority of the newly formed banks have been steadily paying off TARP money. This week, Bank of America offered to repay part of its bailout money, and Wells Fargo followed a day later to announce that it intends to return $25 billion in federal money. Since the government will only allow banks with improved capital bases to pay back TARP funds, these announcements indicate that banks have become much healthier in the recent months.
Stock Market: The fear and volatility of the spring now seems like a bad nightmare and the stock market has woken up to a nice rebound. The S&P 500 has posted a 48% return since the 12-year low on March 9th. While the recent run-up may have been a bit too much too fast, stock valuations are returning to more normal levels and investors are opening their wallets to buy the stocks of the companies that keep our country running.
Earnings announcements in the past couple months have been encouraging, and more than 74% of companies in the S&P 500 beat 2nd quarter earnings expectations. Analysts set very low bars for these companies since everyone feared the worst, so beating these expectations was not a difficult feat. However we are all still relieved to see so many companies displaying resilient earnings data. The second quarter’s losses were less than the first quarter of this year and almost every analyst expects the current quarter to extend this trend. In fact, many companies are expected to post a profit (go figure!) As the financial statements start to look healthier, stocks are likely to climb higher.
Labor Market: To envision the coming recovery in the labor market, one only has to look at the trends in the GDP. In the first quarter of this year, the GDP contracted a scary 6.4%, but the second quarter saw a contraction of only 1.0%. The current quarter is expected to post a GDP growth of 1.6%, and with growth comes jobs. But the jobs will not come quickly or soon. The labor market is usually a lagging indicator since companies hesitate to add workers back to the payroll before they are sure that the improvements will endure. However, the labor market is already showing signs of life: The number of people filing for unemployment claims fell last week by 4,000 to 570,000. Though unemployment is likely to remain around 10% for a few more months, strong earnings and a growing economy will begin to bring unemployment down to acceptable levels.
In these markets and others, we are seeing signs that the economy is slowly recovering. I do not suggest that we are completely out of the woods, but it is certainly nice to see an abundance of positive news after months of struggle. It is important to remember that the economy still has many hurdles to clear and problems to solve. But hopefully the widespread fear of early 2009 will become a distant memory and companies will begin to take risks, hire workers, and invest again.