Last week we talked about a really important event on the near horizon: what happens when QE2 ends?  If you missed that one, I really encourage you to go back and give it a quick read.

By June the Fed will have poured another $600 billion into the credit markets.  That’s, like, a lot.  It’s hard to argue that QE2 didn’t accomplish its secondary objective of re-inflating asset prices.  And it’s not crazy to worry that the whole trend may reverse when the Fed takes all the stimulus away.  Only time will tell if the private sector steps in and picks up the slack.

Today we’re going to talk about the flip side of QE2 which is the value of the Dollar.  As is our custom, we will widen our view and try and bring the bigger picture into focus.  And as usual, I’m not sure the majority of the investment world will agree with what we have to say.

The Burning Buck

When the Fed hinted at QE2 last year the Dollar responded immediately by selling off.  No surprise.  Money printing is bad if you already have money.  But when they actually started implementing the program and flooding the market with more reserves, the Dollar inexplicably found a bid and rallied.  Then the market came to its senses and the Dollar turned back around and has been trending lower since then.

Lately, it seems to go down every day.

There are a couple factors at play here.  The first is a rising and legitimately more attractive Euro.  The European Central Bank just raised their benchmark short term rate 25 basis points.  Higher interest rates are typically a good thing for a currency.  Investors want to own currencies that pay them high interest rates.  But not too high.  The Brazilian Real pays around 6% but they’ve got some honest inflationary problems down there.

Strengthening currency or not, Europe is still stuck in a gigantic mess.  Portugal just got a bailout and will be forced to undergo austere reforms.  The voters threw out the old Irish government and the new one is quietly discussing ways to renege on the promises it made to guarantee the debt of their private banks.  Greece is still Greece.  These problems won’t magically go away.

This is going to end in restructure or default.  It has to.  And I can’t see how that’s not a big negative for the Euro.  Over the long run I’m still very bearish about the Euro.  I’m certainly not optimistic about the U.S. Dollar either– I just like our chances better than theirs.  Gun to my head, I’d take Dollars over Euros.  You?

While you’re thinking about that check out this 25-year chart of the U.S. Dollar Index:

This chart doesn’t get much attention, but I think it’s incredible.  It’s one of the most important charts in the world.

Everybody in the world seems to be worrying that a Dollar crash is on the horizon, and I get that.  I really do.  It’s easy to look at the monetary and fiscal policy and come to the simple conclusion that our beloved buck is destined to go down in flames.

But some nights I wake up in a dreamy fog and am still haunted by the same question: what if this Dollar crash that everyone is so worried about has already happened?  What if we are right now in the late innings of the fabled and oft-prophesied Dollar Disaster?

The Dollar has lost nearly half its value relative to other major currencies in the last decade (or last three decades).  Commodities are up almost threefold relative to the Dollar in the last decade.  And if you want to call gold a currency — which is totally OK by me — then the recent depreciation is even more dramatic.  Relative to gold the Dollar has lost over 80% of its value since 2001. That was when the whole world threw its arms up in frustration and said, “gold sucks!”

I’ve addressed all this in a previous newsletter.  I got a lot of hate mail after that one.  This view that the Dollar may surprise people over the next decade, or at the very least won’t keep disintegrating, is not a popular one.

Do you think commodities are going to rise another threefold in the next few years?  Do you think that the Dollar will fall another 80% relative to gold in the next decade?  Haven’t we all learned from the last decade that when the market makes a gigantic move in one direction the next move is usually not a continuation of the bubbly trend, but a reversion towards a historical mean?

What about everything else?

Understanding all of this and developing a sensible outlook for the Dollar is imperative.  The Dollar affects the price of everything that is denominated in it.  And lately I’ve been wondering how much this weakening Dollar has to do with the rising market, rising oil prices, and rising commodity prices.  You know, all the stuff that was a result of QE2.  As the value of our currency goes down the price of these other things go up.

There are obviously many variables that affect the value of commodities and stocks.  But the Dollar is one that not every investor considers.

Along the lines of this ever-weakening Dollar, here’s another cool chart.  It shows how you’ve done as an investor in the U.S. stock market if you are European or Japanese:

I like images because they are good at telling stories.  This one shares an interesting tale.

Since the good ol’ days of January 1999:

• The S&P has increased a staggering+3.75%
• The S&P has decreased -14.2% in Euros
• The S&P has decreased -25.2% in Yen

It’s a global market nowadays.  When most investors at home sit down to evaluate an investment like the U.S. equity markets, they think locally.  They don’t worry about exchange rates and they don’t worry about the big picture of international capital flows.  These things matter.

And here’s a scary thought, the other side of the QE2 coin: what happens to asset prices if someday our currency starts to strengthen?

I know that’s a big stretch to imagine.  But any student of history understands that most market trends are not indefinite and linear.  They are secular and cyclical.  The Dollar has had a pretty depressing run against most major currencies in the last decade.  What if we get a rally, even if it’s just a relief rally?

Dollar strength won’t necessarily translate to weakness in other asset prices.  But it could act as a headwind.  In the years post-crisis the correlation between the Dollar and stocks has been negative.  In a globalized investment marketplace, that relationship makes fundamental sense.

Wider Windows

Before you guys all drag me out of my economic ivory tower and string me up in the town square, know that I haven’t drunk the Fed kool-aid.  I do think we’re playing a risky game with our currency right now.  Besides, over the long run you never want to own too many Dollars.  There’s no way I’m not about to bet on the U.S. Dollar versus any real asset over the next century.

This chart is why:

Don’t get too excited about that chart.  All it really says is “don’t hold paper currency under your mattress for too long.”

In fact, this is why interest rates exist.  Everybody would much rather have a Dollar today than a Dollar in the year 2100.  Real interest rates are negative right now.  All the more reason to ditch your dollars for basically anything else.

Anyway, all I’m saying is that with the withdrawal of QE2 coming in June I think the Dollar could catch a bid.  Like a wave swelling up in front of the reef, the greenback could rise up and surf a choppy course towards shore.  It won’t last forever, but you won’t want to get blindsided by it.  And if you’re positioned properly it might even be a little bit of fun.

A Dollar rally could be bad for stocks and by definition is bad for commodities.  Treasuries could rally — and really, let’s hope they do because we’ll need all the pressure against rising middle-of-the-curve rates this summer that we can get.  No serious economist thinks that any self-sustaining economic growth cycle will happen without a revival of real estate and new construction.  Higher interest rates are a damper on that, and that’s why the Fed has done everything in its power to keep the credit markets liquid and rates low.

At the beginning of the year we predicted that the rally would carry on through the spring and at some point by summer, volatility would click back in.  I haven’t seen much this year to dissuade me from that baseline forecast.  But you all know how quickly these things can change.

Market Recap

The market has made a new high!

I talked about this a couple of weeks ago and this is all good news.  The market rallied back above its 50-day moving average.  The yellow caution flag has been put back into the closet.

It’s OK to buy the market here, especially on little dips.  The basic technicals are good.  But understand that we’re in the final innings.  The expiration of QE2 in June will introduce more volatility into the marketplace and I’ve spent the last two weeks ranting like a crazy person about why.  So if you want to get long for a little while, just pay close attention and make sure you’ve got an exit plan in place before things get dicey.  Weeks like this are when you do your risk management, not the weeks when everything appears to be falling apart.

If the QE2 withdrawal proves not to be a problem, this market could even retest its all-time highs.  That’s a pretty wild thought.  But why not?  Since we started this newsletter we’ve been writing about how the market will trade in a gigantic range for the next 5-10 years.  This cyclical bull market can continue for as long as people feel comfortable (or are forced into) taking risk.  All I know about risk is that people are happy taking it and taking it until one day they wake up and decide all at once that they want none of it.

So be careful.  The short-term technicals may be good, but the long-term fundamentals still drive the bus.  So far I haven’t heard a single convincing case that we are laying the economic foundation for a new super bull market.  Do you think this is the foundation for the next major U.S. growth explosion?  You don’t get a gigantic secular run like the 80′s or the 50′s or the 20′s unless there’s a real economic foundation to grow from.  You also don’t get them until the market gets fundamentally cheap.

Don’t worry, we’ll get one of those eventually.  The markets are working towards it in their back-and-forth way.  I think that’s something that happens between 2015 and 2020.  The guy who is calling for 38,000 on the Dow by 2025 isn’t as crazy as he sounds.

In the meantime, there will continue to be opportunity in the market.  It’s an environment for traders and an environment for stock-pickers.  That’s fine for a business like ours, but it’s tough if you’re the guy at home who buys index funds with your 401(k).  If you’re that guy you’ll get your shot later this decade.  In the meantime, active asset management will continue to outperform passive strategies.

Two sides to the energy trade

More and more of the random people that I talk to are asking me about gas prices.  Crude oil is up and gas prices are moving back towards a record high as a result.  For the short-term it looks ugly.  And for the long-term we all know it’s ugly.  There is plenty of oil out there but the supply of it is finite and it’s getting more expensive to tap into these new reservoirs.

In between those two time frames I think it gets a lot better.  The news on crude oil is that it’s up because of unrest in the Middle East and because of theeee inflaaation!  I buy into the latter argument — the data on headline inflation doesn’t lie.  But that and our weak Dollar only move the needle so much.  And as for the Middle East, I have news for you: there is always unrest in the Middle East.

I think the real reason why oil and gas prices are up so dramatically is because of good old fashioned speculation.  And even up in my economic ivory tower I understand that’s a controversial viewpoint.

Right now the speculators are overwhelmingly betting on higher prices:

The number of speculative long positions in crude oil is at an all-time high, higher than 2008.  The spread between speculative longs and speculative shorts isn’t as high as it was back then.  But it’s still pretty wide.  It’s also been steadily rising since the early part of last decade.  More and more people are speculating on higher oil prices.

Now, since you are an intelligent reader and visit The Draconian every week (or have it automatically sent to your inbox!) you know a thing or two about how markets work.  You know that there are two sides to every trade.

You might be wondering who’s on the other side of this speculation trade.  The answer, of course, is the commercials.  This is basically any entity that can either take delivery of the actual commodity like an oil refiner or any entity that offers hedging services like a financial institution.

The gap for the commercials is every bit as dramatic as that for the speculators.  These guys are totally stacked up on the short side.  Whether they think the market will return to normalcy and want to lock in these awesome prices ASAP or whether it’s simply mechanical hedging is difficult to say.  On one side of the market you have a bunch of industry-insiders who are worried that prices are going back down and want to hedge that risk out.  And on the other side you have a bunch of speculators and investors are betting on prices to keep rising.

This market is really out of balance.  I wish I knew what exactly what it all meant.

Either way, I think it should be clear that a pretty significant portion of this run up in energy prices is because speculation.  Investors are chasing anything around the world that’s going up in price.  And, well, crude oil has been going up in price.  Speculators keep speculating on it and trend followers keep following the trend.

I won’t call bubble, but conditions like this don’t last forever.  I’ve heard some analysts say that around $20 of the oil price is due to speculation.  This guy says it could be closer to $30, which translates to roughly $0.75 per gallon of gas.  It’s going to be a painful summer if you drive a car.  But by the end of the year, it could be a lot better.  Which is a good thing, because as we also talked about last week, we’re going to have some legitimate economic challenges come 2012.

I still love the energy sector now and for the next decade.  But things are expensive right now on both the commodity side and the equity side.  Times like that are when you take some profits off the table.  As we move through summer and into fall, crude oil could be under $100 before you know it.  Speculators are a skittish and quick-moving bunch.  I think you’ll get another chance to reload your investments in this sector.

It’s yet another trend that won’t keep moving in the straight line that it has been.  Surely not once QE2 stops, right?

Right?

• It’s been an ugly decade for the Dollar and the quantitative easing programs haven’t done much to repair its problems.  If you’ve been a foreign investor in the U.S. markets, you’re probably even angrier with The Fed’s monetary policy than we are.
• If I was a betting man — and I’ve been known to spend some time studying the odds — I’d bet that the Dollar catches a bid and rallies at some point this summer.  That could be a headwind for stocks and by definition a Dollar rally is bad news for commodities.
• At the very least, buckle up for some volatility in the Dollar.  And over the long run physical assets will be just fine relative to the Dollar.  Especially the ones that are fundamentally cheap right now.
• This summer will be painful if you drive a car and everyone knows that over the long run we really gotta do something about how we power most of our transportation.  But in between those two windows, I think it’ll get better.

I’ll admit.  Sometimes I’m guilty of a little hyperbole.  Today, though: no hyperbole.

This is the most important newsletter we’ve done all year.

First we’re going to do a quick market recap on some fairly big news.  But then we’re going to ask the question what happens when QE2 ends?  If you are invested in the stock market, this will have major implications for you.  If you own bonds, this will have major implications for you.  If you are sitting idle with lots of cash, this will have major implications for you.

Those of you old-timers remember one of our predictions for 2010 was that one of the most important things to watch was the unwind of the first QE program.  What happened was the Fed stopped buying assets and the market fell 17%.  The headlines all blamed Europe, but I’d counter that Europe had less to do with it than we initially thought.  Since then Europe has gotten worse with more countries asking for bailouts.  The market has gone back up.

What will happen when the Fed stops this second round of quantitative easing?

If you can’t wait, just scroll down a few inches.  First, some major news.

U.S. Treasuries vs. the Ratings Agencies

The big news of this week came out on Monday.  S&P downgraded the credit outlook for U.S. government debt from “stable” to “negative”.  The U.S. still has a AAA rating and, according to the lead sovereign analyst at S&P, the change in outlook means they have a 1 in 3 chance of downgrading the actual rating within the next two years.  Hopefully this will act as a wakeup call to the goofballs in Washington D.C.  Endless borrowing and spending with no serious plan in place to pay it back without destroying our currency can’t continue forever.  Seriously.

But I remain optimistic here.  There’s no way on earth the U.S. loses its AAA rating.

In fact, I secretly wonder how much of this is about S&P trying to re-establish all the credibility it lost during the financial crisis.  Talking tough and talking proactively are the kinds of things that were always expected of these ratings agencies and the kinds of things they failed miserably to do.  S&P and Fitch and Moody’s still have a lot of egg on their faces.  This could be part of the cleanup.

In a tangential sense, this story is a reminder of everybody’s still-misguided expectations about the future.  Consider all these recent polls which clearly show that pretty much everybody in this country wants a balanced budget but pretty much nobody wants to pay for it.  The alternative scenario is the endless borrowing and spending, also known as a “free lunch”.  The probability of this alternative scenario playing out indefinitely is 0.0%.

So buckle up for both higher taxes and reductions in spending on your favorite government programs.  Middle class savers?  Get ready to be squeezed by price inflation in things like gas and commodities.  Collective sacrifice is the only way the current condition eventually clears.

And those of you that still dispute the notion that “there ain’t no such thing as a free lunch” (TANSTAAFL), I’d encourage you to pick up Heinlein’s The Moon is a Harsh Mistress.

I’m a bit surprised amidst all this Tea Party quasi-libertarian fervor that so few people have gone back to the original masters.  Yes, in some circles Ayn Rand is enjoying a stunning comeback.  But why not this one?  It’s one of the original libertarian manifestos!

Is it because it takes place in outer space???

For the uninitiated, Heinlein was a pretty awesome dude.  He was a graduate of the Naval Academy at Annapolis, an experience which strongly influenced his Starship Troopers. That book basically glorifies the military and the ideological right wing and I’ve heard more than a few people say it was a book that literally changed their lives.  His most famous book is Stranger in a Strange Land, one of the ur-texts of the hippie movement and an ode to liberal ideals and another book that literally changed many people’s lives.  Heinlein campaigned for both Upton Sinclair, a hardcore populist, and Barry Goldwater, a hardcore conservative!  Honestly, we could use a few more open-minded deep-thinkers like him nowadays.  The best the rest of us can do in the meantime is appreciate his body of work.  If you’ve always been curious about real-deal science fiction, Heinlein is a great place to start.

We talk about things like this around here because it is all connected.  Science fiction is about human nature and its effects on society.  Economics and investment are also based on human behavior.

What happens when QE2 ends?

This is a H-U-G-E question that will have mammoth repercussions in the market.  We all know the program is set to end in June, so it’s time to start thinking about it.

Answering this question won’t be easy.  Predicting the future is difficult.  But we’ll try and work through towards something coherent and actionable.

To start, our quest for an answer must consider a corollary: what won’t happen when QE2 ends?  And what won’t happen is QE3.  At least not right away.  I actually do think that at some point down the road, perhaps in a few months or perhaps in a few years, we’ll get another quantitative easing program.  But not right away.

So we can begin with the basic assumption that quantitative easing will stop and nothing will step in to take its place.  The Fed won’t sell all these bonds back into the marketplace — can you imagine what a disaster that would be!  They’ll just stop all the buying they’ve been doing and sit idle while the stuff on their balance sheet slowly runs off.

Next let’s get a little history and background of what happened in the markets while the Fed was doing this QE stuff.  It’s chart time!  I was actually going to draw up this exact chart but saw that the always-awesome Calculated Risk had already done it for me:

Peculiar, don’t you think?  The stated goal of these two quantitative easing programs was to “stabilize the economy and create jobs.”  Understand, however, that’s a political goal.  It requires a logical leap of faith to buy into the thesis that quantitative easing can accomplish that.

The real economic goal of a quantitative easing program is to “increase the money supply and the excess reserves in the banking system.”  Yeah.  Try selling that to the public.

The way the Fed does this is by buying bonds and other stuff and electronically creating excess reserves on the balance sheets of various banking institutions.  It makes prices of things go up and yields go down.   Theoretically, when they increase the excess reserves of the banking system, the banks will be more willing to lend capital out to businesses, which, theoretically, creates jobs and stimulates the economy.  As I said, it requires a logical leap of faith.

It’s tough to measure the direct effect of the two QE programs on the labor market.  The labor market is healthier than it was a year ago, but not by a whole lot.  Was QE2 to thank for that?  I’m not entirely sure.  Get ready for a big public debate about this that will probably never be clearly decided.

It’s much easier to measure and understand the effect on the stock market.  It went up!  It wasn’t an unintended consequence — the Fed knew that this would be a likely side effect — the QE programs have undeniably put a floor in the stock market and help re-inflate risk assets.  All this liquidity rushing into the banking system is flowing back out into risk assets like bonds, stocks, and commodities.

The reason that the banks have been doing other stuff with this money aside from lending it out is in ways that create jobs and grow the economy is because lending standards are much tighter now.  Businesses aren’t getting loans because, well, we’re a lot more careful about how we extend credit nowadays.  And besides, the banks can make more money more reliably by investing that capital elsewhere.  Like loaning it back to the government, for example.

Other examples of QE

Next let’s take a look at what happened in Japan.  They were the first ones to try this whole quantitative easing thing on a massive scale.

Frustrated with a 10-year bear market after their real estate and stock market bubbles, they threw their arms up in the air in 2001 and said, “We give up!  It’s time for a ZIRP and Quantitative Easing!”  ZIRP is not the name of a space monster or rogue AI, it stands for Zero Interest Rate Policy.   You should recognize ZIRP because it’s exactly what the Fed did in response to our real estate and stock market bubbles.  Bernanke just acted more quickly.

How did QE work out for Japan?

Some of my friends are statisticians.  I can hear every single one of you screaming, “it’s correlation not causation!”  You might be right.  But when the Japanese quantitative easing program finally stopped, this guy, a vice president at the Federal Reserve Bank of San Francisco did a much deeper study on this.  He basically concluded that:

1. Yes, interest rates went down because of QE.
2. Yes, risk tolerance increased because of QE.
3. But, it’s tough to say exactly how much, and structural reform in the financial sector was definitely delayed because of QE.

I share this obscure study with you because that’s exactly what has happened in the U.S. in the wake of our first quantitative easing program.

Based on our experience and the Japanese experience, QE seems to be rather effective at fighting deflation (and delaying necessary reform).  It pushes interest rates down even further, encourages people to take risk, and pushes up asset prices.  Indeed, the risk that everybody always freaks out about when talking about QE is that it might create runaway price inflation.  Well, duh!  When you’re locked in a battle against deflation, you’re sort of required to use tools that may have inflationary side effects.

So, back to our question: what happens when it stops?

Does — *gulp* — deflation make a comeback?

The Great Unwind

I don’t think it’s trivial to say that when the QE2 punch bowl gets taken away the market will stop going up.  This is what happened after the first QE stopped and it’s what happened after Japan finally stopped their QE stimulus.  It doesn’t necessarily imply that the fun is over.  The retail and institutional market could keep right on buying and taking on progressively more risk.  People need to make money, after all, and interest rates are still too low to give people a viable alternative.  Full Tilt Boogie could continue to party on.

So while there is definitely risk of the market sliding into a correction I’m not sure where I’d peg the odds.  Maybe it happens, maybe it doesn’t.  I want to be prepared either way.

Aside from that, I think there are two things that I think have a very high probability of happening.

The first is that interest rates will go up, especially in the middle of the yield curve.  Pretty much the only person in town that’s buying Treasuries is the Fed.  Rates just aren’t attractive enough for the private market to step in.  Seriously — does 1.26% on a 3-year note get you excited?  BOR-RING!  There is zero chance that breaks you even after inflation in the next 3 years.  The Fed will buy that because they have to but why would a private investor?

That being said, there are some people out there that seem confident that the private market will step in and keep eating up Treasuries at historically low rates.  I just don’t agree with them.  I’m with Bill Gross on this one.

The other thing that I think has a very high probability of happening is that commodities will get hammered.  Here’s another knockout chart I caught a couple weeks ago at Minyanville:

Crazy, right?

I know the investment world has their hearts a-flutter with commodities right now, but I’m not sure I’d want to be getting heavily long in this space.  At the very least, just hang out for a little while longer to see if there’s any indication at another round of quantitative easing.  If I’m wrong and the Fed does immediately embark on QE3, then go ahead and reload in the commodity sector.

In fact, it would be quite ironic if all of this corrects just as talk is finally getting serious about the legitimate commodity price inflation we’ve seen in the last six months.  The core CPI hasn’t moved much, but inflation hawks always watch the headline CPI.  And that has been moving higher as food and energy costs have risen thanks to QE2.

European central bankers are quite a bit more skittish about inflation than our Fed, and Jean-Claude Trichet has taken an unsurprising lead here.  Nevermind the stimulus, they actually raised rates over there!  The 25 basis point hike won’t be the last, either.

To understand the reason why Europe — who is arguably in a bigger mess than we are — and the U.S. Fed have diverged so dramatically with respect to policy, it requires a simple lesson about cultural psychology.  In Europe the overriding economic concern has always been inflation and the reason for this is the visceral experience of post-war hyperinflation in Germany.  It happened again in peripheral Europe after WWII and again in the 80′s.

Sure, the U.S. is concerned about inflation.  We had a spell of that in the 70′s but it didn’t come remotely close to some of the inflationary episodes that Europe saw in the last century.  Over here our national nightmare is unemployment.  A little piece of the Great Depression lives on in all of us today.  It’s ingrained in our collective psychology the way hyperinflation is over in Europe.  Most of Europe has been battling double-digit employment for decades and at this point they’re kind of like whatever.

This is why Europe focuses on headline inflation (which includes food and energy) and isn’t afraid to raise rates in the middle of an economic mess and difficult labor market.  Preventing inflation is their number one objective.  Our number one objective is keeping unemployment low.  9% unemployment makes everybody freak out, especially politicians.  So over here we  focus on core inflation and holds rates at zero as inflationary pressures start to rise all around us.

Low and lumpy

There’s no more political will for more stimulus.  And with the recent credit outlook downgrade, it doesn’t sound like the market is going to stand for the current equilibrium much longer.

The time has come for the economy to stand on its own two legs.  I think it’ll do it, too.  It will just go slow and take some time and the growth will be lumpy, coming in fits and starts.  The Fed is going to hold short rates low because that’s all it can do to help encourage that process.

The bad news is that this will mean the return of volatility.  The QE net will be gone and with no Fed to fight, the barriers to a new cyclical bear market will be removed.

On top of that, I’m starting to have concerns as I look out to 2012.  The market usually looks ahead about 6 months or so, which means that just as the QE2 program is winding down in June the market will have a few new things to worry about.

We’ll probably get some legitimately great economic data in Q4 of this year.  Holiday spending should be strong as people have some extra money from the payroll tax cut this year.  But the short-term tax bill that was passed last year contained another interesting provision.  It allows businesses to purchase a new asset and depreciate the entire value of that asset this year.  It could be a home run for a lot of businesses and every American CFO worth his salt will be recommending purchases of new assets now and not later.  If your business needs a new truck, do this year not next.  So get ready for some barn-burning numbers later this year on auto sales and computers and that sort of thing.

But remember, it won’t be a free lunch.  This will pilfer demand from 2012.

We saw the exact same thing with the homebuyer tax credit back in 2009.  Immediately after that legislation we saw home sales spike dramatically and prices get a nice bounce.  But since the expiration of that tax credit sales have collapsed and prices are trending back down.  Everyone who was on the fence or toying with the idea of buying house went out and did so in late 2009.  No surprise, the market kind of dried up in the year or so that has followed.

Now we’re doing the same thing with our economy.  I have a hard time imagining the results will be different.  And all of this will begin playing out this summer as the Fed is unwinding it’s epic stimulus program.  It adds up to a whole lot of volatility, right when investors are starting to feel a little more confident about things.

Funny how that always works, huh?

The moon might be a harsh mistress.  But guess what: the markets are an equally harsh mistress.  Trying to manipulate them isn’t always the best idea.

They have an eerie skill at making sure you pay for that lunch you thought was free.

• Time to focus on the unwind of QE2.  When trying to gauge the effects of an unwind, consider the initial goals of the policy.  Then reverse those goals.  That should give you an idea of what might happen.
• Volatility should return in full force this summer and I think interest rates will rise in the absence of all this massive Fed buying.
• Go read Robert Heinlein’s The Moon is a Harsh Mistress if you’re looking for a good story and some fascinating libertarian ideas.  Or Starship Troopers if you are a gun-toting, right-wing patriot.  Or Stranger In a Strange Land if you fancy yourself a fuzzy pinko liberal.  There’s something in his body of work for all of those on the fringe and the rest of us in the middle too.

We’ve got some interesting stuff planned for the coming weeks.  Some different stuff.  We like to keep it spicy here at The Draconian.

Next week we’re going to talk about what happens when QE2 ends and I can almost guarantee I’m going to lose some of my current friends and make a few new ones.  After that, I’ll be on the road through the end of April so maybe I’ll put together something a little more philosophical and introspective.  Travel always puts things into perspective for me.  We’ve talked a lot about strategy in recent weeks — everything from healthcare, to Japan, to why I like dividend stocks.  I’ll see if I can slip in a changeup to balance out all this strategy and forecasting.

Today we’re going to discuss a concept that’s somewhat technical.  But it is really important within the context of everything that’s happening in the markets right now.  This newsletter runs a little shorter than usual.  I think you’ll find it interesting.

First, let’s take a quick look at the markets.

Market Recap

I’ll admit, I looked kind of silly calling for below trend economic growth amidst all the enthusiasm near the end of last year.  But since then, it’s been a rather steady stream of analysts slashing their forecasts for 2011 GDP growth.

The stock market, which showed great strength in its comeback after Japan, now seems to be tiring out a bit.  It failed to make a new high and has now rolled under the 50-day moving average.

The 50-day moving average is one of my early warning bells.  It doesn’t mean PANIC or GO CRAZY.  It’s a caution flag.  When the stock market makes a move above or below that trendline, I start paying really close attention.

Hopefully the market will quickly rally back; that’d be a nice buy signal.  But you should know that one of the first lessons from Technical Analysis 101 is that you need to make sure your defenses are in place any time the market falls through its 50-day moving average.  If you’re a shorter-term trader, that’s when you want to move to cash.  It’s a simple rule of thumb but surprisingly effective.

The 200-day moving average is the other one I watch.  Basically, I don’t do any buying when the stock market is under its 200-day moving average.

Don’t laugh at entry-level technical analysis.  You can see how nicely this stuff has worked in recent years to get you in and out of the market:

These tools are really easy to use and remarkably, most investors don’t use them.

While the market has me slightly on guard, I’m starting to feel a whole lot better about the labor economy.  You all know I don’t pay much attention to the headline monthly jobs report.  It’s a number that is incredibly difficult to calculate — just a few hundred thousand people out of a labor force of 150 million people.  Plus, it’s subject to crazy revision.  Don’t ever get too excited about the reports you see on this number.

I also prefer to look at a much broader measure of unemployment like U-6 to get a sense at how the labor economy is really doing.  That has fallen about 1% since the end of last year, though it’s still pretty high at 15.7%.  For U-6, readings in the 7-9% range indicate a healthy labor economy.

A couple months ago we mentioned that the big thing to watch was the weekly unemployment claims dropping under 400,000.  That did happen and this is another indicator that’s a better one to watch than the headline rate you hear all the politicians talking about.  This kind of improvement in weekly unemployment claims will almost certainly translate to job creation of at least 150-200,000 per month.   We’re also starting to see more stories about a record number of post-crisis job openings.

Regardless of how you measure it, the labor economy is clearly moving in the right direction.  It’s doing it slowly, but it’s doing it.  And, as it should be, the private sector is leading the way.  As we’ve been writing about for over a year now, there is no major risk of economic slowdown in 2011 and continued improvement on the jobs front is one more reason why.  The recovery, as lackluster and bifurcated as it may be, is definitely on.

The economic data points are encouraging and will probably remain so for a little while.  In the meantime expect the stock market to keep doing its own thing.

Risk or Die

All right, today I’m going to drop something on you that’s kind of heavy duty but critically important.  All of you professionals on this newsletter will nod your head and smile in agreement.  For everybody else, it’s time to go get another cup of coffee and really focus for about 90 seconds.  You’ll thank me later.  I guarantee it will help you make sense of much of the madness that you see when you look around.

It’s called negative real interest rates.

In highfalutin economic parlance, whenever you see the world “real” before anything, it means it has been adjusted for inflation.  With interest rates it’s pretty simple.  Take whatever interest rate you’re receiving, make sure it’s annualized, and then just subtract the inflation rate.  BAM!  Now you have a “real” (whatever) rate.

Right now, for investments that are low- or zero- risk the real interest rate is negative.

Yes, Neo.  The real yield on your low risk investments is negative.  Not only is there no spoon but the Fed Matrix is losing you money.

I cannot emphasize enough how distorted the investment world gets when you have negative real rates.  Right now the Fed Funds rate and the rate in your savings account are basically nothing.  The yield on 1-year Treasuries is a scant 0.23%.  Inflation for this year will probably clock in somewhere between 2 and 3%.  That means that after inflation, these risk-free investments will lose money.  They’ll lose money in the sense that they’ll lose purchasing power.  Inflation will go up more than these assets will go up.  But investors hold these assets because they don’t have a choice or have opted not to take risk right now.

The problem is that some people need to make money.  Some of these people are retirees trying to live off of investment income.  Some of them are pension plan managers trying to figure out how on earth to pay out the benefits they’ve promised.  Some are professional fund managers with angsty clients.

Needing to make money is a bit more troublesome than wanting to make money.  Because people that need to make money often do crazy, desperate things in order to make the money.  In the old days they might have stolen a loaf of bread or taken a job as a carnie.  Nowadays they go buy an index fund.  Or junk bonds.

You might not think that’s that big of a problem, and ordinarily I’d agree.  There’s nothing wrong with taking a little risk on some risky investments.  But the problem is that people have basically no other options if they don’t want to take significant risk.  The global policymakers are holding a gun to the heads of investors and forcing them to take risk if they don’t want to lose money after inflation.  It’s “take risk or die!”

Remember way back when?  Your savings account actually used to pay you a couple percent.  You could call up your friendly broker and pick up some risk free 10-year U.S. Treasuries that would yield like 5 or 6%.  AAA corporate bonds paid you almost 7%!  Those were the days, huh?

Now what is the investor who wants to make a couple percent after inflation supposed to do?

The answer is that he has to put that money into the stock market.  He has to buy higher yielding bonds.  He has to chase assets around the world that are rising in value like commodities.  He’s still hung up on that 5 or 6% but doesn’t fully understand that the way he’s currently getting it carries remarkably more risk than it used to.  His only other easy option is to leave the money in his savings account or in Treasuries and slowly lose purchasing power.

Negative real interest rates give people an incentive to take risk.  They also have a tendency to inflate or exacerbate bubbles.

And this is exactly what the Fed wants right now!  They want to reinflate the stock market so people feel wealthy and so that they’ll spend money and so that businesses will invest and hire new workers.  They want to reinflate the housing market so people won’t be afraid about going to the banking system to get a mortgage and so those who already own a home stop freaking out about all of their negative equity.  Policymakers have painted themselves into a corner and this is the last strategy available.

What about the little guy?

OK, I see a few hands raised in the back of the room.  I know what you clever few are going to ask.  You’re going to ask, “who’s reaping the benefits of this distorted environment?”

The obvious answer is anyone who has been long the stock market, which is a smaller group of people than you’d think.  The retail investor still hasn’t really come back into the market yet in full force (when he does, almost assuredly, it will market the peak).

The sneaky answer to who’s benefiting from all this distortion is the banking sector.  They get to borrow from you at — what does your savings account pay again?  0.15%?  So your bank gets to borrow from you at 0.15% and then lend it back to you in the form of a home loan at 5.15%.  Or maybe they give you an auto loan instead.  Or a credit card!  They can charge you 23.99% for those.

A couple weeks ago I mentioned that there is nothing more awesome in the world for a bank than a steep yield curve.  And this yield curve, my friends, is historically steep.  It’s good to be a big bank right now.  The bonuses are fat and Washington D.C. does what you tell them.

Calm down — this isn’t as bad as it sounds.  I haven’t gone all Matt Taibbi on you.

To recap, the banks in this country were naughty.  I mean, like, beaucoup naugh-tay.  They took boatloads of risk because they wanted to earn some gigantic bonuses and when the risks blew up in their faces they were left with huge holes in their balance sheets.  The government gave them some direct loans and injected some direct capital, but that only plugged part of the holes.  The next step was to change the rules about accounting practices to allow the banks to say these assets were worth more than the market was willing to pay for them.

The final step was to jury rig the yield curve so these banks could be super profitable and “earn their way” out of the holes in their balance sheet.  This brings us to negative real interest rates, punishing savers and forcing investors into risky assets to pick up yield.  As I said, there aren’t any other good strategies to fix the financial sector — the other options were to let the banks fail or keep handing them more free money and nobody really wanted to have either of that.  There were lenders that needed to get paid back at 100 cents on the dollar and taxpayers weren’t going to stand for more bailouts.

Is it fair?  No.  It’s not fair.  Life isn’t fair and life on Wall Street is even less fair.

The best we can do every week is talk about things that you can do at home to navigate this deceptively dangerous environment.  It’s certainly possible to make a few percent after inflation without taking crazy risk.  But it’s much more difficult than it used to be.  Most people out there just don’t understand the risks.  It sounds totally insane, but nowadays simple savers actually have to work to not lose money.

Anyway, I bring all of this up because at some point all of this is going to change.  Negative real interest rate environments don’t last forever.  They can’t.

The million dollar question is when this change finally happens.  Some people believe that the end of QE2 could trigger it.  As I teased at the top, I’ll explore that idea next week.  Other people think that it won’t happen until the economy shows signs that it can grow without the aid of stimulative steroids.  Either way, full tilt boogie won’t last forever and I can’t even begin to guess at when the dancing stops.

The other million dollar question is how the environment will change when it finally does.  This is much easier to predict.  In a broad sense, take a look at all of the trends of the last 6-18 months.  Now picture them reversing.  Or at the very least, ceasing.  Negative real rates aided and abetted the market action of the last two years and sending that enabler to jail should turn things back around.

I’m not saying that you should gear your portfolio up to make a bunch of money off that outcome, I’m just saying that make sure you’ve got mechanisms in place to keep your investment portfolio safe in case it does.

That’s what good portfolio managers do.

• The S&P has violated its 50-day moving average, a sign that this selloff may continue or that the market could chop around for a while.  Hang out if you’re on the sidelines look to re-enter on signs of technical strength.  Watch carefully if you are heavily long.
• Negative real interest rates have immensely distorted the marketplace.  It has created a huge misalignment of incentives from simple savers on Main Street all the way to top-level banking executives.  For better or worse, it has acted to reinflate some of the bubbles we had earlier in the decade.
• I don’t have the foggiest idea when this environment of negative real rates will end, but when it does, look for a lot of the market trends to reverse.

Today we’re going to revisit healthcare as a product and an investment.  It’s a sector I like a lot for the next decade.

I also have a story to share and I share it because I have a feeling you’ll be able to relate.  This is really important because within this story is the real secret to what’s wrong with the healthcare system.  It also contains secrets to nailing the investment dimension.

What’s right about the healthcare system

Before we get too far into the weeds with anecdotes and analysis, I want to dispel a few myths about our healthcare system.  Most of today will be about what’s wrong with the system but there are some things that are very much right.

There is this perception in some circles that the U.S. healthcare system is subpar.  These people cite studies about how other countries have longer life expectancies or lower death rates from things like heart disease.  Their conclusion is that other systems somehow deliver better quality.  This is insane.  The U.S. has a phenomenal healthcare system.  The jingo in me chants, “we’re number one!”

Actually, I don’t have any data to be able to state that authoritatively.  But the overall quality of healthcare in this country is incredible.  So it goes with incredibly wealthy nations.

The rest of the developed world may indeed be healthier or live longer than the average American, but I am by no means convinced that it has anything to do with the quality of the healthcare system.  I believe our problems are cultural.  We like to eat garbage and we don’t like to exercise.  Each generation since the G.I. generation has been more overweight at a younger age and at every subsequent stage of life than the generation before it.  Read this if you like real science.  Or spend some time at an elementary school bus stop if you prefer anecdotal evidence.

I would submit that the biggest public health issue of the past 50 years was smoking.  50 years from now we’ll look back and say that the dominant public health issue in the first half of this century was obesity.  And as it was with cigarettes, the real solution will come through a change in culture, not advancements in the healthcare system.  In the meantime our incredible healthcare system will mask the potential damage of these cultural problems.  Until that happens there will plenty of complaining about the quality of our healthcare system.

The legitimate complaining is not about quality but cost.  Per capita spending on healthcare in the U.S. is over double what it is in the rest of the developed world.  We might be getting higher-quality care but the debate centers on whether or not its worth it.  This is not insane.  This is an important debate.  Our system may be better than what they have in Italy but is it twice as good?

It’s like shopping for a car.  Quality tends to scale linearly with cost up to a certain point, a point at which I will say in totally-biased fandom is occupied by my Toyota 4Runner Limited.  It cost about 40% more than a fully loaded Ford Escape.  Is it 40% better?  Damn right it is.  A moderately equipped Mercedes GL450 costs 100% more than my beloved 4Runner.  Is it twice as good?  Doubtful.

TheDraconian.com is all about value.

Here, I made the following diagram which you may find helpful:

The U.S. has the Mercedes Benz of healthcare systems.  You can either get down with that notion or you can’t.  Mercedes sells a lot of cars to people who want that kind of product.  Most of them are very happy.

“It’s been going around”

This all comes to mind because of my experience two weeks ago.  I got really sick.  I’ll spare you all the grisly details.  But I will say this: if you want to make your doctor really nervous, tell them you’ve had a severe headache and uncontrollable vomiting for two straight days.  When I came close to passing out a few times, I finally decided it was time to go to the ER.  For a guy like me that’s a pretty dramatic move.  Because I’m that guy.  I’m the guy who, having been blessed (spoiled?) with a lifetime of remarkable health, doesn’t think he ever needs to go see the doctor.

After a morning of anti-nausea meds, IV fluids, and morphine produced only a slight improvement, the ER doctor suggested that it would probably be a good idea to do a CT scan.  They never tell you what could be wrong when they suggest a test like that.  They just tell you that you should do one and who are you in your feverish delirium to question this guy’s suggestion?  He wore a white coat and carried a clipboard!  I said “sure” and didn’t think anything of it.

I have no idea how much a CT scan costs.  A lot, probably?  Every single major purchase I’ve ever made has been done so within the framework of cost.  But that framework doesn’t really exist with the healthcare system.  I have insurance!

So I had the CT scan which was kind of fun.  Lots of cool clicking and whirring.  They had the results quickly and said — thank goodness — that there was no neurological bleeding.  But the doctor said these tests were only about 95% accurate and thought it’d probably be a good idea to do an MRI just to be sure.  So I bought one of those too.  That wasn’t fun.  I understand why people load up on Xanax before getting one of those.

Now, I didn’t realize this at the time because I had sorta checked out, mentally speaking.  But why not just lead with the MRI?  Why do the CT scan at all?  If you’re going to distrust the test that’s 95% accurate and worry about the 5%, why not do the test that’s more accurate in the first place?

OH WAIT.  They knew I had good insurance.  I’m pretty sure that if they’d asked the insurance company — the party that will actually be writing the check for all of this — they’d give a different answer than the desperately-sick patient.  You might just think I’m being cynical, but if you ran a for-profit hospital and had full understanding of how easily exploitable the structure of the system is, what would you do?  Seriously.  You’d recommend the CT scan and then follow it up with an MRI, that’s what.  It’s just business, and my doctor friends would probably tell me it’s defensible medicine too.

And if you were in my situation as a patient with great insurance, you’d happily agree to both tests.

Let’s say I was paying cash.  Would I have said yes to the CT scan?  I’m not sure, but the first thing out of my mouth would be, “how much does it cost?”  And then I’d think about it for a while.  If I was paying cash, I’d almost certainly reject a $4,000 MRI after a CT scan showed healthy results.  I’d take my chances.

The broken incentive structure

I share this anecdote to underscore the point that when people make decisions in this kind of context — where they are technically spending “someone else’s” money — they wind up spending a whole lot more.

By definition, because of how the insurance industry works, more spending on healthcare services translates directly to higher insurance premiums.  This is a law that simply cannot be bent or broken.  Insurance companies aren’t in this thing for charity.  As they pay out more money in claims for services then they have to raise their premiums to offset that expense.

In an abstract sense, the root cause of the financial crisis was due to one basic problem: a fundamental misalignment of incentives on basically every level.  This problem manifested itself in a variety of ways — from the disconnect between who gets the benefits of the risk (banks & their executives) and who pays the price for the risk (shareholders & taxpayers) to things like mortgage brokers putting dodgy borrowers into dodgy loans because they didn’t have to deal with the consequences of default.  That was for some pension fund in Finland to worry about.

The same problem exists in healthcare.  The incentives are completely backwards from top to bottom.  I reap the benefits of the service but my insurance company pays for it.  And I don’t even pay for my insurance plan.  My employer does that.  Or the government.

What a lot of people may not understand is that we are having a crisis in healthcare right now.  It’s different from the financial crisis because the crisis is not acute.  It’s not the immediate panic of a severe headache & vomiting that makes you cry out, “do something!”  It’s the dull pain of a cancer, slowly destroying its host from the inside.  It’s the kind of pain you delude yourself into ignoring until it’s too late.

I label it a crisis because it will literally bankrupt our country if we don’t alter our current trajectory.  Have you seen the CBO’s projections on this?  We’re talking like 30% of GDP by 2030.  That’s like 100% of tax revenues.  I know everybody is desensitized to the word “unsustainable” thanks to the last decade or so.  But this situation literally cannot be sustained.

Anyway, I don’t mean to sound alarmist or whiny about our healthcare system.  We really do have it good in this in this country.  Getting sick is never fun, but my experience here at the local hospital was absolutely first rate.  Not everybody has insurance as good as mine, but everyone in that ER was getting outstanding care by excellent doctors.

Years back, I fractured my skull on a scooter accident in Greece.  I got to ride in two ambulances, saw six different doctors, and visited three separate hospitals.  There was somebody else’s blood on the gurney when it was my turn to lie down.  The ophthalmologist who checked the inside of my eyes did so while smoking a cigarette.  Nobody washed their hands.  But all I had to pay for was the x-rays.  Everybody that helped me was as nice as can be.

Was that all worth it?  I guess so.  I got quite a bit of mileage out of my $15.

I’d still rather be a patient in the U.S. healthcare system.  Any day of the week.  The doctors and facilities in this country are mind-blowing.

How to play it

So how do you invest around all of this?  Let’s think about it.

You have to start by answering one major question.  Do you think the system is going to change or do you think we’re stuck with the status quo?

If you think the status quo will remain mostly intact, pretty much anything in the healthcare space should be a fine investment.  Demand is only going to increase as the Baby Boomers get older.

The quick and obvious way on how to play it is a generic healthcare sector ETF or mutual fund.  There are lots of these to choose from.  I like the healthcare sector better than a lot of other sectors over the course of the next decade.  You can do worse than having broadly diversified access to this entire sector.  This is a macro play that demand for healthcare will stay strong and health will continue be an important part of our lives and where we spend our money.  People still get sick in recessions, you know.

Remember that healthcare is a defensive sector and it tends to hold up better in bear markets.  In this chart, the blue line is a Healthcare ETF.  The yellow line is Consumer Discretionary, the red line are the Financials, and the green line is Energy.

You can see that Healthcare held up much better than these other sectors but the recovery since then hasn’t been as dramatic.  This is why healthcare as a sector is somewhat out of favor at present.  It’s boring.

If you want a little more zing and are comfortable doing a little more due diligence, there are plenty of specific growth opportunities in this space.  Have you seen a chart of  Intuitive Surgical?  This company makes the robots that Mrs. Draconian and her Doc use to perform their gyn-onc surgeries.

That’s like, whoah.

On a brief side note, Mrs. Draconian actually has a bit of acclaim in this space.  She and her Doc recently published a fairly important research paper on the efficacy of these surgery robots.  They’ve traveled around the country giving lectures at medical conferences.  It turns out that the data show that patients do recover from these robotic surgeries quicker than traditional laparoscopic procedures (depending on the procedure).  Once the doctor gets past the learning curve of the controls, the surgeries can go quicker, too.

There is undoubtedly marginal benefit in using these robots.  The kicker is the cost; these things are not cheap.  Mrs. Draconian likes the robots because they do a better, faster job for the kind of surgeries that they do.  But she’s a PA.  I’m an economist.  I’m skeptical of the robots because I’m unsure whether the marginal benefit is greater than the marginal cost.  One night we went out for Italian food and after a few glasses of Chianti we tried to have a conversation about marginal cost and benefit.  Bad idea.

Now that you’ve got my wife’s medical perspective and my economic perspective on the robot, think about it from the perspective of the average guy on the street.  Odds are that this is someone just like you.  Your area of expertise is probably something different than medicine or economics.  So imagine having the following conversation with your Doctor:

DOCTOR:  Hello, my name is Doctor Awesome.  I specialize in robotic surgeries.  Robotic surgeries are awesome.  They go faster and you’ll recover quicker.  Here’s a bunch of research that proves it.

YOU:  Wow, that does sound pretty awesome.

DOCTOR:  They’re expensive but did I mention your insurance will pay for this procedure?  And that your employer pays for your insurance policy?  Awesome, huh?

How do you respond?

I’ll tell you how you respond: you say “HELLZ YEAH!  Gimme the robot.”

And just like that, the cost of healthcare in the system goes up.

Full disclosure: I don’t own this stock, nor does my company.  But every day I smack myself upside the head for not having bought it.  Mrs. Draconian started raving about the surgery robots several years ago when ISRG was $100/share.  She said that their hospital bought one of the $1.8 million robots and the competitor hospital here in town responded by buying two.  She told me that this was the future.  But I couldn’t get past its sky-high earnings multiple then and still can’t now.  This is the cross that all of us value investors must bear.

This isn’t just happening with robots and MRIs.  It’s happening at every level of the healthcare system.  People are making decisions like that every day which steadily escalate the systemic costs.  The companies that provide these exciting new drugs and procedures really like this structure and since they spend about a half a billion dollars per year on lobbying, they sort of get to write the rules.  And these guys like how the rules currently read.

What if it all changes?

The recent healthcare act does not count as radical change.  If anything, it further re-enforces the current alignment of incentives and brings a whole bunch of new people into some sort of system where they’ll be consuming health services for themselves with someone else’s money.

But if you think there is going to be a radical reformation of our healthcare system — i.e. a shift towards some sort of model where individuals pay more of the costs themselves or at the very least shop directly for their own insurance plans instead of having their employers or the government do it for them — then it requires a slightly different approach.  Some things will win, some things won’t.  Broad exposure to the entire industry is probably not the optimal way to go about it.

If the mechanisms by which individuals bear the costs for healthcare services completely change then I’m not sure that robot is so awesome anymore.  I probably say no the hospital’s MRI, too.  This can’t be good for the companies that make those things.

Some companies will benefit.  In a system where the consumer actually cares about value, companies that can do the same thing for better or cheaper stand in a position of strength.  Organizations like Kaiser and those with similar models should thrive.  Companies that make generic drugs are another great example.

Here’s a chart for Teva Pharmaceutical.  They’re one of the largest generic drug manufacturers:

It isn’t as dramatic as Intuitive Surgical, but still, TEVA has a pretty solid chart.  They trade at about 10x this year’s earnings too and even pay a 1.7% dividend.  So it’s not like you’re paying an arm and a leg for this business.  Mylan is another generic drug company to look at with a similar chart and a similar multiple.  (Full disclosure: I don’t own either of these, nor does my firm.)

I’m skeptical that the system will get the overhaul it needs.  But things like The Purple Health Plan give me hope.  Professor Lawrence Kotlikoff hasn’t been shy about voicing his criticism about our current entitlement system.  But like Paul Ryan — who earlier this week made gigantic waves with his landmark budget proposal and who was one of our Predictions for 2011 — it’s nice to see someone submit an actual plan instead of just complaining.  Professor Kotlikoff is a highly respected economist and after outlining this principles of his health plan last week, he’s already got endorsements from five Nobel laureates.  Check it out.

It’s “purple” because it contains both Republican and Democratic ideas.  Spiritually, I think he’s on the right track.  As you read through it, try and think about what types of companies will prosper under a framework like that and what kind of companies are more heavily reliant on the structure of our existing system.

Both complex and simple

Look, the details of the healthcare system are really, really complicated.  There are a million moving parts.  But in an abstract sense the problem is simple.  The incentives are not properly aligned to move the system capitalistically towards higher quality and lower cost.  And moving it socialistically towards that objective isn’t going to happen either.  If we couldn’t get government-run healthcare under the political constellation of 2009 it’s safe to say we never will.

In the meantime, we’ll have to make peace with a broken hybrid of a false capitalistic system manipulated by special interests.  It’ll continue to give us higher quality for even higher cost.

You’re stuck in this Mercedes Benz.  May as well enjoy it.