-->The Price of Good Health

The Daily Reckoning

Baltimore, Maryland

Tuesday, 25 February 2003

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*** Another GUDD day on Wall Street...Bernanke is back!

*** Sales down...savings up...bankruptcies too

*** A live debate...or a dead one?


It was another GUDD day on Wall Street. Gold went Up, the
Dow went Down. The Trade of the Decade - sell stocks, buy
gold - still looks good.

Ben Bernanke is back in the news. You remember him. He's
the Fed governor who warned foreigner investors:"we
have...a printing press". The euro and gold both soared
when the foreigners realized what Bernanke was saying -
that the Fed was ready to ruin the dollar rather than allow
consumer prices to fall.

Bernanke now says the U.S. economy is in good shape and
that the recovery will be increasingly robust in the months
ahead. Businesses are not doing well, he notes, but the
household sector is stronger than it was a year ago, thanks
to widespread mortgage refinancing.

True, consumers are more deeply in debt, but 90% of the
household debt added last year was mortgage debt, he
continued, and much of it was used to pay down other,
higher interest, debt.

Of course, a lot of the cash-out refinancing booty was also
used to pay for new decks, TVs and vacations; this was the
spending that kept the economy out of recession.

And now consumers are going broke at a record rate...and
businesses are defaulting on their loans at a record level,
too (Eric has more details below). State governments face
their biggest deficits since WWII...and oil prices are
rising...

But don't worry about any of that, say Bernanke and the
Wall Street shills. Once we get this war behind us, the
economy and the stock market will both be fine, just like
they were after the last war against Iraq.

Just one problem...

In 1991, the U.S. economy was about to enter the final and
most gratifying stage of a 50-year post-WWII consumer-led
boom. Today, we are in the 4th year of a major bear
market...and possibly on the downhill slope of that half-
century expansion. Instead of boosting up the markets, war
could have the opposite effect - accelerating the decline.

But here's Eric with the latest news:

-------------

Eric Fry, reporting from New York...

- Well, it looks like the short-sellers aren't panicking
just yet. To the contrary, they continue feasting on the
vanquished bull market like lions around a wildebeest. Most
investors, meanwhile, are cowering in the shadows like
scrawny hyenas.

- The Dow slumped 160 points yesterday to 7,858, while the
Nasdaq dropped about 2% to 1,322. The stock market's losses
accelerated during the afternoon, following reports that
Saddam Hussein had challenged President Bush to a live
debate. Saddam also flatly denied that his"Al Samoud 2"
missiles violate U.N. restrictions and said he had no plans
to destroy them any time soon.

- The Iraqi leader's newly expressed defiance sent
investors scurrying once again into the sanctuary of gold,
oil and government bonds. Gold for April delivery jumped
$4.60 to close at $356.40, while oil surged 90 cents to
$36.48, a new multi-year high. The jump in crude oil was
nothing compared to the blast-off in natural gas, which
rocketed 38% to $9.137 per million BTUs. Suddenly,
America's cheap energy has become very, very expensive.

- Low and falling long-term interest rates might help the
economy somewhat. But not nearly as much as high and rising
energy prices will hurt. The soaring prices of crude oil
and natural gas are sure to take a big bite out of the
consumer's depleted pocketbook.

- Already, evidence abounds of a nationwide consumer
retrenchment. Federated Department Stores, which operates
Macy's and Bloomingdale's, said it expects February same-
store sales to decline by as much as 7.5% to 8.5%, compared
with an earlier forecast of a 4% to 5% fall. Numerous other
retailers reported terrible same-store sales for February.

- Meanwhile, the news on Main Street goes from bad to
worse. Personal bankruptcies soared to a record 1.51
million households in 2002 - 5.7% more than in '01. The
good news - we always look on the bright side here at the
Daily Reckoning - is that 105.6 million households did NOT
declare bankruptcy. And there's more good news: the solvent
98.6% of American households are saving more money than
they used to.

- The personal-savings rate jumped from a low of 2.3% in
calendar year 2001 to 4.3% by the end of last year. Saving
money, while prudent for each individual saver, is not so
great for the economy at large...at least not over the
short term. If consumers don't consume, corporations don't
produce profits. And if corporations don't produce profits,
they reduce capital spending. After a while, all of this
non-spending adds up...and what it adds up to is a vicious
cycle of slowing economic activity. Where it ends, no one
knows. But if it doesn't end soon, today's record corporate
defaults will become even more record-setting.

- Fitch Ratings reports that the U.S. junk bond default
rate soared to a record 16.4% in 2002. Default rates among
investment-grade borrowers also jumped last year.
Incredibly, based on dollar value, more defaults occurred
over the past two years than over the previous two decades.
Default rates will likely remain high in 2003, says Fitch,
ending the year between 7% and 8%. For perspective, between
1980 and 2001, the average annual default rate was about
3.4%.

-"Meanwhile, businesses are finding that various costs
have been stubbornly rising," observes Andrew Kashdan of
Apogee Research."Richard Berner and Shital Patel, of
Morgan Stanley, note that corporate America is experiencing
a 'perfect storm' with regard to cost pressures. While
wages, which make up the majority of costs, have remained
relatively flat over the last few years, costs have
accelerated for health and pension benefits, insurance,
worker's compensation, security services, materials and
energy.

-"For example," Kashdan continues,"health care insurance
premiums for large-cap companies are rising at a 13% rate
this year, wholesale energy prices are up 75% from a year
ago, and pension contributions, says Berner, will eat up
about $20 billion of operating profits in 2003. Our expert
grasp of accounting (profits equal revenue minus costs)
tells us that a problem could be brewing."

See: Retail To The Rescue (Or Not)
http://www.dailyreckoning.com/body_headline.cfm?id=2961

- Perfect storm indeed...If only it were possible to stay
out of the water for a while.

-------------

Back in Baltimore....

*** Commentators blamed yesterday's stock decline on Saddam
Hussein's challenge to George Bush. The Iraqi dictator
suggested a"live debate" between the two men. Most people
were appalled by the idea. But why not? Why shouldn't each
side put forward its champion...and let them fight it out
with words, rather than with weapons of mass destruction?
Better yet, let the two tough hombres meet in a grappling
match...no holds barred! That would be a show better than
the bombing of Bagdad. What a spectacle. Oh, for a piece of
the box office.

If Bush won, he would get his"regime change" in Iraq at no
expense in American lives or money. And if he lost - well,
President Cheney could still bomb the hell of them!

*** The trouble with war is that you never know what will
happen. The American press assumes that the war will be as
quick and easy as a drive-thru burger joint. So confident
is the nation, that detailed attack plans are given away on
the front page of USA today. Iraqi military intelligence
units don't have to do any snooping around; they just have
to buy a paper!

And why not give away the strategy? Everyone knows Iraq
can't really fight back. Which must be what makes the war
so popular in the homeland; it seems to have all the drama
of real war...but none of the risks. It is like a butt-
kicking contest with a one-legged opponent.

But as Gibbon said of the Roman Empire at the height of its
glory, it had little to gain from foreign wars and much to
lose. When you are in a position of overwhelming power, all
luck is bad luck. And there is a lot of luck involved in
war. Right now, America is on top of the world. When you
are on top of the world, your situation can barely improve,
while every mistake, accident and change in the weather
eats away at your authority. And there you have both the
major nuisance and the principle charm of this slippery old
ball we live in: it turns.

*** Yesterday, the Canadian currency, the loonie, rose
above 67 cents. Your editor found yet another way to hedge
against the falling dollar. While in Nicaragua, he was
offered an opportunity to buy land in Nova Scotia. He took
it. What the heck. It may go up. It may go down. But it
won't go away.

^
The Daily Reckoning PRESENTS: Taking a break from the
economic dilemmas du jour, John Mauldin points out a fresh
calamity in the health care sector...one that will"shift
consumer spending habits in ways we do not yet understand".


THE PRICE OF GOOD HEALTH
By John Mauldin

Between the bubble bust, debt bomb, deficit dilemma, dollar
collapse, oil question, and the possibility of war, there
is plenty threatening the U.S. economy right now. But there
might be even more than you think. According to a study
released this week by the Centers for Medicare and Medicaid
Services (CMS), our medical costs will double over the next
10 years.

In the U.S. in 2002, Americans spent $5,427 per person on
healthcare, almost exactly double of what we spent in 1990.
CMS projections estimate that we will spend $9,972 in 2012.
Within another year or so after that, our medical bill will
have doubled from what they are today. Keep in mind that
the Baby Boom did not really get started until 1947...and
so these costs do not begin to reflect the potentially
acceleration after 2012, as my generation gets older and
begins to need ever more medical care.

In 1990, we spent 12% of our gross domestic product on
health care. Today, that has risen to 14.8% and is
projected to rise to 17.8% in 2012. Put another way, that
is 3% of our economy ($500 billion) in 2012 that will not
be spent on imported goods, cars, etc.

Sure, part of this figure will pay the salaries of people
who will buy cars and imported gadgets. But the increase
still represents a huge shift in buying"preferences". It
will not happen all at once, but the decade-long shift in
buying patterns will present significant challenges for
many consumer sales products.

The CMS does put forth that health care expenditures should
rise more slowly in the coming decade than they have over
the past three years - something they attribute to slower
rates of growth in disposable personal income, medical
price inflation, and Medicare spending. But the percentage
of medical spending as part of GDP may be understated, as
the CMS uses a higher estimate of U.S. economic growth than
I would, and assumes we will have no recessions in the next
ten years, which is highly unlikely. However, a recession
would do little to slow down the rise in health care
costs...which rose 8.7% in 2001, as an example.

In 2001 and in 2002, health-insurance costs were listed as
the biggest barrier to adding workers in a poll of 120
chief executives of very large companies by the Conference
Board. Almost 82% of 1,017 members surveyed by the
Connecticut Business and Industry Association last year
said rising health insurance costs were"an important
factor" in decisions about whether to hire new workers.
Survey after survey also shows that small businesses, which
typically provide the bulk of new employment in the
aftermath of a recession, are increasingly seeing health
care as a reason to not hire...or are laying off workers as
a result of higher health care costs.

Think about what this means to the proverbial middle class
family of four, making $50,000 today. Today, the
contemporary company cost of their insurance is roughly
$6,000 or about 12% of their income. Let's say their salary
is going to grow by about 2-3% per year over the next ten
years, to about $65,000. Their insurance costs are going to
double to about 18% of their income, or they are going to
have significantly less insurance. Can business absorb $500
billion a year in increased costs? Not without serious
impact upon their profits.

Hewitt Associates projects that the average cost for
employee health insurance will be $5,134, up 70% just since
1998. Costs rose 14% last year, and will rise by double
digits this year. What workers pay will rise even more.
Projections are that employee out of pocket expenses will
rise by almost 25%, as employers shift part of the rising
expenses to employees.

Let's look at how health care costs affects one particular
industry. Today, the Big Three automakers spend roughly
$1,200 per vehicle on health care, according to this week's
Fortune. Goldman Sachs estimates that the healthcare
liabilities are $92 billion for just the three Detroit
automakers, roughly 50% greater than their combined market
capitalizations. This is three times their unfunded pension
liabilities - if you allow them to project 9% stock market
returns on their portfolios. A real-world analysis would
paint a much darker picture.

There are several scenarios for the carmakers, none of them
appealing. They could let the health care costs double as a
portion of the price of their cars. This puts them at
significant disadvantage to foreign firms which have
established U.S. plants and do not yet have huge numbers of
retirees. With such competition, the Big Three would have
difficulty raising prices to cover the increase in costs,
which of course would hurt their profits and result in
lower stock prices.

Alternatively, they could pass on more of the costs to
employees. That would mean big fights with unions, strikes,
lost profits and lower stock prices. But were the carmakers
to honor their commitments, they would lose profits and
watch their stock prices fall anyway.

This is an industry I do not want to have in my investment
portfolio, and ironically, the reason has nothing to do
with the quality of their products or service. It is the
real uncertainty surrounding their health care and pension
liabilities.

Getting back to the macro side of the issue, what about
federal and state expenditures? Of course, their health
care costs will double, too...rising from $700 billion to
$1.4 trillion! Federal government costs will rise by
roughly $500 million ANNUALLY. And that's without any
increase in Medicare coverage, prescription drug programs,
etc. With 41,000,000 Americans uncovered by health
insurance, a growing cohort of retirees who want (and will
get) a federally subsidized prescription health care plan,
the probability is high that health care costs will rise
even more than these projections.

Could things be improved? Of course. Simply passing tort
reform will reduce health care costs by about 4% a year.
Could we hammer out some increased efficiencies in the
system? Sure.

But the main driver behind rising costs is simply the
availability of new and better processes, drugs and
equipment. Two weeks ago, I was operated on using equipment
and procedures that did not exist ten years ago. Did it
cost more than the old-fashioned system? You bet, but the
cure rate is significantly higher, the procedure was less
painful and the results were far more certain. I was
offered the choice for the old procedure. I opted for new,
better and more expensive.

The point is that health care costs are going to rise
dramatically over the next decade, no matter how we end up
paying for them. And this is going to shift consumer
spending habits in ways we do not yet understand.


Regards,

John Mauldin,
for the Daily Reckoning