Archive for July, 2017

The Appeal of Bonds

Monday, July 24th, 2017

“We must all suffer one of two things: the pain of discipline or the pain of regret or disappointment.”

                   Jim Rhon, entrepreneur/motivational speaker

As fixed-income investments, bonds are all about income. Cash flow will be consistent, based on the bond’s coupon, until the bond matures. Each day that passes, the bondholder is accruing income and shortening the bond’s maturity, even though those changes aren’t reflected in the value of their account.

The risk in bonds is in their price, which fluctuates. Bond prices are affected by many factors, including interest rates and inflation. When interest rates increase, yields increase, too, and bond prices generally move in the opposite direction.

With interest rates rising, many investors are concerned about the impact that will have on the price of their bonds, but the Federal Reserve Board has already said that rates will remain below normal levels for years to come. It’s doubtful, for example, that the yield for a 10-year Treasury will exceed 3% anytime soon.

In addition, inflation will likely remain low for some time. The U.S. inflation rate has dropped from 2.7% in February to just 1.6% in June.

And while changes in price matter, most of a bond’s return comes from its coupon. Recognize that it’s all about cash flow and you’ll understand why bonds are a safer investment than stocks. (more…)

Socialism’s Promise: Medicaid for All

Monday, July 17th, 2017

For an example of how government entitlements always expand and never contract, consider what’s been happening to Medicaid.

Designed to provide health coverage for low-income and disabled Americans, Medicaid was signed into law in 1965 during the Johnson Administration.

Today, Medicaid ranks second only to public school education as the largest budget item in most states. Nationally, Medicaid spending now exceeds a half trillion dollars a year ($574.2 billion in FY 2016).

The true cost is higher, though. Both Medicaid and Medicare pay providers significantly less than what they receive from private payers – and Medicaid pays about two thirds of what Medicare pays. That means less access to healthcare, since one in three physicians refuses to see Medicaid patients. It also means non-Medicaid healthcare costs need to be higher to subsidize Medicaid.

Initially, Medicaid covered 4 million Americans. This year, it’s projected to cover 73.5 million Americans. In spite of the more than $20 trillion spent on the War on Poverty over that period, Medicaid enrollment from year to year has almost always increased, regardless of the overall health of the economy. It has also increased even though the poverty level has remained about the same – about 15% of the population.

But the worst is yet to come. (more…)

Unfunded Pension Liabilities Reach $7 Trillion

Monday, July 10th, 2017

The mean average amount saved for retirement by all working-age families in the U.S. is just $95,776, according to a new report from the Economic Policy Institute. The median average – that is, the average for those in the 50th percentile – is just $5,000.

That’s tragic, as it means that many Americans will be unable to afford to retire. At the same time, they are on the hook to pay unfunded liabilities for government employees as they retire.

Most private-sector employees have “defined contribution” plans, such as 401(k) plans, which are self-directed. Employers typically provide matching funds, but if you don’t contribute, you get nothing. Which is why many have saved little or nothing.

In contrast, employees in the public sector often have “defined benefit” plans, which are traditional pension plans. Defined benefit plans, as the name implies, guarantee a set amount throughout a person’s retirement years. (more…)

The Peter Pan Economy

Monday, July 3rd, 2017

Lowering interest rates is not necessarily a bad thing. It can make borrowing cheaper, which – at least in theory – will stimulate business investment. It can weaken the dollar, making American goods cheaper abroad. It can lower payments on the federal debt.

The problem with lowering interest rates is that eventually they have to be raised again. If rates were to remain at zero indefinitely, the Federal Reserve Board could not lower them to stimulate the economy during a recession, unless it created negative interest rates, which cause a whole new set of economic problems.

And history says a recession is likely to come sometime soon. The current recovery, which has frequently been described as anemic, celebrated its eighth anniversary in June. Now in its 97th month, it is the third longest recovery on record. The average recovery since the end of World War II has been 58 to 61 months.

While the length of the recovery may not determine how long a recovery will last, when unemployment drops low enough to spur inflation, the probability of a recession climbs. And unemployment is allegedly at a 16-year low of 4.3%.

“Expansions, like Peter Pan, endure but never seem to grow old,” according to Fed economist Glenn Rudebusch.

But the current expansion has much more in common with Peter Pan. It’s a fairy tale. And the Fed has run out of fairy dust.

The Fed’s Conundrum

The conundrum the Fed faces is that as it raises interest rates so that it will be able to drop them in case of a recession, it may actually cause one. (more…)