Everything's coming up roses . . .

I am taking some flak, as expected, for the optimism of my piece on the baby boomers. How can I be so darn cheery when we've got $55 trillion in unfunded obligations coming down the pike?

Well, the point of the piece was to stop focusing so much on cash figures. All government spending numbers are impressively large--that's what happens when you're dealing with a very rich, very populous nation.

But our entitlement problem is not that our unfunded liabilities have a net present value of $55 trillion. That is a very big number, but we're not going to get handed a bill for it all next week. It's a slice of a much, much bigger figure: the NPV of our future income.

Prices are very, very useful things. But they can often obscure as much as they hide in economic debate: a $20,000 Hermes handbag does not consume 100 times as many economic resources as a $20 Target handbag, and the illusion that it does fuels much of the current debate over redistributing wealth.

The ultimate price tag of Medicare is hazily unknowable, and really, the number does not much matter. And the argument that this spending is "unsustainable" is not particularly interesting; as Herb Stein famously said, "If something cannot go on forever, it will stop." If the spending is really, actually, unsustainable then the government will eventually stop trying to sustain it. These are not the interesting questions.

My (partial) list of the interesting questions:

1. Is Medicare well structured to provide good health care to the elderly?
2. Is Medicare encouraging today's workers to save less than they will ultimately need? In other words, is the program likely to be severely curtailed in the future, leaving workers who counted on it worse off than they would have been had it never existed?
3. Is Medicare encouraging, or discouraging, the medical innovation that could make future generations better off?
4. What is the deadweight loss of the taxation required to pay for Medicare, and does this represent a good use of our money?
5. Is this massive transfer from old to young just? Does this answer change if it turns out that future generations are likely to massively trim the program?

My answer is that Medicare is a bad program on many fronts: badly structured, economically and medically destructive, and a fairly injust transfer of resources. But none of those things have anything to do with eye-popping NPV figures. A bad program doesn't become a good program just because it's cheap.

Comments

Is this massive transfer from old to young just?

From young to old, surely?

Posted by John Thacker | January 9, 2008 1:30 PM

a $20,000 Hermes handbag does not consume 100 times as many economic resources as a $20 Target handbag,

Yes it most certainly does. The 100x price represents a bid sufficient to draw an intelligent mind away from e.g. curing cancer and into ferreting out the changing fashion senses of wealthy, since the latter can offer a competitive return.

The diversion of that high-grade labor away from other endeavors into such a frivolity *is* a proportionally large consumption of resources.

Posted by Person | January 9, 2008 1:40 PM

Person is the perfect Stalinist or Puritan prig. But here's a hint - the people that get into FIT are not the same as those who get into MIT or Johns Hopkins. Marc Jacobs never had the option to be a leading cancer researcher. So take your ignorant class warfare and go live in Hugo's paradise.

Of course Medicare is a huge transfer from young to old. It is also unjust and unjustifiable, as is Social Security.

Posted by Hey | January 9, 2008 1:54 PM

One thing that's puzzling is that if the long-run situation is as bad as many economists believe, there should have been a sharp rise in real interest rates as things have deteriorated.

According to Larry Kotlikoff of BU, the United States is essentially "bankrupt". Like many others, he says that the government will have to run large deficits and print money to finance its entitlement spending, without radical reform soon.

But the bond market seems inconsistent with this diagnosis. The ten year bond is yielding only 3.8%. If inflation is three percent, that gives a real yield of 0.8%, which is low by historical standards. If the market were anticipating either rapid monetary expansion or heavy government borrowing, the real yield would be much higher.

So what explains the discrepancy between what economists believe and what the markets are saying? This is a question I've been studying lately, and I'm not sure what the answer is.

Posted by rwe | January 9, 2008 1:59 PM

Meghan,

While not Hermes - Louis Vuitton enjoys a gross profit margine of 12.54%. Therefore, a $20,000 purse cost them $17,442 to deliver to the customer.

A LV handbag price includes the cost of marketing, sales, 5th Avenue Real Estate. Not to mention it's made in France, where everyone works 35 hours a week and gets 6 weeks of vacation - not in China where they work 70hrs a week and get no vacation.

It's like when people say a BMW is overpriced. BMW enjoys a 4.7% profit margin. If a 335xi is is over prices at 50k would it be a deal at $47,670(at which point it would be selling for cost)?

Prices do matter - when you adjust for profit margins it tells you how much went into a product.

Posted by Jmo | January 9, 2008 2:00 PM

Herb Stein was right, but that doesn't mean that we can responsibly ignore the fiscal trajectory of Medicare in particular, and entitlement programs in general. If we do nothing, the government will solve this when it can no longer put it off (possibly within the next 10-15 years for Medicare), but the solution will have to be considerably harsher than if we do something today. Also, the uncertainty about how we or when we are going to face up to our entitlement shortfalls increases uncertainty about future tax rates and consequently probably suppresses capital formation and business investment in America to some degree.

Why not build an initial surplus and invest it in real trust funds that can be drawn upon in the future (i.e., trust funds invested in something other than Treasury bonds)? Some of that initial surplus could get invested in the medical and pharmaceutical industries, helping to drive innovation.

Posted by Fred | January 9, 2008 2:06 PM

Hey: I am no leftie class-warrior, which you'd know if you'd seen any of my previous posts on economic issues. As for your point:

the people that get into FIT are not the same as those who get into MIT or Johns Hopkins.

That part is correct but irrelevant. At the macroeconomic level -- the level relevant for Megan_McArdle's analysis -- all labor is fungible. The guy who designed handbags? If the demand for fancy frivolities wasn't there, he'd have shifted his interest into the more useful, about-as-artsy architecture. And then the architect would have seen superior return in engineering, and the engineer superior return in theoretical materials, and the physics theoretician superior returns in nanobot biorepair research. So yes, the tradeoff is there.

rwe: That's perplexed me too, and even more so when you figure the after-inflation, after-TAX return on government bonds. So again, what do I do with my assets if I want to dodge the tax- and inflation-ravaging they're certain to get?

Posted by Person | January 9, 2008 2:09 PM

And the argument that this spending is "unsustainable" is not particularly interesting; as Herb Stein famously said, "If something cannot go on forever, it will stop." If the spending is really, actually, unsustainable then the government will eventually stop trying to sustain it. These are not the interesting questions.

Well, yeah, but if I'm in an airplane that's about to run out of gas, it's not helpful to say, "Eh, one way or the other we'll end up on the ground eventually."

If entitlement spending really is unsustainable, it is an interesting question to ask how we intend to transition to a system that is sustainable. And 9 times out of 10, the sooner the problem is addressed, the less painful the transition will be.

Posted by Bill H | January 9, 2008 2:19 PM

Person,

"If the demand for fancy frivolities wasn't there, he'd have shifted his interest into the more useful, about-as-artsy architecture."

There I think you are wrong. If it wasn't for "fancy frivolities" many of these people would have ended up starving artists, or waiting tables, or tending bar.

Posted by jmo | January 9, 2008 2:27 PM

Person, rwe,

The bond market's current yield signal has little, to nothing, to do with macro- i-rate forecasting..

Take a trip, back, through FOMC operations, for starters..a brush-up on the PPT and CB co-ordination, should help, as well..

And, the massive gearing of our markets-through the use of derivatives(mainly OTC), is perturbing price signals throughout the Economy..

This current regime only holds together if the majority of our lenders, including the FedRes, continue to 'rollover' their positions..

btw, there's a good movie, from the early '80s, by that name: "Rollover".

Posted by MEH | January 9, 2008 2:33 PM

A disproportionate amount of the spending reportedly goes toward heroic attempts to prolong the end for folks who alas, don't make it anyway.

Is this bad? What if it were to result in some breakthrough that increased, productive and enjoyable lifespans for many? What if it doesn't and is just keeping some hearts pumping to no avail? Who decides?

Society wasn't well served when my grandma had a stroke at approximately age 98 and spent the last year plus in a nursing home. Conversely, what kind of society would we be if we just left her to die? Actually, unlike many of the elderly, she died with some money left, so she wasn't a burden to society - except in the sense that she consumed more than her share of Social Security/Medicare benefits. Fair doesn't apply to an insurance program, not that Medicare is a real one.

Posted by MarkD | January 9, 2008 2:39 PM

IMHO, the low bond yields are not really economically justifiable, but there are two large buyers that have different risk characteristics:

1. Pension fund managers. They need to match duration in a way that will not get them fired.
2. Sovereigns. They just want easily fungible reserves to stave off future currency crisis.

If something cannot go on forever, it will stop

Yeah, but it can stop in a really nasty way potentially.

Posted by JoshK | January 9, 2008 2:42 PM

MEH and JoshK have both made interesting comments, but I'm not sure I'm convinced by either. They are both essentially saying that there is some sort of distortion (whether derivatives or pension funds and sovereign investors) preventing rates from rising.

The problem is that US investors like PIMCO and Fidelity should be dumping bonds and pushing rates higher. They shouldn't just be sitting on overvalued debt.

My tentative conclusion, then, is that the Kotlikoff analysis is too dire. I still think that his work is well worth reading though. He has explained the nature of the problem clearly (even if he has exaggerated its extent somewhat)and outlined some interesting solutions.

Oh, and Person, I myself am chiefly invested in equities (Berkshire Hathaway has been a long time favorite). I think they offer the best hope for reasonably good after tax real returns. Long-term bonds stink.

Posted by rwe | January 9, 2008 2:56 PM

I am, more or less, in Megan's camp on this one. The economic tug of war between producers and retirees will eventually force the elderly to continue working longer as their benefits are cut by law or by the workings of inflation and price adjustments caused by tax levies.

Posted by Yancey Ward | January 9, 2008 2:57 PM

"A disproportionate amount of the spending reportedly goes toward heroic attempts to prolong the end for folks who alas, don't make it anyway."

In the end, none of us makes it anyway. Bear that in mind and this slope starts getting slippery. I'm also a little skeptical about the claim. In any case, a Logan's Run approach for the elderly wouldn't be a politically viable way to control health care costs: the elderly are the most powerful demographic politically, and they won't go for it (one reason why I expect they will oppose Dem universal health care proposals).

"IMHO, the low bond yields are not really economically justifiable, but there are two large buyers that have different risk characteristics"

A couple of additional points:

1) Some government owners of SWFs (e.g., China) have another reason to invest in our Treasury bonds: to support our currency, in order to keep their imports competitive.

2) The yields are crap, but there is a chance of capital appreciation in the short term with further declines in U.S. interest rates.

Posted by Fred | January 9, 2008 3:04 PM

The economic tug of war between producers and retirees will eventually force...

That could be true or overly optimistic. I think politicians will avoid dealing with it until the last second to stay in office and not offend powerful interest groups. That could leave the economy in quite a poor situation.

The problem is that US investors like PIMCO and Fidelity should be dumping bonds and pushing rates higher.

These guys are in the business of being right this year, not over 20 years. And, for a private money institution to take the other side ignores their financing costs. ie, the bet is that treasuries will eventually sell off (in the next 4-20 years). Now, who can afford to take that bet and then fund it?

Also, remember that many pension managers are tied into ERISA rules and the like and are almost forced to go to Treasuries b/c of that.

Posted by JoshK | January 9, 2008 3:06 PM

"Oh, and Person, I myself am chiefly invested in equities (Berkshire Hathaway has been a long time favorite). I think they offer the best hope for reasonably good after tax real returns. Long-term bonds stink."

I agree totally. I like BRK too, but for a long-term investor with some cash, this is a great time to put together a portfolio of top-tier stocks with high, sustainable dividend yields.

Posted by Fred | January 9, 2008 3:21 PM

remember that many pension managers are tied into ERISA rules and the like and are almost forced to go to Treasuries b/c of that.

Funding calculations push defined benefit plans into fixed income for some decent chunk of the fund. There is nothing pushing them into Treasuries per se. We discount our obligations on a 10-yr AA bond rate, so we own fixed income and/or buy derivatives to hedge our exposure to decreases in that rate. DB Pension funds are actually pretty flexible and aggressive investors.

Posted by "Mindles H. Dreck" | January 9, 2008 3:32 PM

We discount our obligations on a 10-yr AA bond rate

Perhaps you know in more detail. A few months ago I was having a similar discussion with someone from our rates group and they were saying that a recent change made pension managers downweight equities for fixed with a strong bias towards governments in the mix? I forgot the underlying rule.

Posted by JoshK | January 9, 2008 3:56 PM

Would it be reasonable to estimate that if all pension plans had to be funded on a termination basis with the 10-yr AA discount rate, half the S&P would fold tomorrow?

jmo: Get real. Go through the chain of events that had to occur, and the things the artist had to do, to end up as a high-end purse designer. Think about the intelligence required to do all that. And you're telling me that such a person's brain is sooooooooo narrowly focused, that it can't competitively do ANYTHING else but wait tables?

Posted by Person | January 9, 2008 4:14 PM

Person,

"Would it be reasonable to estimate that if all pension plans had to be funded on a termination basis with the 10-yr AA discount rate, half the S&P would fold tomorrow?" Just about..

Also, your chain of response to incentives is on target..

More peep should spend more time with Bastiat.

Posted by MEH | January 9, 2008 4:28 PM

"These guys are in the business of being right this year, not over 20 years."-JoshK

Josh, As some here know, I'm no fan of the EMH in any extreme form, but I do think that markets are pretty efficient most of the time. Markets are pretty good discounting mechanisms.

What you're suggesting implies that markets a very poor at discounting. This is a radical rejection of efficient market theory.

Your theory implies that there are large opportunites for arbitrage in the bond market that PIMCO, Goldman Sachs, etc... are missing because of their myopia. I find that hard to believe...

***

I'm curious to find out what Mindles Dreck thinks about this whole issue of the low yield on US Treasuries. Perhaps he'll comment on it.

Posted by rwe | January 9, 2008 4:40 PM

Re: Of course Medicare is a huge transfer from young to old. It is also unjust and unjustifiable, as is Social Security.

Why is this "unjust"? The Young owe the Old for the world they inherit and indeed for their very existence. Since far back in antiquity, it has been a standard ethical conviction of human societies that the elderly, when they are unable to work productively, must be supported by the non-elderly. Please note as practical matter that if you proposed to do this in any other manner whatsoever the end result is still the same: non-productive people being supported by productive people. If that strikes you as unjust that I have trouble recognizing you as human and indeed your next logical step would be an Auschwitz for all people unable to produce what they (currently) consume.

Re: So what explains the discrepancy between what economists believe and what the markets are saying? This is a question I've been studying lately, and I'm not sure what the answer is.

When one runs across a discrepancy between academic theory and reality, one should generally conclude the theory is wrong. This is the very basis for empirical science, without which we would still be teaching Aristotle's physics.

Posted by JonF | January 9, 2008 4:43 PM

Person,

"And you're telling me that such a person's brain is sooooooooo narrowly focused, that it can't competitively do ANYTHING else but wait tables?"

No, but their skill set will always run towards what some might call the frivalous. If you look at the difference between a good industrial designer and a good engineer you can perhapse understand the difference.

You seem to object to "frivolous" things - why should we care how a product looks? We should just care how it functions. But, the people who make the world function and the people who make the world beautiful are not the same, and they are by no means fungible.

Posted by Jmo | January 9, 2008 4:44 PM

rwe,

markets are pretty efficient most of the time

I usually agree with that, but there are exceptions.

I think just a common sense test would say that the 30 is overpriced. On bberg now I see the on the run @4.343. 2-3 years of good inflation will make that a joke.

Your theory implies that there are large opportunites for arbitrage in the bond market that PIMCO, Goldman Sachs, etc... are missing because of their myopia.

The problem is how would you arb this? What I was trying to say above is that if you agree that 30's are overpriced, you'll sell them. And then you'll carry them for 15 years on your book. Who's in that business?

Posted by JoshK | January 9, 2008 4:47 PM

jmo: No, but their skill set will always run towards what some might call the frivalous.

Then you didn't run through the task I asked you to do: *What did that designer do* to get where she is today? (I'll make her a "she".) Well, she had to be very cunning in seizing the right opportunities to get her designs noticed. That's not applicable to business? She had to be able to precisely ascertain the kinds of things finicky customers will buy. That's not applicable to market researching? She had to correctly anticipate what other would deem as high-class. That would be applicable to ANY role in architecture?

Again, you have a very bizarre understanding of how brains work, and act like intelligent people are necessarily 100% unadaptable -- when in reality, intelligence correlates with adaptability.

If you look at the difference between a good industrial designer and a good engineer you can perhapse understand the difference.

I haven't looked at what you think you are referring to. Spell it out for me.

You seem to object to "frivolous" things

Whoa whoa whoa, time out. I never objected to frivolous things. FWIW, I think your decision to blow your money on BS is between you and your god, or Minerva as the case may be.

What I was objecting to was Megan_McArdle's claim that buying a $20,000 product does not consume $20,000 worth of real economic resources because it's artsy crap. My point was that yes, it does, the cost does show up, just not in an obvious way. Instead of destroying (through eating) $20,000 worth of pigs, the person who buys it, is diverting a brilliant mind into designing the purse for her. In the former case, the resources used to make the pigs -- the land, the grain, labor in the farms and factories -- can't be used for other purposes. In precisely the same way, the rich person tore the high-grade, brilliant laborer away from doing something else.

Posted by Person | January 9, 2008 5:00 PM

A AA corporate and a Treasury are two very different animals in today's environment. AAs are yielding 1.54% higher yield at the 5yr mark. So the low rates are treasury rates, not sovereign rates. I'll let the macro guys tell you why the 4.8 on the AA might be "too low" in the face of major economic changes, but the treasuries are trading this dear because of the credit crunch.

btw, an awful lot of i-bank and finance paper is AA.

And Pimco is a *bond* manager, so they will stay in bonds. Contrary to Bill Gross' public pronouncements, their fund does not take large directional bets on interest rates. They did, however, make a large quality bet over the last few years that paid off in 2007 in spades. And they don't think the crunch is over.

Posted by "Mindles H. Dreck" | January 9, 2008 5:01 PM

btw, an awful lot of i-bank and finance paper is AA

Yeah, for now ;)

Posted by JoshK | January 9, 2008 5:05 PM

the rich person tore the high-grade, brilliant laborer away from doing something else

That would be the market allocating (voluntary) resources, not rich people taking the genome-sequencer out of poor Craig Venter's hands.

The reason that statement sets teeth on edge is it implies that some centralized body with the power to compel should set those priorities for how people invest their time and abilities - a proven recipe for disaster and a horrible violation of personal freedom. You may not mean it, but you've got several commenters ready to tattoo Road to Serfdom on your forehead.

Posted by "Mindles H. Dreck" | January 9, 2008 5:05 PM

Person wrote: That part is correct but irrelevant. At the macroeconomic level -- the level relevant for Megan_McArdle's analysis -- all labor is fungible. The guy who designed handbags? If the demand for fancy frivolities wasn't there, he'd have shifted his interest into the more useful, about-as-artsy architecture. And then the architect would have seen superior return in engineering, and the engineer superior return in theoretical materials, and the physics theoretician superior returns in nanobot biorepair research. So yes, the tradeoff is there.

The problem with this argument and premise being, it doesn't take much regression to end up at the point where all labor "should" be engaged in either farming or gravedigging.

Posted by anony-mouse | January 9, 2008 5:07 PM

Since far back in antiquity, it has been a standard ethical conviction of human societies that the elderly, when they are unable to work productively, must be supported by the non-elderly.

Yes, but the problem today, what with better medicine and increased life expectancy and fewer back-breaking jobs, is that not-especially-elderly, perfectly-capable-of-working-people are being supported by the non-elderly.

Posted by Rob Lyman | January 9, 2008 5:07 PM

Given the massive rise in the cost and quality of health care over the past few decades even if there had been no medicare private individuals would not have saved enough to pay for their healtcare.

Assume that in 1967 there was no Medicare and you were a very responsible individual planning ahead.
How much would you have set aside for health care in your old age. Assume it would have been something proportional to healtcare's share of the economy in 1967. In that case your savings for helatcare in your retirement probably would only have been half of what you need because healthcares share of the economy has at least doubled over that period.

The basic concept that individual would have saved enough to pay for old age care is completely unrealistic.

Posted by spencer | January 9, 2008 5:17 PM

Mindles_H._Dreck: Yes, sorry for the overuse of metaphors. I'm just trying to show how different consumption decisions ripple through the factors of production, and thus how their opportunity costs manifest in terms of real resources, ultimately to refute the notion that some forms of consumption are more "consumy" than others.

anony-mouse: What are you talking about? I'm just talking about the tradeoffs resulting from different long-term demand curves. If you're asking about "what to do" given precipitously falling birthrates and aging populations, I've addressed that in other threads on the matter. To summarize:

If everyone has zero kids, and everyone wants to retire, that *is* realizable. It just means that all spare resources today must be invested in automating the production of retirement consumption goods, at a minimum: food, shelter maintenance, and personal care. Then, at retirement, everyone owns shares in ventures that produce these things sufficient to entitle them to sustenance until natural death. The automation would likely be of the form: automated farms, robotic home repairmen, and robotic personal assistants (bathers, etc.)

Posted by Person | January 9, 2008 5:22 PM

The basic concept that individual would have saved enough to pay for old age care is completely unrealistic.

?? Then how could it be possible to tax current workers to pay for it? The math should be similar, with the advantage going to the saver who can get a compound return. (Hence the argument for privatizing SS).

Posted by JoshK | January 9, 2008 5:29 PM

"A AA corporate and a Treasury are two very different animals in today's environment. AAs are yielding 1.54% higher yield at the 5yr mark."-Mindles Dreck."

Okay, I agree that risk premiums have risen. As the Economist was arguing for some time, the risk premium was probably too low until recently. But that doesn't get to the main point, which is whether the yield on US Treasuries should be higher given the long-term entitlement problems facing the US.

My guess is that market participants don't expect the government to pay what it is now promising to pay--that is that there will eventually be sharp reductions in benefits (or projected benefits). And that assumption seems reasonable.

All the options are unpleasant--heavy borrowing and sharply higher interest rates, monetization of the debt, crushing tax increases or slower growth of benefits. But the last is clearly the least unpleasant of the options available.

Posted by rwe | January 9, 2008 5:35 PM

"And Pimco is a *bond* manager, so they will stay in bonds. Contrary to Bill Gross' public pronouncements, their fund does not take large directional bets on interest rates."- Mindels Dreck

But they do adjust duration according to their expectations of the future. If Bill Gross did nothing but mirror the index he wouldn't earn so much money. If Gross expected a sharp rise in long-term rates, he would cut the average duration of the portfolio.

If you don't believe me, look at what PIMCO itself says here :

Value Added Total Return seeks to add value through multiple sources including:

Duration Management

Yield Curve or Maturity Structuring

Sector Rotation

Bottom Up Techniques to Identify Undervalued

Securities

Quantitative Research

Credit Research

Volatility Analysis

Cost Efficient Trading

Posted by rwe | January 9, 2008 5:50 PM

The thread about bond yields and risk and stuff looks very interesting but is going right over my head, and seems offtopic. You guys might be better served to find a place like bonddad's blog to hash that out; bonddad's into that technical stuff and I'm sure he'd love the traffic.

The math should be similar, with the advantage going to the saver who can get a compound return. (Hence the argument for privatizing SS).

My persistent objection with "privatizing" SS is that (as I've seen it proposed) it forces people to bet on the market; and as you market gurus know, market returns are not guaranteed. If the market goes in the dumper and takes your 401(k) with it, what then? At least with SS you have SOME support coming in. Without it, you libertarian/conservative types are back to facing demands for government interventions to give the elderly what they're already getting now with SS, if the market tanks. Maybe you see the risk/reward as acceptable given your rosy scenarios with regards to the market going up and up forever, and you're willing to take the chance that the market doesn't tank on YOUR watch. But is that really a long-term solution?

Posted by liberalrob | January 9, 2008 6:23 PM

Oh, and since I know y'all are fascinated with my personal finances, I got my W-2 yesterday and it turns out that due to decreased quarterly bonuses, my income last year was 54k (down from 60k the previous year). Yay Bush boom!

Posted by liberalrob | January 9, 2008 6:31 PM

Yes, but the problem today, what with better medicine and increased life expectancy and fewer back-breaking jobs, is that not-especially-elderly, perfectly-capable-of-working-people are being supported by the non-elderly.

So what is the dividing line between "perfectly-capable-of-working elderly" and "not-good-for-much-but-Wal-Mart-greeter elderly?" Do we pick an age like we do for SS eligibility, or is there some sort of testing we have to set up? And is it wise to set up the system so when that day comes that the mechanical engineer can only work as a Wal-Mart greeter, their ability to secure health care similarly declines?

Yeah, it sucks that the young have to pay for the old, but who else is going to do it? Somebody has to...don't they?

Posted by liberalrob | January 9, 2008 6:39 PM

Do we pick an age like we do for SS eligibility, or is there some sort of testing we have to set up?

Picking an age is probably the best method (as anyone who has dealt with SS disability will tell you), but maybe we should adjust it every so often to reflect the fact that neither life expectancies nor the job market look like they did in 1933.

And of course, we should not confuse "the young paying for the old" with "the government paying for the old." Maybe that really is the best method, but that should be argued, not assumed, as it so often is.

Posted by Rob Lyman | January 9, 2008 6:55 PM

Person:

"If you look at the difference between a good industrial designer and a good engineer"

How about the difference between an architect and a structural engineer. Do you really think you could take a really great structural engineer and train him to be a really great architect? The type of mathematical intelligence you need to be a great structural engineer is quite different from the viso-spatial intelligence you need to be a good architect.

Also, I'm sure you're aware of the concept of conspicuous consumption? Have you read Thorstein Veblen's "Theory of the Leisure Class"? While from your comment "your decision to blow your money on BS is between you and your god" I imagine you think things like 20k handbags are a waste of money - they are not. The human need to signal one's social status is a deep and powerful one. For an economy and society to function, people need to be able to signal social status via material goods.

Posted by jmo | January 9, 2008 7:03 PM

The thread about bond yields and risk and stuff looks very interesting but is going right over my head, and seems offtopic. You guys might be better served to find a place like bonddad's blog..."-liberalrob

Hey liberalrob, this is an economics blog you know. The fact that you have trouble with real bond yields explains a lot about your economic opinions. You might find this more at your level.

Posted by rwe | January 9, 2008 7:12 PM

Hey liberalrob, this is an economics blog you know.

Strictly speaking, it is more than just that. Hey, if you want to talk market X's and O's go right ahead, I was just suggesting a better forum. Your esoterica was making it harder to keep track of the actual topic, however. And economics > bond yields.

Thanks for the Cosmo link, I'm always interested in learning more about the relationships I've never had. And it looks like there's some ideas in there about pleasing women that might come in handy someday. Hope never dies.

Posted by liberalrob | January 9, 2008 8:27 PM

In the row next to me are our rates traders (hi-frequency). We always have a variant of this discussion. I think one other factor in the bond market that they point out is that a lot of participants figure that they can hold long durations but "get out" in time. I think that thinking is common in many markets. And I think that leads to all of those discussions about efficient markets... But that's been done over enough here and elsewhere.

The only real point I wanted to bring in is that "arbing" the 30 year isn't really possible.

A side point of course is that trading something mispriced is only an arb really if there is an equivalent currently tradeable, like stocks and stock futures. (yes, I know it's not a perfect arb either, but it's closer). If the on the run 30 was significantly different that the last one, then there would be a true "arb" opportunity.

My guess is that market participants don't expect the government to pay what it is now promising to pay--that is that there will eventually be sharp reductions in benefits (or projected benefits). And that assumption seems reasonable.

That's certainly possible. Raising the retirement age to 75 would probably just raise GDP and solve quite a few things. Or allowing undocumented/illegal immigrants to earn citizenship in return for paying down some part of the liability.

But, markets are often wrong. They are just more right than a random government bureaucrat will be. The rates guys feel strongly that it's just a trading market and that eventually the fundamentals will come through. But it just might take years.

Posted by JoshK | January 9, 2008 8:30 PM

My answer is that Medicare is a bad program on many fronts: badly structured, economically and medically destructive, and a fairly injust transfer of resources. But none of those things have anything to do with eye-popping NPV figures.

Hmm. This, combined with various NBER research on the topic, seems to me like it would mitigate your criticism of the Medicare prescription drug benefit. At the very least, it's not medically destructive-- the old system of paying for surgery but not pharmaceuticals was horribly medically destructive and inefficient, very distortionary. Not saying that the expansion was perfect, not by any stretch, of course.

Posted by John Thacker | January 9, 2008 8:35 PM

For an economy and society to function, people need to be able to signal social status via material goods.

Woah, I don't know about that...you can't have a society without wide class distinctions and conspicuous consumption? Is the "two Americas" situation actually the positive goal of Western civilization and not something to be avoided?

I imagine a great many people would dispute that...

Posted by liberalrob | January 9, 2008 8:36 PM

"The rates guys feel strongly that it's just a trading market and that eventually the fundamentals will come through. But it just might take years."

SSDD on Wall St.

"eventually the fundamentals will come through"

when the FedRes & Co. stop buying the Yield Curve..

all the more Reason to remember the advice of the sage Martin Zweig: "Don't fight the Fed.."

see you @ USDX .5200

all said, of course, in light of the ol' adage:
"Differin' opines make'm run the Equines"

Posted by MEH | January 9, 2008 8:45 PM

Joshk:

This will never happen:

"That's certainly possible. Raising the retirement age to 75 would probably just raise GDP and solve quite a few things."

Even as the normal Social Security retirement age is being phased up to 67 from 65, more Americans elect the early retirement age of 62. Phasing the start for Medicare from 65 to 67 might save the government some money though -- we'd have to cover a minority on Medicaid for a couple of years, but the vast majority of 65 year olds would simply keep their private insurance for another two years.

And this won't help:

"Or allowing undocumented/illegal immigrants to earn citizenship in return for paying down some part of the liability."

Illegal aliens are net fiscal drains: they pay less in federal taxes than they consume in government benefits. When we're losing money on a per-unskilled immigrant basis, we can't make it up on volume.

Posted by Fred | January 9, 2008 9:05 PM

Philly Fed's Plosser sees potential stagflation threat to US economy
Tue, Jan 8 2008, 13:35 GMT
http://www.afxnews.com

GLADWYNE, PENNSYLVANIA (Thomson Financial) - The head of the Philly Fed, Charles Plosser, today raised the possibility of a stagflation threat to the US economy.

"Although I am expecting slow economic growth for several quarters, we should not rely on slow growth to reduce inflation," the Philadelphia Federal Reserve Bank president warned in a speech here.

"Indeed, the 1970s should be a sufficient reminder that slow growth and falling inflation do not necessarily go hand in hand."

Plosser, who has a vote on the rate-setting Federal Open Market Committee this year, warned that he is getting increasingly worried about inflation.

"Recent data suggest that inflation is becoming more broad-based," he said, "And recent increases do not appear to be solely related to the rise in energy prices. Consequently I see more worrisome signs of underlying price pressures."

Plosser also used today's speech to draw a clear line between what the Fed should do to stabilize the economy and what it should do to stabilize financial markets.

He believes the Fed's three rate cuts will take time to work through the economy and that in the meantime growth will slow.

"Since monetary policy's effects on the economy occur with a lag, there is little monetary policy can do today to change economic activity in the first half of 2008."

In the meantime, "we will get some bad economic numbers from various sectors of the economy in the coming months," he added.

But beyond the immediate short term, Plosser was more optimistic. He reckons the economy will "improve appreciably by the third and fourth quarters of 2008, and that is when any monetary policy action today will begin to have noticeable effects."

On the credit market front, the Fed's new Term Auction Facility (TAF) program should help stabilize financial markets and provide liquidity when the interbank lending markets "are under stress and not functioning smoothly," he added.

Plosser said early evidence suggests the first two 20 bln usd auctions were successful. Two more have been scheduled later this month.

The key point, he said, is that "the TAF did not change the stance of monetary policy. The Fed actually withdrew funds through open market operations as it injected term liquidity through the TAF."

Plosser was already known as one of the inflation "hawks" among the regional Fed bank presidents. His analysis confirms a preference for avoiding further rate cuts and the risk of further inflation as long as financial markets problems do not pose a danger to the rest of the economy.

dem/wash/ss

COPYRIGHT

Copyright Thomson Financial News Limited 2007. All rights reserved.

Posted by MEH | January 9, 2008 9:38 PM

LiberalRob - "you can't have a society without wide class distinctions and conspicuous consumption?"

Can you think of one?

Do you remember the ZIL? The V-8 powered, hand built, 8000lbs armored limousine of the Soviet ruling class? Apparently it's not enough to have the power of life and death over 130 million people - you need a fancy car as well.

People need a way to signal that they've been luckier, smarter, and harder working than other people. Even communists realized that you needed fancy cars, big apartments, and special stores, hospitals, and schools to motivate people.

Posted by Jmo | January 9, 2008 9:42 PM

For an economy and society to function, people need to be able to signal social status via material goods.

Fine fine. But could they choose something more productive to conspicuously consume than handbags? Conspicuous philanthropy? Early technology adoption? (Overpriced hybrids supporting automotive research) etc.

If the purse designer was adding value to any kind of product involving tech research, I'd personally be happier. And when I'm rich in thirty years, I assure you that I will conspicuously consume in precisely that fashion.

Posted by Ryan W. | January 9, 2008 11:53 PM

"Fine fine. But could they choose something more productive to conspicuously consume than handbags?"

What does it matter? If the handbags provide pleasure for the buyers, profit for the producer and stores, jobs for designers, manufacturers, sales people, etc.?

Posted by Fred | January 10, 2008 12:13 AM

I find this idea that one has to use material goods rather, er, provincial. Or as Marx might say, bourgeoisie.

In my circle, your social status is determined by who comes to you for advice. That and the papers you publish. Oh, and if you were to drive up in fancy new car, a Jaguar or something like that, people would look at you in a sort of horrified fascination, wondering if you were really the lout you appeared to be.

Definitely different strokes for different folks, but frankly, I really don't want to meet the sort of people jmo seems to run with.

Posted by ScentOfViolets | January 10, 2008 12:13 AM

To be fair, not everyone has the social and financial capital to spend years in graduate school gaining degrees to signal their status; they have to be contented with electronics.

Posted by Megan McArdle | January 10, 2008 7:02 AM

jmo: I suggest you read The Millionaire Next Door. Most of the really rich would laugh at posers who pay $20,000 for a handbag they'll only use for a few months.

So what such products do is to transfer wealth from those that somehow acquired a small fortune without having much sense about spending it, to others with the brains and social antennae to take advantage of them. And I don't see anything wrong with that sort of wealth redistribution.

Posted by markm | January 10, 2008 8:16 AM

Not much time to post right now, but Ryan_W. is exacty right in response to jmo. Whatever the need for social signaling, the problem is that in making the signals, people draw others toward useless stuff instead of useful stuff.

Wealth can be signaled by massived expenditures. So why not all at once switch to judging others' social status by how much they've given to bleeding edge research, or how much of the fruits of such research they've bought?

Then, we'd get the social signaling, AND resources would be optimally allocated. win, win, win.

Posted by Person | January 10, 2008 8:25 AM

Person,

"So why not all at once switch to judging others' social status by how much they've given to bleeding edge research, or how much of the fruits of such research they've bought?"

Yes, but how can you walk into a room, or pull up infront of a resturant, and have everyone know how much you've given? It may not be important to you, but it is very important to a great many people.

And ScentOfViolets have you ever delt with German or especially Austrian academics? Exampe Herr Dr. Dr. Ing. h.c. F. Diplom Kaufmann Johan Smith. Their obsession with academic titles is almost as obnoxious as any automotive fetish.

And as for the "Millionaire Next Door" I have read it. And I belvied it, until I started dating someone who worked for Louis Vuitton. They were amazed at the number of woman who spent 25k a month at the store. Keep in mind, this was all paid for with a black American Express card. The bills of course, paid for in full, at the end of the month. And that wasn't just 25k a month at Louis - it was 25k at Louis, 25k a Saks, 25k a month at Hermes. Some people are just rich.

It would all be great if we could live in some Rodenberryesque Star Trek utoptia where everyone busted their ass to better themselfes. But, until we can change human nature, that ain't gonna happen.

Posted by jmo | January 10, 2008 9:02 AM

Person:

"how much of the fruits of such research they've bought?"

But they would need to be things you could carry in an obvious way - like a watch, shoes, jewlery, handbags etc. What sort of high tech gadgets are you envisioning?

Person, am I correct in assuming that you think a new $20k 8-core Mac Pro is the coolest thing ever and a $20k handbag is a waste of money?

Posted by jmo | January 10, 2008 9:30 AM

jmo: I think you're missing the point. *If* people chose to judge social status by how much that person has done to advance hyper-awesome research, *then* mechanisms would develop whereby that achievement (whether in money or scientific discovery) can be visibly signal.

Yes, such mechanisms don't exist now, but that's not because something inherent about progress toward scientific advances is unsignalable ("unobservable"), but because that's not what people call high status. Change the metric, and the signals follow.

Posted by Person | January 10, 2008 10:16 AM

Can you think of one?

That isn't the point. Yes, realistically any society is going to need someone to do the dirty jobs (that Discovery Channel show serves a very beneficial purpose in keeping us aware of what some of those jobs are); but it doesn't necessarily follow that the people who do the dirty jobs should be paid less than the people who design $20k handbags. As far as a strict utility analysis goes, arguably we should pay garbagemen more than handbag designers. But we don't.

My point is, I don't see how it is necessary in order to have a functioning society that there be fantastically rich people and fantastically poor people. Why is that necessary? Will the poor not work without the example of the idle rich? I don't object to someone paying $20k for a handbag with the name Louis Vuitton stamped on it. I think it's stupid, and I wouldn't do it, but if you have the money and that floats your boat then OK. I spend several thousand a year on comic books and that's stupid to a lot of people too. But to say we can't have a society without $20k handbags (or comic books) seems to be a stretch.

Posted by liberalrob | January 10, 2008 10:45 AM

Person,

"*If* people chose to judge social status by how much that person has done to advance hyper-awesome research, *then* mechanisms would develop "

Then I think we have a chicken and egg problem. People won't chose until mechanisms develope and mechanisms won't develope until people chose.

How do we get from here to there?

Also, do you see any value in people spending time crafting a mundane object at the limits of human creativity, artisty and craftsmanship?

Do you have a problem with the guys at Screaming Eagle tyring to make a bottle of wine the best it can be? Or Alice Waters at Chez Panise making food as good as it can be? Wouldn't we be all better off if they spent their time doing something more productive and contributed more toward the advancement of mankind?

"Man shall not live by bread alone"...

Posted by jmo | January 10, 2008 11:02 AM

jmo: Again, my point is just that spending $20,000 consumes $20,000 worth of real resources. It therefore consumes 100x as much as a $200 purse. If people didn't value this crap, resources would not be marshalled to produce it. If resources were not marshalled to produce it, they would be producing different stuff. Again, not controversial stuff, but in contradiction of Megan_McArdle's absurd claim. (Maybe she doesn't respond to people named "Person".)

I agree there's a chicken-and-egg problem in getting people to have values conducive to quicker development of hyperadvanced technological wonders. But that doesn't contradict anything I've said.

I'm waiting for Megan_McArdle's retraction, but it's not gonna happen.

Posted by Person | January 10, 2008 11:09 AM

Liberalrob,

You could build a society in which everyone was guarenteed and income of $50k and taxes were 100% on incomes above $100k. So no matter how little you worked, if at all, you could never make less than $50k. And, no matter how hard you worked, you could never make more than $100k.

One would imagine that a great many people would find that $50k a year was enough and they would stop working. At the same time, people already making 100k would have no desire to work any harder.

Now, you argue that "I don't see how it is necessary in order to have a functioning society that there be fantastically rich people and fantastically poor people." But, I imagine that you'd agree that we need to pay the smart and hardworking more than the stupid and hard working and those need to be paid more than the stupid and lazy.

Posted by Jmo | January 10, 2008 11:17 AM

Person,

You may very well be right. But... you assume that "If resources were not marshalled to produce it, they would be producing different stuff." It is possible that if not marshalled to produce something frivolous, nothing would be produced at all.

Some people love fashion, they eat sleep and breath it and expend huge amounts of energy to be a part of it. But, if you told them the only career option was bio-medical research - they would not work nearly as hard, if at all.

Also, what do you think abotu Chez Panise and Screaming Eagle? Is that a big a waste as a handbag?

Posted by jmo | January 10, 2008 11:24 AM

Some people love fashion, they eat sleep and breath it and expend huge amounts of energy to be a part of it. But, if you told them the only career option was bio-medical research - they would not work nearly as hard, if at all.

Perhaps, but it would be counterbalanced by spurring on the guys that like that stuff.

In any case, the purse designer could still design purses -- they would just have to appeal to the set of wifes of successful researchers rather than the set of people who got rich some other way. Maybe Penrose tiling patterns instead of leather. Who knows?

Also, what do you think abotu Chez Panise and Screaming Eagle? Is that a big a waste as a handbag?

I make no judgment. Like I said before, how you choose to blow your money is between you and your God, or Minerva as the case may be.

Posted by Person | January 10, 2008 11:52 AM

liberalrob,

Do please describe your proposal for creating a functioning society that does not have fantastically rich people. Even Sweden has billionaires.

Some people simply have much greater talents than others. Some people simply work much harder than others. Some people produce things that lots of people value highly, and others produce nothing of significant value. This is just human nature. Good luck trying to change it.

Posted by Mixner | January 10, 2008 11:58 AM

Person,

I, for one, would love to live in your proposed technotopia!

It would be a place where Steve Wozniak gets all the power, money and glory rather than Steve Jobs. Woz had the skills to build the computers but it was Jobs who had the drive, ambition, management skills etc to make it happen.

Also, think about this. Let us say you just invented a high temperature superconducting quantum computer. It works, now you need to commercialize it. What are you going to need:

1. Patent Lawyers to secure the applicable patents

2. Venture capitalists to provide you the capital to pay the lawyers and fund you until the profits from your new device roll in

2. Manufacturing Engineers who know how to commercialize the model you have working in your lab

3. You'd need a factory - assuming you don't know how to build a factory - you might have to hire an executive with experience sighting factories and shepherding them through the regulatory process

4. Sales guys

5. Marketing and advertising guys

6. Finance guys to manage all the money

6. Executives and project managers to manage all the people listed above.

If you visit the Louis Vuitton in Palo Alto most of the customers (or their husbands) have made their money doing 1-6. In your world, where all the glory went to those who did the reaserch, what would motivate all those who are needed to do the grunt work that is required to bring any great idea to market?

Posted by Jmo | January 10, 2008 12:20 PM

Whatever motives them today.

This is getting weird and rather off-topic. I'm going to have to sign off at this point.

Posted by Person | January 10, 2008 12:41 PM

Person wrote: anony-mouse: What are you talking about? I'm just talking about the tradeoffs resulting from different long-term demand curves.

What you've been discussing is not an analysis of trade-offs; it's an alternate history. In short, a work of imaginative fiction based on a narrow range of personal prejudices and suppositions (including no small taint of pie-chart fallacy). It might just as well end in the artistically-unfulfilled protagonist slipping into an alcoholic depression of shattered dreams until finally eating a gun.

Personally, I think a $20k handbag is a ridiculous excess of the "Simply amazing what people would rather have than money" variety. On the other hand, someone working minimum wage might well look at my own lifestyle, see that my needs are met with disposable income to spare, and then say the same for some of my mid-range audio equipment. Alternately, they might look at the possibility of being like me and be inspired to work harder, thereby making themslves and the market-based society better off, just like the possibility of being rich enough to dispose $20k (presently almost half of my pretax income) into a personal accessory without blinking, might do the same for me.

Once a person starts making fiat declarations of what the "best" resource allocation looks like, it doesn't take much regression to get back to the point where all labor should either be engaged in food production or burying the dead, since all other possibilities can be tainted with "luxury" or "decadence" by simply sliding the priorities scale a bit.

Posted by anony-mouse | January 10, 2008 1:15 PM

mouse: Again, I wasn't making judgments about how people should be forced to spend their money, and I certainly wasn't writing alternate history. It's simply a matter of well-accepted economic theory that buying $X worth of goods, effectively marshalls $X worth of resources to produce them. No demand for those goods, and the resource are applied instead where they are demanded. I don't claim that "not buying the purse = no nanobots to cure cancer", but it does consume real economic resources in proportion to its market price.

Megan_McArdle claimed that the purse does not use 100x (think she meant 1000x) as many resources as the cheaper one. This is in error, because the consumed resources do in fact manifest 1000-fold. Specifically, instead of using low-grade minds and low-grade tools to make their purse, the buyer drew intellgent people to making a fancy purse instead of applying their minds to satisfy different demands.

Regardless of our moral judgments, that *is* a consumption of proportionally-more resources, namely, a mind with more and better potential uses.

Posted by Person | January 10, 2008 1:36 PM

Am I actually the first to point out that the $20000 Hermes bag is actually 1000x (not 100x) as expensive as the $20 Target bag?

I expected multiple commenters to 'bag' on Megan for this, but I seem to be the first.

Posted by TheWesson | January 10, 2008 1:36 PM

It's my wish that I will *never* "bag" Megan_McArdle. At least, not until she gets plastic surgery or something.

Posted by Person | January 10, 2008 1:58 PM

Person,

"No demand for those goods, and the resource are applied instead where they are demanded."

You seem to be arguing that if resorces(which include human labor) are not used for "A" they will be instead used for "B". But that is not true and no economist argues that. You even admitted as much:

"Perhaps, but it would be counterbalanced by spurring on the guys that like that stuff."

If you conterbalance theory is wrong - which I think it is - then you whole theory doesn't make any sense.

Also, "Whatever motives them today." But you wanted to remove those motivations. If they are today motivated by fancy cars, big houses, expensive dinners, then when all these resources are dedicated to research - how will we motivate them?

Posted by Jmo | January 10, 2008 2:50 PM

You seem to be arguing that if resorces(which include human labor) are not used for "A" they will be instead used for "B". But that is not true and no economist argues that.

Leaving resources idle in anticipation of other needs that may come up, is a use.

Also, "Whatever motives them today." But you wanted to remove those motivations. If they are today motivated by fancy cars, big houses, expensive dinners, then when all these resources are dedicated to research - how will we motivate them?

You're not comparing apples and oranges. Today, people buy expensive pursues. If they were more interested in showing off the productized fruits of research, labor would be applied, with compensation that that labor desires, to such ventures. Instead of plotting to become fashion designers, new laborers would plot more reserach oriented lives. Even if some workers would "shut off", you can see there's a real opportunity cost to the purses.

Posted by Person | January 10, 2008 2:57 PM

Do please describe your proposal for creating a functioning society that does not have fantastically rich people. Even Sweden has billionaires.

Bully for Sweden. I bet there would still be a functioning society if those billionaires didn't exist.

I'm not proposing creating such a society. Just proposing that you don't have to have huge disparities of wealth to have a society.

Posted by liberalrob | January 10, 2008 3:48 PM

Liberalrob:

"I bet there would still be a functioning society if those billionaires didn't exist."

I don't think anyone would argue that it wouldn't function - the arguement would be that it woudn't function very well.

Posted by Jmo | January 10, 2008 4:03 PM

liberalrob,

I'm not proposing creating such a society. Just proposing that you don't have to have huge disparities of wealth to have a society.

And I think such a society is impossible. That's why I asked you how you think it could be created. I assume you agree it's not likely to just spontaneously arise through unprecedented voluntary redistribution of wealth. As far as I'm aware, no such society has ever been recorded in any place, at any time in human history.

Prior to recorded human history, during our hunter-gatherer phase, there probably were no really huge disparities of wealth, but that's only because there was virtually no wealth at all. As soon as we developed the technology to create wealth, vast disparities arose.

Posted by Mixner | January 10, 2008 4:14 PM

Prior to recorded human history, during our hunter-gatherer phase, there probably were no really huge disparities of wealth, but that's only because there was virtually no wealth at all.

But do you claim that there was no "society" there?

Did the pre-Columbian Native Americans not have a society?

That's what I'm getting at. Just because it's not a technologically advanced modern society doesn't mean it's not a society; and I still think you could create a technologically advanced modern society without massive disparities of wealth. And no, I'm not going to lay out for you step-by-step how that would be done, because I don't know how it would be done. It just seems like it should be possible. I don't buy that billionaires are necessary.

As soon as we developed the technology to create wealth, vast disparities arose.

And ever since we've been in a tug-of-war between the desire of some to accumulate wealth far beyond their needs and the desire of others to establish a society where the needs of those without wealth are supplied. It hasn't been all flowers and candy and ponies for everyone.

Posted by