Pharma Greed or Prudent Business Decisions

the principle that all people and institutions are subject to and accountable to law that is fairly applied and enforced; the principle of government by law. – i.e., The Rule of Law

So, what does the above definition have to do with perceived greed of the pharmaceutical companies as touted by the current crop of Democratic presidential candidates? The standard response to cheaper prices abroad for prescription drugs is that the single-payer health care systems in other countries negotiate prices with the drug manufacturers. While this is true, there is another factor that contributes to this practice.

Patent protection virtually eliminates competition for brand name drugs by would-be generic manufacturers.  In the United States, patent rights are vigorously defended and upheld. Beyond on our borders – not so much. So, as a result, drug manufacturers often opt to offer cheaper prices on brand name drugs to shield themselves against illicit production of generic versions.  Unfortunately to the detriment of U.S. consumers, disrespect for the rule of law by foreign countries often results in lower prices of the same brand name drugs overseas.

Like Lemmings Over a Cliff

It’s not exactly a news flash that our country is experiencing one of the most political divisions in history. It seems that every issue, outlook, and opinion is based on partisan politics. Gone are the days of independent thought as a method of arriving at one’s position on a subject.

The other day I was having a conversation with my wife on this very topic that was initiated as a result of my recent vote for our local congressman on my mail-in ballot. Congressman Raul Ruiz is our incumbent representative and he is a democrat. My wife is a Republican and I am an Independent, albeit with a strong Republican bias. My reasons for voting for Mr. Ruiz were based on his record and involvement in our local community as well as his strong commitment to protecting the rights of seniors and veterans.

While my wife agreed with me on the virtues of Congressman Ruiz, she wisely pointed out that above all else, he is still a democrat and unlikely to break party ranks on the larger national issues confronting our population. In other words, politics will prevent him from exercising independent thought if it is not in concert with the democratic majority. Doing so, would brand him as an outcast and likely ostracize him from the ruling class. Furthermore, his chances of reelection would be rendered slim without the support of his Democratic colleagues.

There is nothing on the horizon that suggests that anything will change as the issues dividing the two parties are deep and wide. Unfortunately, it seems that the only time we can come together as a nation is when we are faced with a crisis of the proportions of 911. What a shame!

The Internet of Things and Unintended Consequences

I recentlyInternet of things updated the older wall oven in my home with a new high-tech model. Among the features of this new oven is the ability to control its operation via wi-fi. This got me to thinking about the potential hazards of this feature and generally “the internet of things.”

Last month marked the 50th anniversary of the internet. Like the evolution of electricity, the internet has developed in a similar way. Early internet applications centered around transmitting and receiving limited amounts of data over telephone lines. In other words, they were hard wired. Early adoption of electricity inspired by the inventions of Thomas Edison were hard wired direct current (DC) systems, only to give way to alternating current (AC) championed by the works of Nikola Tesla. Alternating current led to the creation of the electrical grid that transports electrical power across a network of interconnected systems covering vast distances. As the AC power grid expanded in the late 19th century, along came another invention of titanic proportions – the wireless radio. Again, it was Tesla who was instrumental in the discovery of the wonders of wireless radio waves.

Fast forward a mere 100 years. Thanks to the invention of electricity and the harnessing of radio waves, we entered the digital age. The internet and its endless nodes of connectivity, both wired and wireless, simply boggles the mind. The dark side of this phenomena that we call progress is that each point of connection along this digital global highway represents a potential hacking opportunity for those wishing to do harm.  Global cyber-security and the construction and management of firewalls is estimated to be a $125 Billion industry and growing at double digit rates. However, it seems that unscrupulous hackers continue to outsmart the good guys.

Given the real danger of potential apocalyptic cyber events, maybe its time to seriously consider the principle of “data localization.” The best example of data localization is perhaps China’s “Great Firewall,” which severely restricts internet access to its critical infrastructure. China is not alone in this movement, as several other countries are seeking ways to insulate themselves from digital invaders.

It’s safe to say that any movement to limit unfettered globalism of the internet is sure to meet heavy resistance from the social media giants and the huge purveyors of our personal data whose very existence is dependent upon a willing and sometimes naive worldwide user base. Social Media subscribers mistakenly believe that these services come to them for free. The fact of the matter is that if you aren’t paying for the product, then you are the product.

Every day seems to bring new headlines of cyber terrorism, both foreign and domestic, enabled by easy access to the internet. Maybe it’s time we took firewalls to a new level and think about hard wiring some critical access points to our internet and forgo a few freedoms and conveniences in favor of additional security in order to minimize external hazardous threats to our person and infrastructure.

So, who was right – Edison or Tesla? Hard to say. But this beacon of freedom of expression so revered by Americans has indeed led to unintended consequences. Do I really want someone in Bangladesh the ability to control the oven in my home with their cell phone?

To DRIP or not to DRIP

dripDRIP, is an acronym for a Dividend Reinvestment Plan. It is a system of automatically reinvesting dividends in additional shares of the same stock in lieu of receiving cash dividends thereby increasing one’s equity in a position over time. It comes in two forms – an authentic DRIP sponsored by the issuing company and a pseudo-DRIP where a brokerage automatically reinvests dividends according to the instructions provided by the investor. This can be an efficient form of commission-free dollar cost averaging using a fixed dollar amount (the dividend) to purchase fewer shares at higher market prices and more shares at lower market prices. For those situations where the goal is to build additional equity and forgo cash dividends, it is a great strategy for traditional equities. However, there are two types of investments where this system is not advisable.

First, employing a DRIP strategy for Master Limited Partnerships (MLPs) is almost always not a good idea and is not a tax efficient strategy for investors that depend on MLP distributions to supplement their income in retirement. Unlike traditional equities, MLP distributions, with few exceptions, are not dividends, but in fact, Return of Capital. When selling traditional dividend paying equities with dividends reinvested in a DRIP, the tax liability will be treated simply as a short term or long term capital gain or loss, computed by the net difference between the purchase price and the selling price. Prior dividends were already taxed in the year that they were received. With MLPs, it’s not that simple.

Due to the treatment of Return of Capital, the cost basis of MLP sales must be reduced by the earlier distributions received for the lots being sold. This will result in an increase in the taxable capital gain at sale beyond the simple difference between the purchase price and selling price. This additional tax liability for sales of MLP units often comes as a surprise to many uninformed investors, thereby wiping out much of the deferred tax benefit enjoyed in earlier years. If the intent of using an MLP DRIP strategy is solely for the benefit of heirs and not for income, then it becomes a reasonable strategy, as the cost basis will be stepped up for them upon the original investor’s death.

Notwithstanding the benefit of a stepped-up basis for heirs, tax efficient MLP cash distributions should, at some point, be spendable and should therefore be taken as cash rather than additional shares. Further, to receive the maximum tax benefit, MLPs should be held in a taxable account as opposed to an IRA or 401K. One risk worth noting is the potential conversion of an MLP to a C-Corp. This conversion will result in a tax trap causing the MLP units to be sold as they are converted to common shares.

The second form of investment that I do not recommend DRIP purchases is preferred shares. Although qualified DRIP plans for preferred shares are not directly available directly from the companies themselves, the process can still be implemented through the reinvestment of dividends per the instructions issued to your broker. Preferred shares are typically issued at a Par value, usually $25.00 with a fixed coupon rate. Most often, they give the issuer the right, but not the obligation, to buy them back at a future specified call date at par. In a stable or declining interest rate environment, the universe of Preferred stocks tend to rise in value, and conversely decline as prevailing interest rates rise. Because the issuer has no obligation to redeem the shares at the call date, they will most likely not do so if rates have risen causing the market price of the issues to fall. On the other hand, if rates decline, causing market prices to rise, there is a good chance that the issuer will exercise its right to redeem preferred shares at par and reissue new shares at lower coupon rates than those redeemed.

The DRIP problem with preferred stocks is this. As shares climb above par in value because rates are rising, then dividends will be reinvested at the higher market prices, not par. By purchasing shares above par value as a result of DRIP instructions, the investor is in effect granting a no cost call option to the issuer to purchase those shares at below their original issuing price, locking in the probability of a principal loss to the investor.

Another factor to consider for any purchase of preferred stocks above par value is the Yield to Call (YTC) of those shares if the company chooses to exercise its redemption option. The coupon rate remains the same at the “when issued” price causing the effective yield on the investor’s purchase of shares above par to decline. For example, consider xyz preferred issued at $25.00 with a $1.50 dividend yielding 6%. If market conditions cause the same shares to rise in value to $28.00 and are purchased at that price either outright or through dividend reinvestment, the $1.50 annual dividend remains the same, but will now have a nominal yield of 5.4% based on the $28.00 purchase price. While a 5.4% yield may be deemed acceptable to the investor, there is a trap looming. If the call date is three years out and the shares are redeemed at par ($25.00), the effective “yield to call” on those shares will be 1.89%, not 6% or 5.4%. Even though a total of $4.50 in dividends were received during the three year period, a principal loss of $3.00 will be incurred as a result of the company’s redemption at par.

Trade Deficits Indicate Prosperity

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The Trump administration has launched a full-frontal attack on America’s trade deficit with the rest of the world.  The weapon of choice in what is evolving into an all-out trade war, has been to impose punitive tariffs on a host of products, most notably steel and aluminum. Predictably, Newton’s third law of physics, which states that for every action there is an equal and opposite reaction, applies here, as our trading partners have responded in kind with tariffs of their own.

The headline number is the dollar value of goods and services imported versus goods and services exported. In 2017 the trade deficit was $568 Billion. Lost in the headlines, is the fact that United States exports increased by 5.6 percent during the year to the tune of $2.6 Trillion.  Imports increased 6.9% to $2.9 Trillion.

This overall combined increase of over 6% is simply an indication of robust economic activity, particularly in the United States. Witness the year’s economic benchmarks of real GDP growth, inflation, equity prices, manufacturing output, civilian employment, the unemployment rate – all displaying positive numbers signifying a healthy economy.

Meanwhile the Trump administration is complaining that the trade deficit of $568 Billion translates into 3.5 million lost jobs here at home, most of which would be in the manufacturing sector. At the current unemployment rate of 3.9%, it is not clear where these workers would come from. Further, even if these jobs were repatriated, the higher cost of labor to produce the same goods in the U.S. would cause their prices to skyrocket.

So, aside from the positive effects of imports and their role in checking inflation, they also contribute to our economy in other ways.  Dollars used to purchase imported goods do not just disappear or get stuffed under some international mattress. They continue to circulate in the world economy and eventually find their way back to the United States.

For example, when an American buys a Japanese made Toyota or a Korean made washing machine, dollars flow to the respective country. The dollars received are eventually reinvested to purchase assets in the United States. Those assets include Treasury bonds, stocks, real estate – all of which support our economy and keep interest rates low. If a country chooses not to reinvest in the United States, it will sell the dollars in world currency markets to other countries that will. Without these dollars circulating in the world currency markets, the value of the dollar, relative to other currencies, will rise making our exported goods even more expensive to foreign consumers.

So, there you  have it. This may be a rather simplistic view of the complexities of world trade, but it is intended to be just that – simple.  Building barriers to free trade using tariffs accomplishes nothing and will just make everyone worse off.  American businesses rely on low cost imported raw materials to remain competitive and the American citizens enjoy the lower cost of imported consumer goods.

In conclusion, I would argue that a trade deficit is not a sign of economic distress, but quite the contrary. It is a sign of a healthy economy evidenced by the fact that every recent U.S. economic expansion has been accompanied by an expanding trade deficit.

The Case for Universal Basic Income

ubiWe are at the most dangerous moment in the development of humanity… the rise of artificial intelligence is likely to extend job destruction deep into the middle classes, with only the most caring, creative or supervisory roles remaining.” – STEPHEN HAWKING

Between 2000 and 2014, five million manufacturing jobs were lost in the United States. This trend shows no signs of abating. Now there are more American men drawing disability insurance than there are working in production manufacturing jobs. Turning to retail, the pending apocalypse in that sector of our economy is illustrated by the elimination of 100,000 jobs just during the six months ending in May 2017.

The list goes on and on and is now beginning to impact not only the lower end of our country’s income spectrum but is also invading the space of middle-skill and professional sectors. Whenever tasks are routine, these jobs are candidates to be replaced by artificially intelligent robotic devices. With the Federal Reserve categorizing 44% of the current jobs in the United States as routine, that portends an uncertain, if not downright, scary future.

Artificial Intelligence is not the only contributing factor. We have for years exported jobs overseas to low-cost labor countries while we witness the decline of shopping malls as e-commerce sales grow in excess of $50 Billion per year. Meanwhile the income gap between the well-off and the not-so-well off continues to expand. Witness the ratio of CEO pay to the average worker in 1965 at 20 to 1 that now stands near 300 to 1.  Yes Virginia, the stock market has done very well for the top 20 percent that own over 90 percent of the stock market holdings.

While there are many examples of job destruction and the widening income gap threatening our social fabric, space in this article will not permit me to list them all. One solution to mitigate this impending disaster is the adoption of a Universal Basic Income (UBI). Once, only a far-left proposition, UBI is beginning to gather bipartisan interest. Under most plans, it would modify or replace other social safety net government programs. It was reported just last month that Social Security payments are now exceeding revenues collected. Clearly, we cannot continue down this do-nothing path.

Most plans suggest a monthly minimum income to all adult U.S citizens of around $1000, which is near the individual U.S. poverty level. The intent is to grant this payment to all citizens, working and non-working. This could slow the pressure on private companies to increase minimum wage rates which is a chief reason to adopt automation over hiring workers.

Funding is obviously a major issue for such a program. Andrew Yang, in his book “The War on Normal People” is suggesting a European style Value Added Tax (VAT) at somewhere between 5 and 10 percent. Contrast this to the current 17% rate in Europe. Another suggestion is a negative income tax.

Funding issues aside, the first step to solving the problem is to recognize that we have a problem and that we are at an inflection point. And like most systemic social problems, denial is often present in their early stages. As the great Yogi Berra once said… “The future ain’t what it used to be.”

A Defining Decade

“It Was the Best of Times, It Was the Worst of Times” – Charles Dickens; Tale of Two Cities.

To say that the ten-year period between 1965 and 1975 was a defining decade may be one of the understatements of the century. Just as the first of the baby boomers began to graduate from high school in 1964, the era of the “Happy Days” culture was about to become a distant memory. America’s involvement in the Vietnam conflict would forever erase that age of innocence that we enjoyed during the previous ten years as portrayed in everyone’s favorite sitcom by the characters of Richie Cunningham and the Fonz.

If you were an able-bodied young man in that graduating class of 1964, of which I was one, your near-term future would be dictated by the options available because of this conflict. You either secured a college deferment, fled to Canada, or just took your chances on the draft. A fourth option was to enlist in the military service in hopes of landing an assignment to anywhere but Vietnam.

It was in October of 1965 that I enlisted in the U.S. Army for a four-year hitch for that very purpose. However, as things turned out, despite guarantees otherwise, I ended up in Vietnam anyway. I was stationed in a place called Phu Bai, which was located about six miles south of the city of Hue. Hue, which was the northernmost major city in South Vietnam, was the country’s provincial capital until 1945. We were a unit of the Army Security Agency operating under the cover designation of 8th Radio Research Unit. Phu Bai was also the headquarters of the 3rd Marine division.

Up until the end of 1967, Hue (pronounced Huway) was largely untouched by the warring parties. That would all change at the beginning of the 1968 lunar new year, aka, Tet on January 30, 1968.

If there was a tipping point in this decade, it could arguably be the North Vietnamese Tet offensive. As chronicled in detail in Mark Bowden’s recent book “Hue 1968”, it was the single bloodiest battle in the entire Vietnam war, brilliantly conceived and concealed by the North Vietnamese planners with secrecy that could rival that of Pearl Harbor. Throughout the conflict, the U.S. military brass continued to discount and dismiss the strength and resolve of the North Vietnamese invaders. U.S. Marine ground forces who were trained for jungle warfare, were now fighting house to house. The battle continued for a month, and ultimately the city was recaptured, only after heavy U.S. and South Vietnamese casualties.

The misguided judgment and bungling of the U.S. command, headed by General William Westmoreland, in managing this conflict sparked a sea change in America’s support of the war. Within 30 days after the end of hostilities in Hue, President Johnson announced that he would not seek reelection. General Westmoreland was summarily relieved of his command. A brand-new counter culture was born in America. In the first six months of 1968, more than 200 demonstrations took place in colleges across the country.

Throughout this period, we endured bell bottom pants, leisure suits, and the Watergate scandal, until the defining decade mercifully came to an end on April 30, 1975 with the end of hostilities in South Vietnam.