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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 US economy right now. But there 
might be even more than you think. According to a study 
released this week by the American Centers for Medicare and 
Medicaid Services (CMS), US medical costs will double over 
the next 10 years. 

In the US in 2002, Americans spent $5,427 per person on 
healthcare, almost exactly double what we spent in 1990. 
CMS projections estimate that we will spend $9,972 in 2012. 
Within another year or so after that, American medical 
bills 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 
potential acceleration after 2012, as my generation gets 
older and begins to need ever more medical care.

In 1990, Americans spent 12% of US 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 US 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 grew 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 
American 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 see a double- 
digit increase this year. What workers pay will rise even 
more. Projections are that employees' out of pocket 
expenses will climb 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 
capitalisations. 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 a 
significant disadvantage to foreign firms which have 
established US 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 share prices.

Alternatively, they could pass on more of the costs to 
employees. That would mean big fights with unions, strikes, 
lost profits and lower share prices. But were the carmakers 
to honour their commitments, they would lose profits and 
watch their share 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 services. 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 not covered by health 
insurance, a growing cohort of retirees who want (and will 
get) a federally subsidised 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 in the US 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 American health care costs are going to 
rise dramatically over the next decade, no matter how the 
US ends up paying for them. And this is going to shift US 
consumer spending habits in ways we do not yet understand.


Regards,

John Mauldin,
for the Daily Reckoning

Editor's Note: John Mauldin is the creative force behind 
the Millennium Wave investment theory and author of the 
weekly e-mail The Millennium Wave Investor. As well as 
being a frequent contributor to The Fleet Street Letter and 
Strategic Investment, Mr. Mauldin is currently writing a 
book entitled "Absolute Returns", covering the hedge fund 
industry.

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