The FUNDAMENTAL Problem, ECONOMY-WIDE

by Karl Denninger, Market Ticker:

his is a post that I predict will get few reads and fewer shares.

It’s also mathematically provable and, if we don’t cut it out, it will destroy our nation and economy even if we fix all the other problems.

Simply put, it’s this:

As soon as you find a way to collude such that financialization becomes an essential piece of any part of the economy that part of the economy stops serving the end consumer of said good or service and instead serves the financiers.

Consider good or service “X”. The producer has to compute a price to sell at. His computation is comprised of the expense to produce the good or service plus a profit.

Given no constraints the seller would like an infinite profit.

Two things constrain his profit: 1) The ability for the consumer to refuse to buy at all and 2) competition.

Unfortunately there are products and services that people cannot successfully refuse to purchase. Some of those (like water) you must acquire all the time in order to remain alive; if you cannot do so via either a clean natural source or clean the source you have there is no other option but to purchase it from someone who can. Others, such as medical care, are items you can sometimes refuse to buy but at other times you cannot refuse such as when you’re unconscious due to either a medical emergency or accident. Medical care has a further circumstance that arises in that in many chronic condition circumstances while you can refuse the price of doing is literal death; in those cases you are effectively forced to purchase.

Now let’s enter the world of drug prices — which by definition only exist because there is a belief (which may or may not be true) that consuming them in a given case will benefit you. This is what drug executives currently say:

Note what’s missing there: Any discussion of the actual cost of producing the drug.

In other words: We will sell it for whatever we think the value is to you.

That never, ever works in a competitive market and nobody says that in a competitive market. Why? Because it’s an instant prescription for bankrupcy.

Yet in the drug business the model is “how much is an extra year of life worth for a cancer sufferer”? They “figure this out” and that’s the price. Ditto for the claim that the pricing for Sovaldi, which cures Hepatitis C. The question isn’t “how much did this cost, plus a reasonable profit”, it’s how much money would the victim blow if they don’t take the drug up to and including their death from liver failure or liver cancer, and we’re then free to set the price at any amount up to that number minus a dollar.

Now contemplate that “how much is a year of life worth?” has several possible definitions. For many people it’s “an infinite amount of money.” However, there are few people with infinite — or effectively so — funds and the higher the price the fewer people there are that have that amount of money.

In other words minus financialization and cost-shifting even the sort of crap statement that Celgene’s Chairman made can’t work for him because he’s constrained by how much money consumers actually have.

This all changes, however, if the consumer can force someone else to pay; now the limit is whatever funds the forced party has. If that forced party is “society” via a transfer mechanism then there is no limit.

Every company executive would love to price this way but nobody can in a competitive market because (1) there is no ability to force someone else to pay and (2) a second supplier, if you set your price high enough to make it worth their while, will choose to undersell you and they will get all the business while your sales will be zero and finally (3) if there is no other supplier and no other alternative virtually no individual consumers have effectively-infinite amounts of money.

So how do you get the above “infinite pricing capacity” model in the real world?

You break the law and/or you get the government to force others to pay.

You restrain competition.

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