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5-24-15: The South China Sea
by Mark Lawrence

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Stocks made new all time highs this week, then failed to have any follow through. The market continues to want to go up, but appears to be afraid of shocks - a China recession, a US recession, a Greek default. The Greek default now appears inevitable and should happen in about three weeks.


S&P 500 November 24 2014 to May 22 2015

What's going on with the US economy? No one is sure. We had a lousy 1st quarter, due, I think, to severe weather, just as last year. Personally, my business turned up nicely in April and has been good since. However, early reports on consumer numbers disagree with that for the economy as a whole; there's simply no available evidence to show the economy is picking up in the 2nd quarter. Are we headed for a recession? Personally I doubt this, but more and more people are on the other side of this discussion. A couple of noteworthy hedge fund managers are already on the record predicting that not only will the Fed not raise rates this year, but in fact they will institute a new QE program.

Spain just had elections for Barcelona and Madrid. It appears that the capitol of Spain will no longer be ruled by the Popular Party - Spain's leftist majority party which has been in charge for 23 years - but will now be ruled by a coalition of a new party Ahora Madrid and the existing socialists. Both are strongly against EU imposed austerity. Ahora Madrid is the Spanish equivalent of Greece's Syreza. Spain will have national elections in November, and it appears the PP has little chance of holding on to power. The Germans think they're incontrol of the situation in Greece; not only so I question that, but it appears Spain, Portugal and Italy may soon be following in Greece's footsteps. The EU bureaucrats say that the EU cannot be split apart. The popular vote seems to go the other way.

The People's Republic of China is running a scam. I've previously noted that much of the new money in their market run-up is from extremely uneducated people. Meanwhile, Chinese companies have seen their share prices double in the last 16 months. This means the companies' debt has effectively halved - they can sell shares into this market and pay down debt. What happens when the market goes down? The Chinese banks that held the debt have been made more whole, the companies have been helped to survive, and the working class man on the street lost his savings to make this happen. Of Course, This Could Never Happen in The US. Or Europe. Try to imagine the backlash if it were ever learned that the Fed in collusion with Wall Street made ultra cheap money available to engineer a stock market bubble.

China has been trying to engineer a "soft landing" for their economy, where spending shifts from capitol expenditures to consumers. No one has ever seen a "soft landing" in the history of economic statistics, but who knows, maybe they could have been the first. Actually, no. Growth came to a complete stop, hiring stopped, it was all looking pretty dire. So China is shifting back to printing massive amounts of money and building more empty cities. For a while. And when things are moving again, it's not hard to predict another attempt at starting up a consumer economy. Expect a bumpy ride while the Chinese government moves from reform to growth, growth to reform, in order to avoid a hard landing. Of course they will keep perfect control and no mistakes will be made. . .

China is build artificial islands in the south china sea, with the obvious intent of declaring them chinese territory and improving their claim to waters several hundred miles from their shores. This week we flew a P8 spy plane over their island, which was challenged eight times by the chinese navy. We side with Viet Nam, Japan and the Philippines that these are international waters. China believes there is massive oil and gas reserves in this sea and they've no intention of sharing. China called our flyover "irresponsible and dangerous and detrimental to regional peace and stability." I predict this disagreement will only heat up.

The war on cash: Peter Bofinger, an official economic advisor to the German government, told the German magazine Der Spiegel that cash should be done away with. In Denmark a new law was proposed that would allow shops to refuse cash payments. Both countries have negative interest rates which means you should want to take your cash out of the bank and keep it under your mattress. Of course officially this is all about drugs and terrorism. Expect this topic to come up at a G7 meeting. And if they get their way on cash, expect gold and diamonds to be next. 'Cause, you know, drugs and terrorists.

Greece has warned twice in the last ten days that they will not be able to make their June IMF payments without help. What happens if Greece defaults? Economists are now trying to predict. Unemployment jumps from 25% today to 35%. A further 10% cut in the Greek economy. Currency controls - you're not allowed to take large sums out of Greek banks or out of Greece itself. Businesses that import are watched closely. The government plausibly starts to issue IOUs to pay employees and pensioners - effectively printing a new currency. And inflation, especially in the IOUs that cut everyone's buying power and accomplish the cuts in pay and pensions that the government was unable to accomplish on their own. Basically, it will be ugly for Greeks.

Los Angeles is the latest to approve a rise in the minimum wage to $15, phased in over several years. Switzerland has a high minimum wage; the McDonalds in Switzerland take your order by cell phone app or touch screen, and your order is delivered by conveyor belt. A new study from Oxford says that 47% of all jobs are at risk to being replaced by automation in the next two decades. Warren Buffet spoke out this week, saying raising the minimum wage would cost jobs, and a far better approach would be to keep the minimum wage low and increase the earned income tax credit - an approach I've been in favor of for well over a decade. Unfortunately it's becoming clear to me that a large segment of our population is not employable at any reasonable wage. What's the answer to approaching a time when perhaps 50% of our working age population can't find a job? In Washington they seem to believe the answer is to let in yet more unskilled and uneducated.

Much, Much More Fun department: A couple years ago a couple biology professors at Berkeley were sitting around and one said, "Wouldn't it be cool if we could take the genes to make morphine from poppy plants and put them into a yeast?" So they did. There's now a yeast at UC Berkeley that makes beer and heroin at the same time. After they did it they called in a technology ethicist and asked what he thought. The biologists offered that their yeast could be put on the federal controlled substance list, 'cause, you know, we're so very good at stopping the flow of illegal drugs in the world. Isn't that special? Wild overpopulation. Nuclear bombs in the hands of genocidal madmen. Massive pollution of our environment. Over fishing and pollution of our oceans. Running out of arable land and fertilizers. And now home brew heroin. What's going to kill us off? I feel like I'm watching the last 50 laps of the Indy 500, with humanity suicidally zooming past the stands at 225 mph.

Back on February 1 I noted that Shake Shack with 63 locations was valued at six times McDonalds per location. Since then the stock has gone up. Each Shake Shack location is now worth 17 times as much as each McDonalds, 'cause, you know, their burgers are great and they plan to open "hundreds more" in the next few years. McDonalds will be opening 800 more stores this year. Market valuations of Silicon Valley startups have also reached another insane level, not unlike the dot com boom of '97-'99. I continue to think things are basically ok this year and the market will not crash immediately - perhaps a correction of 5% - 15%, but no crash. However, these insane valuations cannot continue in the long run. Stocks must adjust at some point, most likely violently, and people who own stocks where the valuation is based almost entirely on "plans" are going to get wiped out.

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