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Mark's Market Blog

12-9-11: Europe Solves the Next Crisis!

By Mark Lawrence

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Markets bounced around the 200 day moving average this week as people reacted to rumors from Europe, some unrealistically good, some unrealistically bad. It's either time for the famous "Santa Clause" rally into the end of the year on news that the US economy continues to slowly heal, or time for a crash on news that Europe is imploding. So the markets are treading water waiting further evidence.

S&P 500 June 22 2011 to December 9,2011

Greece is now having a full-on run on their banks. No one outside of Greece seems to care. It can't happen here, right? Some countries are thinking that perhaps if they left the Euro their lot would improve. I believe in the near future Greece will be tossed out of the Euro, and will be the poster child for people who dream about leaving the Euro. Things are going to go very badly for Greece in the next couple of years as Germay uses them to set an example of what happens if you don't follow good, simple Prussian orders. Nomura has estimated what various currencies would do in the event of a Euro breakup; the PIIGS currencies would devalue rapidly and significantly.

PIIGS currencies fair value estimates by Nomura

Europe just finished their latest summit to end all summits, the grandmother of all summits, to end this Euro crisis once and for all. What did they decide? Well, we got into this crisis because 17 countries with very different economies and cultures now share a single currency, which has worked great for Germany, so-so for France, and completely sucks for the other 15. During the last 10 years the 15 countries that it wasn't working for ran up huge debts, debts that now look like perhaps they can never be repaid. The result of the summit was that the 17 countries agreed that next year they will hold referendums and change the rule of the Euro zone so that countries cannot any longer run up huge debts. If they try the big, nasty European Court in Brussels will firmly and inexorably slap their hands. So, presuming that 17 countries will in fact actually manage to individually make these changes to the Euro treaty, there will be no second crisis that is just like the current one. Perhaps you're wondering, "But what about the current crisis, the effectively bankrupt European banking system, the trillions of dollars in potentially worthless sovereign bonds?" Ignore that little man behind the curtain and we promise he'll fly away in a hot air balloon. The Titanic is going down, and the Captain and his German engineers have agreed on how to design a new ship that will prove unsinkable. Really. This time it will work.

Interest rates: The ECB has clearly been stepping all over interest rates; in the last week you can see that they got Italy down from the mid 7's to the high 5's briefly before ending in the mid 6's. I'm told by people better informed by me that there is no money printing going on, these are "sterilized" purchases. That is, the ECB sells something they already own and buys other bonds instead to raise prices and lower interest rates. You can see they they've been ignoring Greece, Ireland and Portugal and concentrating on Italy, Spain, Belgium, France and Germany. How long can they continue this without printing money? Perhaps the rest of the year, perhaps a couple weeks into January, then the tide will go out and we'll see who's been swimming naked.

Europe Bond Rates

During WWII we had war bonds, the government's program to get the common man to help pay for the war. Now in Europe multiple club med countries are starting new programs to sell their government bonds to their populace. The bond markets won't touch this junk, it's perfectly clear that in the best case there will be inflation that will eat away at the money, in the worst case there will be defaults. But the Ponzi scheme must go on until the music stops.

French President Nicolas Sarkozy made it clear in a speech in Toulon last week that he wanted the private sector to be given a more-level playing field when it came to the threat of having to bear losses on their bond investments. "It must be clear that what has been done for Greece, in a very particular context, will not happen again, that no other state in the euro zone will be put into default," he said. "It must be absolutely clear that in future no saver will lose a cent on the reimbursement of a loan to a euro zone country." See, it can't happen here. Sarkozy promises.

Standard and Poors lowered the credit rating on a couple dozen European banks, and put several European countries on credit watch. Including France. If France loses their AAA credit rating, this entire European game of "extend and pretend" would likely fall apart almost instantly.

The Irish government is considering various plans to re-introduce the Irish pound, including dusting off their old printing presses and contracting with companies. The last two months have left them thinking that either a Euro breakup or an Irish exit from the Euro is now looking quite plausible.

Citi Strategist Robert Buckland said "Our economists believe the sovereign debt and banking crises are causing a renewed recession in the Euro Area. Beginning in 4Q 2011, they forecast real GDP to contract for 6 consecutive quarters. It is expected to be an especially protracted recession."

Last month, state and municipal payrolls shrank by 16,000 workers. Since state workers are disproportionately women, so are these layoffs. Federal workers are disproportionately men. How to explain this? Two words: Pentagon and teachers.

Government workers by sex

China has made an abrupt order for foreign workers and their employers to start paying up to 40 percent of their wages for pensions, medical insurance and other welfare. It is unclear how foreign workers can collect pension or unemployment benefits, because those foreigners who retire or lose their job usually lose the visa that allows them to stay in China.

A Chinese tax change could raise costs for foreign automakers or other companies that operate several lines of business such as sales, production or financing and are required by the government to register them as separate corporate entities. Tax authorities say they will treat money moved among those entities, such as profits from auto loans that are reinvested in manufacturing, as being taken out of China. They will impose a tax, a charge that would not apply to Chinese competitors. Foreign companies are on edge about patent and copyright rules due to be released soon under an anti-monopoly law enacted in 2008. A vague section of the law forbids abuse of intellectual property to hamper competition and companies worry it might be used to compel them to give know-how to Chinese rivals. Many US companies have invested many billions of dollars in China, and those investments are looking worse every day.

China is reported to have as many as 64 million empty apartments, bought by individuals as an investment for their retirement. The estimates of empty apartments are made by checking utilities records - a new high-rise apartment with no power or water is considered empty. Notice that 64 million apartments could house 200 million people in families of three, well over half the US population. What does this look like? Here's some satellite photos of a few of China's several famously empty cities. A bit over half of China's entire economy is construction of these cities where no one lives, airports where no one lands, malls where no one shops. Keynes famously said during the Great Depression that paying the unemployed to dig holes would be an improvement. China is paying hundreds of millions of workers to dig city-sized holes. I believe this is radically inflationary and will lead to civil and social unrest. Soon, I believe, we'll see if Keynes or I am more right. It's worth remembering that Keynes was also famous for changing his political positions, sometimes several times in a day, and when called on this saying, "When the facts change, I change my opinion. What do you do, Sir?" If Keynes were alive today it would be fun to show him these photos and ask if his opinion on paying people to dig holes was changing.

As the presidential race firms up, I thought it would be interesting to look at historic presidents. Presidents come in age cohorts; we have a few from the same generation, then we move to a younger generation. We don't go backwards. The television age has only enhanced this effect. For example, Kennedy, Johnson, Nixon, Ford, Carter, Reagan and Bush were all from the same generation, 36 years of presidency born within a 16 year span. When we elected Obama we had a choice between moving forwards a generation, or backwards with McCain, who was older than our previous two presidents. Not a difficult choice, Obama won decisively. Today the republican front runners are Gingrich and Romney, both of whom are from Clinton's generation. The US electorate deciding to move backwards to a previous generation is not happening, and the mere fact that these two fossils are the republican front runners makes me think that 1) the republicans have lost touch with the electorate, and 2) they don't really want the presidency in the midst of this depression. I'll take the republicans more seriously when they come up with a qualified and charismatic candidate born after 1955.

US Presidents and Birthdays
Teddy Roosevelt, October 27, 1858
William Taft, September 15, 1857
Woodrow Wilson, December 28, 1856
Warren Harding, November 2, 1865
Calvin Coolidge, July 4, 1872
Herbert Hoover, August 10, 1874
Franklin Roosevelt, January 30, 1882
Harry Truman, May 8, 1884
Dwight Eisenhower, October 14, 1890
John Kennedy, May 29, 1917
Lyndon Johnson, August 27, 1908
Richard Nixon, January 9, 1913
Jerry Ford, July 14, 1913
Jimmy Carter, October 1, 1924
Ronald Reagan, February 6, 1911
George Bush, June 12, 1924
Bill Clinton, August 19, 1946
George Bush v2, July 6, 1946
Barack Obama, August 4, 1961
John McCain, August 29, 1936
Newt Gingrich, June 17, 1943
Mitt Romney, March 12, 1947

Recently Ohio had an election on the topic of public unions, wages and benefits. The Ohio governor stupidly called an off-season election just for this issue, and in low turnout the union trashed him. The fight is not over. California teacher Patrick Godwin just retired at age 59 after 36 years teaching English and in school administration with a pension of $174,308 per year for life; if we assume he lives to 79, that's about $3.5m in pension benefits that he "earned," raising his effective working years salary by $100,000 per year. Police and firefighters often can retire starting even younger, typically at around age 50. The average CHP retires at about age 52 with a pension of about $150,000 per year for life, about $4.25 million per CHP in value. An Associated Press survey earlier this year found the 50 states have a combined $1.1 trillion in unfunded pension and health care obligations. Said Matt Mayer, president of the Buckeye Institute for Public Policy Solutions, "Frankly, I don't have as much a concern about when they retire as I do about when they get access to the pension. I believe in the economic freedom of workers. If a teacher wants to retire at 55, fine. They just don't get their pension until 65."

The Occupy Movement: This weekend, perhaps as many as 100,000 Russians took to the streets of Moscow to protest vote rigging and election fraud by Prime Minister Putin's party. The protesters were described as mostly young people in their 20s and 30s, dissatisfied with a social contract that promises them economic gains in return for nominal political dictatorship. The dictatorship is real, the economic gains not so much. December is not a great month for revolution in Russia; this will likely get much worse next May or June. This thing where the whole world over, my generation and the generation ahead of me is destroying the economic future of our youth with our deficits and debt and unfunded pensions and free retirement health care and layoffs, this is now reaching critical temperature.

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