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Mark's Market Blog

2-13-10: Politics in the Euro Zone

By Mark Lawrence

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The markets had an uninspiring rebound on news that the EU would not allow Greece to default, although no details were given. China raised bank reserve requirements again at the end of the week, announcing that they were worried about inflation. They're the only country in the world that is using the "I" word, everywhere else there is too much idle manufacturing capacity and unemployment to even dream of inflation. Except in assets, what with all the loose money floating around all the loose banks.

S&P 500 October 23 2009 to January 15 2010

A new analysis suggests eating about a bar of chocolate a week can help cut the risk of stroke by 22% and lower the risk of death after a stroke by 46%.

Social Security took in only $3 billion more in taxes last year than it paid out in benefits, a $60 billion decline from 2008. The slide in revenue occurred sooner than Social Security actuaries had expected, for three reasons: 1) Payroll tax revenue flattened out in 2009 because of rising unemployment and no pay raises; 2) The number of retired workers increased by 20%; those taking disability jumped by 10%; and 3) Monthly benefits were raised 5.8% because of a spike in energy prices the year before. Social Security was saved from bankruptcy in 1983 by a bipartisan deal that increased payroll taxes, taxed some benefits and gradually raised the retirement age to 67. That was supposed to keep the system solvent at least until 2058, but the projection has slipped to 2037.

This may seem like not such a big deal, but the ugly truth is that the feds were using the $80 billion surplus to fund other programs. They replaced the surplus with treasury bonds, effectively a promise to raise taxes in the future to pay off the bonds. Well, the surpluses are gone and the future is here.

Our exports dropped last year rather dramatically, by about 18%, however, our imports dropped even more dramatically by 26%, giving us the, um, "best" balance of trade we've had since 1992. We have a ways to go still to get to primary balance. The last 18 months have shown us all that running a large trade deficit for a long time leads to big financial problems.

US Imports and Exports 1960 to 2009

Germany is a country of clever, hard working people who live on an indefensible plain - no mountains or huge rivers to protect them from outside aggression. The result of this is that last century they armed themselves for various reasons and got into two huge wars. To prevent a recurrence, NATO and the EU were formed to give Germany a sense of security. The EU has a bunch of rules for member states, but no way to enforce those rules. So a lot of Mediterranean countries with poor budgeting habits joined, adopted the Euro at unrealistic exchange rates, and got to borrow huge sums of money in Euros at German interest rates instead of Greek or Portuguese or Italian rates. The Euro is based on the premise that one currency policy and one exchange rate works for 16 very different economies. For the last 40 years Germany has been funding far more than their fair share of the costs of this, in addition to absorbing East Germany and bringing them into the 21st century. One of the reasons the UK has consistently refused to join the EU is that they believed they too would wind up funding poor habits in their southern neighbors.

Well, those days are here now. Greece and Portugal are close to default, too close for comfort. What they really need is an IMF bailout with the strict austerity measures the IMF would impose, including a currency devaluation making their imports more expensive and their exports more competitive, but it's thought in Europe that this would destroy the EU and the Euro and leave Germany isolated again. The French, as usual, bring lots of opinions on what should be done but no checkbook. So, all this year behind closed doors a new deal is being worked out. Apparently Germany will continue, for a time, to bail out the Med States, but in return now they want a much bigger say in the European Central Bank. We'll likely never hear the details of this deal, but we'll see the results: a far more activist and strict Central Bank, which acts a lot more like the tight-fisted Bundesbank and has more power to enforce EU rules on member states. In the next couple of years we'll see if this works out or if it's too little too late.

Today as times are tough the northern countries need low rates to stimulate their economies, and the southern countries need to devalue their currencies and dramatically cut government spending. Can the Euro hold together? I can't predict that, but in order for this to happen, there needs to be some kind of controls on the various governments. In the US most of the states have balanced budget amendments in their constitutions that keep, for example, Louisiana or West Virginia from effectively printing money at the expense of California and New York. The Euro zone needs similar constraints.

Who stands to lose if Greece goes down? 80% of their debt is owned by European banks, 50% by French and Swiss banks. Germans apparently are supposed to bail out French and Swiss banks. Of course the talk is all about bailing out Greece, their inept socialistic government, and their over-indulged citizens, but those people won't see a dime of any bailout. The real bailout is for bankers who didn't pay attention to risk, knowing in the end German taxpayers will get screwed, not them.

Remember, this entire Greece thing is just the warm-up band for the main act: Portugal, Ireland and Spain. Europe spent last year complaining about how the US was bringing down the world with our horrible banking practices. Soon, Europe will be having similar problems due to their unsustainable socialist promises to their own aging citizens. Expect to see the Euro, which has been over $1.50, trade at $1 sometime this year. To save the PIIGS all of Europe will have their currencies devalued, which will raise tension with the US. We're expected to see our exports drop and lose jobs to lower-priced Europeans to help bail out these French and Swiss bankers. If you're thinking of buying a Volkswagen, Audi, or Benz, wait a few months.

I think I speak for Joe Six-Pack everywhere when I say, The Superbowl is our one official sacrosanct holiday each year. No house painting. No cleaning gutters. No running to Home Depot or the Dump. We get to sit on our butts, eat potato chips and brats and drink beer, and no one can stop us. This is what Father's day was meant to be and never was. Having said that, Obama's 14 minute political speech on health care in the middle of the pre-game show was incredibly unwelcome, more than a little stupid, and 14 minutes too long. I know there's never been a camera he could resist, but this was one day when he should have found it in himself to just STFU. He didn't do any favors to himself, the democrats, or health care with his incredibly mistimed and inappropriate free commercial time. And Katie Couric. . . well, all I can say is I would love it if they gave me 14 minutes of air time to talk about quantum physics in the middle of the Olympic Figure Skating Compulsories. Or the Oscars. Trust me on this, Joe Six-Pack would rather listen to me than watch that stuff.

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