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Mark's Market Blog

3-6-10: Sovereign Debt

By Mark Lawrence

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This week the market was flat until Friday's employment report came out. "Only" 60,000 people lost their jobs in February, and the stock market shot up Friday on these unexpectedly "great" results. The economy is obviously mending.


S&P 500 November 19 2009 to February 19 2010

Toyota has "repaired" a bit over 1M cars in the last month for sudden acceleration. The NHTSA now has reports of 60 "fixed" cars repeating the problem. Toyota and Lexus vehicles have now killed at least 52 people due to this problem, which may date back as far as the 1996 Camry, and certainly includes the 2010 Prius and various Lexus cars. Toyota has resolutely stated this is not an electronic problem. It is. This issue is going to cost Toyota several billion dollars in direct costs and lawsuits, and several points of market share. Toyota at #1 world-wide will prove to be a short-lived phenomenon. Honda and Ford are doing everything they can to wipe those smirks off their faces.

The German press is nearly apoplectic over the idea of German money being used to bail out Greece, or more properly the French, Swiss and German banks that lent to Greece. In a recent German newspaper article it was proposed that Greece sell off their nearly 6,000 uninhabited islands to raise money. As appealing as that sounds, I don't have the $2M - $20M the smaller islands would bring.

Europe is having continued discussion about how to avoid future Greece-like situations. There are many who want more central control over member governments budgets. And many who don't. There is also talk of a new 10 year plan (who does that sound like?) with goals like raise jobs from 69% to 75% of all Europeans and raise college degrees from 30% to 40% of everyone. It's obvious how the college degree thing will happen: more colleges will be built, and degrees will be given to lower standards for flakier majors - the European equivalent of "women's studies." These degrees will happen because they will be heavily subsidized, but businesses will be completely unimpressed. The real question is will they water down the standards for their science and engineering degrees? 100 years ago French universities were among the best in the world, but French Socialism has already watered them down to where in the US they wouldn't make the top 100 list. I don't think there's a university in France as good as Cal Poly Pomona, much less UCLA or UC Berkeley.

In a year or three, the Fed will think they have deflation whipped. So, then they'll tighten policy, right? Well, no. We have a good example in history of what they will do - after WWII they run inflation up on purpose to help pay down the national debt. They will have continued loose money, and will likely tell banks they have to own more government bonds. Because of the artificial demand for bonds, bond prices will stay high (interest rates will stay lowish) and inflation will hit perhaps 10% for perhaps 10 years. What should you own? Real estate, commodities, blue chip stocks. The interesting question is, since hospitals will automatically raise their rates to meet or beat inflation, and most entitlements are already indexed to inflation, where will the government save money? I think they're going to have to fudge the CPI. Yes, it's true, I'm predicting that our government will lie to us about inflation.

Bill Gross, the god of the bond market, put out an interesting chart the other day. He plotted countries' national debt v. budget deficit. It's widely believed that when your national debt exceeds about 100% of GDP, growth suffers. At about 200% you start to spiral down - the interest on the debt means you can't put your budget into surplus, and you find yourself borrowing money to pay interest. Also when this happens, people get worried about your ability to pay and the interest rate you have to pay on your bonds starts to climb. In the chart below, countries (read: Norway) to the upper left are doing great - low debt, budget surplus. Countries to the lower right are doing various measures of poorly. Japan has had no growth for two decades, and would be bankrupt but for their citizen's amazing savings rate, which the government has sucked up. Italy and Greece are in trouble right now. France, the US and Britain are not far behind.


Bill Gross' Ring of Fire

In the table below, we see total debt, meaning the government debt plus business debt plus individual debt. The US is three year's total income in debt; the UK and Japan are almost five year's total income in debt. There are some who think the real crisis will start not when Spain or Portugal trips, but when the UK falls completely apart like Iceland did a few months ago. Dubai was about $60 billion in debt, this compares to GM before their bankruptcy. Greece's economy is about the size of Massachusetts. Spain is about the same as California, four times as big as Greece. The UK has twice the economy of Spain.


National Debt by Country
I used to think that if there was reincarnation, I wanted to come back as the president or the pope or as a .400 baseball hitter. But now I would like to come back as the bond market. You can intimidate everybody. -- James Carville, political advisor to President Clinton

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