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Mark's Market Blog

5-29-11: Europe smolders

By Mark Lawrence

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Markets continued their volatility last week. So far we're down for the month of May. There are growing demonstrations across southern Europe and growing fears about the solvency of Greece and Portugal; in short the European banking system and indeed Europe as a political unit itself is being called into question. I think the trend is clear: a major Euro crisis is coming hard and fast, like a major train wreck with cars transporting toxic chemicals. But the time isn't now, it's still many months in the future. This fear will evaporate as people realize no disaster photos are forthcoming.


S&P 500 November 28 2010 to May 27 2011

S&P downgraded Italy's debt outlook to "negative." Italy was always one of the PIIGS, we just haven't talked about it before. European bank holdings of Italian debt are about twice as large as their holdings of Portuguese, Irish, Greek and Spanish debt combined. If Italy goes, the Euro goes. However, Italy is not in political or economic crisis at this time like the others. Credit Default spreads tell us the betting line on who are the most likely defaults in the next 12-18 months: Greece, Venezuela, Portugal, Ireland, Argentina. S&P completely failed at warning anyone about the 2008 US crisis, so now they're warning about everything. Expect S&P to issue a credit outlook statement about you soon. Like many on Wall Street, I've lost all respect for S&P, Moody's and Fitch: when it really mattered, they didn't warn us about anything, and now they cry wolf at every shadow.

The Euro, which was nearly $1.50 just a couple weeks ago, is $1.39 and dropping. If you export to Europe (I do), this trend, if continued, will start to show up soon as decreased sales to Europe. The Australian dollar is also dropping fairly hard. The two best large currencies right now are the Canadian dollar and the Swiss Franc. If you're apocalyptic about the US dollar, then you should own some Canadian dollars.

Demonstrations across Europe continue, and continue to increase. There are 100,000 Greeks demonstrating against austerity even as I write this, and perhaps another 100,000 Spaniards. Demonstrations are also gaining momentum in Ireland, Portugal, Italy. The demonstrations are about youth unemployment, cutting welfare and retirement, perceived political corruption. They're not anti-left or anti-right, they're anti-establishment. Basically, southern Europe is starting to look a bit like Arabia, except these countries are democracies. Thinking of a vacation this summer in southern Europe? I recommend you think again.

Greece's problems are being discussed at the highest levels in Europe, and it appears that a consensus is emerging: in order to qualify for another bailout, Greece is going to have to give up some sovereignty, in particular other Europeans will take over the functions of tax collection in Greece, and monitor and direct the selling off of various Greek assets to prevent nepotism. No one in Greece pays income taxes, and this is one of the major sources of their problems. I can't see that this will work: Imagine your doorbell rings, and a pair of French and German guys are standing there like Jehovah's witnesses, except they're saying, "Hi, we'd like to talk to you today about your bank balance, your paychecks, and how much tax you owe us." I'd really hate to be those two guys in West Virginia, Texas, Idaho.

Rhode Island is the latest state to enter a pension crisis. Taxpayer contributions to the pension system doubled from $139 million in 2003 to $302 million in 2010 and are expected to rise $621.8 million by next year. "Each day that the state avoids comprehensive reform, the liability grows," wrote state treasurer Gina Raimondo, a Democrat. "It is unfair to ask taxpayers to pay for the growing level of required contributions and it is dishonest to let state employees, teachers and retirees believe that full benefits will be there for their retirement. The time to act is now."

The USPS is a wondrous American creation. Six days a week it delivers an average of 563 million pieces of mail - 40 percent of the entire world's volume. For the price of a 44¢ stamp, you can mail a letter anywhere within the nation's borders. The service will carry it by pack mule to the Havasupai Indian reservation at the bottom of the Grand Canyon. Mailmen on snowmobiles take it to the wilds of Alaska. If your recipient can no longer be found, the USPS will return it at no extra charge. It may be the greatest bargain on earth. It takes an enormous organization to carry out such a mission. The USPS has 571,566 full-time workers, making it the country's second largest civilian employer after Wal-Mart. It has 31,871 post offices, more buildings than Wal-Mart, Starbucks, and and McDonald's combined. Last year its revenues were $67 billion, and its expenses were even greater. Postal service executives proudly note that if it were a private company, it would be No. 29 on the Fortune 500.

Since 2007 the USPS has been unable to cover its annual budget, 80 percent of which goes to salaries and benefits. In contrast, 43 percent of FedEx's budget and 61 percent of UPS's pay go to employee-related expenses. As email and texting get more popular than sending letters, the post office is getting squeezed. "The postal service is already carrying more junk mail than first class," says postal consultant Campbell. "Pretty soon it's going to be a government-run advertising mail delivery service." Postmaster General Donahoe wants to close post offices and move some of their operations into convenience stores and supermarkets, where nonunion workers can staff them. The USPS is targeting 2,000 of its 31,871 post offices, despite a federal rule that forbids the closing of post offices solely for economic reasons. He tells anybody who will listen on Capitol Hill that the prohibition makes little sense at a time when his agency's coffers are nearly depleted. "I really believe that the USPS is going to get to a point where, regardless of what it does with retiree health care, it is going to implode," says Richard Geddes, a professor at Cornell University. "It is either going to default on the obligations to its retirees or we are going to have to give it a direct bailout from the United States taxpayers."

In the 3rd world, particularly Africa and India, there's a need for more modern forms of electronic money, but banks are unwilling to give out credit cards, and ATM cards require balances that people cannot maintain. So they're developed a new form of money: balances on your pre-paid cell phone. Nearly everyone has a cell phone. You buy a $10 phone card, then you can spend the $10 at nearly any retailer by more or less texting them money. Now this is coming to the US. On Thursday Google Wallet was introduced, a mobile application that will allow consumers to wave their cell phones at a retailer’s terminal to make a payment instead of using a credit card. The app for the Android operating system, will also enable users to redeem special coupons and earn loyalty points. You can link Google Wallet to your cell phone pre-paid balance, to your Visa or Mastercard, or to your bank account. With its wallet, Google plans to make money by offering consumers promotions as they shop. For instance, it plans to introduce "Google Offers," advertising deals from local and online businesses that can be found online or sent through the phone. Like Groupon, Google will collect a fee from participating retailers every time a person redeems a coupon. If you own stock in Visa, it might be time to sell. No organization staffed by bankers is going to out-think and out-innovate Google. In the last 10 years, checks have all but disappeared, replaced by ATM cards and remaining only for businesses and a very few old ladies buying groceries. In the next 10 years ATM and credit cards will vanish, replaced by smart phone apps.

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