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Mark's Market Blog

5-30-10: Governments and Great Depression II

By Mark Lawrence

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This week the markets did in fact rebound a bit, and in an interesting way. Most days, while America slept, Asians and Europeans bought up US treasuries and stock futures, to my eyes moving their money into the only reasonable safe haven left on the planet right now. The US markets would open with a leap higher due to this activity, then close lower as the US showed it was perfectly willing to sell bonds and stocks to foreigners at current prices. Stocks closed sharply lower on Friday, but this was only selling before the 3-day weekend: people didn't want to be holding stocks, waiting to see what idiocy European politicians came up with over the 3 days. Forecast for the coming week or two: cloudy, with a chance of scattered showers.

S&P 500 November 29 2009 to May 28 2010

China's position on the Koreas has become clear. China is focused on their own economic growth and wants stability, especially in their own back yard. The clearly will not support armed conflict at this time from either side, nor anything like severe UN sanctions that might prove provocative. The idea that China would have their own economy disrupted over the deaths of 50 or so Koreans clearly is not part of their agenda. Now the unanswerable question is, what kind of behind-the-scenes pressure are they putting on the North to constrain their unruly client?

Obama sent 1200 National Guard to the Mexican border to placate the roughly two-thirds of Americans who are livid over illegal immigration. The assignment of the National Guard? To help stop the drug trade, thereby making the flow of illegals less unpalatable.

Nial Ferguson, a Harvard economist, did a presentation this week on historic financial crises and the response of governments. From his presentation:

Lessons of history (1)
What do governments NOT do with world war size debt burdens?
• Slash expenditure on entitlements
• Reduce marginal tax rates on income and corporate profits to stimulate growth
• Raise taxes on consumption to reduce deficits
• Grow their way out with out defaulting or depreciating their currencies

Lessons of history (2)
What do governments USUALLY do with world war size debt burdens?
• Oblige central bank and commercial banks to hold government debt
• Restrict overseas investment by firms and citizens
• Default on commitments to politically weak groups and foreign creditors
• Condemn bond investors to negative real interest rates

Lessons of history (3)
What are the geopolitical consequences of crises of public finance?
• In fiscal stabilizations, discretionary military spending is usually the first casualty
• In cases of default on external debt, conflicts with creditors can arise
• In cases of currency depreciation, reserve currency status can be lost to a rising rival

Each day in the U.S., two women die of problems related to pregnancy or childbirth. Maternal mortality rates in California tripled between 1996 and 2006, from 5.6 deaths per 100,000 births to 16.9. Nationally, the rate rose from 7.6 per 100,000 to 13.3 per 100,000. Though the U.S. spends more per birth than any other nation, maternal mortality is higher here than in 40 other industrialized countries, including Croatia, Hungary and Macedonia, and is double that of Canada and much of Western Europe. Researchers say they are unable to identify the cause. I can help: about half of our births are now to Hispanics, many of them teenage unwed mothers who are the women most at risk. In California the proportion is only higher. Our statistics are looking more and more like 3rd world countries because our new mothers are looking more and more like 3rd world mothers. How is it surprising that our statistics now look like a blend of Germany's and Mexico's?

Commissioner Marc Sarnoff of Miami is suggests bankruptcy is near. "We are not the only city, municipality to be going through this. It looks like Los Angeles sometime next week or the week after will be going bankrupt. It looks like there will be 30 more cities following suit." Increases in public worker salaries is one of the main reasons why the budget is so tight. The average salary for a Miami city employee is $76,000. The average salary for a Miami city resident is $29,000. Employee pensions are choking the budget too. In 2000, pension payouts cost taxpayers $16 million. In 2009 that number spiked up to $70 million. Bloomberg News reported that from the last peak businesses have let go 8.5 million people, or 7.4 percent of the work force, while local governments have cut only 141,000 workers, or less than 1 percent. In 2008, according to the Cato Institute, the average federal civilian salary with benefits was $119,982, compared with $59,909 for the average private sector worker; the disparity has grown enormously over the last decade.

Strikes are breaking out across China. Workers who build transmissions for Hondas are on strike, looking for a raise from the $200 per month they make now to the $330 per month car assembly workers make. Apple employees who make the iPad are looking for a 20% raise. Raises such as these are inconsistent with wages across the rest of Asia, and will cut down employment growth in China.

I've decided that our current financial crisis has three phases, and we're moving into phase II. Phase I was about financial uncertainty and risk generated by individuals piling up in banks and destroying their reserves. This problem grew silently until, today, 18 months after the fact, we identify the key moment as the bankruptcy of Lehman. The government "fixed" this problem by swapping government bonds for bank-held mortgage debt, so today this problem is more or less contained inside of Fannie Mae, Freddie Mac, and the FHA. But that's over now, the near-collapse of the banking industry and resulting government bailout is the last war, the war the generals wish to keep fighting 'cause they understand it. Two weeks ago Cramer said, in the depths of the latest stock price drop, "In 48 hours we'll either have a new European Lehman or the crisis will have passed." There will be no "new Lehman," we know all too well how to deal with that now. It's not a crisis if you know how to deal with it. Europe passed a $1T bailout fund to support the bonds, pushing the problem out two to three years.

Phase II will prove, I expect, to be about cities and states: California, Florida, New Jersey, Miami, Los Angeles, Oakland. Just as Lehman seemed to be the first in a line of dominoes, and their potential tip scared everyone into a 50% drop in the markets, sometime in the near future I expect to see a major city like Miami or Los Angeles declare bankruptcy, and this will prove to be the next "first domino." Once a major city goes under and transfers control of their finances and union contracts from the city council to a federal judge, it will be almost instantly realized that there are dozens of cities and several states that will want to follow this path out of the union wage / retirement wilderness. The ensuing panic will start the next major leg down, only to be abated after Obama announces his new city bailout plan. Remember, the last drop was intensified when TARP was announced, and intensified again when it was passed. The drop only stopped when the stress tests and improved bank reserves and huge Fed lines of zero interest credit were put into place. The next bailout plan will similarly not reverse the drop until it's seen that the cities and states are no longer hemorrhaging money, the problem has been moved into the federal purse. City and state employees should thank whatever gods may be that the current president is the union-loving Obama and not Reagan.

Phase III will come in a couple years, when the $1B euro-bailout fund has run its course and we see that the concept of governments bailing out banks, then cities and states, and finally other governments has moved from the sublime to the ridiculous. It will be realized sometime in perhaps 2012 or 2013 that there simply is not enough money in the world to bail out Spain, Italy, Ireland, France, and the UK. That's when we hit the real end game.

Suppose you make $100,000 per year and have no savings. You spend $120,000 per year. Apparently you're borrowing $20,000 per year. Debt + deficit spending = 0. Now suppose you're married. The only thing this changes is the equation is now family deficit spending + your debt increase + your wife's debt increase = 0. This is not an economic theory, it's accounting. You can mask this for a bit by having yard sales - that $150 vegetable juicer that Aunt Edna got you last x-mas might bring in $50. Now change "family" to "country", and your wife is now the government. Trade deficit + government borrowing + personal borrowing = 0. Again, this is just accounting. Our government borrowing has gone up enormously, and the trade deficit has gone down only a little bit. So individuals are saving money and paying down debt. This will continue until either the government reels in their spending (like that's going to happen. . .) or the trade deficit decreases.

Spain, Portugal and Greece are having this problem: their government borrowing got so huge that no one believed they could pay it off. So they're having a yard sale: the Euro is going down in value, meaning Greek Olives and Spanish vacations are suddenly cheaper. And the government promises to stop borrowing so much. Really, truly, cross their hearts, they really mean it this time. However, the yard sale will continue: the Euro will certainly drop in the near future from $1.50 in January to $1.25 today to $1.16 in the next few months, and eventually $1 or perhaps even $0.85. These yard sale prices means that they want us to buy the stuff their people make instead of the stuff Chinese or American people make. In other words, they want to export goods and import jobs, which means they want us to borrow more money, run a bigger trade deficit, and lay off more people. Sudden large drops in currencies like this is the stuff trade wars and the Smoot-Hawley act are made of.

Meanwhile, the bond market has scared Europe into cutting government budgets to lower their deficits and fight inflation. Nobel laureate Paul Krugman says this is a huge mistake - lowering deficit spending in a recession will result in a slowdown to the economy, more layoffs, lower tax receipts, and little or no overall improvement in the deficit. This is, he says, exactly the mistake the Fed made in 1931 that helped drag out the great depression for 10 more years, the mistake for which Bernanke famously apologized and promised wouldn't happen again.

Net Worth of the Presidents

1 George Washington $525 Million
2 John Adams $19 Million
3 Thomas Jefferson $212 Million
4 James Madison $101 Million
5 James Monroe $27 Million
6 John Quincy Adams $21 Million
7 Andrew Jackson $119 Million
8 Martin Van Buren $26 Million
9 William Harrison $5 Million
10 John Tyler $51 Million
11 James Polk $10 Million
12 Zachary Taylor $6 Million
13 Millard Fillmore $4 Million
14 Franklin Pierce $2 Million
15 James Buchanan <$1 Million
16 Abraham Lincoln <$1 Million
17 Andrew Johnson <$1 Million
18 Ulysses Grant <$1 Million
19 Rutherford Hayes, $3 Million
20 James Garfield <$1 Million
21 Chester Arthur <$1 Million
22 Grover Cleveland $25 Million
23 Benjamin Harrison $5 Million
24 Grover Cleveland $25 Million
25 William McKinley $1 Million
26 Theodore Roosevelt $125 Million
27 William Taft $3 Million
28 Woodrow Wilson <$1 Million
29 Warren Harding $1 Million
30 Calvin Coolidge <$1 Million
31 Herbert Hoover $75 Million
32 Franklin Roosevelt $60 Million
33 Harry S. Truman <$1 Million
34 Dwight Eisenhower $8 Million
35 John Kennedy $1 Billion
36 Lyndon Johnson $98 Million
37 Richard Nixon $15 Million
38 Gerald Ford Jr. $7 Million
39 James Carter $7 Million
40 Ronald Reagan $13 Million
41 George Bush $23 Million
42 William Clinton $38 Million
43 George W. Bush $20 Million
44 Barack Obama $5 Million

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