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Mark's Market Blog

6-4-10: The Death Spiral of the Welfare State

By Mark Lawrence

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Markets were mixed this week. Up in the middle of the week, when Obama hinted at the coming fabulous jobs numbers. Down at the end of the week when the jobs numbers were released and the jobs were all from temporary Census hiring, and Hungary and Romania joined the ranks of countries threatening default. Helpful hint: Obama can't handle numbers, he's better with stirring emotions.

S&P 500 December 5 2009 to June 4 2010

Rough week for Obama - completely out of touch on the unemployment numbers, fumbling around on the BP mess while stating emphatically he's in charge and he's angry. And it's starting to look like there's a cover up on the Sestak thing - apparently Obama offered Sestak Sec.Navy if he wouldn't run against Specter, which is election tampering and a violation of federal law.

People are lining up to sue BP. It's thought that this will be the largest court case in the history of the US, totaling perhaps $60B or more. It's likely that BP will wind up in bankruptcy. One part of the case hinges on a missing o-ring, the same type of part that brought down the Challenger 25 years ago. Previous to the blowout, BP and their contractor Haliburton skimped on testing and ignored trouble signs against warnings from their own engineers. Normally there is an EPA safety report required for off-shore drilling, but BP was granted an exemption under a program designed for hiking trails and outhouses. Finally, there's evidence that BP knowingly used an insufficient blowout cutoff device. All things considered, don't be surprised if the elegantly colored Green and Yellow BP signs disappear from the US landscape in the next couple of years. There's one part of this I find deeply confusing: BP made some mistakes, damage will be assessed and likely paid, but why are we going to let a bunch of tort lawyers make $1B over this? How do lawyers help? Personally, I think if the lawyers are going to be involved, they should have ready access to all the facts, so I think they should all be transported down to 5,000 feet below sea level to see the problems first hand.

In a clear act of damage control, the Feds are starting to get involved in the BP mess. They want to start pouring dispersants on the oil. Suppose you have a dirty fry pan, oily and greasy. You add water, nothing happens. You add dish soap, the oil and grease dissolve in the water, and you have a clean pan and some seriously dirty dish water. Dish soap is a dispersant. The Feds want to take oil floating on the surface of the gulf, where it's highly visible and a huge political disaster, add soap, and dissolve it into the gulf. Now the oil and poisons are still there, but instead of floating it's dispersed in the water where fish and seaweed and algae eat it. A month ago some Louisiana red necks produced a little you tube demonstration of how dumping straw on an oil spill soaks it up, and the straw is easy to pick up later and burn. Today, now that the oil is no longer confined to a couple square miles but spread out over several hundred miles, now we're talking about maybe straw isn't such a bad idea after all.

Internet and pornography, here's some facts: There are 26 million porn sites, 12% of the entire Internet. 70% of men visit a porn site in any given month. One third of porn viewers are female. Pornography is roughly a $5B / year industry, half of that coming from the US. 8% of all emails, 25% of all searches, 35% of all downloads are pornographic. The #1 state is Utah, with 5.5 porn site subscriptions per 1000 high-speed Internet connections. The #1 day for porn viewing is Sunday.

What are rare earths? They're metals which are, well, rare. These are important in a lot of technologies. Solar panels depend on rare earths, and so do the magnets which make hybrid cars, LEDs and wind turbines possible. Rare earths are classified as "light" and "heavy." Most deposits are about 97% to 99% light REs. China has a couple deposits which are 20% heavy REs, has over 50% of the world's proven reserves, and produces 95% of the world's supply of many of these metals. China has over 6 times the proven reserves that the US has, and most of our reserves are in places where mining is not currently allowed. This week China announced export restrictions on rare earths - some fear in preparation to outlawing exports entirely, forcing everyone else to buy solar panels and high efficiency motors and generators from China, instead of buying the metals and making their own. For example, your car has rare earth magnets in the speakers, air conditioner, power steering and brakes, starter, fuel pump, alternator, hard disks, and most of the sensors. REs are also critical in LEDs, flat screens, and numerous defense devices. Export controls would allow China to engage in monopoly pricing until other deposits are found and developed, which will take anywhere from several years to many decades. Rare earths currently sell for $3 to $300 per pound, but that could be changing real quick. Prepare to pay more for anything green, high-tech, or electric.

Israel has had a busy week. First, they shot up a bunch of barges transporting weapons to Palestinians, killing several people in the course. They claimed they were shot at first. Then they announced they will be permanently stationing nuclear armed submarines off the coast of Iran. Some people are beginning to say it's getting difficult to tell N.Korea from Israel - both are belligerent states supported by a major power who are seen by all of their neighbors as a threat, and get reported to the UN frequently. Personally, while I have some sympathy for the Jewish people, I don't understand why we send them a couple billion dollars a year in various forms of aid, thereby enraging the Muslims against us. I frequently remember what King Saud said in the 60s about Israel: "So, you say the Jews had a difficult time in WWII? Well, I don't know, perhaps that's so. And now they deserve something for it? Perhaps that's so too. Give them something of yours, not ours."

If monthly foreclosures were to double to 180k from Aprilís record 92.5k and stay at that level it would take 42 months to clear the 8mm loans that will ultimately be liquidated. If foreclosures remain at Aprilís record high of 92.5k, it will take 101 months.

Phoenix, Arizona features an astounding annual car theft rate of 57,000 vehicles and has become the new "Car Theft Capital of the World." US law enforcement authorities claim that there are now over 1 million gang members in the US. These 1 million gang members are responsible for up to 80% of the crimes committed in the US each year. Only 26 percent of American teens between the ages of 16 and 19 had jobs 2009 which represents a record low since 1948. Only 58% of those in "Generation Y" pay their monthly bills on time.

Market Cap means the price per share of the company's stock times the number of shares of stock. This is one way to say how much it would cost to buy a company, the market cap is the current cost to buy up every share. Apple just passed Microsoft in market cap, and is projected to pass them in profits in the next year or so.

According to the Tax Foundationís Microsimulation Model, to erase the 2010 U.S. budget deficit, the U.S. Congress would have to multiply each tax rate by 2.4. Thus, the 10 percent rate would be 24 percent, the 15 percent rate would be 36 percent, and the 35 percent rate would have to be 85 percent. If you paid $10,000 in taxes last year, you would have to pay $24,000 this year.

States are starting to worry the bond market - CDS spreads, the cost of insurance against default on bonds, are raising for many states. New York, Illinois and California are currently having a race to have the most corrupt out-of-control state government. New York, for example, has 8,074 transit workers who make more than $100,000 per year, including a "chief diversity officer" who makes $148,438 and one conductor who makes $239,148. The Disneyland Monorail has been running on time for 40+ years, and its conductor makes $11.50 per hour. In spite of New York's and Illinois' 80+ year head start on government corruption, I'm afraid the high-tech thinkers of California have pulled out to a substantial lead, leaving even Spain and Italy in their wake. The People's Republic of California is clearly aiming at Greece, apparently thinking that their 2,500 year head start on government ineptitude can be overcome with enough brains and dedication.

Top 10 states / countries worrying investors about default.
StateCDS spread
Texas 75
Connecticut 119
Massachusetts 121
Ohio 137
Nevada 191
Michigan 211
New York City 212
New Jersey 222
New York 224
Illinois 234
Italy 250
Spain 260
California 301
CountryCDS spread
Portugal 361
Hungary 380
Latvia 406
Dubai 476
Iraq 492
Ukraine 622
Greece 760
Pakistan 802
Argentina 1162
Venezuela 1403

Spain has real issues with employment. Their government wanted everyone educated (sound familiar?) so they lowered college standards until now nearly everyone has a 4 year college degree. Result: Employers don't believe in 4 year degree, it takes a masters minimum to get any recognition for management positions. Spanish jobs, by law, include 4 weeks vacation, high minimum wage, high severance pay, and 50% employment taxes to pay for all the retired people. Spanish McDonalds is ordering new equipment so that they only have people who assemble the burgers, people who hand the food to you and janitors. Everything else - cooking, order taking - will be automated. Not only are the jobs that have been lost in the US not coming back, there will be more low level job losses in the coming years as this level of automation becomes standard. Minimum wage service jobs are the next on the chopping block, and these jobs account for 40% of our workforce. The people who take your orders are already machines anyway - a typical conversation I have goes something like this, "6 chicken tacos, 3 tostadas, that's all, to go." "Ok, I have 6 chicken tacos, would you like anything else?" "3 tostadas, that's all, to go." "Ok, would you like any drinks with that?" "that's all, to go." "Is that for here or to go?" Really, this is normal, not unusual. The result of this coming automation? Fewer and fewer workers paying into social security to support more and more retired boomers.

Workers per Retiree

Paychecks from private business have shrunk to their smallest share of personal income in U.S. history while government-provided benefits from Social Security, unemployment insurance, food stamps and other programs have risen to a record high. 40 million Americans are now on food stamps; U.S. Department of Agriculture is forecasting 43 million Americans in 2011. This not sustainable, says economist Donald Grimes. The federal government depends on income taxes to pay for its ever-more-expensive programs. "People are paid for being, rather than for producing," says economist David Henderson.

Robert Samuelson says this is not entitlements, it's a welfare state, and the welfare state is in a death spiral. The welfare state's death spiral is this: Almost anything governments might do with their budgets threatens to make matters worse by slowing the economy or triggering a recession. By allowing deficits to balloon, they risk a financial crisis as investors one day -- no one knows when -- doubt governments' ability to service their debts and, as with Greece, refuse to lend except at exorbitant rates. Cutting welfare benefits or raising taxes all would, at least temporarily, weaken the economy. Perversely, that would make paying the remaining benefits harder. To get their bailout, Greece embraced budget austerity. Average pension benefits will be cut 11 percent; wages for government workers will be cut 14 percent; the basic rate for the value-added tax will rise from 21 percent to 23 percent (remember what I said, the VAT in this country will be sold as a national sales tax of around 5%). These measures will plunge Greece into a deep recession. In 2009, unemployment was about 9 percent; some economists expect it to peak near 19 percent. Developed countries represent about half the world economy; most have overcommitted welfare states. They might defuse the dangers by gradually trimming future benefits in a way that reassures financial markets. In practice, they haven't done that; indeed, President Obama's health program expands benefits. What happens if all these countries are thrust into Greece's situation? One answer -- another worldwide economic collapse -- explains why dawdling is so risky.

Obama's health care "fix" is based on two assumptions: health care costs are out of control, and the government can do something about that. We all know when the government gets involved, things cost twice as much. As to health care costs being out of control, certainly the drug companies are out of control. However, as health improves in this country and life expectancies go up, health care costs go up. It used to be a lot of people died young, quick and cheap of alcohol or tobacco related illnesses. Today those types of deaths are very much on the decline. People who retire healthy at age 65 wind up having 20% to 30% higher lifetime medical expenses than people who retire sick at age 65. Sicker people have higher temporary medical costs, but they die earlier, so their total costs are far lower than healthy people's total costs. Healthier people, because they live longer and need increasingly expensive age-related health care longer, have higher lifetime health care costs.

Defenders and critics of Obamacare inevitably focus on poor, unemployed, single mothers or their children when making their cases for reform. The typical medical welfare recipient is not a single mother living on food stamps. It's a retired person in a sun hat, wintering in Florida or Arizona. Society could easily take care of the legitimate medical needs of disadvantaged younger people. The big, overriding problem is the transfer of money from a shrinking percentage of younger workers to an increasing percentage of older retired people.

What's going to happen? That's easy to predict. Entitlements were designed when life expectancy was about 62, so less than half of everyone hit the retirement age of 65. Today life expectancy is more like 75. Retirement age is going to go up, a lot. The good news: those older people thrust back into the workforce won't be working at McDonalds, unless they can repair automated order taking and sales machines. Maybe Walmart will have automated robot greeters soon.

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