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Mark's Market Blog

7-21-13: Detroit is bankrupt. We're shocked, shocked.

By Mark Lawrence

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Nothing much happened this week. Data showed that $2 billion per week poured into the stock market for the past several weeks, a record sum. People are convinced our economy is largely healed. Word on the street is we will continue to grow through the rest of 2013 and all of 2014. Don't ask me how they know that. In any case, optimism currently knows no bounds, so I think it's nearing time for a real correction.

S&P 500 January 25 2012 to July 19 2013

This week we have a growing scandal in Spain, where years of kick backs on government construction projects are coming to light and threatening to bring down the government.

European banks are getting loans to European residents off their books, leaving them with a larger and larger percentage of bad or suspect loans. The average European bank has a price to book ratio below 1, meaning the market thinks the bank is worth more broken up. Italy's two largest banks have a price to book ratio of .34 and .42. Many EUropean banks continue to load up on their own government bonds, which is choking off all other forms of lending. European bank loans to European corporations are shrinking at over 2% per year. Japan tried this in the 90s and had a decade of no growth and deflation. Europe, already choked with unacceptable unemployment and soul-crushing youth unemployment, is heading down a path that will make things easier for the banks and governments at the cost of their citizens.

Washington, in their infinite wisdom, mandated back in 2007 how many gallons of ethanol must be used by gasoline refiners. Since then gasoline use has been dropping; the mandate will soon require gasoline to exceed 10% ethanol. However cars and the gasoline supply system cannot handle gas with more than 10% ethanol. Refiners are being forced to purchase exemptions - Renewable Identification Numbers - for ever increasing prices. RINs went up 10% just this week. The result is that gas prices are going up as refineries pay higher and higher prices for their RIN exemptions. That supply and demand stuff? Nah, the government is smarter than that. Will this get fixed? Remember, Obama's choice for his science advisor, Steven Chu, said in his first news conference "We need to find a way to get gas to $8 / gallon." But good news: Monsanto is making lots of money on genetically engineered corn seed.

Several new startups are working on agricultural robots. There's a working prototype now that manages a lettuce field, thinning the herd right after planting time then harvesting the lettuce several weeks later. Another company is working on grapes, and another on strawberries. Erik Nicholson, national vice president of the United Farm Workers of America, asks, "The fundamental question for consumers is who and, now, what do you want picking your food; a machine or a human, who with the proper training and support, can take significant steps to ensure a safer, higher quality product." The CDC estimates that each year roughly 48 million people Americans get sick, 128,000 are hospitalized, and 3,000 die of food borne diseases, most often caused by unsanitary bathroom habits of agricultural or restaurant workers. I'd rather have the machines, thanks. We're going to have some form of immigration reform in the next several months, which will most likely result in about 12 million new low-education low-skill citizens, many of whose jobs are about to be replaced by these robots. We're going to have the mother of all welfare states. And if we keep paying them to breed, we're going to wind up a 3rd world country in 75 years.

June retail sales numbers were disappointing. Is the US consumer getting tired? Or after several months of being snowed in all over the US, did everyone go on vacation the day school let out? If the US consumer is getting tired, that will spell serious trouble for many other countries that are counting on our people to help bail out their export industries.

Employment continues to chug along at a coal burning train rate. What will pick up employment? Last week we talked about business investment being very low, while companies hoard cash outside the US. Here's a chart.

My favorite company, those paramours of virtue at Goldman Sachs have been trading aluminum for some years now. There are laws about how long you can keep aluminum in a warehouse to prevent hoarding and price fixing - apparently Goldman has been skirting the laws by shuttling their aluminum between various different warehouses, all owned by Goldman. It's estimated that this has raised aluminum prices enough to cost US consumers $5 billion. Of course no one will go to jail. Bernanke says the Fed is considering new rules against trading houses owning metals. More Rules. New Improved Rules. We have millions of rules and ever increasing bad behavior. I wanna see some jail time for these crooks. I don't care how gorgeous their $6,000 suits are, they're just well-dressed sleaze.

House prices seem to have bottomed out, sales are increasing, prices are starting to increase a bit. Will it continue, or will rising interest rates choke off the recovery? Bernanke says rates must stay low for an extended period, in contect that would seem to mean until 2015. Yellen is a bigger dove than Bernanke. I expect rates to stay low, and hoses to continue to sell.

Detroit filed for bankruptcy with debts perhaps as high as $20 billion. Now the fight starts: are they in fact eligible for bankruptcy? Expect this fight to drag on for years. Detroit, once America's second city in terms of average income, has lost over 60% of their peak population, dropping from 1.8 million in the 50s to about 700,000 today. Nearly 80,000 houses and buildings in Detroit have been abandoned. 83% of Detroit's population today is black; Detroit is our most violent city and has an unemployment rate that's double the US average. Detroit has pension obligations that they can never meet with two retirees for each taxpayer, and has at least half again more city workers than they can afford. On Friday a state judge found the bankruptcy illegal under Michigan law and ordered the bankruptcy action dissolved and the Michigan Governor to step in and rescue Detroit; however bankruptcy is handled by federal law and federal courts, and if she pushes her decision she may be found in contempt by the federal bankruptcy judge. You can buy spectacular 5,000 square foot homes there on beautiful streets for $130,000 or so, but then you have to live in Detroit and often pay some outrageous property taxes, as high as 5%. Also there's a pretty decent chance your beautiful new home has been stripped of all metal, sold off for $50 or so for scrap; you'll pay $5000+ to get your home re-plumbed and rewired. Due to how rich Detroit was 60 years ago it's a remarkably sprawling city for the east, probably four or more times as much area as other comparable cities. Being the motor city with a huge budget problem you can forget about public transport. Violent, out of money, poor climate, awful schools, poor business environment - I can't imagine who would want to live there or how this city might be revived. On the other hand, you get to live in a big house in a large city with good museums, an NFL team, a hockey team, a baseball team and a good university. Just be sure to bring your job with you. And your snow blower.

Is Detroit a special case or just the next domino? Santa Fe, New Mexico has pension liabilities that are six times their operating revenue; Chicago comes in a 5.4. The Detroit bankruptcy will be watched carefully by many city administrators and union officials. Some will choose to bargain, even though most state laws say pension benefits may not be touched; some will dig in and their cities will also wind up in bankruptcy.

Medicine: A five year study of Scottish men showed that prescribing cholesterol lowering statins to healthy men lowered their number of heart attacks by 30% and their hospitalization costs for heart disease by 20%. Statins have their own risks, including diabetes, memory loss and muscle weakness, but none of the men were hospitalized for any of these problems. Statins are available in the US for as little as $12 per month. We can expect in the near future that it will be common for men over 45 and women over 50 to be prescribed these drugs.

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