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Mark's Market Blog

7-22-11: US Default?

By Mark Lawrence

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Markets went up a whole bunch last week. If there is no good news out of Washington in the next few days, we can expect them to go down just as fast, perhaps faster and further. Maybe a lot further. If it starts to look like a default, S&P 1200 is not unrealistic. If we actually have a default, S&P 1000 or perhaps even lower is very possible.

S&P 500 February 1 2011 to July 22 2011

It's summer now, too many people are on vacation to make much news. Markets went up on news that Europe has a new broom and the PIIGS troubles were once again being swept under the rug. It's getting quite crowded under that rug. This is the sixth time in 18 months European leaders have announced a definitive solution to the Euro crisis. I'm expecting the rug to rip some time later this year.

The US economy is now almost completely split in two: people making over $50,000 per year, the top 20% or so of our earners, who are doing fine; and everyone else who is unemployed, unemployable, and living on food stamps. The people making over $50,000 tend to be better educated and more aware of what's happening in the world and the markets. Every time news about Europe or Washington gets spooky, my phone stops ringing and my sales dry up. As has been my experience for 26 years in business, all the other small businessmen I talk to are having pretty much the exact same experience - restaurant owners, car dealers, merchandise stores. Although the world economy is doing just fine today, we all keep looking up because we all feel like the sky might start falling at any instant.

McDonalds China just announced their 4th price increase in the part 12 months. This one varied between 25% and 30%. McDonalds is telling us that Chinese inflation is completely out of control.

China had a high-speed train derail on a straight portion of track. Very confusing. This calls into question the quality of all their big infrastructure projects. Since some 60% of their economy is dedicated to building roads, trains, shopping malls, airports, even entire cities, many of which no one uses, this makes us wonder if in five to ten years any of these structures will still be standing. It's hard to imagine you build throw-away cities and that makes you the world's second largest economy.

A Norwegian man set off a truck bomb in Oslo next to a government building, killing at least 7. He then traveled about 18 miles to a nearby island hosting the annual summer camp for the youth wing of Norway's ruling Labor party. Dressed as a policeman, he said the campers should be assembled so he could tell them about the bombing. When they assembled, he opened fire with automatic weapons, killing at least 85. Norwegian police have him in custody now; surprisingly, as it took them over 90 minutes to get to the island after the shooting started. He faces the possibility of being convicted of "terrorism," which carries a penalty of up to 21 years in jail - Norway's harshest sentence. He will be out, free, at age 53.

There were rumors of a grand compromise on the US budget and debt ceiling; however after markets closed on Friday it was announced that talks had broken down. Although we're told August 2 is the drop dead date, it's not entirely clear when the US would actually go into technical default. It could easily turn out the Treasury can manage to not default on our debt until very late in August, although this would almost certainly entail not sending granny her SS check. Several poorly thought out and nearly completely undocumented plans are on the table. Most of them promise to do big things, important things, soon, very soon. My read: the republicans want to most or less solve our debt / medicare / budget problems this week, once and for all; the democrats want to promise to get to it some other day, any other day. There's strong consensus that the deficit and debt should just go away; after that there seems to be near complete disagreement on pretty much everything. There is clearly a lack of unification of views even within the republican or democratic parties. It's very unobvious that there are 218 members of the house that absolutely don't want a default.

Reid in the Senate has a vague plan, but he cannot for sure deliver even the senate democrats for his plan. Boehner has a plan but cannot for sure deliver the house republicans for his. Obama just wants to be on TV. There is no consensus in Washington that a default would be the end of life as we know it. Heck, truth be told, I'm not certain that a default is the worst outcome for my children - it might be good if the US were forced to balance our budget, quit being a reserve currency, and have to balance our trade. I suppose there are better ways to accomplish this than to start by trashing the world economy, but, hey: we're Americans. We love fireworks.

S&P, an organization for which I have absolutely no respect, has issued a warning that less than $4T in budget cuts will likely mean a drop in the US credit rating. Then they announced that they liked the Reid plan better than the Boehner plan. I consider this completely unwarranted and unacceptable politics on the part of an organization that rated sub-prime mortgages AAA. Who is this unelected actuary dweeb who would like to enter into the debt / budget / tax debate as a major player? David Beers, my personal nomination for Jerk of the Month.

What happens if we default? For so long as we are in default, no one knows what the dollar is worth or what the correct interest rate is for t-bills. This means, for example, you cannot calculate a LIBOR. Banks will completely stop lending to each other. In the worst case, your ATM card might stop working. Almost certainly the dollar will drop in value by 25% or more pretty much instantly. Remember 2008? Back then, everyone knew what the dollar and t-bills were worth, but no one knew what the banks were worth. This time no one will know about banks or dollars or t-bills. What can you do? If you have cash savings, you might consider converting your money to Canadian, Australian, or Singapore dollars, or perhaps gold. You might consider drawing out $2,500 or so in $20 bills, so you can eat for a week or three. If you have a bunch of cash and the default drags on for a few weeks, start calling people selling 2008 Corvettes and offering them $15,000 in hundred dollar bills. Or 8 ounces of gold. I caution you, it's very dangerous to short stocks, bonds, dollars.

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