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Mark's Market Blog

8-21-10: India: Emerging power or train wreck?

By Mark Lawrence

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This week the market bumped up a bit, then dropped back down to finish roughly even on the week. News about the future economy and jobs was poor. Volume continues to be low, as more and more money is pulled out of the stock market and put into bonds. Large investors are preparing for the end of days.

S&P 500 March 1 2010 to August 20 2010

Unemployment claims rose this week to 500k, the first time they've been that high in several months. There are worries that the recovery was all fake, all based on stimulus dollars, and now that they've run out the economy will sputter to a halt. Goldman Sachs, the evil empire, has released their estimation of the effects of the federal and state budgets on the economy. Their claim is that stimulus peaked Q1 2010 at about 2.5% of GDP, and the outlook for next year is that the combination of federal and state budget cuts and the expiration of the Bush tax cuts will shrink GDP by almost 2%, choking off any realistic hope of a continued recovery.

Disputed India / China Borders.

Saturday apparently Iran inserted fuel rods into their new Nuclear reactor. This makes it much harder to bomb - before the rods are inserted it's just a big pile of concrete, now there will be radioactive fallout. Iran test fired a new surface-to-air missile on Thursday, apparently letting us know that they're ready to take on the air force.

Australia just had elections, and was left without a government. No doubt one will emerge after several days of haggling, but no party got anything like a majority. Like us the Oz voters are choosing to deadlock their government in a time of dire need.

Fannie Mae and Freddie Mac continue to bleed real blood. Their losses in the last two years are $148B, which more than wipes out all the profits they ever made. Their losses are projected to rise in the next couple of years to a total of perhaps $500B. This $500B, about $4000 per taxpayer, should be thought of as a subsidy to try an experiment: if you help people who can't afford a house to buy one, then they will miraculously transform into people who can afford a house. The idea was to lift minorities into the economic mainstream by getting them each their own house. The reality is that most of those people and the taxpayers all got seriously burned. Meanwhile Frank Raines, the CEO of Fannie from 1998 to 2009, was paid something a bit north of $150M total in 12 years to manage this train wreck. He's been accused of manipulating the earnings per share with illegal accounting tricks to pad his bonuses and stock options, exactly the same thing Ken Lay did with Enron. No one is looking at this, these two companies were not a part of the recently passed financial reform bill and won't be looked at until after the 2012 elections. Senator Barney Frank recently said that Fannie Mae and Freddie Mac "should be abolished. Public policy has been too much to try to push people into home ownership." Of course this entirely neglects the inconvenient fact that Franks helped invent this public policy.

How is Greece doing? When last we visited them, they were being punished because German and French banks lent them too much money at too low a rate. In the shipbuilding city of Perama unemployment hovers between 60 and 70 percent. In Athens a quarter of the shops on Stadiou Street are for rent. 17% of all shops in Athens have filed for bankruptcy. Unemployment is 12% and expected to reach perhaps 20% in 2011. Panayiotis Peretridis, says "The only thing that interests me anymore is my daily wage. A loaf of bread is my political party. If you take away my family's bread, I'll take you down. The government needs to know that."

The FED has started buying 10 year bonds, driving prices up and interest rates down. China sold a bit of their US bond holdings, apparently to protest this drop in their interest income, perhaps to protect themselves from a projected drop in bond prices as interest rates go up again some day. Some fear that without China as a buyer, prices will fall and higher interest payments will cripple the US government. In the long run, imports = exports. Since China exports a lot to us, they have a choice: they can import a lot from us, thereby losing the jobs that make those goods; they can do nothing, which will cause their currency to rise and exports to fall, costing them jobs; or they can buy more bonds, keeping their currency low, exports flowing, and jobs. For China it boils down to buy foreign bonds or face a revolution fueled by unemployment. For all their saber rattling, China needs us more than we need them.

Oil spiked up to over $130 / barrel in 2008 - we all remember the $4 / gallon gasoline. What happened to production? At nearly double their typical prices, did Venezuela and friends turn up production and rake in the money? When the price collapsed to $40 a few months later, did Saudi Arabia cut production to support prices? Interestingly, neither the price run-up nor the subsequent collapse had much affect at all on production. It's widely believed that sometime in the next few years, perhaps already, world oil production will hit a peak and then decline from there. Declining production and raising demand from India, China and friends will mean oil prices only go up. This lack of response in oil production to a nearly factor of four change in prices is evidence that we're near "peak oil."

Oil Production and Price, 2001 to 2010

The LA Times just broke a story that the city of Vernon, which borders on the infamous city of Bell and has about 100 residents, has paid several of their top city employees over $1M per year. Vernon is an industrial town that contains businesses providing over 50,000 jobs. Some of those jobs apparently pay pretty well. Um, just not so much the private business jobs. Their city manager made something like $700k per year, then billed the city an additional $650k or so for legal work at $535/hour. Apparently he's an extraordinarily good lawyer.

State finances are in pretty bad shape, and they're going to stay in pretty bad shape for at least a couple more years. 48 of the states are projecting deficits in 2011, and every state with a forecast is projecting yet more deficits for 2012. Persistent unemployment means income and tax receipts are down and demand for social assistance programs is up. State emergency funds are exhausted. Housing foreclosures mean property values and therefore property taxes continue to fall. Continued state budget deficits mean state employees will continue to be laid off, reducing tax receipts even more and increasing assistance costs even more. In this environment, more and more state employees are choosing to retire rather than face an increasingly stressful workplace, putting ever growing pressure on under funded state retirement programs. Declining stock and house prices and the expiration of the Bush tax cuts mean the wealthy will continue to spend less. Banks continue to prefer to put their money into risk-free treasury notes rather than make loans; consumers prefer to pay down debt rather than borrow more money. In this environment a businessman would have to be on serious drugs to start hiring a lot of people. Basically the states are in a feedback loop where more bad news generates yet more bad news, with no end currently in sight.

The House just passed a supplemental appropriations bill with an amendment, the "Public Safety Employer-Employee Cooperation Act." The act would require all states to allow police, firefighters and emergency medical personnel to collectively bargain with taxpayers. If they don't create their own system, the federal government will impose one on them. Unions once fought for higher wages. Now they fight for higher taxes. In Oregon they recently outspent businesses 3-to-2 to pass two ballot initiatives raising income and business taxes. About a dozen states have decided not to play this game and do not collectively bargain with government workers. Virginia and North Carolina outlaw it altogether. Now Congress will force these states to collectively bargain no matter what the cost to taxpayers. There are people saying that after the election, congressional lame-duck democrats, having already lost power, will pass a lot of unpopular bills to further their agenda. Perhaps that's starting a couple months early. If the senate also passes this, it will be so destructive to state finances that it will, in my estimation, cause a complete dependency of the states on federal funding and spell the effective end of federalism. Last week I asked, "Doesn't anyone care about the 10th amendment?" I guess we're getting the answer.

India and China are on a collision course, and it's India that will lose. India has a serious population problem - half of their 1.2 billion people are under 25. In the 60's India literally dropped IUDs out of helicopters; untrained people caused thousands of punctured uteruses, with the result that you can't pay Indians today to have an IUD. In the 70s the government tried forced vasectomies with a similar result. China, with their powerful central government, simply legislated a stop to population growth a couple decades ago with their country-wide one child policy. India's government is far more dispersed and dysfunctional, no such legislation is possible in that culture.

Disputed India / China Borders.

Meanwhile 80% of Indians live with water substantially below EPA health limits, and half their population lives with amoebic dysentery. One of India's largest rivers, the Brahmaputra, starts with watershed areas in Tibet, part of China; there are concerns among Indians that the water will soon be diverted to Chinese farmers, leaving north east India and Bangladesh with a serious water shortage. This is exactly like when the US diverted the Colorado River to cities and farms in Arizona, Nevada and California, devastating northern Mexico. As the world population grows and we run out of fresh water, rain which falls in a country will stay in that country. China and India, in addition to competing for water resources, find themselves increasingly competing for oil which is becoming more expensive and scarce daily, at exactly the time when both countries need cheap oil to fuel their manufacturing and emerging middle classes.

China currently controls an area roughly the size of Switzerland which India considers historically a part of their Ladakh state; India controls an area several times larger which they call Arunachal Pradesh, which is claimed by China and annoyingly the place where the Dalai Lama may "choose" to reincarnate. The last time they had a border war, 1962, China pretty much kicked India's butt, which has not been forgotten. This year India has moved 60,000 additional troops to Arunachal Pradesh. However, should China divert the Brahmaputra river to Chinese farmers, the troops may well find themselves defending high desert.

India is a demographic train wreck. Much of their water comes from China; their population growth far exceeds their current water and food supplies; and their decentralized government is unable to act effectively. Although their economic growth today is very impressive, I believe we're looking at a country that in ten years will have half a billion people living without enough food and water. Competition with China for Himalayan water and oil will only intensify; prices for water, oil, food will only go up. Add in the 40 million unmarried young men that China may well have by then, and it's possible that both countries will find it in their interests to have an extended border altercation.

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