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Mark's Market Blog

8-26-12: Vacations almost over.

By Mark Lawrence

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This week we got a small correction in the markets, again on thin volume. Very unconvincing in either direction. I expect the markets to continue to drift around sideways for another week or two, until vacationing politicians come back and the realities of September come into focus: a potential announcement by the Fed of more free money in the form of QE3; the republican national convention, which could perhaps generate enough of a bounce for Romney to put him near or in the electoral lead; elections in the Netherlands; EU reports about Greece and whether they should get another slice of money; the German high court ruling on the constitutionality of the proposed European bailout mechanism. We live in interesting times.

S&P 500 February 25 2012 to August 17 2012

Rumors continue to fly in Europe about Super Mario using the ECB to stop the crisis dead in its tracks. The Euro is going up in value, Spanish and Italian stock markets are recovering, optimism is growing everywhere. Will there be massive free money without spending concessions? I see this as being like when mom says "Everyone clean your rooms and we'll go out for ice cream," and the kids hear "blah, blah, blah, Ice Cream!" Draghi clearly, if rather quietly, mentioned that if certain commitments were made on spending and budget authority, then he would be able to peg interest rates. The devil is in the "blah, blah, blah." Excitement is growing about this program; the thought is the ECB would turn into the Fed, stimulate Europe with a couple trillion dollars, and growth would resume. There's three huge holes in this theory, IMHO: 1) Germany, the Netherlands, Finland, Austria and a few other countries are mortified at the thought of inflation and this is completely unacceptable to them; 2) There's actually little to no evidence that the Fed's actions in this country have helped anyone but Wall Street and the banks; and 3) Europe does not have a liquidity problem, they have a solvency problem. They can't pay the interest on the debts they have now and there's no credible path for most of their countries to return to balanced budgets. If the ECB were to adopt such a program Europe and the world stock markets would get a huge boost for a time, but this program does not address the central issues of Europe: no jobs, excessive growing debt due to unfunded social programs, uncompetitive economies that import rather than export.

China's data continues to deteriorate. Export growth is down, banking problems are up. Inventories are up and sales declining in high- end Chinese jewelry stores. Iron ore futures are at a two year low and dropping fast, 10% this last week. China is the world's #1 producer of steel, but apparently steel production is slowing rapidly. Japanese exports to China are down by over 10%. Chinese restaurants are closing at a reported rate of 15% per month - six more months at this rate and only KFC will be left. In Beijing even the McDonalds are offering discounts. Chinese citizens in the top 1% by wealth continue to leave China, especially for commonwealth nations like Canada and Australia. When rich Chinese leave they take their money with them which puts further strain on the Chinese banking system. Unfortunately this is how you have to diagnose China - by looking at iron and copper futures, by looking at electricity consumption, as perhaps more than most other countries China lives on statistical lies. I've expressed in the past my reluctance to call a Chinese recession because in a command economy such things can be put off for a long time, but it looks more and more like it's here now.

I've noted in the past that not only is China using infrastructure projects to employ millions, but their projects are highly suspect: malls where no one shops, airports where no one lands, roads that go nowhere, cities where no one lives. And I've claimed the construction is suspect, it's very unclear how long all this concrete will last. Here's a pretty self-explanatory picture of a new Chinese bridge:

The US has a national debt of about $11T, and also owes about $4T to social security, so our nation debt is almost exactly 100% of GDP. As scary as this is, Japan's national debt is 200% of GDP. There is one difference: about a quarter of our national debt is held by foreign countries; Japan owns almost all their own debt internally. In the past ten years many promising Wall Street careers have been broken when people bet heavily that Japan had hit the limit and their interest rates would start to rise now; in fact Japan continues to enjoy some of the lowest rates in the world. But Japan is now running a trade deficit - eventually they will have to fund that by exporting debt. This could be the first tiny crack in Japan's fiscal dam.

The Greek economy is now more or less turned off. Stores are closed all over Greece, and those that are open have few goods on their shelves. The Greek government has started trying to enforce tax laws which are widely disregarded in Greece. For example they're using Google Earth to identify swimming pools, then go to those houses to collect property tax. Homeowners are covering their swimming pools with military-style camouflage nets to hide them. Businesses in tourist areas frequently don't give receipts to foreigners, meaning the business is not declaring the sale and pocketing the 17% VAT tax. German newspapers report this and say, "If the Greeks are unwilling to pay for their government services, why should we?" It's apparent that many in Greece believe the government owes them services, electricity, healthcare, retirement, but without anyone having to pay taxes to support this. To fix Greece will require a change in culture along with huge economic changes. I expect it will take at least generation.

Germans are now talking about Greece "temporarily" exiting the Euro. There's widespread agreement that Greece must default, and also it would be good for Greece to devalue. It's impossible for them to devalue while they're in the Euro, but if they were to leave at, say, 1 drachma / Euro, and re-enter a couple years later at 2 drachmas / Euro, that would go a long way towards restoring Greek competitiveness. Of course it also means savings and incomes in Greece would be cut in half too. Greeks are no dummies, you have to believe a lot of those savings are already converted into foreign accounts in Swiss francs or Canadian or Singapore dollars or gold. Greece will run out of money some time in October, so that's one window where this could happen. Predictably Obama already has people in Europe pressuring to hold everything together until after the election. Can this ever happen in the US? Yah, we do it all the time, but instead of revaluing quickly we draw it out over a decade and call it inflation.

Automobiles - so 1900s. Ford expects to lose $1 billion in Europe this year; GM has lost $14 billion in Europe since 2000. Europe is estimated to have 30% overcapacity to build cars; meanwhile new car registrations are down 20% in the last five years. The younger generation is not driving - they prefer to connect over their iPhones rather than in person at the burger joint. China is the only country experiencing growth in auto ownership, and I don't expect that to last. However, national airlines and car brands seem to be a point of national pride, and governments just can't let the industry go. European car makers have already shed 800,000 jobs this century and look to shed another 500,000. We're not immune to this, remember we've spent $25 billion in the last four years rescuing GM and Chrysler. As oil prices continue to stay high or increase, car sales will continue to decline. Governments tell us we should use less imported oil and produce less carbon, you would think they would be happy about the decline of the auto industry. India, with a fifth of the world's population and growing fast, will likely never have a car culture: there will never be an Indian James Dean.

Obamagration: For $465, a background check and some paperwork, you can get a work permit in this country now. California has announced that illegals with such a permit will also be allowed to get driver's licenses. Also the California legislature has passed a resolution (not a law) that illegals with law degrees who pass the bar may practice law. The word "illegal" may soon be non-PC.

The US drought continues, and continues to worsen in the plains states of Oklahoma, Kansas, Nebraska, Arkansas, Missouri, Iowa, Illinois, and Indiana. Grain prices, especially corn, continue to go up. Georgia is also in serious trouble, and on present trends the west's Green River might be the Brown River this year.

Biolite makes a stove called the "HomeStove" which they supply to third world countries. The stove uses 50% less wood and produces 95% less smoke than a normal stove by generating a small amount of electricity to run a fan that keeps the fuel burning optimally. You can also plug in your phone to a USB port for charging. The HomeStove is only available in 3rd world countries, but we can get a sexier version - the CampStove. $130, boils a quart of water in under 5 minutes, charges your kindle or phone or LED flashlight, weighs 2 pounds, burns twigs, pine cones, whatever you got, and stores in less space than a 2- liter bottle of Coke. And "proceeds support the HomeStove." Campers and survivalists should look at this.

What's the difference between Romney and Obama? Coming soon to a government near you is the Fiscal Cliff - due to the deficit reduction agreement made a couple years ago, on January 1st the Bush tax cuts expire and automatic cuts are made to many government programs. These tax increases and program cuts will put us on a solid path to a nearly balanced budget, but they will almost certainly also cause a recession in 2013. CBO projects a ½% contraction in GDP and an increase in unemployment of about 1%. In my view, it takes a recession to make major economic changes, and I'm very much in favor of getting the deficit under control. Romney has already announced that if he's elected he will quickly negotiate continuing the Bush tax cuts and putting off the government cuts, thus delaying the recession and continuing with the deficits. Obama, on the other hand, is likely to face a congress made up of republicans who are in little mood to bargain with him, so under Obama we're more likely to get the recession and the deficit reduction. How did the republicans mutate into the party of big spending and big deficits? In the Congressional Budget Office charts below, the blue bars are if we end the Bush tax cuts and cut government spending; the rest of the colors add these back in. As you can see, taking our medicine now has a huge impact on the deficit, reducing it from 5% - 6% of GDP to under 1%. In the second chart we see the federal debt, which shrinks by a third if we take our medicine and rises if we postpone. Lower class families borrow money at obscene interest rates from "check to cash" businesses, believing that soon things will be better. Things never are. Why is our government apparently no better at handling money than an under-employed high school dropout looking for a payday loan?

Battleground States

Battleground States

Media 1: HBO's excellent Too Big To Fail is available on DVD now, about $9 on EBay, about $15 at or Watch this and you'll never forgive Wall Street. Or Washington.

Media 2: Not Coming Soon to a Theater Near You: The Bubble - who caused it, who called it, what's next. A new movie being released in the next few weeks about our current economy and where it's likely headed. Starring many of my favorite sources including Jim Rogers, Peter Schiff, Marc Faber, Jim Grant, Ron Paul, and several presidents. I have no clue right now how we'll get to see this film.

Election watch 1: What is Romney's plan? Romney has to believe he has a chance. He's taking in more money than Obama, and spending it more slowly - Romney is preparing for a last minute ad blitz. On current trends Romney might outspend Obama in the last months 2 to 1. He cannot convert Obama's key constituencies to vote republican - blacks, Hispanics, Jews, gays, those on the far left will not vote for Romney under any conditions. He can hope to separate them from Obama, pointing out that Obama has done nothing for black education or unemployment, Obama has not been a friend of Israel in any sense of the word, and Obama has not furthered the agenda of the far left by instituting a single-payer health plan, raising taxes or getting us out of foreign wars. If Romney can discourage Obama's voters and keep them home while Ryan energizes the tea party and far right to get out and vote, he could hope to convert Florida, Colorado, Wisconsin, Iowa, Virginia and Ohio. Will it work? I see it as a long shot, but his only hope. Obama currently leads in these states by a thin 1% to 2%. Obama is clearly aware of his weakness and has worked hard to shore up his Hispanic support with Obamagration and his gay support by moving more towards supporting gay marriage. At the same time Obama is probing Romney for weakness with his voters and looking to do the same thing. I continue to consider this election Obama's to lose. He continues to have a solid lead, and it would be deeply startling for a master orator and campaigner to lose in the face of such an advantage.

Battleground States

Election Watch 2: Obama, 2008: I am absolutely certain that generations from now, we will be able to look back and tell our children that this was the moment when we began to provide care for the sick and good jobs to the jobless; this was the moment when the rise of the oceans began to slow and our planet began to heal; this was the moment when we ended a war and secured our nation and restored our image as the last, best hope on earth. Fox News 2012: Has the country changed for the better in the last four years, changed for the worse, or has the country not changed much either way in the last four years? Forty-six percent answered it's changed for the worse. Twenty-nine percent said it changed for the better.

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