Markets continued down in a historic trend; this is one of the ten worst declines ever. It's far from over, folks. There will be a couple times in the coming months when the markets go up for a week or two; we call these "bear traps." US debt has been downgraded by S&P, our budget and budgetary process are both clearly out of control, and the PIIGS look like they're about to go boom. Empty words and minor gestures from various politicians will not change these facts.
Standard & Poors (read: David Beers, JotY) downgraded US debt from AAA to AA+. Fitch and Moody's, the other two worthless ratings agencies, have not changed their US rating. There are now four US companies with AAA ratings, higher than the US government: Microsoft, Exxon, Johnson & Johnson and Automatic Data Processing. Also the UK and France remain AAA, which personally I think in simply hilarious: these two countries in particular are quite close to serious banking trouble.
The S&P downgrade will have little effect on treasury interest rates or government policy. In fact, the single biggest loser in this event is obviously Obama, who will have to field campaign allegations that his budgets resulted in the first US downgrade since 1917. Although I personally don't like Obama's policies very much, I even more dislike unelected individuals like David Beers entering the political scene with this big of a splash. Here's what a few people had to say about the downgrade:
Unemployment in this country is barely budging off the bottom. We have about 17 million unemployed. Why don't we get them jobs? In the Great Depression, dust bowl conditions plus automated reapers and pickers meant millions of farm workers, especially in the south, were laid off. They were never rehired on the farms, of course. They did eventually find jobs working on the new manufacturing production lines of the north. In the Great Recession, millions of workers have been laid off from manufacturing, as computers, robots, and the internet replace production line workers and inventory / purchasing workers. Millions more have been laid off from construction as it's discovered that we actually have too many houses and commercial buildings in this country. These people will not be rehired in manufacturing or construction, any more than okies returned to Oklahoma to farm. The question you have to ask is what industry will be the next employer of millions of substantially unskilled workers? When I ask myself that question, the answer I get is 'no one in the US.' I think most of these people are permanently unemployed. Notice in the graph below there are two clear difference with this recession: it's far deeper and wider than previous ones; and previously the jobs came back about as fast as they went away, this time they're coming back far more slowly. Now, imagine what this graph will look like a year from now if there's a new recession starting sometime on the next few months.
According to the British Centre for Economics and Business Research, Italy is likely to default, but Spain might just avoid it. Germany's Angela Merkel and France's Nicolas Sarkozy announced an emergency conference call on Friday. I'm glad the leaders of Europe are obviously taking quick and decisive action, Friday in the form of an emergency conference call. Maybe this coming week they'll actually meet, shake hands and pose for cameras. Germany is staunchly against a bailout of Italy. Since the bulk of Italian bonds are held by French banks ($500B) not German banks ($190B), Germans think the French should bail out Italy. Like the US, the interest rates on UK, French and German bonds are dropping as people flee to safety. When these bonds rates start to go up, it's time to get religion.
How are those PIIGS doing? Below I've put together some graph of their interest rates. As a free bonus I've included Belguim. Belgium is split in half, Flanders in the north (think Germans / Dutch), Walloon in the south (think French). The northerners in Flanders want to have an economy like Germany, where people work hard and save; the southerners want an economy like France where people work 32 hour weeks, get 8 weeks paid vacation, and drink a lot of wine. The result of this is that the last election was hung, and Belgium has not had a government for 14 months. Belgium is not the center of stability in Europe. Greek bonds have been over 6% for over a year. Last October Greece was joined by Ireland and Portugal in the over-6%-club. In the last few weeks Spain and Italy have also joined. Belgium doesn't look all that far behind, and personally I'm pretty worried about France and the UK.
What will happen when the PIIGS default? That's still several months off, in my estimation - although things have been developing far faster than I had imagined. When a country defaults, there is a run on the banks. Therefore there must be a plan in place to save the banks, and then default must be announced quickly with no warning. When Greece defaults, there will naturally be a run on the banks of Ireland, Italy, Portugal, Spain; and perhaps France and the UK. If you ran the governments in these other countries, you would be thinking that if one defaults, all should default at the same moment; the laggards will suffer a likely collapse of their banking system. I'm expecting that sometime in the coming months most of the PIIGS default and perhaps exit the Euro, all at the same time, likely some Friday evening. Monday morning their banks will re-open and start issuing Drachmas and Lire and Pesos and Pounds to customers instead of Euros. Trust me on this, you'll know when it happens, but probably not before.
For a couple years now I've been saying that Fed attempts to stimulate the economy would fail, as we are deep in a liquidity trap. A liquidity trap is where there is no one to whom the banks are willing to loan, so if you give them more money they just sit on it. Here's the strongest evidence yet for my statement: The Bank of New York Mellon Corp. announced last night that customers that have deposited more than $50 million will be charged 0.13%. They don't want the money, they already have more than enough deposits and they cannot find a way to loan more out and make money. You walk in with a deposit of $50,000,000 and they ask you for a $65,000 deposit fee. Of course your account pays no interest. Now you have no choice, you have to buy treasuries. This is one reason the S&P downgrade will not raise treasury rates.
China is also facing massive bond problems, with as much as $1.7 trillion of debt wracked up by local governments to build arenas, shopping malls, airports, even entire cities that no one uses. Standard and Poors estimates that 30% of this debt will never be repaid. Yin Zhongqing, a Chinese Communist Party official, predicted in early January that 70% will go bad. Defaults would likely lead to the third Chinese banking bailout in 20 years. "To avoid a bank default, we believe the authorities need to take decisive action to restructure local debt," Qu Hongbin, chief China economist at HSBC Holdings wrote in a report. "We see the issuance of municipal bonds as the best option." That is, issue new bonds to pay off the old bonds. The entire Chinese banking system will likely have to be recapitalized to the tune of over $1.5 trillion. So much for China's foreign reserves.
My view of China is very different from most other peoples'. Common thought is that this is the century of China, that their economy will be larger than the US and Europe put together in 40 years, that soon we'll all need to speak Mandarin. I don't believe it.
I think China is headed for some seriously rough times: crippling inflation and unemployment, food and water shortages, civil unrest, armed conflict with neighbors, growing retired population, shrinking workforce. I just can't see this as the recipe to brew up the world's next economic super power.
As I've said, without question mine is a minority opinion. Most think China will be the next Japan, except 10 times larger - 1.2 billion people instead of 120 million.