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Mark's Market Blog

9-17-10: Trade war coming. Buckle up.

By Mark Lawrence

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Last week I predicted the markets would drop a bit early, and end up for the week. I didn't get my early drop. However, triple witching day did keep the markets up, on very low volume, for the week. This coming week I expect prices to drop, as we're at the top of our 5 month wide trading range (purple lines below.) Note that trading volume continues to trend down (green line below). This is far from a healthy market. Individual investors are completely spooked and want nothing to do with it; institutional investors are convinced that another leg down is inevitable, it's just a question of when. The way European banks and Asian property look, it's hard to see anything other than another leg down.

S&P 500 March 29 2010 to September 17 2010

There's a new game in town: with long term interest rates around 3%, major companies like Microsoft, HP, Cisco are issuing record amounts of bonds and using the money to buy back their stock. Why have shareholders when borrowing is so cheap? A couple more years like this and the stock markets won't have much left to trade. Wall Street's Masters of the Universe may soon find themselves the High Priests of a Low Industry.

For my entire life the Fed open market committee has presented a uniform front to the world, but it seems that's over. Just as the world is currently split between Europe, who is cutting budget deficits and the US, who is running deficits to stimulate the economy, the Fed is split between those who want to buy more bonds to lower interest rates and those who are afraid of lighting off runaway inflation. The public nature of this debate, as representatives of the regional Federal Reserve banks give conflicting speeches, is getting quite unnerving. In my opinion, parents and Reserve Bankers should argue behind closed doors.

One can use CDS rates to calculate the market's estimate of the probability of default. Based on this, the market thinks Greece will default on their bonds in two to four years, but not in 2011. Two years = 50% probability of default, four years = 75%. Greece's debt, including future pension pay outs, stands at 250,000 euros per person, about $375,000 per person. Greek college graduates ages 22 to 35 are packing up and leaving: 40% are actively seeking jobs outside of Greece, 70% say they want to leave. Greece is going to export their smart, educated youth.

Ireland's CDS rates are leaping up on rumors that they will shortly follow Greece with an IMF / Euro tarp bailout. Barclays bank estimates the total cost of bailing our Ireland's banks at 30% of GDP. About three-quarters of that cost will go to just one bank, the Anglo-Irish bank. To put this in perspective, TARP was $700B, about 5% of US GDP. 30% of US GDP would have had TARP at $4T. The Irish crisis, like the US crisis, is largely about over-built housing, which means they can expect crushing unemployment and falling house prices for the next several years. Irish ministers today denied that there are any talks with the IMF.

August core CPI: 0.0% inflation. September commodity prices to date: Wheat +11%. Oats +30%. Corn: +20%. Sugar +25%. Pork +40%. Coffee +10%. Cotton +12%. Copper +5%. Palladium +10%. Silver +10%. Platinum +7%. If we ever get run away inflation, it will start out just like this: with a quick big jump in commodity prices. Notice that food prices are continuing to go up. Who gets screwed by high food prices?

Countryper capita GDPFood, % total
household consumption
Romania $9,300 49.4%
Lebanon $6,978 34.0%
Bulgaria $6,546 49.5%
Azerbaijan $5,315 60.2%
Algeria $4,845 53.0%
Angola $4,714 46.1%
Dominican Republic $4,576 38.3%
Tunisia $3,903 36.0%
Ukraine $3,899 61.0%
China $3,267 39.8%
Morocco $2,769 63.0%
Sri Lanka $2,013 39.6%
Egypt $1,991 48.1%
Philippines $1,847 45.6%
Nigeria $1,370 73.0%
Sudan $1,353 52.9%
Vietnam $1,051 50.7%
India $1,017 49.5%
Pakistan $991 47.6%
Kenya $783 45.8%
Bangladesh $497 53.8%

One American in seven now lives in poverty. "Poverty" means less than $11,000 per year for a single person under 65. Per capita GDP for the entire world is $10,400, so the US poverty line is a bit better than the world average. $11,000 per year is more than the average income in 130 countries, and more than double the average income in 92 countries, according the CIA world fact book. Pretty much any citizen of any of the countries in the table above would just love to come to the US and live in poverty.

How is the US doing at selling debt (and jobs) to foreign countries during this debt-fueled unemployment crisis? Very well, thanks. Foreign owned US debt has nearly doubled in the last two years, recently passing $4T. Remember, every time we sell debt to foreign countries, we sell US jobs with it.

Foreign Holdings of US Treasuries, September 2010

Imports at the docks were up 25% in August, exports at the docks were down 3%. Looks like the trade deficit is growing again. When we import more goods than we export, then we export jobs and debt too. Unfortunately, after a full generation of running a trade deficit, it seems we've forgotten how to export. Germany and China, by contrast, don't seem to know how to import. Speaking for myself, I export perhaps 20% of my production. Shipping out of the US is incredibly expensive, delays are frequent and difficult to predict or resolve, tracking is nearly non-existent. The Internet, Google, EBay, and English being the new lingua franca gives US companies a huge advantage in foreign markets. If the government were serious about jobs staying home, they would give FedEx and UPS tax breaks for reforming export procedures, and they would subsidize the post office for export shipping and get a real tracking system installed there, like just pay FedEx to give the post office a copy of theirs. China and Germany export wholesale, a container ship at a time. They're helped in this by Walmart and US Volkswagen who import many billions of dollars worth of German and Chinese goods. We could crush them exporting retail, a 5 pound box at a time, if the government would help make shipping work. Their edge is cheap manufacturing labor. Our edge is superior marketing and rapid company and product formation. Containers play to their strength, small packages play to ours. However, exporting 5 pounds at a time, I pay nearly $50 at the post office, over $100 at FedEx or UPS. It's impossible to export small inexpensive goods at these rates. Hong Kong has somehow addressed this issue, they mail small packages to the US for a fraction of my cost. We've seen that jobs in this country are created by small startup companies. If the government wanted to get serious about jobs, here's a place where a stimulus would actually help.

A couple months ago China announced they would let their currency trade in a larger range. Since then the yuan has gone up by 1%, leading Treasury Sec Geithner to say "We are concerned, as are many of China's trading partners, that the pace of appreciation has been too slow and the extent of appreciation too limited." China is more and more being viewed as stealing profits and jobs from the US and Europe. In the current economic climate, where jobs are scarce, money is tight, and politicians need to be seen doing something, the prospects for a trade war are only increasing.

Ding Yifan, a senior member of China's Development Research Center warns China's $1.5T in US bonds would give them a huge advantage in any trade war. It seems that China's politburo believes this. They're nuts. If a trade war ignites and they start dumping bonds, US interest rates would rise in the short term, but the Fed can counter that by simply buying the bulk of the Chinese bonds. Meanwhile, if China starts exporting debt, jobs will follow the money and at the $1.5T level they would be looking at staggering job losses. Lenin famously said, "No country is ever more than three meals away from a revolution." History backs this view completely: it's always the exporters that lose a trade war. Meanwhile, on the US side, we just filed a complaint with the World Trade Organization, accusing China of dumping steel and having illegal import duties. A trade war would certainly hurt the US in the short term. But, as Sun Tsu said in The Art of War, they cut your skin, you cut their muscle. How would China do without exports? In the US, about 72% of our economy is from consumer spending. With no exports at all, we would still run a very large economy. In the last 25 years China's consumer spending has dropped from 56% of GDP to 36%. Without exports, half or more of their economy simply stops, half or more of their employment simply goes away. Their threat to dump US bonds reminds me of the joke of a husband who comes home early, finding his wife in bed with a neighbor. He leaps for his gun and holds it up to his head. Wife and neighbor start laughing. Husband says, "Yah, you laugh now, but you're next!"

California is now a record 79 days into operating without a budget. Teachers are not being paid. How will this be solved? Medicaid will be cut. Children's health benefits are likely to be cut. CalWORKS employment program for the poor is history. In-home care for the elderly is in trouble. State employees are looking at pay cuts, benefit cuts, pension cuts, layoffs. School class sizes will increase. Meanwhile, California politicians continue to demonize Arizona for trying to end illegal immigration in their state. I predict the Arizona solution will only become more and more popular in the next couple of years as more and more states wrestle with impossible deficits.

Obama is setting up a Bureau of Consumer Financial Protection. His choice to run it, Elizabeth Warren, is deeply disliked and mistrusted on Wall Street, and not at all popular in the senate where she would have to be confirmed. So, he's appointing her "interim director," which doesn't require confirmation. Personally, I've seen her in several interviews and I've been impressed. For example, while still a law professor at Harvard, Warren wrote, "It is impossible to buy a toaster that has a one-in-five chance of bursting into flames and burning down your house. But it is possible to refinance an existing home with a mortgage that has the same one-in-five chance of putting the family out on the street -- and the mortgage won't even carry a disclosure of that fact to the homeowner." Friday, upon taking over, Elizabeth warned banks, "The time for hiding tricks and traps in the fine print is over." I believe I'd vote for her - I'm a huge fan of disclosure, like the fat-protein-calories chart now on nearly every kind of food. When Obama has such large majorities in congress, I'm befuddled why he feels he has to go behind everyone's back. I'd feel better if he acted more like a President, sending her up to the senate with the message, "If you can't find something illegal in her background, then confirm my choice." Critics include David Hirschmann, senior vice president at the U.S. Chamber of Commerce, "By not allowing Warren’s nomination to be considered through the regular order of the full Senate confirmation process, the administration has circumvented one of the very few checks on a big new agency that already has been given an unprecedented concentration of regulatory powers. This maneuver is an affront to the pledge of transparency and consumer protection that’s purported to be the focus of this new agency," and Republican Sen. Bob Corker of Tennessee, a member of the Senate Banking Committee, "This particular position, one that was created just months ago, is unprecedented in the nature of its unfettered and unchecked authorities, which makes the confirmation process even more important to the interests of the American people."

How would you like to be strapped into a high chair while flying? Current airliner seats, which no one likes, allow about 34" leg room. By placing passengers in a non- reclining semi-standing upright position, the Skyrider seat allows for as little as 23" of leg room, letting airlines cram as many as 40% more people on a flight. You know how the air in jets is already nearly unbreathable? Imagine trying to get a canister of oxygen or a gas mask through TSA: "No, really, it's just so I'm not in a coma by the time we land." People trying them out at the recent Aircraft Interiors Expo in Long Beach, CA said "Don't take the center seat if you might have to use the bathroom." On the plus side, in her safety speech the Air Goddess can say, "Your flight attendants will be by shortly with your bowl of mashed carrots, sippy cup of juice, and a cookie. If we don't hear any more whining. Otherwise, it's going to be nap time."

Pennsylvania will provide its capital city Harrisburg with a $3.3 million advance, so that the city can meet an upcoming bond payment. The idea behind this mini-bailout is that should one city default, then the borrowing costs could go up for others.

BofA is looking to sell $100B of "non-core assets." One can't help but wonder why they think they need the capital. Perhaps their balance book is holding more foreclosed and delinquent loans than the rest of us know.

Home repossessions were up 25% in August year on year, hitting a new record even for the past two years. Less than a third of foreclosed houses are on the market, banks continue to sit on a huge inventory. My neighbor stopped paying her mortgage 5 months ago and her house has no foreclosure signs on it, no one has moved. It would appear we're entering the 2nd stage of foreclosures. If you think your house value has bottomed out, well, good luck with that. Houses changed during my adult life from something you buy for a reason, like to raise a family, to a guaranteed investment, and now back to something you buy for a reason. How's housing looking as an investment lately? Decent in South Dakota and Maine, lousy pretty much everywhere else.

Foreign Holdings of US Treasuries, September 2010

The NFIB report on small business is out; members (including your intrepid writer) report poor sales and continued recession. No one has plans to hire. The head of the NFIB said in an interview that tax cuts and loan programs are pointless because the sales aren't there, and it's sales that drive expansion. My own sales are starting to show contraction, so in a defensive maneuver I'm developing new product lines. This would be defense in the sense of "offense is the best defense." I don't know what I'll be selling in three years, all I know is I'll be making money doing something.

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