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Mark's Market Blog

9-30-11: Europe Is Saved! (or not)

By Mark Lawrence

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And, another week, another stock market direction. The markets jumped up on rumors that there's a Big Plan for Europe, and This Time It's Different, This Time It Will Work. Then it dropped on news that the plan was for a bunch of broke people to bail out more broke people. In the US we call this "debt consolidation," the mantra of the lower classes. I've drawn some helpful blue lines on the market chart below. Any decent engineer looks at this - an oscillation with an increasing frequency - and thinks, "This will not end well. . ." Some are predicting the markets will break out to the upside, and perhaps that's true. But how high can they go? S&P 1250 (+4%)? S&P 1300 (+10%)? Maybe I'm in need of glasses, but I just can't see any more upside here than that. And how low might they sink if they break downwards? 1100(-10%)? 1000 (-20%)? Suppose Greece defaults and there's a run on European banks. 850 (-35%)? All those numbers seem completely realistic to me. The downside risk far outweighs any upside potential in the markets right now, in my semi- humble opinion. And if there's a run on the banks, don't think your gold will suddenly be worth $2500 / ounce. When there's a run on the banks, people start selling everything they can get their hands on. Including daughters in many parts of the world. Maybe I'll pick up a couple for my boys.

S&P 500 March 28 2011 to September 30, 2011

Inflation is up in Europe to 3%, and there's broad consensus that a recession is coming soon for the US and Europe. When I was a kid it was well known in economics that you could not have inflation, recession, and unemployment all at the same time. Then came the '70s. Now we're getting inflation, deflation, unemployment, recession, and illegal immigration all at the same time.

Ok, the Europeans have a new plan to rescue the Euro, save all the banks, and keep Greece, Ireland and Portugal happy and in the Euro family. I'm going to try to explain this, but it's not going to go well. Frankly, my explanation is going to read a bit like the script to "Who's on first?" ok, so there's a bunch of countries in Europe that are broke, plus France which is not quite broke yet and Germany which is doing ok right now. That's the problem, something like 15 broke or nearly broke countries who are out of money. These guys will collectively form the European Investment Bank (EIB), which will issue bonds backed by the 17 (broke) countries and sell them to the broke banks. Totally broke countries like Greece and Portugal will also be allowed to trade their countries bonds for these new worthless bonds, then sell them to banks to raise money. The banks will then be allowed to deposit these (nearly worthless) bonds with the European Central Bank (ECB) and borrow more money against the worthless bonds. This will then recapitalize the banks - borrowing money they can't pay back based on bonds issued by broke countries. Sorta like a dog chasing its own tail. Got that?

Sorry, I'm not done. The countries are seemingly only interested in taking on about $200 billion in new debt, but estimates are that it will take about $2 trillion to solve this on-going European banking crisis. So their solution is that the broke countries will fund the EIB with $200 billion, but allow them to issue the full $2 trillion in bonds. The nearly broke countries will issue bonds with 10 to 1 leverage, and these bonds will be used to bail out the nearly broke banks and the totally broke countries. If the new bonds go bad, apparently the banks will only get to collect $10 on a $100 bond from the EIB. Someone else, somewhere else will be on the hook for the other $90. Got that?

And this is why the stock markets went up in the beginning of the week - on rumors of this great new plan. I've a friend, Kurt, who's been telling me for some time that bond traders can eat stock traders for lunch and have room for desert. I'm just now understanding that. The stock markets are drinking this kool-aid and begging for more. The bond traders are continuing to dump all their suspect-to-worthless bonds and move their money somewhere safe; they're not even a little bit fooled by this nonsense. Here's the difference: stock market guys ask themselves, "What will this stock be worth in a couple months?" This is a very tricky question. Bond traders ask themselves, "Who's going to pay me back my money?" This is a very simple question.

Thinking of hiring someone? Obama has a new plan. If you advertise a position, and interview a currently unemployed person, but hire someone else, then Obama is going to make it legal for the unemployed person to sue you for discrimination. I don't know about you, but I suddenly feel intensely motivated to advertise about three jobs right now and get myself into eight or twelve federal discrimination lawsuits. Obama is definitely going to go down in history as the Jobs president, but I don't mean that in a good way.

Gary Schilling sees deflation on the horizon: "In my new book, I identify seven different types of deflation. Now five of those are already in place -- we're having financial asset deflation, tangible asset deflation, commodities are coming down, wages are coming down. The one that hasn't kicked in yet is goods and services deflation. The point is that the whole world is really marking down assets. It's marking down the whole spectrum. I don't think goods and services are going to hold up in terms of inflation. I think that we will move to deflation fairly soon." Most economists will tell you that inflation is like a bad cold; deflation is like a heart attack.

No Child Gets Left Behind (or gets ahead either): For the last 40 years about one million kids have taken the SAT every year; the number taking the SAT has hardly varied at all. But the scores have. In 1972, 2817 got verbal scores of 750-800, the top score. Now? 1483, half as many. In 1972, 71.084 got scores between 200 and 250, the lowest possible score. Now? 136,841, nearly twice as many. The smart are getting dumber, and the dumb are getting dumber. Our schools are failing badly, and, in my experience and opinion they're most badly failing boys and the smartest. In the 60's when I was a student, we were terrified by Sputnik and the push was on to identify the smartest kids and prepare them for the space race. Today it seems the emphasis is on forcing everyone to sit still and perform at the 40% level, or as they say in Japan, "The nail that sticks up gets hammered down." On the plus side, my own boys are doing spectacularly well given the almost total lack of competition. Richard, my oldest, is being actively recruited by graduate schools before he's made a single application. He's that increasingly rare artifact, an American male getting good grades and good test scores in math and science. More and more, our colleges are filled up with women studying "early childhood education," "family counseling" or nursing, and our high schools are filled up with inmates, teenagers just doing their time. Our graduate schools are filling up with Asian kids, the last group on the planet getting educated. Science and engineering are almost dead, not because there are no problems left to solve, but because we're choking the educational life out of our youth. How do we fix it? We have to abandon the idea that all kids are created educationally equal, we have to identify our best and brightest and get out of their way. Else we will become a culture that lives by the saying, "Last year I couldn't even spell Injineer, now I are one."

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