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Mark's Market Blog

7-16-11: Sovereign Debt

By Mark Lawrence

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European debt and the US debt limit dominated the news this week, as republicans and democrats staked out seemingly intractable positions. We're told on August 2nd the world will end if there's no deal. Wall street waits impatiently for the almost inevitable last-minute deal that no one likes, or alternatively apocalypse.

S&P 500 January 10 2011 to July 8 2011

Europe seems a bit quiet this week, however the scares in Europe are getting bigger and coming closer together. Any engineer sees this instantly as a out of control oscillation. Ireland, Portugal and Greece now all have interest rates on their bonds over 10%, which means they are effectively locked out of the private bond market, they have to turn to EU and government agencies for help. Spain is at 6%, and Italy just behind at 5.5%. These are the threshold numbers: when Ireland, Portugal and Greece each hit these numbers, shortly afterwards their interest rates took off straight up. Talk in Europe that bond holders must be prepared to help bail out the PIIGS means bondholders are dumping their PIIGS bonds and not buying any more, driving up interest rates. We're very close to the end game for Europe, and I don't see a solution. That leaves us with two questions, what will happen and when. The what seems clear enough, there will be some kind of default, followed with decent likelihood by one or more countries leaving the Euro. If this happens there will be no visible buildup and no warning - those just allow time to have a run on the banks. It will come as a huge "surprise," at least the first time. That means there's good reason for Ireland and Portugal to leave the Euro at the same time Greece does. The when - 3 months ago I would have said sometime in 2012, but now I don't see how Europe can last out the year. Although the Euro is holding value around $1.40, more and more people are shorting the Euro in anticipation of the wild ride to come.

Italian and Spanish Bond Rates, August 2010 to July 2011

Standard and Poors, the people who grossly mis-rated the risk on the sub-prime mortgage bonds and were highly complicit in bringing us the Crash of 2008, have continued to downgrade European debt and are now threatening to downgrade US debt unless $4T in budget cuts are found and agreed to in the next two weeks. One Wall Street analyst said, "Hello, if you think US bonds might be junk in 3 weeks, then how can they be AAA today?" Europe fired a couple shots across S&Ps bow, essentially saying if they couldn't play nice they would have to leave the playground. Personally, I think they're playing a very high-stakes game and their days are numbered. I won't miss them.

The Arab countries continue to look ungovernable. Libya continues to have an indecisive civil war, and unrest in Syria and Yemen continue unabated. We don't hear about it because no one cares. When this spreads to Iraq, Iran, Saudi Arabia, the real oil exporters, then we'll hear. Every day.

Estimates are that Iran will have a nuclear bomb this year. The president of Iran is a member of the "Mahdi Army," a group of muslims that believes the 12th Imam will emerge from a cave and lead the muslim people to world domination. First there has to be an Armageddon style war going on. So many in Iran, including the president, believe dropping a bomb in Israel will start a war that will lead to nearly the entire world becoming muslim. It's no coincidence that US forces in Iraq, Afghanistan, Pakistan and the gulf now almost completely encircle Iran.

S&P 500 January 10 2011 to July 8 2011

It's now extremely difficult and expensive to get a visa to wander around China. Scanty reports available to us in the west seem to indicate that inflation continues to increase, particularly in property and food and unemployment is increasing. The government's response, to raise interest rates to engineer a "soft landing" is having no effect that anyone can see or measure. It's looking more and more like most of China's banks are technically bankrupt due to bad loans to cities, totaling perhaps as much as $1.5T. Few believe China's banks will be allowed to fail; in a command economy the central government can simply order the bad loans to be ignored. This will, however, leave them with increased inflation and civil unrest. To those who think China will lead us out of the world's economic problems: I think China has their own set of problems that are just as bad, perhaps worse.

How's the world population doing? See the very pretty color coded map below. We have seven billion people on the earth today. Personally I think that's about 6 billion too many. Of these seven billion, one billion each are "low income," $1000 per year or less; "upper middle income," $4,000 to $12,000 per year; and "upper income," $12,000 per year or more. Four billion are "lower middle," with incomes of $1,000 to $4,000 per year. China and India make up about 60 percent of these people, the people who are thought by many to be the emerging markets that will save the world economy. Given their problems with water, food, inflation, and poor governments, I think they'll be very lucky to continue to feed themselves. It will take more than luck for Africa to continue to feed themselves.

World Population and Income, 2011

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