Sovereign Debt Blues
Research for Online Investors

by John Dalt

2/8/10

Last week we reported Portugal had a failed bond auction.  World markets saw this is a serious threat, and we finished the week with a general sell-off followed by short covering and institutional buying on Friday.

Sovereign debt by small European countries can wreck havoc on the Euro, but to the world economy may not be as big as it seems.  It is a problem because the European Union does not have a way to deal with member states that cannot control their finances.  But, it must be put in context.  Portugal and Greece’s populations are only about ten million each, roughly the size of Ohio.  Ireland is home to about four million souls, about the same as Kentucky.

The PIIGS (Portugal, Ireland, Italy, Greece, and Spain) are in trouble because they cannot control their spending on social spending, balancing promises by politicians with tax receipts can be a tough lever.  The G-7 met over the weekend in Canada.  Hopes were high for some statement of coordinating action to address sovereign debt problems.  The market got a weak statement from Jean-Claude Trichet, president of the European Central Bank about Greece meeting new budget tightening goals, “We expect and we are confident that the Greek government will take all the decisions that will permit it to reach that goal.”

Roughly the same problems are faced by some of our states that are facing financial difficulties, but because they are part of the United States are not seen as a danger to the world economic recovery.  The Federal Reserve or the U.S. Treasury may come to their rescue rather than force them into bankruptcy.

California has a population of almost 40 million and faces a budget deficit of $19.9 billion in the remaining five months of this fiscal year. Greece needs to borrow $30 billion to finish this fiscal year. Portugal’s government debt reached 77% of GDP in 2009

California is faced with issuing IOU’s again this spring and Greece/Portugal bonds are selling at a spread of over 400 basis points above German Bunds.

Oregon voted last week to increase taxes on individuals that make over $125 thousand and companies with profits over $250 thousand per year.  Chicago’s mayor, Richard Daley commented, "It will help our economic development immediately. We'll be out in Oregon enticing corporations to relocate to Chicago.  Businesses can go to Wisconsin. They can go Indiana. They can go to India. They can go to China. So if you want to beat up businesses, go beat them up and when they leave, just wave to them, and they're going to wave back to you."  Did you ever think you would hear a politician from President Obama's home state voice such heretical views?

This sentiment is the bases of the federalist system our country was based on.  If one state raised taxes or barriers to success by over regulation, citizens could move to another state.  The competition between states would serve as a check on stupidity of politicians.  Texas, Florida, and Nevada are among the states with the highest growth rates, because they low or no state income tax. A friend left California years ago, state tax savings in the first year paid for the move.

The growth of the U.S. Federal Government and nationalization of many programs and regulations has suppressed the ability of citizens to move.  This has allowed the federal government to grow without check.  The European Union is getting a taste of competition, Switzerland’s Zug canton (state) offered Diageo executives a deal to move out of England.  The top 200 executives would pay no income taxes and the company would get a low corporate tax rate.  So far, Diageo has not accepted.  Last year, more than 1200 companies moved their headquarters to Switzerland!

" A liberal is a person who will give away everything he doesn't own ." ---Unknown

The information presented in this newsletter is based on generally available news releases, corporate filings, current events, interviews and the editor’s opinions.  It may contain errors and you should not make investment decisions based solely on what you believe you have read here.  Do your own research, it is your money.  If you lose it, it is your responsibility, not ours or your grandmothers!  The editor may or may not have a position in any securities discussed.  The editor may have held a position in a security earlier, or in the future.

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