Madness in Pennsylvania and One
More Bankruptcy in California

Bankruptcy in CaliforniaSan Bernardino, with a population of 209,000, has become the third California municipality to declare bankruptcy within the last few weeks.

The budget deficit that San Bernardino faced was $46.0 million and its money was gone, leaving the council little choice but to declare bankruptcy, especially in an economy that feels like a recession. The reason for the bankruptcy vote was that when the city council looked at its projected budget deficit in the next five years, it saw no way out. Besides that, they were staring at total government debt obligations of $243 million! (Source: L.A. Times, July 10, 2012.)

The City of San Bernardino reduced its government workforce by 20% and was able to cut wages marginally, which led to savings of $10.0 million for 2012. However, this was not enough to meet the gaping budget deficit.

In what has become a common theme—and what will most likely take down many more cities and states—the city council in San Bernardino noted the relentless rise in pension costs and high union government worker salaries as the main culprits for the ever-expanding budget deficit. This was combined with the fact that tax revenues have declined since the recession, with one of the main culprits being the falling value of home prices, which further exacerbated the budget deficit.

As the recession-type environment continues to claim more municipal and city victims, the mayor of Scranton, Pennsylvania, is attempting another approach. The city’s budget deficit is so large that, in order to continue to make payments, the city needed a loan of $16.0 million.

The market refused to provide Scranton with the money until it addressed its budget deficit. Faced with the possibility of bankruptcy, the mayor implemented a new approach regarding employees. He forced everyone, including himself, be paid minimum wage—$7.25 per hour—until the budget deficit came in line and the $16.0-million loan could be had.

He assured everyone that once the loan money came in, he would pay everyone back. The police, firefighters and public works unions filed for an injunction, which was granted by the courts.

However, for now, the city is just paying out minimum wage to its workers, not because it wants to go against the courts or the injunction, but because the money is just not there to pay everyone their full salaries.

In this recession-type environment, tax revenues have fallen dramatically while pension costs and civil worker costs have continued to increase, creating a budget deficit mess.

The unions now are less receptive to taking a salary cut and the city council of Scranton is proposing a tax increase in this recession-type environment. The courts get to decide how to sort out this mess, but the budget deficit will be hard to close. (Source: Huffington Post, July 5, 2012.)

Unfortunately, these won’t be the first and the last municipalities to implement unprecedented and unheard of policies to meet their budget deficits. More and more cities will declare bankruptcy putting more and more pressure on states, which will eventually visit the steps of the White House. (Also see: “Deeper Cuts Are on Tap for U.S. Municipalities in Distress.”)

Michael’s Personal Notes:

Gold bullion imports from Hong Kong into mainland China increased 600% in May 2012 when compared to May 2011! (Source: Bloomberg, July 9, 2012.)

China is set to take the lead from India as the largest purchaser of gold bullion in 2012. The World Gold Council estimates that China will buy at least 870 tons of gold bullion in 2012.

Just to give an idea of how large these purchases of gold bullion are, in the first five months of 2012, China has imported over 300 tons of gold bullion from Hong Kong. Just isolating this number alone would put China as the 17th largest holder of gold bullion in the world!

As I’ve been writing in these pages, as the price of gold has fallen, China has provided money to its gold miners, which they in turn have used to buy other gold miners around the world. These Chinese gold mining companies then bring the gold bullion back in the country, but the statistics surrounding these imports are not published.

The only reason why we know of China’s insatiable demand for gold bullion is that it is Hong Kong that publishes the statistics quoted above.

As of a few years ago, China also banned the export of its gold bullion. The country had the capacity to pull roughly 390 tons of the yellow metal out of the ground, but has kept it all for itself.

Despite the country’s concerted effort to buy as much gold bullion as possible, the price of gold remains in a trading range. One of the factors holding the price of gold down is India.

Dear reader, it is important to note that China will become the largest gold bullion buyer in 2012, not because demand in India has fallen off, but because India’s currency, the rupee, has fallen in value, hiking up the price of gold within the country. With the currency off over 10% from last year’s levels when compared to the U.S. dollar, it is now more expensive for the consumer in India to buy gold bullion.

As the price of gold remains stuck within a range of roughly $1,550 on the downside and $1,700 an ounce on the upside, the demand for gold bullion continues to be very strong.

Besides China and India, many other central banks around the world are increasing their holdings of gold bullion, making it only a matter of time before the price of gold reflects the strong demand. (See: “Who Has Money Buys Gold.”)

Where the Market Stands; Where it’s Headed:

Is the bear market rally in stocks finally over? After all, the stock market has been down six out of the last six trading sessions.

Yes, dear reader, we are almost there. The rally in stocks that started in March of 2009 will soon give way to Phase III of the secular bear market (which means the low of March 2009 on the Dow Jones Industrial Average could be tested).

But although the Federal Reserve cannot bring short-term interest rates down any lower than they are, the Fed can increase the money supply again to boost the economy, which will give a lift to stocks. The big question is: will the stock market react big-time to more quantitative easing or will it brush it off this time because QE1 and QE2 had no structural impact on the economy? We’ll soon have the answer.

What He Said:

“Investors have been put into an unfair corner. Those who invested in stocks because they got caught in the tech boom (1999) have seen their investments gone. Now, those who have leveraged heavily to play the real estate game, because it is the place to be (2005), could see the same fate as the stock market investors. Thanks again, Mr. Greenspan.” Michael Lombardi, Profit Confidential, May 27, 2005. Michael started warning about the crisis coming in the U.S. real estate market right at the peak of the boom, now widely believed to be 2005.