The Risks to the Global Financial System in 2012

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. We have coined this term to describe the current monetary and fiscal policies of the U.S. government, which involve unprecedented money printing. This is the official blog of the New York Investing meetup.   
As 2012 begins, markets are rallying as they did at the beginning of 2011 -- a year when the S&P 500 closed flat after many huge moves up and down. The problems in Europe that rattled markets in 2011 have not been resolved and new problems are or will be emerging in China and Japan. At the very least, investors should expect another rocky ride in the upcoming year.

The debt crisis in the EU is far from over. It is simply being momentarily contained by another short-term solution that will hold things together for a while until the crisis erupts again. The mid-December LTRO (long term purchase operations) announced by the ECB excited the markets as any money-printing scheme would. This new "solution" to the debt crisis is essentially an attempt to handle a problem of too much debt with more debt. Already close-to-insolvent EU banks are able to hold fewer assets for collateral in exchange for cheap funding from the ECB, which can in turn be used to buy questionable sovereign debt from the PIIGS. While this will keep Italy, Spain, Portugal and Ireland financially afloat for a longer period of time, it may collapse troubled EU banks sooner (the real epicenter of the debt crisis). 

Half way across the globe, problems are emerging in China. It is estimated that there are between 10 and 65 million empty housing units in the country that investors have purchased with the hope of selling at higher prices. There are in fact entire "ghost districts" there that are filled with new buildings and no residents. Prices have become so high that by last spring the typical Beijing resident would have to have worked 36 years to pay for an average-priced home. The pressure appears to be coming off though with new home prices dropping 35% in November. Beijing builders still have 22 months of unsold inventory and Shanghai builders 21 months. In the peripheral areas, existing home sales have plummeted -- down 50% year on year in Shenzhen, 57% in Tianjin, and 79% in Changsha. Investors should take note that the Chinese real estate bubble is far worse than the U.S. one that brought the global financial system to its knees at the end of 2008.

Twenty years ago, Japan had a massive real estate bubble and it is possible that prices have finally bottomed there, but that doesn't mean that they are ready to go up. Japan has had two decades of economic stagnation (and is heading toward a third, if it is lucky) because of the collapse of its real estate and stock market bubbles. Massive borrowing by the government has prevented the situation from getting worse. The debt to GDP ratio in Japan is now estimated to be 229% (well above the just over 100% in the U.S.).  More people are leaving the workforce there than entering it and this bodes ill for tax receipts. The aging population is using up its savings instead of adding to them. This is a potentially serious problem because the massive debt the Japanese government has incurred has been funded mostly internally by the savings of the Japanese people. A lot of old debt has to be rolled over in 2012 and additional debt is still being incurred. Where the money will come from is not clear.

None of the problems that could strain the global financial system originated in 2011. They have been building up for years and even decades. The first major blow up was the Credit Crisis in 2008. In every case, that problem was "solved" by more debt and money printing. This approach has of course only postponed the inevitable since taking on more debt only creates a bigger debt problem down the road and you can't create something of value out of thin air by printing money (although you will ultimately create a lot of inflation). The markets have already spent most of 2011 in an unstable state. It looks like continuing and even bigger crises await investors in 2012.
Disclosure: None
Daryl Montgomery
Author: "Inflation Investing - A Guide for the 2010s"
Organizer, New York Investing meetup
http://investing.meetup.com/21

This posting is editorial opinion. There is no intention to endorse the purchase or sale of any security