Why You Must Invest for Inflation From Now On

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.


The Fed made history today by announcing an open-ended money printing policy — a policy heretofore unseen outside of history's hyperinflation havens. The news conference that followed the announcement revealed a central bank acting out of extreme desperation.

While the Fed is doing another round of quantitative easing, QE3 is not the same as QE2. The previous QE involved the purchase of U.S. Treasuries. This time around, the Fed is buying MBSs (mortgage-backed securities). In QE1, various types of securities were bought. The previous QEs also had specific limits to the amount of money that was going to be printed whereas QE3 doesn't. QE3 is supposed to be ongoing until somewhat after the economy and employment situation have been improving for a while. How long that will be is anybody's guess.

Despite several questions in the press conference that followed the announcement, Bernanke made only vague statements about how the Fed would determine when enough money printing was enough. The purchase of mortgage-backed securities is likely to continue for some time because doing so is supposed to reduce unemployment. How that will work is not clear other than perhaps reducing unemployment in the construction industry. The Fed's actions should lower already historically low mortgage rates and Bernanke specifically stated more than once that getting the price of homes up was one of his major goals (he seems to have forgotten that the global financial collapse in 2008 was the result of the collapse of the housing bubble).

Anticipating the obvious objections, Bernanke tried to head off the major criticisms of the Fed's new plan at the beginning of his news conference. While he admitted that the Fed's action hurt savers and would make it difficult to prepare for retirement, he said that if you don't  have a job you wouldn't have any money to save anyway. So, apparently the large majority of people who have a job should risk having their retirement unfunded in order to pursue Bernanke's high risk policies that have been tried for the last five years, but haven't worked. I wouldn't have been surprised if a couple of retired people were brought up to the podium and Bernanke kicked them a few times to emphasize his point.

Bernanke also denied that the new round of money printing will cause inflation. The basis of his argument was that the members of the FOMC aren't prediction inflation in their projections, so obviously it's not going to happen (these are the same people that failed to foresee the subprime crisis coming). Also Bernanke claimed inflation has been around 2% for years, so there is no problem. Even a casual perusal of commodity prices since 2009 shows increases of 100%, 150%, 200% and sometimes more however. It is true the government isn't reporting inflation, but that isn't the same as it doesn't exist. The head of the Weimar German central bank also claimed inflation wasn't a problem as he printed more and more money. Eventually, inflation reached 300 million percent.

One of the real eye-openers of the Bernanke news conference was his admitting the impotency of the Fed and monetary policy. Over and over again Bernanke stated that the Fed's actions were, "not a panacea". He said that, "We [the Fed] can't solve the problems by ourselves". He also emphasized that the Fed's, "tools are not so powerful that they can solve the problem". If the chances of success are so limited, why is the Fed taking a course of action that could have serious negative consequences for the American people?

In addition to his desire to reinflate the housing bubble, Bernanke was also proud that when the Fed speaks, economic forecasters change their numbers and that, "markets respond to [the Fed's] guidance".  This was a blatant admission that the Fed purposely manipulates the stock and bond markets and financial news. Obviously, this destruction of free market mechanisms is not something that he considers shameful, even though this represents a major power grab on the part of the Fed.

Bernanke was much more coy however when the question of whether or not the Fed's money printing decision was base on political considerations. One reporter mentioned that Romney was not planning on reappointing Bernanke and asked if the policy shift was an attempt to help reelect President Obama. Bernanke denied this of course, his voice almost breaking when he stammered out, "our decisions are based entirely on the state of the economy." I must admit that I am personally surprised that the Fed did this before the election because this question is only going to be the beginning and the Fed has now made itself an ongoing issue in the presidential campaign. I didn't think Bernanke was so foolish to take this risk, but obviously I overestimated his political awareness.

Earlier this month, ECB head Mario Draghi promised unlimited bond buying. This is different from what the Fed is doing because those purchases are supposed to be sterilized (new liquidity put in is neutralized by liquidity being removed). Many people however believe that the ECB will have to engage in money printing despite its claims. Added to the Fed, this means inflation investments will have a bid under them for some time to come.  Investors should be looking at gold and silver, energy and agriculture. Ironically, shorting Treasury bonds also look like a good bet now as well, since the Fed is not buying them as part of its QE program (Operation Twist though will be going on to the end of 2012 however and this acts to lower interest rates around the 7 to 10-year maturity level so be careful). Keep buying as long as the Fed keeps printing.


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.

Draghi's Sterilization Makes ECB Monetary Policy Impotent

 

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.

In response to concerns about the inflationary risk of more money printing, European Central Bank President Mario Draghi is going to propose "sterilizing" unlimited purchases of government debt for struggling Eurozone countries. A failed government bond auction in Germany this morning indicates why the plan won't work.

Draghi's newest strategy will focus only on government bonds of three year duration or less. These bonds from the peripheral countries have been snapped up by hedge funds in recent trading days driving their yields down considerably. Draghi will apparently also stress conditionality for the ECB's purchases. Governments must agree to ECB control to get aid and must meet the conditions they agree to in order to continue to have their bond markets supported (Greece has been notorious for violating its promises in this regard).

When central banks sterilize transactions, they pump money into one area of the financial system and remove it from another at the same time. Bloomberg reports that there is an estimated €800 billion of excess liquidity in the eurozone banking system. So, policy makers figure there will be no problem draining an unlimited amount out of the liquidity rich north and transferring it to the cash-strapped south. While this sounds good in theory, reality might be a major stumbling block for this idea to go forward.

While Draghi's plan will only be officially announced tomorrow morning, there was already a failed 10-year bond auction in Germany this morning (only the second time this has happened in recent several years). Germany attempted to sell €5 billion in bunds, but only managed to find buyers for €3.61 billion of its debt. The other more solvent credits of the Eurozone such as Finland, the Netherlands and Denmark are also likely to face this problem in the future. It is simply common sense that this will happen. If the size of the money pie isn't being made larger and some people are getting bigger pieces, someone else has to be getting smaller pieces. Lower interest rates in Spain and Italy are going to mean higher rates in the north.

The voters of the northern Eurozone countries may not be amused when they find out how they are paying for the escalating debt problems in Spain and Italy. Retail sales figure released this morning were lower month over month for the whole Eurozone and manufacturing is continuing its contraction. While Spain is in a full-blown recession, the economies of the northern countries are weakening. Higher interest rates there will not help the situation. It should be an interesting meeting of ECB officials tomorrow. 


Disclosure: Not a Central Banker

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.

If an EU Leader Says It, Don't Believe It

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.

German leader Angela Merkel revved up the markets on Thursday by saying once again that she and the other EU leaders would do everything possible to save the euro. If traders realized how reliable previous official statements concerning the Eurozone debt crisis have been, markets would have experienced a major selloff.

When the debt crisis first appeared in Greece, Merkel said there would be no bailout and the Greeks would have to solve their own financial problems. ECB President Trichet made it clear that Greece wouldn't receive any special treatment. It wasn't long before they both backtracked on their public statements. On April 11, 2010, a €30 billion bailout was agreed to and this was raised to €45 billion on April 16th. By May 2nd, a total package of  €110 billion had been arranged. This amount was meant to fix Greece's debt problems once and for all. The Washington Post reported that IMF director, Dominique Strauss Kahn, and EU Commissioner Olli Rehn stated, "the plan would lead to a more dynamic  economy that will deliver the growth, jobs, and prosperity that Greece needs in the future". If there were a worst-forecasting-prediction-of-all-time award, both Strauss-Kahn and Rehn could be potential winners.

Not only did the Greek economy not prosper, but it went into a tailspin. Other claims made by the EU proved to be equally absurd as well.  As reported by BBC News, the Greek debt to GDP ratio was supposed to rise from 115% at the time of the bailout to 149% in 2013, when it would then fall. Instead it rose to 165% in 2011. Greece's budget deficit was expected to be down to 3% of GDP (the EU target rate that all members states are obligated to meet). If Greece is lucky, it's deficit will only be 7.3% of GDP this year. It is expected to rise again in 2013 however to 8.4%. So much for that.

Even though Greece missed the EU and IMF's projected targets by a mile, this was only possible because a much bigger bailout took place in 2012. Greece received an additional €130 billion  and got to effectively write off almost 75% of its government debt held by private bondholders (the ECB and IMF were exempt from the write down). Certainly Greece must be better off after €240 billion in bailouts and writing off a big part of its debt, isn't it? Well, no it isn't. Before the first bailout in 2010, Greece had around €300 billion in government debt. Just released figures indicate in now has €303 billion in debt. While debt is no lower, GDP has collapsed, falling over 9% in 2011 alone and currently on target for an over 6% drop this year. Unemployment has skyrocketed with the someone under 25 being more likely not to have a job than to be working. By almost any criteria you wish to chose, the EU, IMF and ECB program has been a complete failure.

Now the EU and its partners are preparing to bailout Spain. Already a €100 billion loan has been committed for Spanish banks. This doesn't include any funds to bailout the government. How bad is the situation in Spain?  Well, Reuters has reported that one of Spain's regional mayor robbed a number of supermarkets last week and distributed the stolen food to the poor. As a member of  a regional parliament, he is immune from prosecution. Government stealing from those that have is of course nothing new, but apparently in Spain there's no attempt to hide it.

It looks like Spain will be asking for a full-fledged bailout soon. The EU will then directly take over its finances.  The total bailout could easily involve a trillion euros or more, unless some EU country stops it after realizing the damage this is going to cause the EU itself, let alone Spain. The long-term implications are likely to be quite ugly for both.

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.

How Much Stimulus Will Be Done by China, the EU and UK?

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.

Much weaker than expected trade data out of China on Friday indicates more economic stimulus will be forthcoming there soon.  Even bigger stimulus is expected from the ECB as it revs up the printing presses to bail out Spain and Italy (unless Germany stops it of course). According to a recent released report, the recessionary economy in the UK may need massive doses of quantitative easing to recover.

Exports in China rose by only 1% year over year in July and this was well below forecasts of an increase of 8.6%. Imports were up 4.7%. For a country that has an export-based economy like China does, this is a serious problem. Like the U.S., Europe and Japan, China engaged in a massive amount of stimulus during the Credit Crisis in 2008/2009, spending $586 billion or 14 percent of its GDP in addition to cutting interest rates and lowering banking reserves.  This led to a big expansion of local government debt, a major housing bubble that has yet to burst and consumer inflation. Apparently, there are unfortunate side effects when governments apply a lot of economic stimulus (notice you rarely read about them in the mainstream media).
This time around, China has already cut interest rates twice and reserve requirement ratios for banks three times since November. Its economy has slowed for the last six quarters and probably by much more than official figures indicate (China's economic numbers should be taken with a grain of salt).
China is still in spectacular shape though compared to Japan, which had a massive trade deficit in the first half of 2012. Japan has been economically troubled for 22 years and despite zero percent interest rates and an unending number of stimulus measures its economy remains in the doldrums. While all the stimulus hasn't solved Japan's economic problems, it has led to a debt to GDP ratio of over 200% (worse than Greece's).
One reason China's exports are doing so poorly is the weakening economy in Europe. On Thursday, the ECB cut its growth forecasts and is now predicting the eurozone economy will contract by 0.3% in 2012.  They are still hopeful of slight growth in 2013 however. Maybe they think it will come from all the money they plan on printing to bail out Spain and Italy. The Eurozone is basically tapped out from all the bailouts it has already done in Greece, Portugal, and Ireland (Cyprus and banks in Spain are now on the list as well). Greece needs a third bailout and is struggling to make it through the month until it receives its next welfare payment in September. The situation there is potentially explosive. The IMF has stated Ireland will need another bailout by next spring.
When ECB President Draghi said on July 9th that the central bank will take any measures within its mandate to save the euro, the inevitable conclusion was that he was willing to engage in massive money printing. The amount of money needed for the huge bailouts that Spain and Italy would require simply doesn't exist so it has to be created out of thin air. The Draghi proposal is for the ECB to buy bonds, but the ECB has already tried buying bonds under the SMP program.  The moment the buying stopped, interest rates shot right back up. This approach is costly and only effective in the very short term — a typical government program. It won't prevent the Eurozone's failure, it will merely delay it and make it worse when it happens.
The UK is not part of the Eurozone, but its economy is also contracting. Citigroup economists have stated that the UK will need to print an additional £500 billion and lower interest rates to 0.25% to prevent continued stagnation. Apparently, they don't think there are serious risks if this approach is taken. Neither did the Weimar Germans in the early 1920s, the Zimbabweans in the 2000s, the Chinese in the 1940s, the Brazilians for most of the 20th century, the Yugoslavians in the 1990s or the Hungarians in 1946. In fact, countries that create hyperinflation always claim the risks of money printing are minimal before it takes place. And there are usually a large number of top economists that support this view.  

There are serious structural problems in the major economies today. The usual Keynesian quick fixes that have been applied since World War II no longer seem to work, nor will they. These have led to a world drowning in debt and all debtors eventually reach their borrowing limit. When this happens with countries, they then try to print their way to prosperity. History makes it quite clear that this doesn't work either. 

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.

Central Banks Sucker the Market

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.

Three major central banks met on August 1st and 2nd and none of them took any decisive action. Markets in the U.S. and Europe have been rallying since late June on expected policy easing they've been promised by reports in the mainstream media. So far, empty talk is all the central banks have delivered.

Traders had high expectations for the Fed's monthly meeting on July 31st and August 1st. A week previously, news hit the wires (only a few moments before Apple's disastrous earnings were announced) that the Fed was definitely going to do some easing at this week's meeting. The source was the Wall Street Journal and they followed up with a front page article the next day. And what did the Fed do?  Nothing, zilch, nada. So much for the Wall Street Journal being a reliable source of investing information.

For the previous meeting in June, Goldman Sachs claimed the Fed was going to be doing quantitative easing (or maybe some other form of easing, but you would have to have read the entire coverage to find that out). What happened when QE wasn't forthcoming? The market hypsters came out of the woodwork with assurances that QE3 would be announced at the July/August meeting. Now that that hasn't happened either, we are hearing "just wait until September". You might as well wait for Godot. The only way the Fed will be doing QE before the election is if the financial crisis in the Europe gets out of hand. This will not stimulate the economy, but prevent a total collapse of the stock market (not a drop, but a total collapse).

The Bank of England and the ECB also met today. No rate changes from either of them (unlike the U.S. and Japan both have rates slightly above zero and they could lower them). The Bank of England is already doing QE2 and has been doing so since the fall of 2011. The UK is in a recession and QE has not stopped its economic decline.

Mario Draghi, the ECB chair and one of the biggest windbags to ever run a central bank, held a press conference after his meeting. He said that the ECB would undertake "outright" open market operations and would be using non-standard policy measures. Bonds rallied on the news. Unfortunately, only minutes later, Draghi was forced to backtrack on his boisterous pronouncements. He admitted that he was only providing "guidance" of what was going to occur in the future and details wouldn't be available for weeks. Draghi continued that even if the ECB was ready to act now, it would not have the grounds to do so. Someone should give that man a bagpipe.

How long the markets will continue to fall for promises of stimulus that never comes remains to be seen. Whatever happens, there is no reason be confident that things will be getting better. If the Fed could fix the U.S. economy, it would already have done so. If the ECB could solve Europe's debt crisis, it also would have already done so. Doing more of the same is not going to work, so it's not worth waiting for cental bank action as is. Eventually, the markets will figure this out.

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.

The EU May Have Reached Its Bailout Limit

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.

Today, yields on Spanish 10-year sovereigns tested their yearly high yield of 7.28%, while Italian rates reached 6.16%. This was after funds for the Spanish bank bailout were approved by the EU, although the money won't be going directly to the banks. Earlier in the week, the IMF admitted that  the only solution to Europe's debt woes was to run the printing presses at full speed.

The situation in Spain is ugly and getting worse. Unemployment is almost 25% there and the country is in a recession. The Spanish economy is dependent on public spending and building empty houses that no one buys. The government has recently announced severe spending cuts and higher taxes, both of which will lower future growth. Yet, until today Spain was forecasting GDP growth of 0.2% for next year. It now thinks that GDP will decline by 0.5% in 2013. This is not just an optimistic scenario; it's a Harry Potter fantasy scenario. As is the case with Greece, Spanish economic and financial numbers cannot be trusted. Greece in the early stages of its bailout also produced optimistic projections of how easily and quickly everything would be fixed. Instead, its financial problems escalated out of control.  The same outcome should be expected in Spain.

Bailed-out Bankia is a good example of the how reliable the books are for Spanish banks. Bankia claimed to have earned a €300 million in profits in 2011, but in late May revised that to a €3 billion loss. Now Spain is in line for a €100 billion bailout from the EU, although it has claimed that it needs less. Based on how Bankia did its accounting, Spanish banks are likely to need more, maybe ten times more than that amount. This does not include money for bailing out the bankrupt Spanish government.  

Originally, the EU planned on providing the bank bailout money (structured as a long-term loan) directly  to Spain, who would in turn distribute it internally. When this caused Spain's sovereign debt rating to be downgraded, creating greater fiscal problems for the struggling government, the EU then decided to route the loan directly to the banks. Yesterday, the German parliament refused to go along. They were only willing to approve a loan directly to the Spain itself. It wasn't easy to get even that passed. Twenty-two members of Angela Merkel's coalition voted against it. The leader of the Free-Democrats described the bailout as "a bottomless pit". It doesn't look like German legislators have an appetite for any further bailouts and this is bad news for Spain and Italy as well.  

The IMF has an idea of what to do instead, but its solution could hardly be described as constructive. In a report issued on Wednesday, the organization essentially advised the EU to engage in every type of money printing possible, do a lot of it, and to start doing it immediately. The ECB has already expanded its balance sheet by more than the U.S. has and it hasn't solved the EU's problems so far. Massive money printing as suggested by the IMF would debase the euro significantly. So, in order to save the currency union, the currency it issues must be destroyed. Somehow, there seems to be a logic flaw in this line of reasoning (sort of like, a debt crisis can be solved by incurring more debt).

The bailout news today was disastrous for Spain and Italy. The Spanish IBEX index was down 5.79% dislocations  — a mini-crash and the worst drop in the two years. The Italian market was down 4.4%. The euro hit a new yearly low. The ETF FXE traded down to 120.78. This is below its bottom during the Credit Crisis, but still above the 2010 low made when the debt crisis first appeared. As the situation continues to unravel, more selling should be expected.


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.

Europe Continues Its Slide Toward the Precipice

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.

The Finnish finance minister has said all eurozone countries are making contingency plans in case the currency union breaks up. With debt downgrades, bond market anomalies, troubled bailouts, and austerity packages with their associated riots becoming the new EU norm, their worries are obviously justified.

Last night, Moody's downgraded Italy's government bond rating two notches from A3 to Baa2. This is just above junk status. Moreover, the outlook is negative with further downgrades possible in the near future.  So what happened in the Italian government bond auction this morning?  Did buyers  demand higher interest rates to buy Italy's increasingly risky debt as basic economic principles would predict? No they didn't. Italy sold €3.5 billion of three-year bonds at an average yield of 4.65%, much less than the 5.3% it had to pay last month.  How is this possible? Apparently Italian banks couldn't resist an urge to grossly overpay for their governments newly issued debt. The ECB was most certainly backing them up behind the scenes. If this is how Italian banks do business, can we assume that they're solvent?

There is little need to pose that question for Spanish banks. Recent data indicate that they borrowed €365 billion in June from the ECB — a record amount. This compares to €325billion in May. These numbers indicate that Spanish banks have been closed out of the interbank lending market (a good indication of insolvency). The highly troubled Spanish banking sector, which has €3 trillion in debt on its books, will be receiving an immediate infusion of €30 billion in bailout funds from the EU and another €45 billion in November. This represents 2.5% of its total debt and that amount is supposed to fix the problem. The actual funds needed will be many times that. It is impossible to say exactly how much because the financial numbers for Spanish banks are not reliable.

Spain seems to be following Greece's descent into a self-reinforcing economic collapse. This week Prime Minister Rajoy announced further budget cuts of €65 billion over the next two years.  VAT was raised from 18% to 21%. Almost a quarter of the Spanish work force is unemployed, even worse than Greece's 22.5%. Spain though seems to be making a more serious effort at fiscal austerity than Greece. According to reports in the German daily Rheinische Post, the troika on its latest visit found that the Greek government failed to implement 210 of the 300 budget savings requirements it had agreed to in exchange for its bailout money.

While interest rates are pushing against unsustainable levels in Spain and Italy, they have gone to theoretically impossibly low levels in northern Europe. Negative interest rates first appeared in government debt in Denmark and the Netherlands last December. Then Germany paid negative rates on some of its short-term bonds starting in January. This week, France sold six-month Treasuries at a yield of -0.03% and two-year bonds at -0.001%. Below zero yields are a sign of severe market stress.

The euro this week has traded below 1.22 to the U.S. dollar, but is slightly higher today. Investors should watch the 1.20 level. If the euro breaks and stays below this area of support, it could drop to parity with the dollar. The major central banks would intervene to prevent this though, so the ride down wouldn't be smooth.

Stock markets reacted bullishly in late June and early July to the news of further bailouts in the EU. Most traders didn't ask where the money would come from, nor if the plans were even legally possible. They may not be. The German constitutional court will be ruling whether or not Angela Merkel's promises to participate in the ESM (European Stability Mechanism) can go forward.  Even if they rule favorably, there is little actual money committed to the ESM. More money printing (and the ECB has already done quite a bit) is the only option left to fund the various bailout schemes to save the euro. Of course, it's logically absurd that a fiat currency could be saved by producing excess amounts of it. The same is true for trying to solve a debt crisis by taking on more debt.  But hope reigns eternal in the land of euro make believe.

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.

Central Bank Action Supports Credit Crisis View

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.

There was another confirmation of an emerging credit crisis yesterday as central banks in various parts of the globe took coordinated action to pump money into the financial system. The banks involved though claimed it was mere coincidence that they all acted at the same time.

Central banks are generally only interested in dealing with their own internal matters. On ocassion though, they act together as they did in October 2008 at the height of the Credit Crisis. Massive stimulus from lower interest rates and quantitative easing finally allowed the markets to put in a bottom six months later.

On Thursday, the People's Bank of China cut its key lending rate by 31 basis points (a basis point in one-hundredth of a percent) to 6%. This was a previous cut less than a month ago. Manufacturing has been declining for months now in China and there are some estimates that GDP will barely be above 7% this quarter. While this would be enviable for any North American or European economy, below 7% growth would feel recessionary in China. Lowering interest rates is not without risk for China since the country also has a massive real estate bubble and this will continue to feed it. 

At the same time that China was cutting rates, the ECB cut its refinancing rate to 0.75% from 1.00%. The banks' deposit rate however was lowered to zero (obviously not much room to maneuver left there). While the ECB has still not fully implemented ZIRP (zero interest rate policy), which Japan and the United States have now maintained for years, it is so close that the difference is irrelevant for all practical purposes.  The Bank of England did not lower its 0.50% benchmark rate, but instead raised the ceiling on its current round of quantitative easing by 50 billion pounds. They've obviously come to the conclusion that once rates have gotten close to zero, money printing is the only way to go.

Absent in any obvious way from yesterday's action was the U.S. Federal Reserve. It already had its monthly meeting at the end of June and announced an extension of Operation Twist (an attempt to drive 10-year yields lower even though they had already hit all-time lows on June 1st). The market bulls were claiming that the Fed would announce a third round of quantitative easing, but they didn't. The Fed is also going to have trouble engaging in more QE in the near future because the U.S. is once again near its debt limit. National debt is now over $15.8 trillion and the debt ceiling is $16.4 trillion. The two will come together at some point this fall. To implement quantitative easing, the Fed has to buy newly issued treasuries. When the debt ceiling is reached, there won't be any. It took months to raise the debt ceiling last time and it is likely to be just as contentious an issue this time as well.

The current global financial crisis is centered in Europe and nothing has been fixed there. The EU has been trying to keep 10-year bond yields below the critical 6% level in Spain and Italy since last summer. They have utterly failed in the case of Spain. Spanish 10-year governments were over 7% in June (higher than last fall, which was in turn higher than last summer). After being driven down close to 6% twice in the last two weeks, the yield was as high as 7.04% today. Italian 10-years traded at 6.08%. Rates continually above 6% mean that Spain and Italy will need bailouts, but the necessary money will have to be printed. Germany holds the keys to the printing press however and may not let them be used.

Stock markets worldwide have held up remarkably well considering there are serious problems in the financial system and the global economy is weak. Liquidity from central banks is responsible for this. However markets have a tendency to revert to realistic prices and if they aren't allowed to do that gradually, they will do so suddenly.

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.

Bidirectional U.S. Stocks, Spanish Bonds and the ECB

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.

The new mantra for the U.S. markets appears to be "if it's Tuesday, it must be bidirectional market day".  Once again the Dow went up strongly, while the Nasdaq was trading in negative territory. Events in Spain seem to be connected with this unusual and bearish market action.

At one point during the trading day, the Dow Industrials were up 123 points. Nasdaq on the other hand was down by 20 points at its worse. The S&P was caught in the middle. The same strange behavior took place last week. Spanish bonds and the euro rallied both times and money pumping from the ECB (with perhaps some dollar swap activity from the Fed) explains these seemingly unrelated events.

The yield on the 10-year Spanish government bonds exceeded the dangerous 6% level last week and suddenly heavy buying came in and drove yields back down to around the 5.86% level. Today, the yield on the Spanish 10-year reached 6.049% and suddenly buying came in and drove the yields down to 5.86%. The Euro rallied both times. As measured by the ETF FXE, it rose to 131.19 today. There is no reason investors should be buying either one. Spain is at risk of developing a full-blown debt crisis just like Greece and the Dutch government fell and the French election went badly over the weekend.

Money pumping causes markets to rally. It is directly being aimed at the Spanish bond market and the euro however. It spills over into other markets though. Since the Dow consists only of very liquid big cap stocks it will be impacted the easiest. The rest of the U.S. market has serious problems though. Tech stocks have led it up and now they are struggling. The ECB money pumping isn't enough to counteract the forces driving them down.

Money pumping can't go on forever and every time there has been a pause, stock prices have suffered. Problems in Spain are merely part of a much larger ongoing debt crisis in Europe. The balance sheet for the ECB has already been increased by much more than has been the case in the U.S. and the chart line is going straight up. A pause will eventually take place and when it does stocks will weaken globally -- and this includes the Dow.

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.

Remerging EU Debt Crisis in Spain Will Damage Stocks

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.

The yield on Spanish 10-year government debt was as high as 6.16% on Monday. Credit default swaps on Spanish debt hit a record even though the peak yield on the 10-year was 6.70% on November 25, 2011. After a big selloff on Friday, stocks were rallying on Monday despite the new emerging crisis in Europe.

The 6% yield level is watched closely because when rates went over that level in Greece, the Greek debt crisis emerged. Spanish 10-year yields were over 6% three times last year. Prior to last November they reached 6.32% on July 8, 2011 and 6.28% on August 4, 2011. The ECB (European Central Bank) has intervened directly in bond markets under its Securities Market Program (SMP) to hold down interest rates in the peripheral countries. At least one Spanish official has called for a renewal of these efforts.

The ECB also established the European Financial Stability Facility (EFSF) and the European Financial Stabilisation Mechanism (EFSM). Massive money-pumping operations have also been conducted through the two LTROs (Long-Term Refinancing Operations), one for $645 billion and a second for $713 billion.  The massive liquidity coming out of Europe has led to the recent global market rally. This will be just one of its unintended consequences. Later on we will be experiencing a large uptick in consumer price inflation as another.

While the inflation caused by the ECB is likely to last, the lower interest rates aren't. Spain has now broken above the 6% line in the sand four times. Portugal has never even gotten down to that level. Its 10-year governments were yielding 12.7% on Monday. So far they have peaked at 17.4% on January 30th. Italian 10-year governments have also yielded over 7% last November and this January, but were driven back down to below 5%. They are now rising rapidly again and heading toward 6%.

European stock markets were damaged significantly on Friday and the U.S. markets to a lesser degree. Despite the ongoing bad news markets across the pond were rallying today. And why shouldn't they. Another bailout (and another bailout and another bailout and another bailout and even another bailout) is expected. So far, even with the massive amounts of printed money thrown at the bond markets in the peripheral countries, the debt problems keep emerging . And now the global stock market rally looks like it is beginning to fray around the edges.


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.

Market Rallies on Bungled Stress Test News Release

 

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.

The Federal Reserve released its stress test results of 19 banks two days early yesterday. JP Morgan Chase forced its hand by making a public announcement that it had passed the test. Although the news was not particularly good, nor the results completely believable, U.S. stocks had their best day all year.

The Fed said on Tuesday that 15 of the 19 banks tested would have enough capital, even if they suffered a financial shock.  Citigroup (C), Ally Financial, SunTrust (STI) and MetLife (MET) failed the test. It should be considered shocking that any bank would fail a stress test after all the lavish government bailout and support programs that have funneled considerable amounts of money to them.  The U.S.  government had to semi-nationalize Citigroup and owned 27% of its stock by the time the Credit Crisis was over. Citi received approximately $45 billion in TARP funds alone and when it started paying them back, it got a $38 billion federal tax credit. And it still can't pass a stress test?

Of course, if Citi did pass a stress test, it might bring too much attention to the test's credibility. The Fed claims it set tough conditions and major banks complained that the tests were made too rigorous by considering a scenario where unemployment reached 13% and housing prices dropped 21% (presumably the Fed meant the official unemployment rate being 13% and not the actual rate). While these conditions sound tough, they aren't comprehensive, nor where the attention should be focused.

What prevented hundreds of U.S. banks from failing in 2008 and 2009 was a government willing to provide an effectively unlimited amount of money to keep them afloat.  The feds also propped up the housing market with minimal interest rates and mortgage relief programs and kept the unemployment rate (at least officially) out of double digits by running trillion dollar deficits. It should be expected that these policies will continue, so how could there be any risk to the U.S. banking system?

The policies themselves are creating the risk. Easy money is inflationary and always has been (and no, things will not be different this time). Inflation devalues financial assets and destabilizes banks.  The Fed however denies that inflation exists and that it will exist, so it is not politically tenable for it to do ever include any realistic inflation scenario in its bank stress tests.

Stress tests do not exactly have an unblemished record as is. The ECB tests in Europe passed Dexia bank with flying colors. Only three months later, it was in serious trouble and then it collapsed. Major Irish banks also passed the test, although Ireland itself had to be bailed out shortly thereafter to prevent its financial system from collapsing. Central bank stress tests are essentially public relations gambits meant to tell the public how good things are regardless of the actual state of affairs.

The release of the U.S. stress test also inadvertently revealed the true relationship between the Federal Reserve and the banking system that it supposedly regulates.  Even though the Fed was scheduled to release the stress test results after the market closed on Thursday, Jamie Diamond  announced that JP Morgan Chase (JPM) has passed the stress tests while the market was still open on Tuesday. He also stated that his bank would be raising its dividend and doing a stock buyback. Shortly thereafter, U.S. Bancorp (USB) and American Express (AXP) raised their dividends and announced stock buybacks. Wells Fargo (WFC) and BB&T (BBT) announced that they would be raising their dividend. 

Diamond's announcement forced the Fed's hand and it had to take emergency measures to move its own announcement up. The imbroglio was described by the mainstream media as a "miscommunication" between the Fed and Jamie Diamond. Oh really?  This is quite difficult to accept considering Jamie Diamond sits on the Board of Directors of the New York Fed. A more plausible scenario is that the big banks do what they want and the Fed follows their lead.  This nicely explains how the Credit Crisis came about in 2008 and why the banks will get into trouble once again.

The market rallied strongly on the news starting around 3:00PM with the Dow Jones industrials closing up more than 200 points. Anyone who knew that the accidental "miscommunication" was going to take place made a lot of money.


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.

Greece Interrupted — Bond Swap is Not the End

 

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.

Greece is set to swap its privately-held government bonds today for new ones that will represent a three-quarters loss of the original investment. The deal will allow the country to receive 130 billion euros in funds from its second bailout. Like the money from the first bailout, those funds will eventually run out however.   

The Greek bond swap is the biggest debt writedown in history. Over 85% of  private investors (essentially banks, the deal does not include bonds held by the IMF or ECB) holding 117 billion euros ($234 billion) agreed to the "voluntary" exchange. The CEO of one major European bank described the transaction as about as voluntary as a confession during the Spanish Inquisition. The loss to bondholders is twofold consisting of a reduction in face value of 53.5% and then lower interest payments stretched over a longer period of time. All in all, private bondholders are taking an approximately 74% hit (assuming of course there isn't another writedown or Greece doesn't renounce its debt completely in the future).

Credit rating agency Moody's decided to call a spade a spade and declared Greece to be in default. Moody's line of reasoning in stating the obvious is that it considers a loss greater than 70% to be a "distressed exchange" (that's putting it mildly) and is therefore indicative of a default.  The matter is not merely academic, since there is a significant amount of credit default swaps (bond insurance) outstanding on Greek debt. On Friday, a committee of the International Swaps and Derivatives Association —  the regulatory authority on credit default swaps — ruled that the Greek debt restructuring was a credit event, and this will trigger payouts. How much CDS holders will receive remains to be seen.

Commentary from the EU political leadership on the swap deal was more mixed than after the first Greek bailout (statements back then were upbeat and generally confident that the problem had been solved and Greece was on its way to recovery). French president Sarkozy stated, "Today the problem is solved. A page in the financial crisis is turning." Christine Lagarde, head of the IMF said, "The real risk of a crisis, of an acute crisis, has been, for the moment, removed." German officials were far more cautious however. The French may be correct as long as their words are taken literally. The problem is indeed solved for today. That doesn't mean it is solved for tomorrow.

It is actually highly unlikely that the situation in Greece will be turning around any time soon because of the massive reduction in its debt load from the bond swap. If Greece had a functioning economy, there would be hope. However Greece's economy is heavily dependent on government spending and in exchange for bailout money the IMF and ECB have demanded severe cuts in Greece's budget deficits. Greece is now entering its fifth year of recession, after GDP contracted by 7.5% in 2011. Investment fell by 21% last year after sliding 15% in 2010.  For Greece to continue to operate at all, continued bailout money will be needed. Greece has effectively gone from a welfare state to a state on welfare.

Not surprisingly, some analysts are sounding a note of caution. Predictions are that the financial bleeding in Greece will show up once again later this year. Problems may arise even sooner depending on when the next election takes place (now supposedly in May) and how much power the fringe parties gain. The bond market doesn't seem hopeful either. One year Greek government bond yields were last at 1143%.  Such yields represent collapse, not solvency.

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.

Greek Deal is Another "Fiscal Solvency in Our Time"

 

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.

Once again Greece has avoided a messy default and once again its creditors have had to take a greater loss on their loans and once again standards had to be abandoned to make the deal go through. And once again, we're not done yet.

Realistically, Greece is actually undergoing a messy default; it's just doing it in slow motion. When creditors are not fully paid, there is a default. The original default terms for creditors last summer were for a 21% loss for private bondholders (read banks). This percent has been raised more than once and with the latest round of negotiations, it will be above 70% according to Jean Lemierre, who co-headed the talks for the IIF (Institute of International Finance). The ECB and national central banks in the eurozone have agreed to "forgo profits on their holdings" (presumably this means the interest payments on Greek government bonds -- something which also indicates default).The eurozone countries will reduce the interest on Greece's first package of bailout loans to 1.5% over market rates from the previous 2% to 3%. This is the first time the ECB and other eurozone central banks have agreed to take a hit on their own holdings.

What prompted the further concessions to Greece was an attempt to get its 2020 projected debt to GDP ratio down to 120%. Without them, the ratio would have been 129% even under the bailout troika's (EU, ECB and IMF) most optimistic scenario (for the non-political reader, this means the complete fantasy scenario). Projections during the first bailout deal proved too good to be true and it should be presumed that these are as well.

There are still a lot of approvals needed to ensure that the current deal goes forward. If it does, every Greek man , woman and child will have received the equivalent of $29,000 from bailout payments. Greece holds elections in April and support for the anti-bailout parties is increasing. Whether or not it will be enough to derail the bailout deal remains to be seen.

Greek one-year government bond yields reached a high of 682% today according to Bloomberg.  To say that the market is not giving the bailout deal a vote of confidence would be an understatement. Last summer, they were around 40% and have been rising continually since then. While euro-politicians are once again claiming the problem is solved, the market indicates that Greece is imploding.

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.

EU Debt Crisis Spreads Worldwide

 

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 the situation in Greece deteriorates further, Moody's announced today that it intended to downgrade 114 European financial institutions and 17 global banks. Hopes that China will buy up   EU sovereign debt to help prop up the faltering eurozone may wind up costing the U.S. more than it does China. 

The hostility between Greece and the EU/IMF/ECB bailout troika is palpable. Nevertheless, there are claims that a deal should be reached by Monday. Whether the severe budget cuts demanded will actually be implemented is another story. Greece's GDP is shrinking 7% this year and additional budget cuts will only make the situation worse. Athens is already riot torn and elections in April (assuming a democratic government still exists) are not likely to produce a government favorable to the bailout terms. The market remains increasingly skeptical of Greece's near-term future with one-year government bond yields reaching 528% today.

While all attention is focused on Greece, the European debt crisis permeates the continent. Banks have lent too much money to not just Greece, but to Portugal, Spain, Italy and Eastern European countries as well. There is a still a hangover of pre-Credit Crisis debt that wasn't resolved in 2008, but merely papered over with newly printed money. Moody's just announced it was planning on downgrading 114 European financial entities including 7 in Germany, 9 in Great Britain, 10 in France and over 20 each in Spain and Italy. Global banks Nomura and Bank of America are in line for a one-notch downgrade, while Barclays, BNP Paribas, Credit Agricole, Deutsche Bank, HSBC Holdings and Goldman Sachs could have their ratings lowered two notches. UBS, Credit Suisse and Morgan Stanley could be reduced three notches.

China with its vast foreign reserve holdings has been considered the potential savior of the eurozone. If this does occur, it won't be only China that is paying however; the U.S. will be sacrificing as well. China has previously announced it wants to diversify its reserve holdings. Since a disproportionate amount of these are in U.S. treasuries, the obvious implication is that it will be funding less U.S. debt as it funds more EU debt. The most recent figures for November 2011 indicate that China decreased its U.S. debt security holdings by almost 3%.

The EU debt crisis is likely to be us for some time to come. The situation with Greece is not stable and at some point it will have to leave the eurozone. Attention will increasingly focus to the other debt-ridden countries and the weak banking system. Just as the crisis spread from Greece throughout Europe, it will then spread from Europe to the rest of the world. We are already seeing this happen.

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.

The EU Has Fallen Into a Liquidity Trap and It Can't Get Up

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.

While the EU is still reeling from S&P's downgrade of the sovereign debt of nine of its members on January 13th and the latest talks to keep Greece afloat have hit a wall, there is an even bigger problem with the effectiveness of its stimulus programs -- the money is just not finding its way into the economy.

Global markets were jubilant in December when the ECB (European Central Bank) pumped 490 billion euros of three-year loans into the EU banking system. These funds were used by eurozone banks to buy high-risk government debt from the struggling peripheral countries. This indeed caused a temporary decline in interest rates, especially for Spain and Italy. Money from this program and other EU stimulus measures is stuck in the banking system however and it is doing little to keep the EU from sinking into a deep recession. As of Monday January 16th, the ECB had 493 billion euros on overnight deposit -- more than the entire December stimulus package.

Large amounts of funds on deposit at any central bank are an indication of a crisis in the banking system. Before the current EU debt crisis, eurozone banks usually kept only around 100 million euros on deposit at the ECB. Even during the height of the 2008 Credit Crisis, EU banks kept only around 33% of money lent out by the ECB on deposit. The percent now is over 70% (the ECB has lent out 664 billion euros in total) meaning things are in much worse shape in the EU than they were after Lehman Brothers collapsed. When money is trapped in the banking system, the economy suffers and extra stimulus measures don't help to revive it. EU money-printing measures meant to rescue its profligate debt-ridden members aren't likely to help its economy, which in turn will result in a self-feeding cycle of more and more debt (as happened in Japan during the last two decades) or more and more money printing (as has been taking place in the U.S. since the 2008 Credit Crisis). Like the U.S., the EU has run out of borrowing power, so debt without money printing is no longer an option.

Weaker economies mean more downgrades from the ratings agencies can be expected. On Friday, both France and Austria lost their coveted triple A ratings from S&P. They were downgraded a notch as was Malta, Slovakia and Slovenia. Italy, Spain, Portugal and Cyprus were downgraded two notches. Italy is now rated BBB+. The only countries in the eurozone that still have triple A ratings are Germany, the Netherlands, Luxembourg, and Finland. S&P put the later three on negative outlook for a possible future downgrade however. The EFSF bailout fund itself may also be downgraded.

The current debt crisis that is now impacting the entire eurozone started in Greece in late 2009. The problems there have yet to be fixed despite numerous mainstream media reports to the contrary in the last two years. Greece is now on financial life support. Any missed bailout payment from the EU will send it immediately into default. Talks have broken down once again, but as before will once again be resuming shortly. The market has never been convinced that any of the proposed Greek bailouts will work.  On Monday, Greek one-year government bond yields hit a high of 416% and 10-year yields a high of 35%. These rates have continued to rise after each bailout proposal. Greece has to make substantial bond payments this March.

The EU's debt crisis is not getting resolved because it is no more possible to solve a debt crisis with more debt than it is to sober up a drunk by giving him more alcohol. Yet, every mainstream news article has comments from well-placed sources that are hopeful that some resolution will be coming to the EU's problems soon. Rarely is it mentioned they have been hopeful -- and wrong -- for the last two years as the situation has increasingly deteriorated. Nor is it mentioned that the Japanese with similar problems in their financial system have now been hopeful for twenty years that their economy will fix itself. Wishful thinking doesn't fix markets, nor do plans involving spining straw into gold -- no matter what central bankers and their toadies claim.

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.

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