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

BOE Kicks Off New Global Money Printing Cycle

 

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.

Markets like money printing. The Bank of England (BOE) today announced its own QE2.  Statments from Fed Chair Ben Bernanke and talk of the EU recapitalizing its banks was already juicing up global stocks before the BOE took this earlier-than-expected action.

In its latest round of quantitative easing, the BOE will be purchasing 75 billion pounds in bonds. While some news reports euphemistically described this action as the BOE will be "spending" the money, the correct phraseology is that it will be "printing" this money. The BOE has previously printed 200 billion pounds to buy bonds starting in 2008 during the first credit crisis. The U.S. Fed has already engaged in two rounds of quantitative easing (only one of many ways that money can be printed) and a third should be expected.

Stocks had already turned around on Tuesday with big rallies. Fed chair Ben Bernanke made a statement that he was willing to do more to help the economy. Bernanke has been "helping" the economy since he started lowering the fed funds rate in September 2007. While he has helped the economy, the U.S. has experienced the worst recession and worst bear market since the Great Depression in the 1930s, the official unemployment numbers have remained close to double digits, the U.S. has had the largest number of bank failures since the Savings and Loan crisis, and thanks to his quantitative easing, the U.S. has been able to run a series of trillion dollar plus budget deficits that are going to lead to serious problems in the future.  Why shouldn't markets rally with more of that in prospect?

In the short term, markets don't care about dire consequences that are somewhere down the road. They rally based on liquidity and money printing provides it for them. While the news that the EU is going to recapitalize its banks sounds positive, there is little if any discussion in any article about where the money is going to come from. For the answer, picture a giant printing press spewing out fresh euro bills at break net speed. Investors should also expect a lot of nationalizations as part of this process. Belgium has just announced it will take over failed bank Dexia (described by the news media as "troubled"). Dexia is the largest bank in the country.

Market volatility is common during credit crises. Investors should expect continued market selloffs interspersed with big rallies. Ultimately, money printing will not save the day however because real value can't be created out of thin air. The day that will happen, is the day that PIIGS will fly. 

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.

World Markets Catch PIIGS Flu Virus

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 PIIGS (Portugal, Ireland, Italy, Greece, and Spain) markets are now all trading in bear territory. The selling that began there is now spreading around the globe in a financial contagion reminiscent of a number of previous financial crises and market crashes. Major Asian markets were down around 3% last night and the large European markets are lower by similar amounts today. U.S. futures dropped over 2% lower before the opening bell.

Market contagion is a not a new problem. A collapse of the weakest link in the global financial system can bring everything down if there are excesses in the system. This was seen in 1997 with the Asian financial crisis that began in Thailand and which soon engulfed all of East and South Asia. U.S. markets then had a 10.1% drop on October 27th and 28th of that year. A sharp bear market in U.S. stocks followed in August 2008. At the time, the U.S. economy and the global economy were in excellent shape. Today, the contagion that started in Greece and then infected the rest of Europe is occurring during a period when the world financial system is extremely troubled and still suffering from the damage inflicted by the U.S. centric Credit Crisis.

The latest round of selling in Europe is taking place as EU leaders are warning that European governments need to institute major economic reforms to promote growth or their economies will stagnate (stagnate apparently is synonymous with sinking into the sea). How they managed to figure out that it isn't possible for a government to continually spend a lot more money than it takes in is a mystery. Perhaps someone woke them from their naps and gave them an Economics 101 textbook. Hopefully, they will share this important insight with the U.S. and Japan.

EU leaders essentially ignored the Greek debt crisis for six months until the damage had become formidable and global. Only after the U.S. markets had their 9.9% plunge on May 6th did they come up with their almost $1 trillion euro rescue plan.  This amount was more than the U.S. TARP bailout in the fall of 2008. The positive effects from it lasted only a few days and stocks turned down once again. It looks like a trillion dollar bailout just isn't what it used to be. A much larger amount appears to now be needed than was the case only two years ago during the Credit Crisis.

The current handling of the problems with the euro by the EU shows the approach world leaders have taken to the deep and serious problems the financial system is facing. First you ignore the problem, then you try to manage it by public relations instead of taking the difficult decisions, and once a collapse is under way throw unlimited amounts of freshly printed money at it. While PIIGS flu is spreading throughout the markets, it looks like mad cow disease already infected central banks and elected officials of major countries long ago.

Disclosure: No positions.

Daryl Montgomery Organizer,
New York Investing meetup
http://investing.meetup.com/21

This posting is editorial opinion. Like all other postings for this blog, there is no intention to endorse the purchase or sale of any security.

Monday Update on the 2nd Global Financial Crisis

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.


It's Monday May 17th and the Euro is heading lower, having broken its low from Friday. The trade-weighted dollar has hit new highs for this move. European stocks are having a mild rally, while U.S. stocks are mostly flat. Asian stocks sold off on Sunday night. The ECB is withdrawing liquidity from the market and this should be a negative for stocks going forward.

If there is to be a near-term recovery in world stock markets, it is important that the euro rallies back to and above the 125 level - its low during the Credit Crisis.  The euro (FXE) traded as low as 123.24 on Friday and today has been as low as 122.71 in New York morning trade. A significant break in support has taken place and this is a major development. In all likelihood it indicates a much lower low in the future. What that low will be and when it will take place are of course the key questions that need to be answered. The euro's next support is at 1.20, and it is now heading to that level. That support is relatively minor however. A number of technicians claim better support around 1.07. The equivalent strong support that existed at 1.25 would be at 1.00 however. What unfolds in the future depend on how the EU continues to handle matters affecting the currency. Up to this point, we have only seen world-class ineptness coming out of Brussels.

For its part the ECB (European Central Bank) announced that it would launch a program on Tuesday to re-absorb the liquidity that it pumped into the market early last week. They intend to withdraw $21 billion (16.5 billion euros) through this operation. If the liquidity injection was good for stocks (the market did indeed have a huge rally coincident with the ECB's move), investors should consider the withdrawal of liquidity should be bad for stocks.

In Asia the Nikkei in Japan was down 2.17% last night and the Hang Seng in Hong Kong fell 2.14%.  European markets had a modest rally today, with the FTSE in England and the DAX in Germany rallying about half a percent. U.S. markets were basically flat in morning trade (they turned down dramatically just around noon). The trade-weighted dollar (DXY) was as high as 87.06.  The U.S. markets had a massive gap up on Monday May 10th. This can be seen most clearly by looking at Nasdaq, where no specialists delay the open to balance buying and selling. Prices fell into the gap on Friday and the very short-term technicals in the day's trading were ugly. The rule of thumb it that once a gap is partially filled, it will be completely filled (prices will go down to the bottom of the gap in this case).

Investors need to realize that the world's central banks are well aware of this crisis. How much comfort this should be to them is open to debate. The central banks all saw the global financial disaster that resulted from Lehman's failure in the fall of 2008. They all know that a small currency crisis in Thailand in 1997 spread throughout Asia and then damaged world stock markets for more than a year thereafter. This knowledge though didn't prevent the ECB from sitting on its hands for more than six months while the situation in Greece escalated into an international problem. The central banks then finally acted with a trillion dollar bailout (likely to be just the beginning). So, we can conclude the central banks haven't learned to react in time to prevent a future crisis, but they do know how to print money - a talent that has some serious downside risks if you don't like inflation.

Disclosure: No positions.

Daryl Montgomery Organizer,
New York Investing meetup
http://investing.meetup.com/21

This posting is editorial opinion. Like all other postings for this blog, there is no intention to endorse the purchase or sale of any security.

Liquidity from Euro Rescue Pumps Up Stock 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.


As I have said many times, liquidity is ultimately the driver of stock prices. A perfect illustration of that took place on Monday when a trillion dollar rescue package was announced for the euro before the market opened. After finding out about the latest big liquidity injection into the global financial system, traders went wild and the Nasdaq gapped up 100 points. Huge volatility though is rarely a good sign for the stock prices going forward.

The extreme move up could be seen as a positive event, if the problems in the eurozone will actually be solved by the recently announced euro rescue package. This is unlikely. First the need for a large-scale regional bailout indicates that we are still suffering from conditions that arose during the Credit Crisis. These have been papered over by previous massive bailouts that have paused the problems the world faces, but have not created long-term solutions for them.  Spending more money on bailouts means printing more money and this will ultimately have unpleasant consequences down the road.

Investors need to realize that the euro rescue effort is a bailout for the big banks, the ultimate beneficiaries of the many trillions spent previously by government  and central bank Credit Crisis programs. The debt crisis in Greece could have been solved instantly and without spending one penny on a bailout, if dollarization had been used to deal with the problem. Under this approach, Greece would have been allowed to continue to use the euro, but been kicked out of the currency union. This would have prevented contagion to the entire eurozone and markets worldwide. It would have cost nothing. Instead, we now have another trillion-dollar bailout to rescue the global financial system.

The euro rescue package consists of three parts. The biggest part is $560 billion in new loans from the 16 countries that are part of the eurozone. Of those 16 however, five - Greece, Portugal, Ireland, Spain and Italy (the so called PIIGS) are troubled. So it might be more accurate to say that these loans are really from the 11 more solvent countries in the currency union. The second part of the package is $318 billion from the IMF. The IMF is controlled by the United States from which it gets around 40% of its funding (if not more). So American taxpayers are participating in bailing out Europe for its misdeeds and incompetence. The third and smallest part of the rescue program is a $76 billion lending facility from the European Commission.

The huge gaps up in stock prices on Monday morning came after a short-lived market meltdown in U.S. stocks the previous Thursday. In a span of 16 minutes, the Dow Jones Industrial Average dropped 700 points and then rose 700 points. The Dow essentially opened up 400 points higher on Monday morning. Healthy markets don't have multiple big moves up and down, especially within a short period of time. Sudden big drops in the spring can frequently lead to much bigger drops in the fall. Recovery in the middle, usually lulls investors into a false sense of security. You may want to think about that while you're relaxing at the beach this summer.

Disclosure: None relevant.

Daryl Montgomery
Organizer, New York Investing meetup
http://investing.meetup.com/21

This posting is editorial opinion. Like all other postings for this blog, there is no intention to endorse the purchase or sale of any security.