The following editorial was published in Price Perceptions issue #1436 on June 18, 2011

Tipping Point for World Economy?

As indicated in the 6/4/11 editor's note of Price Perceptions, a preponderance of negative economic news has evolved in recent weeks. We indicated it had become obvious fiscal stimulus has not solved US economic problems. We concluded without additional government pump priming, investors were moving away from equity and commodity markets and into cash and government bonds. Since that issue, economic indicators have continued to deteriorate...

  • This week, China released consumer inflation for May this week at 5.5%. That was the highest rate in three years. Most importantly, food inflation increased in each of the past five months and reached an untenable 11.7% for May. Following the inflation announcement, the Central Bank immediately raised bank reserve requirements for the ninth time since last October. They have raised interest rates four times during that period. Riots and demonstrations have increased sharply in recent months over food prices, rampant corruption, wealth disparities and individual rights.

  • Last week, the Chinese government announced they would provide a $463 billion bailout of bad loans made to Local Government Financing Vehicles. This bailout is about half the size of the US TARP program of 2008. When comparing the bailout to GDP, China's bailout is the equivalent of 150% of the US bailout.

  • It is becoming apparent China's economy is also moving toward massive debt problems and bailouts. As their economy slows in months ahead, additional debt problems are likely to surface.

  • The overthrow of governments in the Middle East has led to chaos and extreme political and economic problems. Although foreign nations have provided significant aid and credit for food and essentials, it appears the need for future credits will continue indefinitely. With larger economies struggling throughout the world, credit may dry up for these nations, creating an even greater drag on the world economy.

  • Greece recently indicated they would be unable to service their debts next month without another bailout. However, member nations of the Euro Zone are in disagreement on the amount each will bare in a new bailout. As reported in The Gartman Letter, the European Central Bank holds 48 billion euros of Greek debt. However, their capital is only about 11 billion. Therefore, the European Central Bank faces major problems if Greece defaults on their bonds.

  • European banks also hold sizeable quantities of Greek debt. Moody's Investor Service warned this week they may downgrade three French banks with sizeable exposure to Greek debt. These banks rely heavily on US money market funds for short term capital. Fitch Ratings indicated this week that 44% of assets in the ten largest US money market funds were tied up in short term loans to European banks. Therefore, if Greece is forced to default on its bonds, not only would the contagion spread to European banks, but could also result in problems for US money market funds.

    Although hopes are high politicians the world over will come up with satisfactory solutions to these and many other financial problems, large investors are beginning to worry and are moving money out of markets and into the perceived safety of US treasuries. It appears the world economy is once again nearing the tipping point of financial stress. If solutions are not forthcoming in the very near future, equity and commodity markets could suffer much greater losses than many expect.

    Bill Gary
    President/Editor
    CIS, Inc.


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