Why The Financial Meltdown May Happen Sooner Than Expected

When I recently wrote my column on potential catalysts of financial crisis, I made a mistake. I assumed that these events may come to fruition in 2012. It looks like the world decided not to wait. The global markets entered panic mode recently. Numerous concerns about the condition of the European economy, the U.S. economy and the Chinese economy led to massive sell offs in financial markets across the globe. Institutional investors as well as small retail investors felt uncomfortable keeping their money in anything other than the safest investment in the world. For the time being that investment continues to be U.S. Treasury securities.

Some of the most widely-owned commodities and stock indices showed significant losses. Indices provide a simple way to measure the performance of entire sectors of the economy without having to measure the performance of each individual stock.

• The Dow Jones Industrial Average (“DJIA”) has fallen nearly 10 percent over the past six months. The DJIA is an index which measures the performance of the shares of 30 large capitalization companies that represent a cross section of our economy and are owned by a broad number of people.

• The NASDAQ Composite index has fallen 8.25 percent during the past six months. This index represents the performance of over 3,000 securities traded on the NASDAQ stock exchange.

• The S&P 500 index has fallen 11.45 percent over the past six months. The Standard and Poors 500 is an index which measures the performance of the shares of 500 actively-traded companies that are representative of our economy. Unlike the DJIA and the NASDAQ, the S&P500 is a float weighted index. This means that there is a direct relationship between the total value of the shares available for purchase by the public (“the float”) and a stock’s weight in the index.

• Commodities have also fallen significantly in recent weeks. Oil is down 24 percent over the past six months. Gold is down 9 percent in the past month. Silver is down 21 percent in the past month.

Why is everything falling?

Investors believe that the global economy is headed towards a serious recession. In the United States, unemployment continues to be high, the housing crisis shows limited signs of abating and the long-term fiscal condition of the federal government remains precarious. The odds of the United States entering a second recession have increased significantly in the past few months. The Federal Reserve’s attempt to prevent a second recession was met with large scale skepticism.

In Europe, serious doubts remain as to the long-term viability of the Euro as a currency. The sovereign debt of Italy was recently downgraded. Greece, on the brink of defaulting on its sovereign debt has reached a political impasse. Germany, the economic engine of Europe, lacks the domestic political support to in effect bailout its fellow Eurozone countries.

Even China is reporting disconcerting economic data. Manufacturing growth in China is starting to show signs of weakness. Local indebtedness, skyrocketing real estate prices and political pressures due to income inequality have increased the risk of China’s economy weakening in the short term.

How much more can the global economy take?

October will be a critical month. The European Union must decide if it will transfer additional funds to Greece so it can pay its bondholders and avoid default. The payment is part of a previously agreed plan but the lack of domestic progress in Greece on improving the underlying economic problems leave some doubt as to wither Europe will bail the country out. Should Greece default, it would lead to a global banking crisis as many of the bondholders are international financial institutions. Let’s wait and see how things play out.