The Big, Continuing Stories That Could Derail 2011

Kim Jong-Il North Korea
Kim Jong-Il North Korea

It's the nature of major news stories to ebb and flow, rising to the headlines and then slipping out of the spotlight. But even if they fade from attention, a handful of long-term issues with the potential to disrupt the U.S. economy and global recovery will continue to play out throughout 2011. Despite the healthy jump stock prices made on the first day of trading this year, here are some stories that investors are better off not losing sight of during the next 12 months.

North Korea: After decades of stagnation and horrific hardship for its citizens, North Korea has reached a new and potentially dangerous juncture: Its aging dictator Kim Jong-Il is handing the reins of power to his son Kim Jong-Un, an untested leader with little military and political experience.

Transitions of political power in closed societies ruled by dictatorships are notoriously unpredictable. Adding to the potential for unexpected crises is South Korea's abandonment of its policy of appeasing the North's saber-rattling. For the past 15 years, South Korea and its ally, the U.S., have responded to North Korean aggression with subsidies that included grain shipments and increased trade.

South Korean patience has finally run out, and now North Korea has hit a wall. The strategy of aggression that has always paid handsome dividends for it has finally run dry. The problem is North Korea has no plan B. Without subsidies from China and the West, its fragile economy has nowhere to go but down.

Now, South Korea has proposed a plan for peaceful reunion of the North and South, along the model of China and Hong Kong -- one country but two systems. But there can still only be one central leadership, and the South has made it clear that it won't be the North. North Korea may reject that model in favor of ramping up its aggression in an attempt to force more concessions from the South and its Western allies.

If the North pursues a strategy of increasingly bellicose and deadly military provocations, the chances for miscalculation and wider conflict increase dramatically. Such a conflict would greatly damage trade and diplomatic relations between China, Japan, South Korea and the U.S.

Skyrocketing public pension costs: Americans are finally waking up to the unwelcome fact that unaffordagble pensions and retiree medical costs are a key reason for state and local government budget crises.

Cities, counties, university systems, school districts and states face staggering shortfalls in pension funds and rising costs of public retirees' health care benefits. Pittsburgh is grappling with a shortfall in the billions; North Carolina has an estimated $32 billion pension obligations and a $3 billion hole in its current budget; and the Manhattan Institute for Policy Research estimates that New York has a $120 billion public pension funding deficit.

Municipalities and states are raising property taxes to increase revenues, but declining property values mean they're raising property tax rates substantially just to keep revenues from falling. Higher taxes offset the recent extension of federal tax cuts, and they leave consumers less money to spend on goods and services.

The causes of these intractable pension funding shortfalls are numerous and complex, running from demographics (people living longer), ever-higher medical costs and Baumol's Disease, the economic theorem that the productivity of public services workers are inherently lower than goods-producing industries.

Trimming costs and raising taxes are often proposed as solutions, but the shortfalls are so large that "trim around the edges" strategies are unlikely to resolve the imbalances between what has been promised and what is affordable.

Income and wealth disparity are reaching extremes: Many commentators have addressed the growing income gap between America's top 1% and the other 99%, and a number of analysts have concluded that tax and political policies are the main causes of this extraordinary divide.

Unfortunately, the Federal Reserve's policies of zero-interest rates (ZIRP) and quantitative easing are encouraging the sort of financial speculation that benefits the top 5% of Americans, who own the majority of the nation's financial wealth. The Fed's goal is to stimulate a "wealth effect" by encouraging the appetite for higher-risk stocks, but the policies only improve the wealth of the top slice of American households.

The concentration of income gains and wealth in the highest tranch of American society and the failure of the Fed's "trickle-down" policies will have long-term political and economic consequences.

Housing will remain moribund: The robo-signing foreclosure crisis isn't going away, despite making fewer headlines lately. Trust in the institutions that govern homeownership and mortgages has been lost, and the mortgage-backed securities industry has been discredited for a variety of deep-seated reasons.

As a result, many observers see the potential for home prices to stagnate or even decline further in the years ahead. Economist Nouriel Roubini recently noted: "12 million households are already in negative equity, and 8 million more have a loan-to-value ratio of between 95% and 100%. Thus even a 5% fall in home price will push an extra 8 million in negative equity with risk of millions walking away from their home -- i.e. jingle mail."

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Eurozone debt problems haven't been resolved: Despite the recent bailout of Ireland, the eurozone's banking and sovereign debt crises are still very much alive. Austerity measures may not be enough to rescue banks and economies burdened with crushing debt loads, even as they reduce incomes and economic activity.

China's rising inflation: That nation's rapid growth has helped lead the world economy out of recession, but its growth depended on massive expansions in credit and borrowing, which have created a housing bubble and high inflation.

By the simple metric of comparing everyday prices for groceries and apartments in Boston and Beijing, a recent study found that prices are higher now in China than in the U.S., even though the average Chinese wage is roughly one-eighth the average U.S. income.

Skyrocketing costs for food and housing have the potential to trigger financial tightening by the Chinese government and even civil unrest. If China slows its torrid growth and Europe buckles under austerity budgets and higher taxes, then the global economy -- including the U.S. -- will feel the effects.