In Asia, bourses around the region mostly weakened in July- early August. Currencies including the Thai baht Indonesian rupiah and Korean won fell against the US dollar, which itself slipped against the yen and the euro. In contrast the strongest and most credible floating currency there, the Singaporean dollar, was the exception that proved the rule by gaining in value due to a regional "flight to quality". Risk premiums on Asian debt increased: the spread, for example, between US 10-year Treasuries - themselves experiencing a sharp increase in yield -and an index of equivalent Asian sovereign debt widened sharply from under 220 b.p. in early July to over 280 b.p.

Elsewhere, financial and political instability resurfaced in Russia. Latin American markets weakened: Brazil's BOVESPA Index was down 10% in July. In the euro-zone, industrial performance remained flat. Germany reported a strong increase in business confidence, but this has not been matched by performance because the latest survey showed industrial output to be "unexpectedly" flat. An important indicator of perceived risk, the TED Spread ('Treasury bill- Eurodollar'), which is the market interest rate differential between the US Treasury and the less liquid Eurodollar yield, has begun to widen. Starting June at 52 the Ted spread had risen to 85 by the middle of August.

Meanwhile the US economy and the similarly-behaving (though paler) UK economy continued to perform strongly. Everyone is aware of the remarkable record of non-inflationary growth in America, but in the UK too, the story is similar. The expectations earlier this year of a mild recession here have now disappeared. Unemployment is down, average earnings are growing "faster than expected" at 5.2% year-on-year according to the latest data, house prices in the prosperous regions of the country are rising at the highest rate since the housing boom of the 1980s, and there is a record trade deficit, whilst consumer price inflation remains below the government target of 2.5%. But in both the UK and the USA economic growth and particularly signs of wage cost inflation have begun to trigger alarm bells in the minds of central bankers and investors, and interest rates are considered to have bottomed for now in both countries. The markets see interest rate increases in both, though much sooner in the USA than in the UK where the consensus seems to be that they will be held steady until early 2000. The Standard & Poor's 500 index has fallen 6 percent from its high of 1,418.78 mainly on interest rate concerns. In London, the overall stock market is hovering near a six-month low.

The expectation of rising interest rates in both countries has, at first sight perhaps somewhat perversely, also resulted in a weakening of their currencies against the yen and the euro. The fall reflects the weakness of the dollar more than it does a strong euro. The pound has not moved as sharply: sterling appears to have moved from a period in which it strongly outperformed other major currencies to one in which it is holding its value well and is acting almost as a surrogate for a diversified basket of currencies.

Much of this all has a familiar resonance. There is similar pattern to that in autumn last year, even to the extent that there are rumours that another big hedge fund got into difficulties during the recent volatility through incurring big losses on its derivatives trading activities. But the resemblance is superficial and lest we jump to a conclusion too rapidly we had better note the huge differences.

I doubt that that is the way it will go. First and foremost the present degree of financial turbulence is not all that severe. It is nowhere near as virulent and there is certainly not the same appearance of "contagion" as last year. And, even more importantly, there are deep differences other than differences of degree between now and last autumn.

Last year the epicentre was Russia. A sovereign debt default and market plunge at a time of severe economic problems and deep pessimism about Asia and elsewhere was the immediate trigger for the crisis. Back then, there was fear of deflation, the yen was being propped up, and the dollar was benefiting from a near panic flight-to-safety of capital.

The present situation bears only a superficial resemblance. This time it is not events in Asia, Russia and the emerging markets are the driving forces. Last year's problem regions are merely responding, and, so far, responding in a reasonably measured and controlled way. With one exception, there is little economically or financially that is new - i.e. anything that constitutes an unexpected emerging threat - arising from within Asia, Russia or Latin America. The current weakness of their financial markets is due to two main factors. The expectation of higher interest rates in the USA is causing some downward revision of asset prices. Adding to this, events such as the effective bankruptcy of Daewoo, South Korea's second largest chaebol, and the resurgence of fears that the Chinese may be forced to devalue the renminbi, have forced many investors to wake up to the fact that rising stock markets in the region over the past half year were caused by optimistic investment flows more than they were reflecting real underlying improvement in the health of the region's corporations and economy. Progress in dealing with the underlying problems has been slower than the optimists expected, and the economic data coming out of Japan and elsewhere show this. In Japan domestic demand - which must be seen to be recovering for their to be any real end to their economic slump - remains very sluggish. But note that neither have the underlying problems, bad as they are, shown much deterioration either.

The exception that I referred to is China. If there is another massive shock that hits the global economy before Wall Street does the job for us, it is likely to emanate from The Peoples Republic. Forget about chest thumping over Taiwan, all they have to do about Taiwan is wait patiently. The danger is purely economic. China's economy is deteriorating. It is in the grip of deflation. Prices for farm produce have crashed, due to bumper harvests, and retail prices have been falling now for twenty consecutive months. On balance however, unless the US dollar plunges in value, a point which I will return to below, I do not see this tightly controlled nation imploding economically in the near future. An open society yes, democratic pressures would come into play, but not the PRC. And it has shown a steadfast commitment to a stable currency throughout the Asian crisis. It bears watching though.

Today, in sharp contrast to what was happening at this time last year, it is fears of inflation and of rising interest rates in America that are rippling around the world. There is no panic flight of capital from Asia. The yen is having to be held down rather than propped up. And, a really important difference this, the dollar is not benefiting from a flight-to-quality. Instead it is weakening on the foreign exchanges. This is a very big change indeed in market sentiment. As recently as mid-May, when we were seeing the beginnings of this bout of nervousness in the emerging markets sparked by the resurgence of fears of rising US inflation and rumours of an imminent Argentine devaluation, US Treasuries briefly gained as usual from flight-to-safety capital flows. Many investors presumably expected the same pattern as before. But it did not last, and instead, as nervousness continued to increase in global markets, the effect reversed, and the dollar and Treasuries fell.

In 1997, the crisis appeared Out of Asia. In 1998, Out of Russia. I have said it before, and I will say it again: I expect the next crisis to come Out of America. The epicentre has moved to Wall Street.

But the dynamic is different at every stage. It is the ongoing dynamic that offers some hope of understanding what is happening and thus of making prescriptive forecasts that are of practical use.

There is a large measure of agreement about the implications should the dollar plummet against the yen and other major currencies. They are enormous and they are dire: as I have repeatedly emphasised the dollar-yen exchange rate is the most critical factor holding together the sick global economy. A plunging dollar will bring down the US financial markets, finish off the floundering Japanese economy, sink China, and in turn bring the whole global economy to its knees. Which is why the authorities have for a long time been manipulating it, intervening in the currency exchange markets time and time again in order to maintain it within some desired range. This policy has been especially crucial in recent months with the ongoing effort to sustain a sort of stasis long enough for global markets to strengthen before Wall Street goes over the cliff. The Bank of Japan spent $35 billion in just June and July attempting to prevent the yen rising too much against the US currency.

It is worth briefly looking at what these implications are in order to understand why this is taken so seriously.

In America, what has been happening in the domestic economy is often called a "virtuous circle". I can see why, but am dubious about the use of such a term for something that looks more like an out of control feedback loop that will inevitably self-destruct. Whatever it is called though, what is certain is that it is fuelled by an inflow of foreign capital. The economy and the financial markets have become dependent, like an addict on his fix, on the continuation of this flow of funds. US households (believing that their capital gains in the stock market and mutual funds are permanent) are now spending more than they earn, thus drying up the domestic supply of capital and producing a soaring current account deficit, predicted to exceed $300 billion this year. Continuation of this inward flow depends on the continued attractiveness of dollar assets to overseas investors: and for that not only must financial asset prices continue to rise but the value of the dollar must be seen as safe to protect the value of their holdings. Lose faith in the strength of the dollar (especially with the huge amount of leveraged dollar-yen and dollar-euro "carry trade" bets out there), so the argument goes, and the direction of this capital flow will quickly reverse, triggering a surge in inflation, and bringing down the stock and bond markets.

In Japan domestic demand is not yet showing any real sign of recovery, so corporations are very dependent on exports for earnings. The negative effects of a stronger currency have already appeared. The average value of the yen in the first half of 1998 was 132 to the dollar. It was 118 in the first half of 1999. The effect on trade? Japan's current account surplus in the first half of 1999 dropped 15% from the same period in 1998, the first drop in two and a half years. It is not clear at what exchange rate the yen becomes too strong. Purchasing power parity is at about 115, but PPP is a very fuzzy statistic. I suspect that a sustained decline in the dollar/yen below 110 will be problematic but not critical whilst at under 100 Japanese exporters will no longer be able to cope.

A big decline in the dollar will also push China over the edge. There, domestic prices for agricultural products have already crashed: and since they are primarily priced in dollars export earnings will be hit badly too. Devaluation of the currency would become unavoidable to remain competitive in commodities. A collapse in the dollar would also destabilise Asia as a whole.

There is a natural tendency for those who understand that the world is tottering on the brink of economic disaster to pounce upon any sign and jump to the conclusion that "this is it!". But this is a danger; a siren song born of frustration with the irrationality of it all. It is especially dangerous now to use the fundamentals as a guide. I have warned before that because these markets have disconnected from economic reality, it does not make sense to use the fundamentals to predict when it will all fall apart. It has been a long frustrating tedious wait indeed. But patience, everyone! The consequences should the dollar plunge are dire. But we have not had a dollar plunge. It has merely weakened somewhat and, as I will explain below, the amount of currency movement that we have seen thus far may actually be thought to be desirable from a policy point of view. The questions we have to pose are - is a fundamental shift in global capital flows underway and is it possible that a dollar plunge will result?

To answer these we have to start from a different perspective; that of looking at why the dollar, whose value is widely accepted to have been too high on a sustainability basis for years, is as high as it is. The reason is that it has been maintained by governmental policy and central bank intervention. There is no doubt about intervention. The dollar-yen exchange rate has been manipulated for years with a great deal of success (although the indirect consequences have been unintended, negative and severe). Accept that and we can see clearly what we really want to know: which is have the authorities started to lose control?

The evidence is that they have not. The key turning point in the dollar: yen rate really occurred a year ago, and there has been no sign of loss of control since. In fact just the opposite. The facts point to successful intervention. In mid-1995, the dollar stood at a low near ¥83, rising steadily to approximately ¥100 at the end of that year. This trend continued and accelerated, with the yen standing at a low of 147 on June 16th 1998. On June 17th, massive joint US-Japanese intervention in the market pushed the yen up by almost 5% against the dollar within hours. That was the turning point. Apart from some periods of volatility, a trading range of ¥115-123 was maintained from October 1998 until the breakout a few weeks ago.

There is no reason to believe that this is anything more than an acceptable adjustment: one that may even have been desired. The markets can not only survive with a slightly weaker dollar/stronger yen, it may be seen as being healthy. Remember that the strong dollar is deeply implicated in the growth of the US asset bubble: perhaps this is an attempt to slow down and delay the growth of the bubble? In any case the stock markets in both America and Japan have not slumped so, if it is a planned adjustment, they have got away with it.

But, any sign that the move is going too far, and all the stops will be pulled out to head off a dollar plunge. Any run on the dollar and there will be joint intervention on a big scale. There is simply too much at stake. And intervention can work very effectively in these markets. How is that a free market analyst like me can say that the currency markets can be artificially manipulated? Well, it is because the other side of the equation - the traders - are not working on the basis of fundamentals either! The market now is just a big game of will and wit. Yes, the market will win in the end, but it will buck back in unanticipated ways.

On the balance of probabilities I am convinced that it will not be the dollar that brings down Wall Street, it will be Wall Street that brings down the dollar, and everything else.

Although further interest rate increases are anticipated, the Federal Reserve is clearly still endeavouring to make them without frightening the markets and triggering a crash. Each move is being signalled well in advance, testing market reaction very carefully to make sure that it is not going to react badly before the decision is made, and accompanying rate hikes with calming reassurances. What we have to watch for therefor is a hint that something more vigorous is about to happen:-

"There is however one set of circumstances . . . that might give us advance warning (of a crash). That is if the US Fed eventually decides that it has to take action and end the party. I think that they may signal their intent in advance. I am looking for evidence of first (a) a decision by the US Fed that the balance of risks favours popping the bubble, followed (b) subtle signals, mainly ignored by the markets, that it is their intent to do so in the near future."
(The Skeptical Investor 20, B. July 1999)

The crash may of course happen spontaneously without the Fed doing anything, in which case I expect to miss seeing it coming. But I think that monitoring their public presentations for hints offers us the best slight chance we have of predicting it.

If my analysis of Fed strategy is correct, then it would be expected that they would back off temporarily in response to the current bout of weakness in the markets. This is what seems to have happened.

In his testimony on June 17th, Alan Greenspan was uncharacteristically forthright about the economic imbalance that the level of asset prices is propagating through the economy - he saw it as an inflation threat - and he reiterated this at one point in his Humphrey-Hawkins testimony on 22nd July, viz.:-

"To an important extent, this excess of the growth of demand over supply owes to the wealth effect as consumers increasingly perceive their capital gains in the stock and housing markets as permanent and, evidently as a consequence, spend part of them, an issue to which I shall return shortly."

But, significantly, despite saying that he will, he never does return to it. Instead, later in the written transcript of his testimony we find the following:-

"Going forward, the Members of the Federal Reserve Board and presidents of the Federal Reserve Banks believe there are mechanisms in place that should help to slow the growth of spending to a pace more consistent with that of potential output growth. Consumption growth should slow some, if, as seems most likely, outsized gains in share values are not repeated."

The inflationary danger that was central to his testimony on June 17th had, it seems, waned considerably a month later! It looks to me like the testimony was revised from an earlier draft that leaned towards predicting a growing inflationary imbalance, to a final draft more reassuring that things remain under control.There was no unexpected economic data that can explain this apparent change of heart. It was not really a change of heart at all of course: AG was just backing off, exactly as expected. There is no intention to pop the bubble. Not yet, that is.

PT SECTION: THE PURE TYPE.

The Pure Type PT is the true Perpetual Traveller: an individual who moves from place to place, never staying in any one jurisdiction long enough to become legally resident. The tax man sneeringly calls them "international floaters". Wherever they happen to be they are never anything but a tourist. From just the point-of-view of the legalities, for most people this is surprisingly easy to do. Most countries will let you visit for quite a long time, typically up to six months, as a tourist and, provided you do not make any income from employment or from a business within their borders, you have absolutely no liability to pay any local income or capital gains taxes. Such a person simply moves every few months from one jurisdiction to another - keeping track of course of the local tax residency rules in each place as they apply to multiple visits.

This vagabond lifestyle sounds extreme to most people, and only a few will even contemplate it never mind go ahead and do it, but it is not as strange as it looks. The rich have known about it and have been doing it for decades. Some have houses in several different places, and move between them. They used to do that before the tax implications added a financial incentive. Season to season. Town to country, or follow the sun. Then there are the yachts. The very rich, unlike the poor, rarely spend money unless there is going to be a return on it. Luxury oceangoing yachts can be a good investment in their own right. But then add the option of spending your time cruising from Monte Carlo to the Caribbean and back, legally avoiding all tax liabilities, and the reason for many floating palaces becomes clear. But it is easy for the really rich: they can provide themselves with all the creature comforts they wish anywhere, anytime.

For the rest of us, becoming an international romany involves sacrifices and will only ever appeal to a special few. But it can be done: I have met Pure Type PTs of very moderate means. Surprisingly, it is not money that is usually the limiting factor. If half your income is not being confiscated at the point of a gun, and you live in low cost countries, you do not need much. What you do need are the following. First - right attitude. Then - right (good) health. Then - right kind of income. Then - right paperwork, which primarily relates to citizenship and passport.

RIGHT ATTITUDE. You have to enjoy this way of life of course; it is silly to do it even for the considerable financial advantages if you do not like it. But it is important to realise that many of the barriers that most people think are there do not actually exist. They are illusions - the result of social conditioning and brainwashing. Read "How I Found Freedom in an Unfree World" by Harry Browne. It says it all.

GOOD HEALTH is self-evident. Medical insurance cover is another consideration, but is a big topic that I cannot attempt to cover here, except suffice it to say that excellent medical services are available in many so-called Third World Countries at a fraction of the cost in the West. Local medical insurance can often be had very cheaply, with services offered in excellent clinics staffed by well-trained doctors and nurses. For most people leaving behind their national health system is not the problem they think.

RIGHT INCOME. The Pure Type needs an income from an investment portfolio, held in a jurisdiction where there is no taxation of non-residents or non-citizens or investment withholding taxes; from a suitable business that can be run tax-free from an offshore financial center (which is what tax havens now prefer to be called); or from cash-in-hand work. A pension income may sometimes be all right, provided that it is not taxed at source. Some governments have defrauded their own citizens by forcibly extracting pension "contributions" (another government lie; they are really taxes) from them for decades, then later changing the rules and imposing new claw back and/or withholding taxes in order to avoid their moral and contractual obligations. Canada for example has done both with the Canada Pension Plan.

Complicated, and expensive, Trusts are usually not needed by the PT of moderate means in order to protect his assets. Such an individual tends to protect himself by keeping a low profile, and anyway a moving target is hard to hit. Even for a business an offshore corporation structure may not be essential. It depends.

RIGHT PAPERWORK. The Pure Type PT has to arrange his personal paperwork in such a way that no country can claim him as subject to its taxes. This is possible for almost everyone, except the unfortunate citizens of the three countries that tax their nationals wherever they live - the USA, Libya and The Philippines. US nationals may have to give up citizenship if they want to be a PT and stay within American law. Other countries impose taxes based on residency, not citizenship, so cease to be a resident and you are no longer liable. For people in many countries that is easy. Just leave. But most countries make you go through a bureaucratic dance in order to disentangle yourself from their clutches. This is done simply to make it so difficult to understand or to do that most people think they can't. But usually it is just a matter of understanding the rules and going through the steps in the right order.

More about this in a later Issue.