Issue No. 11. June 1998
Posted 14.VI.1998
Time will also tell whether, as suggested in the very first Issue, the world economy has entered the winding down phase of a global credit expansion/contraction cycle similar to that in the late 1920s and 1930s. Events in the last year have however made that prediction much more, not less, likely.
Last, but not least, I got through the entire year without using either of the words "impact" or "impacted"!
The stock markets of those Asian nations directly involved in the ongoing economic crisis have all fallen again. But the above list shows that there is a substantial second group of countries that now also are experiencing falling markets - notably Russia and Poland, South Asia (India and Pakistan), Mexico and South America (Brazil, Chile, Argentina, Columbia and Peru), and Australasia (Australia and New Zealand). The proximal causes of declining markets in this second group differ from country to country, but there are good reasons to see them as a second wave of economies that are falling victim to global contractionary forces.
Both the cause and the consequences of the big global trends are to be found in the interplay between the two mightiest economies on earth and their currencies: the USA and Japan. Given the combined dominance and power of these two nations it is not surprising that it is they that drive events whilst the rest of the world merely follows in their wake. Some day Euroland and the Euro will establish themselves as another such giant global economic driving force, but not just yet, and I am discounting the significance of the Euro for now. Even further out the Sleeping Giant, China, is going to emerge and may become the dominant world power sometime during the 21st Century. But not yet, though we certainly have to keep our eyes open for signs that the Yuan may be devalued again. For now though, it is still mainly the USA and its dollar and Japan and its yen that we should look to in our task of interpreting what is going on and using that interpretation to divine as best we can what may be coming next . . .
A long period of prosperity has, as it always does, resulted in the creation of more and more credit and global industrial overcapacity. There are complex economic reasons - relating to the level of interest rates, inflationary expectations, etc. - but suffice it to say here that obviously in good economic times banks become willing, even eager, to lend and entrepreneurs and businesses to invest in new projects and productive capacity to meet the ever growing demand. This process continues until eventually irrational optimism results in too much investment. Particularly insidious is the over valuation of real assets due to the unrealistic expectations that now dominate thinking. Malinvestment continues. This is invisible at first, but eventually something happens, some trigger that makes it apparent that much of the credit that has been extended has paid for fundamentally worthless projects and capacity. The whole thing unwinds. A business slump follows.
It looks today as though this is what is happening on a global scale. First to go were the fast growing Asian economies because they were the most vulnerable. Blaming "crony capitalism" for it is disingenuous. Crony capitalism stinks and I wouldn't be unhappy to see many of those involved strung up from lampposts, but it is just one of the things that caused over investment and malinvestment in Asia. No, the nations involved were the most vulnerable because of massive over investment, particularly in manufacturing for export, because this depended on continuing huge inflows of overseas capital to maintain it, and because of their dollar-linked currencies. (July 1997 Issue)Next in line, mainly because of its large investments in the region, was Japan. Had this nation by last year cleaned up the huge bad debts that had been carried ever since its own asset bubble burst, then it probably could have absorbed the effects of the addition of all the new bad debt created in the falling Asian Tigers, but it had not and the consequence is that it has been driven into a recession and the start of a deflationary slump.
The flow of flight capital from Asia and Japan into the dollar has continued, exacerbating the US asset bubble and worsening the crisis in Asia.
During the first phase of the Asian crisis last year, there was some weakening of currencies and stock markets in Latin America and Eastern Europe due mainly to the fear that they would be affected too. This fear receded to some extent as people began to think that the worst was over as Asian currencies temporarily stabilised and investors began bargain hunting for what they thought were cheap stocks. But real economic effects flowing from the events in Asia have increasingly started to appear. Worldwide demand is slowing and commodity prices are falling (the Commodity Research Bureau Index is at a five year low) so the economies of the next most vulnerable countries are now also being affected, resulting once again in weakening stock markets and capital flight (much of it into the dollar) from nations in Latin America, Eastern Europe and Australasia.
The reality of these capital flows and the forces driving them are not in doubt. Taken to their logical conclusion there can also be little doubt about what the outcome will be. There will be further economic collapses in more nations, and at some point a collapse of North American stock markets taking with them a crippling percentage of global wealth. When this happens there will be nowhere left to drive the global economy: we will then be in a worldwide depression.
As I write this, there is nothing going on to indicate that this is not what is going to happen. There is simply no slowing or reversal of the fundamental trends, most disturbing is the absolutely crucial dollar:yen exchange rate which is rapidly deteriorating ($1 = ¥144). Remaining confidence in the yen is evaporating everywhere. Every attempt to arrest or confine the spreading crisis has so far been an abject failure. Can anything now be done to prevent a global economic contraction?
The question now is whether there can be successful intervention to arrest this slide downhill. (By asking that question I am not joining the supporters of statist intervention. Anything that is done will inevitably cause worse problems somewhere down the line. But it is essential to assess what is likely to happen, not what I hope will happen.)
KEY STOCK MARKET INDICES.
Market..........July 1997.......June 12 close...Percent decline.
Hong Kong.......15055...........7915............47.4%
Indonesia.......731.00..........408.37..........44.1%
Malaysia........1230.0..........472.37..........61.6%
Philippines.....2815.0..........1829.0..........35.0%
Singapore.......1981.0..........1091.5..........44.9%
South Korea.....770.00..........302.81..........60.7%
Taiwan..........9000.0..........7117.1..........20.9%
Thailand........569.00..........279.37..........50.9%
CURRENCIES v. US DOLLAR
Market..........July 1997.......June 12 close...Percent decline.
Indonesian Rupiah...2432.........13800..........82.4%
Malaysian Ringgit..2.52.........4.00...........37.0%
Philippine Peso.....26.50........40.30..........34.2%
Singaporean Dollar........1.43.........1.74...........17.8%
South Korean Won........842.00.......1398.0.........39.8%
Taiwanese Dollar.......27.75........34.90..........20.5%
Thai Baht...........25.90........43.36..........40.3%
GDP FOR FIRST QUARTER 1998 (1Q98):-
Hong Kong................-2.0%
Indonesia................-8.5%
Malaysia.................-1.8%
South Korea..............-3.8%
So the first lines of defence - the provision of IMF bailouts to Thailand then when that failed to contain the problems, to the other countries, have been a failure. The next line of defence is Japan . . .
Western governments are still calling for Japan to do "something" to arrest the growing crisis. Their tone seems to imply that it is up to Japan to save the world economy, but there is little that Japan can do. They are now entering a full-fledged deflationary contraction. This is the first time this has happened in a major economy since the 1930s. Confidence and demand are drying up, and the country is in what an economist called Hicks in 1937 coined the term "liquidity trap" for. Further decreasing official interest rates, already at record lows, has not and will not stimulate business investment and enterprise. In a moribund economy where are the sound projects for which the banks, already gun shy of making any new loans because of the vast bad loans already on their books, will ante up the money? Or the entrepreneurs who will take the risk of investing in such circumstances? Lowering tax rates (without corresponding cuts in government spending) does not help either: the resulting increase in the government deficit means that the cuts will only have to be clawed back again in the future and many people know that and save the money rather than spend it. The Japanese are big savers anyway, and this admirable propensity is made stronger by a recession (many Japanese are very worried about the future now, and there are no investments available to them that offer significant returns). So, what about trying massive public spending as advocated by Keynes? Well first, Japan's budget deficit is already 7% of GDP and the country is also facing having to meet the growing unfunded needs of a rapidly aging population, as well as the consequences of the present recession. A soaring deficit now would destroy the Japanese economy for a generation.
Keynesians counter that such public spending will stimulate the economy and thus result in a falling deficit. It won't do either. This plausible sounding rubbish has been tried time and time again and has always been a failure and always will be. I suspect that many in the Japanese government think this too, hence the inaction that we keep hearing them accused of. (Prime Minister Hashimoto said as much a couple of months ago).
Some of the prescriptions being suggested (as far as I can see always by public funded academics in the West who will not have to personally suffer the consequences of their proposals) are bizarre. Media reports have described some of these Western economists as "positively bubbling with excitement" at the prospect of a great nation of 126 million people providing them with a real life empirical example of a liquidity trap and an opportunity to test their (in my opinion morally repugnant) theories. If you think that last statement a little strong, please reflect on the implications of the advice emanating from some very prominent economists that the Japanese central bank should print money day and night, flooding the economy and producing so much inflation that frightened Japanese citizens will run down their savings. And that the Central Bank should buy everything in sight - bonds, property, stocks . . . everything. Almost totally monetise the economy. Just put yourself in the position of a Japanese who has been saving all his life to provide for his and his family's old age having those savings wiped out by inflation.
"Rubin said the crucial job now was to stabilize conditions in other countries that have seen their markets swoon as investors have grown concerned about Asian-style meltdowns happening elsewhere. He said problems in Russia and South Africa and market turbulence in other parts of the world in recent weeks was attributable in part to fears the crisis could be spreading."
Does this mean that the authorities have given up on holding the line at Japan? More massive IMF bailouts on the way perhaps, this time for Latin America and Eastern Europe?
SE ASIA AND KOREA. There will be no more financial help other than those IMF and other programs already in place, and more debt rescheduling. Their economies will continue to wind down for now: international attention will shift to concern about political instability. As a proxy for the region, have a look at a 12 month chart of the Hang Seng Index. It was unaffected July-early August (the conventional thinking then was that the Thai crisis was irrelevant), then began to slide steadily during August and September as some Hong Kong corporations began to be affected (rational revaluing of some stocks based on new information). October saw crash and panic, bottoming in January (psychological collapse - no rational basis for valuing stocks was available). Recovery until the end of March (returning confidence meets reality of declining equity values as the real effects of the Asian crisis show up in corporate results). A trend line from the early August peak to the present approximate level of 8000 reflects the reality. Simply projecting this trend gives a reasonable forecast for the Hang Seng, and I expect something similar for the other countries.
EASTERN EUROPE. Part of the Second Wave. Russia is the key here. Despite a $10bn IMF loan which is already in place, the ruble has been under massive attack and the stock market is near collapse. Moody's has downgraded Russian sovereign debt to B1. During a recent bout of speculative attack on the ruble, the Central Bank had to take draconian measures to defend the currency, raising interest rates to 150% and massively reducing the availability of rubles (so that they would not be available for the short-sellers to borrow). These measures worked this time, but during the crisis it became obvious that other countries including Poland, Hungary, Ukraine and the Czech Republic were being directly affected. If the ruble is devalued, this is going to be another whole region plunged into financial chaos. Ominously too, the problems with the ruble weakened the German mark.
Market..........52-wk high.......June 12 close...Percent decline.
LATIN AMERICA. Also part of the Second Wave. One of the major factors here is the dependence of these economies on the export of raw materials. Prices are falling as economies elsewhere weaken. Oil prices, which have fallen severely, create real problems for Mexico and Venezuela, but most commodity prices are falling as demand declines globally. I expect these trends to continue: currency crises and stock market crashes are possible in this region.
Market..........52-wk high.......June 12 close...Percent decline.
AUSTRALIA. Australia is very vulnerable to the Asian crisis because of (a) the scale of its direct trade and other economic links with the region (for example Japanese Life Insurance companies are some of the world's biggest holders of A$ denominated assets and they have now virtually ceased making new investments), (b) its raw materials exports (which are affected by decreasing prices as the economic slowdown bites), and (c) a soft socialist anti-business political, legal and tax environment. The A$ is already at record lows, and without big interest rate increases, likely to push the economy into recession, it is expected to weaken further. Economic recession in Australia is now probable (GDP growth is still officially forecast as positive, but is being revised down): I think of Australia as another of the Second Wave countries.
CANADA. Not as directly vulnerable to the Asian crisis as Australia, but it also suffers from the effects of falling commodity prices and is economically weak due to its socialistic policies. The C$ is already at an all time low against the USD, and I expect it to deteriorate further. The stock market has been somewhat weak recently. The Canadian economy will probably slide into recession more slowly than, say, Australia - in fact it may not experience anything very severe unless and until the United States' stock markets crash (the Canadian markets will follow them down).
Copyright© 1998 Max Moseley and The Skeptical Investor, All Rights Reserved.