Issue No. 6. November 1997 Posted in parts
All these elements are present in the economic Tragedy now unfolding in Asia. There is the noble hero: the hard-working, productive, disciplined Asian worker and manager. And economic hubris has been present in scads: nothing could go wrong. But, to me, the greatest resonance of true tragedy has been the inevitability that, as audience not participant, I have felt throughout as the drama has unfolded.
And the plot has not yet progressed to a conclusion. There is more to come in this play.
Back in June of this year, when I wrote the first Skeptical
Investor
The IMF provides various services to its members. Technical assistance is
offered in monetary and fiscal matters, and it also carries out what it
calls surveillance, which is "the process by which the IMF appraises its
members' exchange rate policies within the framework of a comprehensive
analysis of the general economic situation and the policy strategy of each
member" (Ref: IMF Web site). But the service of which most people are
aware is the financial assistance (credits and loans) extended to member
countries with balance of payments problems. Financial assistance, which
is usually in the form of short- to medium-term repayable loans, is
provided "to support policies of adjustment and reform" i.e. the money is
there to meet immediate needs while the recipient's economy is
restructured.
This approach can be very effective. The IMF is always extremely tough
minded--which of course is the reason that the South Korean government
resisted so long, unsuccessfully attempting instead to get direct aid from
America and Japan, and why the Malaysians refuse to even consider it. In
consequence an IMF aid package, though it may be very hard on many of the
residents of the country concerned, carries with it enormous credibility.
It is very effective medicine, and thus ought to boost the confidence of
creditors and investors: an absolute essential to prevent a further slide
and pave the way for eventual recovery. There is though an important
assumption in all this. It is that the root causes of the problems that
are besetting the nation concerned are mostly or entirely domestic.
What if, speaking hypothetically, the causes are primarily external? An
IMF package may then provide temporary relief, but obviously in itself it
is not addressing and correcting the international forces that are the
real causes. In a worst case where the problems are symptoms of
deep-rooted systemic global economic forces, country-by-country action by
itself will have no more overall effect than the manipulations and
gyrations of our national governments have had in the past in artificially
intervening in and manipulating our economies in the face of implacable
market forces. We are touching here on the nub of the
problem of divining the course and global implications of the events in
Asia. Are major underlying causes global or are they essentially domestic?
If domestic, then the analysts who project the effects on the rest of the
world in terms of current trade balances and business sectors will likely
not be far off the mark: the earnings of some corporations will decrease,
a tenth of a percent or whatever will be shaved off the GDP of this or
that country, "irrational exuberance" in the USA will decline a bit --a
good thing too--and all will turn out well. But if they are global, then
the picture is much bleaker.
In the last couple of months, I have been assailed by reports and news
items that clearly make the assumption--without supporting it--that the
problems of the Asian nations are domestic. A typical example is this
editorial from our local daily newspaper :- (The
Chronicle-Herald, November 27th 1997).
The fact that all these things were there while the Asian countries were
booming does not seem to have struck the editorial writer. There is an
element of truth in them of course, nothing in economics is simple, but it
is difficult to make a case for them as the ultimate cause of the
problems. Such arguments are little more than misleading rhetoric. They
spring from a left wing Western mind set, not economic analysis.
You will find such "explanations" throughout the media and financial
press, especially in Canada and the USA. The European press has been more
thoughtful, while the Asian (and Australian) press--being more directly
aware of the harsh realities--has often sounded closer to my own
position.
Among the pieces of evidence that I can offer in support of the importance
of non-domestic factors being driving forces are firstly (1) the
obvious"domino effect" as one country after another has succumbed. This is
much more than the kind of (initially short-term) reverberations felt by,
say, the European stock markets. It indicates an underlying systemic
problem, and the suggestion that all of these economies are suffering
simply because they all share the same domestic weaknesses, is an argument
that, for me, is hard to swallow. What about Hong Kong? And now Japan?
Both are very different in many important ways from Thailand, the
Philippines, Malaysia and Indonesia, but both have been affected.
Secondly (2) is what the actual economic response has been to the IMF
bail-outs so far being negotiated or in place.
Considering that IMF packages are potentially such effective medicine for
sick economies, I will argue that any real evidence that such intervention
is not working also constitutes evidence--not proof mind you--that
important underlying problems are external in nature.
At this point (end November) early evidence is that IMF intervention in
several countries has not arrested the slide. ( I know that it can be
argued that things would be much worse without them. But that is
untestable. And it is not the point anyway.) IMF intervention in the
Philippines,Thailand, and Indonesia, and anticipated help for South Korea,
has neither prevented the effects of the crisis from spreading, nor even
prevented further deterioration in the nations concerned. Now that the crisis has spread to much bigger countries, the nation
where the problems first surfaced--Thailand--is no longer front and
foremost in the news. But it was the first, obviously has importance in
the mosaic, and is a pointer to what may happen elsewhere. Despite a $17
billion IMF-led assistance package, its currency and stock markets have
continued to slide. By last night (28th Nov ), Bangkok's SET Index had
fallen to yet another new low of 395, off 77.5 % from its peak ( 1753 ) in
1994. On the same day Moody's Investors Service cut Thailand's sovereign
debt ratings to one notch above the level for junk bonds. And consider South Korea. When this nation's currency collapsed in
mid-November and it too had to throw in the towel and go cap in hand to
the IMF, the announcement that it was seeking a $20 billion package was
followed not by stabilisation but instead by further financial and
economic chaos. Amidst panic selling and demands that the markets be
closed, by last night the KOSPI had collapsed to a low of 412, the lowest
level in more than 10 years. (Note added 29th November: the KOSPI fell
further to 408 in the abbreviated Saturday trading session: down 17% in
one week.) The stock index (High = 1138 November 9, 1994) has fallen 37
percent so far this year. The recent plunge was led by bank stocks, which
began falling sharply after Moody's downgraded South Korea's foreign
currency ceilings for bonds, notes, and bank deposits.
I must emphasise again that none of this constitutes proof that the IMF
packages are not working. It is suggestive though and for investors
attempting to assess the severity of the Asian crises I
suggest:- Point 1: Watch not only whether the crisis continues
to spread geographically but also what is happening in those economies
that receive IMF help.
My own view remains as follows. Systemic global forces--especially the
movements of capital being engendered by the strength of the USD--are the
important factors. The Tragedy that we have watched playing itself out
upon the global stage probably has several more Acts in store.
Point 2: with the crisis in Asia still fluid, I do not see any
evidence that it is yet the time to "bottom-fish" any of the equity
markets there.
It has been pointed out by some commentators that Japan is different and
the problems there are not the same structurally as those being
experienced by other Asian nations. This is certainly true: particularly
in that they are facing huge external foreign currency denominated debts
whilst Japan has huge reserves to draw on. But remember also that it is
facing the current crisis before it has recovered from the collapse of its
own 1980s bubble.
One of the things to watch for in gauging the underlying severity of their
financial problems is evidence that funds are being redirected from
international holdings to domestic needs. In the initial stages, this will
not be from the strong currencies (USD, GBP, DM, etc.). Weak currencies
including the Australian and Canadian dollars are the vulnerable ones:
these may prove to be leading indicators.
The flow of capital--driven by both the strong dollar and by the risks of
Asia and elsewhere--has continued to support Wall Street and has also
driven down US government bond yields. Equity investing by domestic
investors, as evidenced by net mutual fund inflows, was reduced for a
while, but many investors now appear to be convinced that the overseas
crisis has been contained. Many are anticipating a resumption of the long
Wall Street bull market.
Alan Greenspan's remarks last month--which left no remaining doubt that
the Federal Reserve considers US stocks to be overvalued--suggest that
investors will worry about a preemptive interest rate hike if the DJIA
looks like it is going to reach its August 6th high of 8259 again. I think
this will limit gains. However a reader e-mailed me the other day
suggesting that the market in 1929 seemed much more "frothy" than today.
This can also be said of the Japanese market at the end of 1989, so I have
to accept the possibility that we may experience a speculative blow-off.
The ultimate economic consequences will be very severe if that is what
happens.
Point 3: For now, I see a continuation of the well-established
trend of strengthening USD assets. The dollar may strengthen further, US
T-bill yields may remain around 6% or even fall, and stock markets are
likely to remain range bound, though a final speculative blowoff is
certainly a possibility. Investors have, however,
apparently lost sight of the fact that even before the Asian crisis, when
everything looked to be going well everywhere, US equities were already
grossly overvalued. One of the underpinnings of the New Era thinking that
could be trotted out as--in my opinion spurious--justification for these
valuations was the benign effects of globalisation. This has now been
dealt a severe blow. Japan, Hong Kong, South Korea, Singapore and Taiwan
together take almost 25% of American exports. Thailand, the Philippines,
Indonesia and Malaysia take 4%. Thus almost 30% of exports go to the
region directly affected. And the anticipated surge in exports from the
region will further erode America's already bad trade imbalance. Just
these facts alone ought to make the bulls take pause.
At some point it will all fall apart. I now believe that a fall of 40%-50%
in average stock prices (rather than something similar to 1987) is the
most likely consequence. By a very rough comparison with America (1929-
),Japan (1989- ) and SE Asia (1994- ) it should be a couple of years to
bottom: implying late 1999. The Last Act.
The bank rate stood at 3.25% in mid-June. There have subsequently been
three increases of 25 basis points each (June 26, October 1 and November
25), but, despite this and several bouts of direct intervention in the
market, the currency lately slid to its lowest level against the USD in
several years (now just above US$0.70).
Considering that I can remember when the Canadian dollar was worth more
than the USD,it has suffered a secular decline over the last two decades
of about 30%. The eighty cent dollar is a pipe dream.
I expect further interest rate hikes (the business press here seem to
think another 50 basis points) just to maintain it in the US$0.70-0.71
range, or instead a further depreciation. Further speculative attacks are
also likely.
The Canadian stock market is weaker than that in the US, and, in the event
of a bear market or crash there will almost certainly suffer at least as
much here. The Asian turmoil is bearish for Canadian resource stocks,
which are overweighted in our main market indices (reflecting the
economy).
Point 4: If you are a Canadian resident, consider the possibility
of currency diversification to hedge against further currency weakness.
Others, in my opinion, ought to avoid CAD denominated assets
altogether.
Question: One question that crosses my mind
is that of the U.S. dollar. It would appear that investors outside the
U.S. have chosen to park their funds in the USD as a ( temporary?) safe
haven. This appears to have driven the U.S dollar to unrealistic high
values in relation to other currencies world wide. I am tempted to take
advantage of this artificial high and convert funds to a different
currency. The problem, which one?
Response: "There is no totally safe haven. Have you considered holding a
diversified portfolio of several currencies? Because their "values" are
mostly just relative to each other, that may offer some degree of safety.
And, if I am correct that we are entering a period of global deflation,
the purchasing power of such a portfolio ought to increase.
Those currencies that spring to mind include the Irish punt, which is very
strong now; the Pound Sterling, which is also doing very well (the UK has
a very strong economy and the pound is also seen as a "safe haven"from EMU
and the Asian crisis); the German mark; the Austrian schilling; and the
Swiss Franc (weak these days, but being near its recent lows versus the
dollar some pundits think is a good buy. Maybe.). I would include the USD
in my mix. I would not myself include any Canadian dollars. You can get quite good interest rates even on instant access
deposits in most of these currencies (e.g. 7%+ on Sterling) from Offshore
Building Societies in the Channel Islands or the Isle of Man*.
Another strategy is to use an offshore Managed Currency Fund. Though that
is for medium or longer term investments (they typically charge a 5% front
end load).
All this is just in my opinion of course, but I hope it gives you some
food for thought."
[Offshore British and Irish Building Societies offer currency accounts in
Sterling, Irish punt, US dollars and D-marks. They are very safe
institutions, well regulated, and set up so that you can conveniently
operate your account by mail, or --subject to some common sense
restrictions--by fax or telephone. These are interest bearing deposit
accounts, not cheque accounts. Often used by international investors who
are looking for reasonable interest rates combined with great safety. If
you would like to find out more, pick up a copy of the monthly London (UK)
magazine INVESTMENT INTERNATIONAL: it always has lots of ads and
information about these institutions. As for managed currency funds there
are many to choose from: the above mentioned magazine usually also has
some information and adverts.]
Copyright© 1997 Max
Moseley and The Skeptical Investor, All Rights
Reserved.The International Bail Outs. (posted 28.XI.97)
The International Monetary Fund (IMF) was established at a conference held
in Bretton Woods, New Hampshire, USA, from July 1-22, 1944. It came into
official existence on December 27, 1945, when 29 countries signed its
Articles of Agreement (its Charter), and commenced financial operations on
March 1, 1947. It now has a membership of 181 countries.Whether it is bad
debts, corporate losses, political cronyism, weak bank regulation or a
lack of respect for human rights, the countries now in trouble have
largely got themselves there by hiding things.
Japan (posted 30.XI.97)
Events in the last month have lent increasing credence to my stated
outlook. Within the five weeks subsequent to the Nikkei 225 falling
through the 17000 level (see Issue No. 5 October
1997), four financial firms have collapsed. The yen too has weakened
against the dollar and the major European currencies. The timing of these
events shows them to be correlated with the ongoing regional chaos. Given
that the situation elsewhere in Asia continues to deteriorate, it is
reasonable to assume that we will see the same in Japan, and I will be
very surprised indeed if no more financial firms go under. I also expect
that the country (which has been experiencing low but positive growth for
several years) will slide into recession, but it is too early to predict
whether this will be as far as things go. If the worst that happens is a
mild recession, then it is likely that the western economies will
experience nothing more serious than some slowing of growth. But a severe
deflationary recession or depression in Japan will, as discussed in
previous Issues, be very damaging here too. The Japanese economy certainly
now looks to be the key, and it is too big for the IMF to bail out so for
some time it may be wise for those of us living and investing in the West
to listen as carefully to Tokyo as we do to Alan Greenspan in
Washington.What is Japan Doing? (posted 1.XII.97)
The Nikkei 225 climbed back above 17000 by the close: this partial
recovery has been driven to a considerable extent by finance stocks.
Apparently what is behind this is the belief that government is about to
abandon its long-standing position that it would not loosen fiscal policy
to stimulate demand. This was an election promise, but there has been
frantic international pressure in the last couple of months for Japan to
resort to Keynesian pump-priming to boost the economy. And the severity of
the problems may have caused them to lose their nerve: I also wonder if
some secret deal was made at the recent APEC meeting in Vancouver.
Whatever has happened, this will be a dangerous course. The only thing
that gets an economy going again is real business activity generating
wealth through real enterprise. Government spending never has and never
will succeed in stimulating productive activity: it is more likely to
destroy enterprise. Worse, pumping liquidity into a dispirited economy
increases the money supply whilst not increasing total business
capital--by which I mean productively employed money--and is thus
inflationary. If such a scenario develops in Japan over time, the only
choice may be to allow runaway inflation, or do an about face.The United States (posted 1.XII.97)
There is nothing mysterious in the apparent paradox that America* can
experience a growing economy, even potentially inflation, whilst at the
same time being inextricably woven into a deflating global environment.[*
and the United Kingdom too]Canuck's Corner (posted 1.XII.97)
Every year around this time I go along to the investment seminars offered
by the major Canadian banks and brokerages, and listen to the (now
predictable) opinion that the Canadian dollar is "fundamentally
undervalued". I understand why this is believed, but have consistently
disagreed: in the last thirty years Canada has been turned into a
thoroughly socialist nation crippled by confiscatory taxes and every
species of Politically Correct claptrap known to man. No state run on such
lines can do well, and this one will continue to decline until there is
real change. Canada survives now only because it is a huge country, rich
in natural resources and with a small population. The much vaunted Federal
deficit reduction has been achieved mainly through massive tax grabs:
spending reductions have been restricted to a large extent to "soft
targets" such as the Armed Forces. Currency Diversification
A reader recently raised the question of which currency to park cash in
for maximum safety:-