From PEI

"Is the Global Economy Cracking Up?"

This week, our computer models begin with a Panic Cycle in global capital flows. The volatility is starting to breakout, and the entire global economic system is starting to become increasingly distressed. In mans eternal quest to always be optimistic, far too often the truth remains in denial. The economic disease that began in 1997 in Southeast Asia has not subsided. In fact, like the great flu strains of yesteryear that began in one region of the world and eventually spread to all others, the same can be said of the global economic debt crisis.

The US economy remains vulnerable to this global threat of economic chaos, and this chaos is emerging primarily from Russia, China and Japan. All three economic situations are having a dramatic impact upon the entire global economy, but the effects are slow to move, thus allowing periodic intervals of undue optimism to still flourish. The debt crisis is not over. It has simply been in temporary remission.

Russia is on the brink of another default. This is not speculationit is a fact. When the USSR broke up, Russia assumed the debt of all the former Soviet partsabout $100 billion to be exact. Since the collapse of the USSR, Russia itself has added another $40 billion in debt. The servicing of this debt has now reached virtually 100% of the entire national income of the government. They are bankrupt by every standard except those used by the IMF. What has been taking place is nothing more than a giant game of Russian roulette orchestrated by the IMF itself. The IMF lends Russia another $4.5 billion so it can then take that money and make interest payments so everyone can pretend that the world is safe and the debt crisis of the last two years is over. But this game is insane. Russia will never be able to pay off the debt of the USSR and it is starting to be viewed as unfair by the Russian people that they are being held responsible for the debt of all the former USSR states. There is a high degree of probability that the USSR portion of Russian debt will move into default. We see this issue coming to a head in early August or during the September/October time period.

The economy of China is also silently imploding. With 70% of its civil work force still employed in the production of agriculture, there is little hope that the deflationary trend in global commodities will not force the devaluation or floating of Chinas currency. We suspect that China can argue for a float and still go for WTO because the major G12 nations also float their currencies. It would be a difficult argument to insist that China must hold its currency in a fixed rate system when the dominant global exchange rate system is indeed a floating one. Continuing to maintain such a fixed rate system in the midst of higher global volatility would ensure a Chinese economy in serious distress, threatening not merely Asia, but the world. We cannot afford another bankruptcy case bristling with nuclear weapons and a taste for revenge.

Japan remains the real issue of concern. The BOJ foreign exchange intervention has clearly failed. Japan NEEDS a lower yen in order to stimulate its economy and prevent unemployment from rising sharply. Japan originally attempted to keep a strong yen because the government feared that a weak yen would be seen as a failure of the current administration. The shift to a weak yen policy in February was an admission that a strong yen perpetuates deflation and weakens the economy. Now, the failed intervention has raised the significant risk that government itself could lose its entire support next year. The government continues to resist the next step to monetization for fear of a major collapse in the yen. However, they may be able to postpone this until early 2000, but certainly not beyond that date. Any decline in the dollar/yen below the 111 level will have a DEVASTATING impact upon the whole of Asia and push Japan itself into an even worse economic implosion than we have seen over the past 10 years. This would destabilize Europe due to liquidation of 250 billion euros against the yen, with our models suggesting that the euro would simultaneously collapse well below the par level to the dollar. A decline in the dollar would also push China over its own wall (since agricultural products are primarily priced in dollars around the world) and a devaluation would become MANDATORY to remain competitive in commodities. A collapse in the dollar would also destabilize Asia as a whole. The net capital repatriation from US bonds could also have its impact by forcing US interest rates sharply higher. This would destabilize the US economy, and the economic contraction on a global scale could easily become unprecedented.

Indeed, the world may outwardly still appear happy, but inwardly it is not a happy place right now. The sins of the past still exist and are still waiting to be resolved. We need to see monetization in Japan to relieve this global deflationary trend. Japan is the second largest economy in the world and it represents 40% of total cash savings. The capital contraction taking place in Japan remains of vital importance to the global economy. The European situation is also critical and only a devaluation of the euro will help to smooth out the uncompetitive economic conditions that continue to plague this important segment of the global economy.

On the domestic front in the United States, the innovation of the Internet is so important economically that it can only be compared to the industrial revolution and the birth of the railroads. It was the invention of the railroads that provided the means to deliver goods coast to coast, which in turn broadened the possibilities for economic growth. The growth was so strong that the economy soon found itself restricted by the money supply that itself was limited by the gold standard. This gave way to the bimetal standard and the introduction of silver and the famous William Jennings Bryan speech about thou shall not crucify mankind upon a cross of gold. This time around, while the Internet burgeons the global economy ahead, growth is being restricted by the capital contraction in Japan.

The Internet is already reshaping our economy and forever altering our future. In a recent study by Piper Jaffrey, the online brokerage industry has captured $420 billion in assets and 8.5 million accounts. This is expected to exceed $1 trillion by 2003 with more than 23 million investors online. Banking is rapidly moving in this direction as well. As e-commerce expands, it will displace vast sectors of the old economy and in its own way contribute to the overall deflationary trend as the cost of doing business is further reduced.

Indeed, it has always been said that the Chinese curse of May you live in interesting time seems to be appropriate for our modern situation. Japan must now monetize to save not only itself, but also the world. During the Great Depression, that responsibility fell upon the shoulders of America. Roosevelt was forced to DEVALUE the dollar by 69%. His confiscation of gold was an act to ensure that the bulk of that profit fell into the hands of the government, rather than the private sector. This is where we now stand in the timeline of history. If Japan FAILS to recognize its responsibility and continues to launch investigations of foreign firms in an effort to shift the blame to private banks for the sins of the past 30 years, then a great deal globally may be lost. While the US lost two-thirds of its banks during the Great Depression, it must be understood that the majority survived until the last 6 months. It was during 1932 that the bulk of US banks collapsed in a wholesale manner. We fear that the same fate of Japan lies around the corner. With the government 100% guarantee on all deposits expiring on April 1st, 2001, we are already finding Japanese companies seeking to prepare for the future by shifting their deposits out of the banking system. The Japanese corporate community will have little choice but to become more like their American counterparts who rely upon the capital markets rather than banks for support and deposits. There is no reason with time that Japan cannot and should not reemerge as the powerhouse of Asia. However, we may have a very difficult period immediately ahead as Japan gives birth to a long awaited financial reform.

Fasten your seat belts. We are about to enter the most volatile segment of the global economys journey into the 21st. century. The known deflationary pressures are clearly pitted against the potentially reflationist policy moves that we still await out of Russia, China, and Japan. In such an environment, how ironic it is that the popular media spends so much time, effort, and attention focused on Mr. Greenspans next 25 basis point rate decision. The media has once again succeeded in obfuscating and largely ignoring the truly important economic issues of our times.

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-- Andy (2000EOD@prodigy.net), July 31, 1999

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