(August 30, 1997)
France had a colony named Guinea whose currency was ascoubidou. When that currency was sufficiently devalued it evolved into a French slang word meaning "worth next to nothing."
We have predicted for many years that the next bear market on Wall Street and corresponding boom in the precious metals would be ushered in by a crisis in the international currency markets or banking systems, yet another reason why all portfolios should maintain a "core position" in the precious metals. For example, we do not believe it is a coincidence that gold shares began to rally around the beginning of July, when Thailand devalued its currency, and that Mass Contagion triggered devaluations in Southeast Asia, Latin America and even distant Poland. In a sense, this gives us a "laboratory" to study what happens during devaluations, perhaps granting us insights into what we believe will eventually happen worldwide.
| Typically, central bankers print too much paper money, bankers lend on hyperinflated real-estate prices, governments run up too much debt and, suddenly, capital flees, sending a currency plunging. In an effort to correct their original bungling, central bankers then blunder into the Low State of raising interest rates to make holding that currency more attractive but ironically making it less attractive because of the perceived increased risk; meanwhile, the higher interest rates devastate business. |
During Mexico's devaluation two years ago the crackpots running their central bank pushed interest rates above 100%, which meant that people with credit cards had their debt doubling each year, wreaking havoc on the economy and especially harming poorer Mexicans unable to engage in more-sophisticated hedging procedures. As outlined in your editor's second book The Invisible Crash, their currency instead should have been backed by gold or silver, which would have sent interest rates plummeting because the paper could have been exchanged for "real money" at any time. Central bankers resist backing paper with gold because it would prohibit them from printing as much as they like. Precisely the point of gold-backed paper.
| Predictably, interest rates are soaring in Southeast Asia, yet another of what we call "Vesuvian tremors" with far-ranging implications. For example, half of Thailand's debt is owed to Japanese banks, which are still reeling from their own fiasco of having overloaned on bloated real estate in the 1980s; some of their banks have already failed and we continue to expect a much worse calamity ahead. |
Chinese communists' mindless exporting using exploited labor is undercutting Southeast Asian economies, bringing to mind TDL's old prediction of, "The Coming Competing Currency Devaluations." Many nations are devaluing against the US dollar, even including formerly hard-monied Germany, which we believe is the modern version of the infamous Smoot-Hawley Act, whose high tariffs aggravated the First Great Depression. Scooby-doo!
According to DRI/McGraw-Hill, China is one of the world's riskiest emerging stock markets because of the danger of a banking crisis; their huge percentage of bad loans carried by banks is the result of the communists having forced its banks to lend money to inefficient state industries in order to avoid unemployment, a form of welfare bribes. With one of the world's largest economies, a banking crisis in Japan would bring Mass Contagion to a frighteningly high level, with an unimaginable impact on its smaller and weaker neighbors. China exported $150 billion last year, almost as much as Malaysia, Thailand, the Philippines and Indonesia combined. The winds of change are again wafting over Asia, with Chinese overcapacity deflating prices, scarcely noticed by a Wall Street fixated instead on Hong Kong's prosperity. The devaluation of the Japanese yen, combined with Japanese dumping, might well be joined by a financial meltdown in the Philippines. The property glut in Thailand might undermine its banks' collateral just as in Japan in 1989. The Thai companies that borrowed in dollars or yen now owe more, at higher interest rates, so bankruptcies there are sure to rise dramatically, further undermining their banking system, in a self-feeding downward spiral. Indonesian banks' problem loans to real-estate projects more than doubled in the first quarter, and have since soared to nearly half of all Indonesian banks' non-performing loans. Raising interest rates by central bankers in Malaysia and the Philippines to defend their currencies only works until Mass Fear negates any interest height, militating against holding that currency at any interest rate regardless how high.
Those who follow our work know that TDL was bullish on Asia starting in 1979, but turned negative on Japan in 1989, and has become increasingly negative on the area since 1993. Hong Kong is still ebullient, but how long can they hold out?
As currency devaluations spread, it does give their exporters a competitive advantage, but imports of oil for example go up, which is an inflationary factor. Worse, England's central bankers have been raising interest rates "to head off inflation" like some - imagined cyber-posse corralling stampeding steers, but the higher pound is devastating their exporters. The world needs the stable currency that gold could provide as per "The Dines Plan" that we outlined long ago. With so many countries devaluing against the US dollar, it means our exporters are heading for trouble also, maybe in 1998, so we advise all TDLrs who do export to hedge in the futures markets. See how Brazilian markets plunged in July on fears of their currency's devaluation, and Latin America's largest economy spread its jitters to Mexico, Argentina, Chile, Colombia and Peru, as the fools at the central banks continue to raise interest rates.
Now that "everyone knows" Asia can only grow, on the bandwagon, agreeing with our former position from 1979 to 1993, up to their ears in emerging market funds, it's time for Asian pollyannas to pause, sense the wind, and take more seriously our position of increasing discomfort with investments in Asia in recent years.
As we observe nations pegging their currency to the US dollar, employing currency boards, the European Monetary Union, SDR's, these are all efforts to evade the unbending discipline of a gold-backed currency, and our unbending position since 1960 is that they are all doomed to fail.
| Eventually, Mass Fear will see an unbelievable flight out of common stocks and into the precious metals, and perhaps it has already begun in platinum and palladium. Plunging currencies and soaring interest rates will eventually translate into a demand for the security of gold, only awaiting a spark; perhaps it will be a spectacular bank failure, a currency collapse even bigger than Mexico's by some country, or maybe even a seemingly innocuous event such as a big gold discovery, waves of mergers and acquisitions, or a short-covering panic by sold-out funds and forward sellers in gold's futures markets. |
Also notable was Malaysian accusations that their currencies were being "sabotaged" by Westerners such as George Soros as punishment for having admitted Myanmar into Asean. Last month, - Malaysia's Foreign Minister complained about having been "bedeviled by currency fluctuation caused by hostile elements" which he called "villainous acts of sabotage and the height of international criminality." Considering the Low State of Blame (see Mass Psychology book, page 92), we can expect the Dines Nature of Paradox (DINOPA) to kick in and make their problems much worse. The cause of Malaysia's troubles are not Western "speculators," but their own unwise financial policies, especially having excluded gold from their monetary system, but the point we make here is that the Low State of Blame will be hurled at capitalists everywhere during the next bear market; beware having too high a profile. Southeast Asia might soon suffer runs on their banks, military coups, and the laughable prospect of Japan bailing out Thailand merely because it cannot afford to let Thailand go broke. And what will happen when Japanese taxpayers discover that their higher taxes are bailing out Thai banks? Will Japan pressure Thailand to raise taxes, and wouldn't that sink Thailand even faster? And why doesn't the world's press comprehend that the various currency crises, from Czechoslovakia, to Mexico, to Southeast Asia, are all part of an international malaise due to the lack of gold in the monetary system? Last week Russia lopped three zeros from their ruble, sloughed off by their central bankers as "saving unnecessary arithmetic." There are more US dollar notes circulating in the Russian economy than the supply of rubles, as the blind lead the blind. Poland dropped four zeros from the zloty in 1995, which was their way of concealing inflation from the public, and letting it go on longer than it would have had the zeros remained. We don't know of any other commentator in the world looking beyond local economic considerations when predicting interest rate trends, without grasping that a sudden currency upheaval could wrench interest rates drastically higher regardless.
The crisis in palladium continues as Japanese speculators have sold short around 1-million ounces, equal to perhaps 15% of annual production. Worse, US dollar strength has doubled the price of palladium in Japan. Russia produces about 70% of the world's palladium, but exported none in the first half of 1997 and has only dribbled out tiny amounts since then. Platinum and palladium are in severe backwardation, which means that supplies are so tight that there's a premium for immediate delivery but this is also true for three of the seven metals traded on the London Metal Exchange: aluminum, copper and zinc. All these short squeezes are yet again subtle "straws in the wind" that suggest inflation lies directly ahead, regardless of majority opinion.
South Korea's ailing property market seems set to erode further, spelling more trouble ahead for this country's slowing economy. Although unlikely to match the disasters in Japan and Thailand, South Korea's property problems could bring more pain to a country that has been shocked by bankruptcies at some of its most prominent companies. Korea's struggling banks, which rely on real estate as collateral, are watching their bad loans mount. Such declines seemed impossible during Korea's boom years. But by 1992, as Korea's economy began to slow and the supply of commercial property increased, the market began to turn. Michael Schuman, WALL STREET JOURNAL, 28 Jul 97
Today, the Thai Government formally decided to seek - International Monetary Fund assistance, underscoring the severity of its troubles and its inability to contain them. In the three weeks or so since, the Philippines has sought assistance from the IMF, and the currencies of Malaysia and Indonesia have fallen, making life more expensive and creating a welter of economic and political problems. From small towns to meetings of top Asian leaders, the talk is of devaluation, of economic stability or instability and of the perfidy of the West. "Asia has to be prepared for much slower growth in the coming 10 years," said Nikhil Srinivasan, a vice president at Morgan Stanley in Bangkok. Analysts, and bankers at the Union Bank of Switzerland, have estimated that Thailand will need as much as $20 billion in credits. Old cities have been transformed into stretches of mirrored towers. Roads are clogged with the sclerosis of growing wealth, private cars and motorcycles. Airports, once genteel single-runway, cozy-terminal affairs, are woefully inadequate. Growth seemed unstoppable. Now, the euphoria has dissipated as the global currency traders have decided that some of the shine on Asian economies glittered over growing patches of rust. The swiftness with which devaluations have swept the region suggested that underlying problems had been ignored in the charge into economic growth. Mr. Srinivasan of Morgan Stanley pointed to other economies whose growth will increasingly challenge South Asia's. The future, he said, "lies with the big economies of Asia, China and India." Edward A Gargan, Front Page, NEW YORK TIMES, 29 Jul 97
Southeast Asia's economic miracle survives for now. A month ago, Thailand quit propping up its currency and unleashed the world's worst financial storm since Mexico's near-bankruptcy in 1995. Across Asia, once-stable currencies were battered, interest rates rose, stock markets sank, governments shivered and, for the first time in years, Asian economies suddenly looked vulnerable. Much has changed all over Southeast Asia. The sudden loss of confidence by global financial markets wasn't supposed to happen to Asia's once-sure-footed tigers. The turbulence rattling Asian stocks and currencies is prompting many US investors to pull their money out of mutual funds investing in the region. All this lends an aura of prescience to Paul Krugman. Two years ago, the Massachusetts Institute of Technology economist won fame and scorn in Asia for he wrote, Asia's growth curve would eventually flatten. Thailand's government tried everything to forestall devaluation; police even raided two foreign brokerage firms it accused of starting rumors to drive down the currency. Thailand's central bankers faced a dilemma: Cutting interest rates to stimulate growth would threaten their ability to hold the currencies' value against the dollar. (Lower rates tend to drive down a currency's value.) Raising interest rates to protect the currencies would choke the economies. David Wessel, Front Page, WALL STREET JOURNAL, 5 Aug 97
Almost every economy in Asia will feel the ripples from this summer's wave of devaluations: higher interest costs because international markets fear further devaluations, lower export prices because the devaluations will intensify competition, reduced capital inflows because once ebullient foreign investors have become suddenly wary, and maybe a growth slowdown. Is this the end of the Asian miracle? It's now clear that growth in Japan's potential output began declining more than a decade ago, just when Western pundits became convinced Japan had all the answers. That slowdown was masked by the "bubble economy" of the late 1980s. Paul Krugman, FORTUNE, 18 Aug 97
The Dines Letter
June 7, 1997 June 14, 1997 June 20, 1997
June 28, 1997 July 12, 1997 July 21, 1997
August 1, 1997 August 18, 1997
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