(November 10, 1997)
"Hong Kong is in danger of beginning a Major decline around the summer of 1997" - THE DINES LETTER, Annual Forecast Issue, 17 Jan 97, Page 19
"Mt. Pelée in Martinique, 4,583 feet above sea level, erupted massively in 1902 killing more than 30,000 inhabitants of the city of St. Pierre; only two people survived, and only because they were in a thick-walled prison cell."
We have been warning about what we call "Vesuvian tremors" for a long time, and now the currency crash in Southeast Asia has transformed a financial crisis into an economic collapse from tremor to tremble.
The first reaction to a currency upheaval is to blame "speculators," as Malaysia's Dr. Mahathir has been accused by George Soros of being a "menace to his own country." This will someday happen on Wall Street, when investors ruined by "The Coming Father of All Bear Markets" will turn on speculators in anger. Wall Streeters are kings now, but the wheel turns and they will be blamed for the next bear market. Today's "investors" will be called "speculators" later. Indeed, already noted, currencies are finally impacting on US markets, as the Dow tends to rise and fall with the US dollar, supporting our theory that this has become a "Currency Market."
Brazil's central banker, 41-year-old Gustavo Franco, unabashedly admits to a policy of gradual depreciation of his currency against the US dollar, fulfilling one of the predictions in The Invisible Crash ("The Coming Competing Currency Devaluations"). Devaluations are erupting practically worldwide now, each nation trying to sneak a competitive export advantage over others, a modern version of the infamous Smoot-Hawley Act of 1930. Over half of Thailand's debt is owed to Japanese banks; we have been warning of trouble in the Japanese banking system since 1989. Thailand's debt is bigger than Mexico's, and might need a rescue of as much as $50 billion. Thailand's interest rates are moving steadily higher, to compensate for currency risks by holders. Korean banks are staggering under a mountain of bad debts, and a banking panic there could reverberate throughout Asia's creditors. The Russian banks are no prize package either, and on the Internet somebody in the Netherlands is warning that the Euro is going to be a weak currency, bypassing the press and media that had ignored him. The Internet is producing a truly new era, to which we plan to return in our upcoming 1998 Annual Forecast Issue. Meanwhile, the fools in Germany's central bank raised interest rates for the first time in five years, knocking down stock markets and triggering rate increases in France, Belgium and the Netherlands. Their purpose was to insure that inflation did not emerge as the economy improved. With German unemployment at record levels, higher interest rates as a cost of doing business will mean more unemployed, and as usual it is the working class that suffers from the folly of central bankers. The trouble with using experience as a guide is that the final exam often comes first and then the lesson!
Adverse Effects of Currency Contagion - Varied Sources
1. The Thai devaluation and its aftermath is a typical example of exchange-rate "contagion." The emerging academic literature on "contagion" describes how a fundamentally justified exchange-rate crisis in one country (such as in Thailand) can spread to other countries where the fundamentals are better (such as Poland and Brazil). A crucial insight from the literature is the notion that there is no magic shield, no unique combination of economic policies, that can guarantee the sustainability of a fixed exchange rate. This threatens to lead to a domino effect in a potentially very unstable wave of speculative pressure on the currencies of the region. If developing countries cannot borrow, they cannot buy products from other countries. The US runs a trade deficit with many Asian countries, and the effect of the contraction of these economies might be to increase the US trade deficit. Remember that the Mexican crisis converted a Mexican deficit with the US into a surplus and was slightly contractionary for the US economy. For Japan, which runs a trade surplus with many Asian economies, the effect will be to reduce the Japanese surplus. This will hurt the Japanese economy. Ravi Bulchandani, Morgan Stanley Dean Witter, 21 Jul 97
2. Many investors, skittish about the recent stock-market and currency turbulence in Asia, are yanking money out of Asian mutual funds. Dollars are flooding into European equity funds and Latin American funds, according to several fund-management companies. Pui-Wing Tam & Charles Gasparino, WALL STREET JOURNAL, 5 Aug 97
3. Who's next? That's the question many emerging markets investors are asking as they watch the roller-coaster ride taken by currencies and stock markets around Asia, from Bangkok to Manila. Some of them fear the next casualty may take place half a world away in Latin America. High on their list of candidates is Brazil. But many Latin American experts say the risk of currency contagion in Latin America and Brazil in particular is probably exaggerated. "We are not believers in the Asia-currency-contagion theory with respect to Brazil, and we consider the market attractively valued," says Jay Pelosky, Latin America strategist at Morgan Stanley, Dean Witter, Discover. In today's global markets, where capital flows in and out of countries can take place freely and almost instantaneously, the risk of currency contagion is a valid concern. After all, many investors remember how the Mexican peso crisis starting in December 1994 infected faraway Asia, sending ripples through Asian currency and stock markets. Morgan Stanley's Mr Pelosky says the meltdown in Asian stocks in August "had a big effect on Latin America," mainly because global emerging-market investors appear to have taken profits in Latin America in order to free up cash for redemptions in the wake of the Asian turmoil. Sara Webb, WALL STREET JOURNAL, 15 Sep 97
4. Echoes of Thailand are starting to resound through Malaysia's financial community. Tell-tale signs of depositors' unease also presaged Thailand's banking crisis and led ultimately to the suspension of 58 of the country's 91 finance companies. In spite of the similarities, bankers and banking analysts in Kuala Lumpur do not foretell a crisis of Thai proportions. But there is likely to be an acutely painful couple of years during which loan losses spiral upward and some weak banks and finance companies are forced to seek mergers with stronger counterparts, analysts say. James Kynge, FINANCIAL TIMES (London), 8 Oct 97
From the British pound's crisis of '92-'93 to the Mexican peso crisis of '94-'95, the knee-jerk response from policy-makers has been to focus on the events first, economics last. Malaysia's Prime Minister, still smarting from an over 20% drop in the dollar value of his nation's money, alleges a conspiracy to thwart Southeast Asia's upstart "Tiger" economies. "A few people ... in the media and in control of the big money seem to want to see these Southeast Asian countries and in particular Malaysia stop trying to catch up with their superiors and to know their place," he said in a recent speech to the annual World Bank-International Monetary Fund meeting in Hong Kong. In the speech, he labeled currency traders such as billionaire George Soros "unscrupulous profiteers" involved in "unnecessary, unproductive and immoral" trading. "Currency trading should be illegal," he said. His comments didn't inspire investor confidence. Malaysia's ringgit went on to lose another 3% of its value the following Monday. Peronet Despeignes, INVESTOR'S BUSINESS DAILY, 10 Oct 97
6. It is exaggerating only a bit to say that Japanese investment drove Southeast Asia's economies to prosperity. The Japanese are thus acutely concerned about the rumbling crisis on their doorstep, while their Asian friends, Thailand in particular, are desperate that Japanese banks and manufacturers do not react to the region's present turmoil by investing and lending less. For an economy that shrank by 2.9% in the second quarter, and may be lucky to grow 1% over the entire year, such a potential drag on growth is anything but insignificant. Out of pure self-interest, the Japanese are doing all they can do to help Southeast Asia overcome its crisis. According to a Thai central banker, Thailand's precarious financial sector will require another $10 billion or so. Investors in Japanese shares are also concerned. Although Asia accounts for only about 4% of the overall earnings of Japanese companies, car makers and manufacturers of electrical machinery have a particularly big exposure in Southeast Asia. These sectors account for more than a third of this year's expected growth in Japanese corporate profits. If demand in these countries falls further, so, almost certainly, will such companies' earnings. Of Thailand's $70 billion of external private debts, $37.5 billion are to Japanese banks.
| In Indonesia, around $22 billion of the officially reported $55 billion of foreign debt is owed to Japanese banks, and some analysts think that the country's true foreign indebtedness is much greater. The further their currencies fall, the greater the Southeast Asian countries' foreign debt burdens become and the greater the risk of default. |
In Thailand alone, some $40 billion of private foreign-currency debts fall due in the next 12 months. And rumors circulate in Bangkok of a moratorium on debt payments. This would sting Japanese banks, still struggling to cope with their domestic bad loans. In all, such worries could give an already shaky Japanese stock market the vapors. Last year, Japanese companies invested about $5.7 billion in factories or property developments in Thailand, Malaysia, Indonesia and the Philippines. This represents just over a third of all foreign direct investment in the region last year, and far more in Thailand. ECONOMIST (England), 11 Oct 97
China's economic gains show signs of slowing. Gross Domestic Product the measure of all goods and services produced by the economy grew 8% during the July-September period, a sharp drop from the 9.5% growth rate recorded during the first six months. If China's monetary authorities share that view, analysts said, they soon might lower interest rates and pump new loans to business to speed the economy along. Ian Johnson, WALL STREET JOURNAL, 21 Oct 97
8. An `Asian miracle' now seems like a mirage. The first twinges are being felt in a sharp economic downturn that has swept through Southeast Asia. Economists say the real pain the bankruptcies, the rising prices, the job losses is still to come, and many people here are bewildered about what is happening to them. "We all believed things were just going to get better and better," said a well-to-do woman who insisted on anonymity. "Nobody ever stopped to think." With their booming economies weakened by mismanagement and by the pressure of international exchange rates, their currencies have plummeted since the summer; then their stock markets followed. Their future growth has been thrown into doubt and their confidence is badly shaken. Foreign investors have fled. Hit first and hardest, Thailand demonstrates most vividly the costs of the downturn: collapsing banks, stalled construction sites, empty new office buildings and half-empty hotels, rising prices, spreading joblessness, an increasingly restive public, even suicides. Economists and politicians are scrambling to understand the causes of the contagion. The prospect of a future like this is particularly crushing in a country as assertive as Malaysia, where billboards proclaim, "The future is here!" Overloaded with suddenly more expensive foreign currency debt, enterprises around the region were plunged into crisis. Seth Mydans, NEW YORK TIMES, 22 Oct 97
...and the Currency Contagion Continues
The Dines Letter
June 7, 1997 June 14, 1997 June 20, 1997
June 28, 1997 July 12, 1997 July 21, 1997
August 18, 1997 August 30, 1997
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