Greenspan Commentary:

WASHINGTON, February, 24 1998 (AP) - Federal Reserve Bank Chairman Alan Greenspan hailed the remarkable performance of the U.S. economy today, but warned that "storm clouds coming out of Asia carried unusually high uncertainty about the future."

Delivering his semi-annual economic report to Congress, Greenspan may be forecasting the same grim scenario seen and reported here by John Kutyn.

With the recent rise of the Nikkei to the 17,000 area and record breaking levels from the Dow, it would appear to most that Asia's financial problems are under control. In their greedy search for gain, people are under the spell of an illusion - not able to see what is really happening. They fail to see that financial collapse relentlessly gathers steam on a hourly basis.

There are now two things that will trigger the collapse of Japan: Financial deregulation of the country, or the devaluation of the yuan.

A credit crunch of alarming proportions is developing in Japan. Nomura Research Institute's chief economist, Richard Koo, recently said that Japanese financial institutions tried to call-in loans of 30 trillion yen, equivalent to 6% of the Japanese economy. Interest rates have increased - some higher-risk borrowers being asked to pay between 18 and 20 per cent for funds. Additionally, the inter-bank loan market has dried up, causing great liquidity problems for financial institutions. Depositors are moving funds from smaller Japanese banks to foreign banks (Citibank in Tokyo recently ran out of account numbers due to the heavy influx of new customers), and to the larger Nippon banks, or the gigantic Postal Savings System.

Come April 1,1998 Japan's financial system is to be deregulated. This will free-up regulated deposits totaling an equivalent of about U.S.$2 trillion. These funds are sitting idle in insolvent financial institutions. Depositors are receiving a miserly interest of 0.50% per annum. It is widely feared by financial experts that if these funds abandoned these banks, they will collapse. Consequently, some are calling for a delay in financial deregulation. Mr. Yoh Kurosawa, Chairman of the Industrial Bank of Japan, recently said: "It is impossible that all 148 banks would survive. I think that less than 10 banks can survive international competition."

After years of financing the losses of corporate Japan, Nippon banks now brace themselves for onerous loan losses mounting daily in South-East Asia. Exacerbating the situation is the burdensome difficulty in obtaining offshore borrowings, and threat that nervous Japanese depositors may soon desert their own banks. It must be emphasized that Japanese bank losses are much larger than anyone now believes. For example: Chuo Trust & Banking Co recently took over the deposits and 1.3 trillion yen in performing loans from Hokkuido Takuskoko Bank. Concurrently, the Deposit Insurance Corporation assumed 1.7 trillion yen in non-performing loans (representing 57% of total loans). This demonstrates a growing negative stream of bank failures, where non-performing loans exceed performing loans. This situation is indeed grim… and growing grimmer by the hour!

Nippon bank losses reflect much larger losses within corporate Japan. These losses have suffered cancerous growth due to the crisis in South-East Asia. Subsequently, Japanese businesses are facing sharply higher interest rate costs. Moreover, major banks have curtailed lending. And if that weren't enough, Japanese consumer spending is plummeting – December's level declining 5% from last year's level. Unavoidably, massive bankruptcies will soon destroy the Japanese economy.

Fixed capital formation in China has risen from 20% to 34% of GDP since 1980. This led to a massive over-supply in high-end office and residential properties, resulting in a number of coastal provinces having excess power capacity surplus, and over-capacity in numerous capital intensive industries, and under-utilization of a large number of infra-structure projects. This translates into diminishing returns on investment. It's a financial mess.

Bad loans at China's banks now exceed several times bank capital - many state enterprises are incurring substantial losses, and inventories are unprofitably high, and uncontrollably increasing. Unfortunately, spending for new capital formation is not going to solve China's financial problems. They must sell what they produce at a profit… or else. Moreover, they must increase sales to reduce inventories, and must strive to more fully utilize existing manufacturing capacity. ALL THIS can only be achieved by a major devaluation of the yuan. China's economy will implode without a currency devaluation.

It matters NOT if the Chinese hold off devaluation until Japan collapses, because the ramifications of Japan's collapse will so decimate worldwide demand that China will suffer grievous difficulty selling goods at any price. On the other hand, a major devaluation of the yuan will trigger the immediate economic collapse of Japan. Japan's industry cannot tolerate another pricing shock. There are now two things that will trigger the collapse of Japan: Financial deregulation of the country, or the devaluation of the yuan. Should the Japanese deregulate AND China devalue, the collapse of worldwide financial markets will occur within months, if not weeks.

ALL THIS can only be achieved by a major devaluation of the yuan. China's economy will implode without a currency devaluation.

The West has it own dire problems. In Europe, particularly Germany and France, unemployment rates exceed 12%. Under-employment rates are estimated to equal this amount, leaving about 25% of the working population with no or marginal jobs.

Needless to say European banks and their financial base is unprotected to the large exposure of current and future trouble spots worldwide. Per the Bank of International Settlements, European banks lent U.S.$757 billion to Asia, Latin America, and Eastern Europe. To be sure, their third-world loan exposure risk is indeed high. As Japan pulls Asia into financial collapse, Europe inevitably must fall as well.

In the United States, domestic savings rates are far below investment needs. The U.S. needs foreign savings to close the savings-investment gap. In addition, the U.S. has a huge trade deficit - totaling $114 billion in 1997. The U.S. as a capital deficient nation is also obliges to spend billions of dollars in interest payments on its massive foreign debt. Some experts estimate that by 1999 the United States will Need capital imports of $250 billion to fund its growing deficits. If the rest of the world does not send their savings to the America, its economy will falter. Moreover, should the holders U.S. national debt (principally T-Bonds), dump on the market, this also will cause collapse. When Japan and China collapse, this is exactly what will happen. As long as money is moving out of Europe and Asia into the U.S., the American economy will produce the illusion of appearing solid. However, once these money flows reverse, the U.S. will take a dive.

Problems in Indonesia, Malaysia, South Korea and Thailand are well-documented. Taiwan could be the next major trouble-spot - with domestic borrowings 1.6 times GDP, and two-thirds of bank loans backed by property collateral. Interest rates are rising. Taiwanese companies are slashing prices to compete with Southeast Asia and Korea. And exports fell 26% last month. These are all the disaster signs in a highly leveraged economy.

Trade balances in Latin America have recently suffered major contractions Mexico's 1997 trade surplus decreased to $624 million from $6.5 billion in 1996, then plummeted to a $733 million deficit in December. Chile's deficit in 1998 is expected to increase to $3 billion from $900 million in 1997, due to falling copper prices. Argentina expects its 1997 trade deficit to be $4.7 Billion. Countries like Canada and Australia have huge public debt loads, much of it owned by foreigners. Recorded in their secret ledgers are the banks' exposure to derivatives. These contracts total tens of trillions of dollars. Few understand what impact these will have on world financial markets - though J.P. Morgan's filing two lawsuits totaling $480 million dollars against Korean financial institutions is most likely only the beginning of the horrendous losses which be ultimately incurred.

John Kutyn
25 February 1998