The Domino Effect

Ramifications of the Asian Banking & Currencies Crisis

December 4, 1997

Since my first writing about a world wide financial collapse, the world has witnessed the bankruptcies of Korea, of two Japanese banks, and the fourth largest Japanese securities company. This is the start of a domino effect that will topple world financial markets. While timing is uncertain, as Asia struggles under a mountain of bad loans with over capacity in manufacturing and empty buildings, the end result is not. With inventories starting to pile up, and more manufacturing capacity coming on stream in 1998, deflationary forces will accelerate.

The world is starting to see that Japan's banking system needs to be bailed out and is talking about using the vast resources of the postal savings union. What the analysts fail to mention is that the resources of the postal-savings union have already been utilized to bail out the Japanese economy and that the real value of assets securing depositors money, like all Japanese banks, is far less than the value of the deposits.

Moreover, to fund a cash infusion into the banking system, they would have to sell an equivalent amount of assets already invested. A significant amount of the deposits in the postal-savings system has been lent to Japan's Fiscal Investment and Loan Program (FILP). Japan's FILP has borrowed 374 trillion yen from the public pension and postal savings systems and used the money to lend to 57 government agencies who in turn used the money to benefit the economy as directed by Japan's bureaucracy. Japan's FILP is in itself a fiscal time bomb, that may soon be unable to meet loan repayments and will implode if it were required to repay a significant amount of funds it borrowed.

The postal savings system could raise money by selling some of its stock holdings, but as the government has been using the postal savings system to purchase stocks to prop up the stock market, any significant sales by the postal savings system would devastate the stock market.

The postal savings system could also raise funds by demanding repayment of loans from borrowers, but this would cause a severe credit squeeze in the Japanese economy.

The postal savings system likely has its own bad debts to deal with, and has already used its resources to funnel money into Japan's FILP and to prop up the stock market. Any help that it can give the banks is at best limited.

Another option that Japan has is to cash in its holdings of U.S. Treasury debt to inject into the banking system. The problem with this is that even selling $200 billion in U.S. Treasury Bills is not likely enough to bail out the banks, and that selling this amount of U.S. Treasury will have significant effects on the world economy. While some argue that any sales by the Bank of Japan will be offset by other Asian purchases, it is more likely that instead of standing in front of the train, investors will catch a ride and move the market in conjunction with the Bank of Japan. Also, sometime, all the loans made for the yen carried trade must be unwound which will also put downward pressure on the U.S. dollar. If the Bank of Japan sells U.S. Treasuries, there would be severe ramifications: we could have a situation where the unwinding of yen carried loans causes a huge trade deficit; and speculative selling creating havoc with the U.S. dollar, driving its value down. Concurrently, interest rates would be rising substantially. A major drop in the value of the U.S. dollar and climbing interest rates could tank the U.S. stock market. I think that the Japanese yen is headed to zero, but it is possible that before this happens, sales of U.S. Treasury Bills by the Bank of Japan will tank the U.S. dollar.

There has been some talk about the Japanese not selling their U.S. Treasury, but borrowing against them. People should see this for what it really is: THE U.S. TREASURY PRINTING MONEY TO PAY FOR THE JAPANESE SALES.

The third option open to the Japanese is to call on the resources of the Bank of Japan and print money. This has already started through unsecured loans to bankrupt financial institutions. Ultimately, this will lead to a vast exodus out of all Yen denominated assets totally destroying the financial system.

The fourth option is to let financial institutions fail, allowing depositors to salvage some funds from whatever assets the banks really have. Undoubtedly, this would devastate the stock market and hurt depositors. However, as long as the market did not question the government's ability to service its own debt, the currency might be saved. Nevertheless, this option is still very questionable, as direct and indirect debt of the Japanese government is 150% of GNP, and therefore would not be serviceable in a major economic downturn (indeed, not that it is serviceable now).

The so-called "wise men" running Japan tell us that "all is well," that "no banks will fail," and that "THEY will guarantee all losses." We must indeed be very patient as to how THEY will accomplish this financial miracle. Has anyone asked, If these men are so wise:

"Why have THEY allowed the direct and indirect liabilities of the Japanese government to reach 150% of GNP?" ...and

"Why have THEY created a financial system, where banks and insurance companies have massive losses, which threaten the savings of the nation?" ...and

"Why, when the rest of the world has shown substantial growth over the last seven years, their economy has not grown, but in sharp contrast is now contracting at an annual rate exceeding 11%?"

I would be very cautious in trusting the wisdom of these "wise men."

The liquidity supplied by the Japanese banks has been a major force driving the world's economic expansion over the last several years. As the source of this liquidity contracts, the dire effects on the world wide economy will be devastating. Moreover, all direct exposure of the world's financial system to Japanese banks - whether through direct loans to Japanese banks or derivative exposure - will exacerbate the financial collapse.

The futile and mis-guided efforts of Japanese and other Asian banks still do not deal with the real problem. The reason that banks are in trouble is that borrowers cannot repay loans. This will not change, no matter how much money is pumped into the banks.

We are about to witness the transfer of wealth from the many to the very few. The savings of the many have been spent building and investing in assets that are now worth far less than the savings of the many. However, in a financial collapse, these tangible assets, the buildings and manufacturing capacity will be the only assets remaining. Whoever owns these assets will control the wealth of the world.

The demand for gold is now the highest it has been in the history of mankind. At the time demand is increasing, central banks around the world are telling people that gold is a terrible asset, while they flood the market within their gold loans to drive down the price. If ONLY 1% of the U.S.$12 TRILLION in Japanese savings moves into gold, this represents a demand for 400 million ounces at today's price. This will force all shorts to cover, which are reportably as high as 8,000 tons. Combined with normal industrial demand, this would explode gold demand to a level equivalent to 10 years of mine production. Should more than 1% of Japanese savings, or other investors in the world purchase gold, even this number will be ultra-conservative.

Having said that I must observe that in the short-term, the price of gold may continue to suffer... due to the public's current mis-guided perception of gold. NONETHELESS, it behooves us to understand and appreciate that the short position is so huge that it cannot possibly be covered. Therefore, the only hope for salvation of the shorts is (try) to destroy the value of gold.

The laws of economics are like the laws of science. They are based on logic and reasoning and pure mathematics. When man chooses to ignore these laws or create new ones unto himself, he must face the ultimate consequence. One day we will go to sleep as the world is now. And when we awaken, it will have changed in a manner that will never be the same.

India and the U.S. trump Italy as top gold jewelry exporters.