The Global Market Strategist®

G7 Bail-Out of Brazil: How Many More Band-Aids can the Global Economy Take.

November 2, 1998

This week U.S. investors were reassured that the Clinton Administration's agenda to "do something" about the global economic crisis is, in fact, now being implemented. The world's wealthiest countries Friday announced a plan to allow the International Monetary Fund to more quickly send emergency loans to countries facing investor panic. The U.S. stock market responded with a sharp rally, now bringing it to a level representing a 62% retracement of its July to October plunge.

Yet, as I will discuss here, investors can be considered obstinate in their constant resolve to keep the bull market alive seemingly no matter what happens in the global and domestic economy. Moreover, as I will discuss, the powers that be--the governments and central banks of the world's wealthy countries--are applying Band-Aid remedies to a global crisis that slices to the deepest structural levels of the global economy in a situation of the magnitude not seen in sixty years, and they are virtually panicking themselves.

To be sure, U.S. economic figures from a soaring Trade Deficit (now $200 billion this year, fully replacing the $200 billion budget deficit of the past--has the government taken what was in the right pocket and put it in the left?) to plunging manufacturing and other economic figures strongly argue that contagion has arrived. Verily, Alan Greenspan's panic reduction in the U.S. Discount and Federal Funds Interest Rates on October 15 was, in part, arguably testimony that the Fed is more than concerned, too. Declining corporate earnings this quarter punctuate the slipping U.S. economic outlook.

Indeed, our report published as the bull market was topping last spring, Gold In A Deflationary Economy, discusses as part of its analysis the deleterious effects on the global economy of the international tendency to bail out countries "in trouble" with "emergency" loans. The report makes a case that Mexico 1995 only started a series of global shocks that will this decade and early next throw the decrepit global monetary system right in the face of investors and the powers that be for "review." That review will bring on many modifications, and possibly a return to the gold standard, as Alan Greenspan himself has favored for a few decades now. Investors in their "review," then, have clearly adjusted portfolios for 15 months now, and are still doing so with respect to countries still in grave trouble--large economies such as Brazil and Russia, among others.

None of this is to say that the wealthier economies should do absolutely nothing at all to help the Brazils, Koreas, Mexicos, and Russias of the world when they get into trouble. However, clearly even while ostensibly calm, the powers that be are in a state of virtual panic as they realize the present global monetary system does not work for the entire globe and its integrating economy and component countries. To be sure, a monetary system that requires countries like Mexico 1995, Hong Kong, Thailand, Indonesia, and Korea 1997, and Russia and Brazil 1998 to jack interest rates through the roof just to defend their respective currencies during investor flight capital episodes--thereby risking recession or even depression even in the process--leaves something to be desired. Even Europe in 1992, inclusive of one of the largest financial capitals of the world in Britain, had to jack rates through the roof to defend their currencies and stem a global flight capital episode then in progress. Britain that year was extruded from the European Monetary System as a result of the situation and has yet to re-enter, albeit for other reasons besides the 1992 episode.

To be sure, then, the pattern is not just to experience one crisis after another--Europe 1992, Mexico 1995, Asia 1997, Russia and Brazil 1998--but to experience a situation in which each crisis is worse than the last, and the latest series of crises has engulfed the entire globe in ways not seen since the last great depression in the 1930s. (For more on this situation, see our article below on the global monetary system in Supernova).

The bottom line is that even though there is value to be picked out of the U.S. stock market after 40% to 60% declines in key banking, brokerage, and other stocks this year, investors appear obstinate in their resolve to keep the bull market alive at any cost and any risk, and appear complacent in their strategy to bid the market back to a Dow Industrial Average level of 8700 even as the S&P 500 still showed a Price/Earnings ratio of a lofty 23 at the October low. Typically that P.E. ratio has plunged to levels between 10 and 15 the past decade or so after 15% or more declines in the S&P 500. This time, even in the face of the worst global fundamentals in decades, are investors truly to remain content with a 23 P.E. ratio and a panicky global economy?

So, what to do now with the market carrying a 25 P.E. ratio again, at a 62% retracement level of Dow 8700 (already), and panicking powers that be dealing with a global crisis that won't seem to go away? That is the subject of our next section of this analysis.

For more analysis and key recommended strategies in the "next section of this analysis" to which the above capsulized commentary above refers, see our November issue of The Global Market Strategist® due to be published no later than November 3.

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