TDL's Latest on Currencies: The Mexican and Canadian Pesos Make new Lows

September 18, 1998

Life is just a bowl of pits. Rodney Dangerfield


The Mass Psychology of the press now almost universally views the world's increasingly-frequent currency collapses as a form of "Asian contagion," that they are somehow "spreading" as if by some mysterious form of bacrobial infection, often blaming ubiquitous "speculators." To say speculators cause currency problems is like concluding that wet sidewalks cause rain. It annoys us that they continue to do so despite our having repeatedly informed the public on TV, radio and in the media that each central banker has made the same mistake of having sold the gold backing behind his currency and then running the printing presses, but they hear and do not listen. Instead of some kind of communicable disease, waves of currencies are falling like tenpins in a bowling alley, unconnected but bowled over for the same reason.

The reason we have recommended investing primarily in the US since 1993 is that we knew the US dollar would go down last; unlike other nations, America's gold in Fort Knox is not being sold. However, our predictions of crashes in the Canadian and Mexican currencies might finally break the US dollar, because they are two of our leading trading partners, and we are watching them carefully over our shoulders. Canadian TDLrs who got out of the Canadian dollar as recently as last year have already saved themselves over 10% of their entire capital, which was one good thing.

With the Canadian dollar at its lowest point in a century, as we expected, the Bank of Canada in a surprise counterattack this month wasted perhaps $2 billion (US) buying the Canadian currency in hope of buoying it, and have perpetrated several smaller interventions since, a distinct change from their previous attitude of "benign neglect." The Bank of Canada is running the printing presses full blast, yet is dumbfounded that the value of each unit declines in the marketplace, proving that their heads are deeper in the sand than armless clamdiggers.

We have been predicting that Canadian central bankers, increasingly in a state of frustration over their inability to prevent their currency (called a "loonie") from making more new lows, would raise interest rates, an immoral bribe to innocent Canadians to hold their depreciating currency yet longer, which they did on August 27th. That it did not trigger a loonie rally means that they will need to raise interest rates yet again to stop a loonie crash. When the loonie does rally, that will be your final opportunity to sell out and run into US investments. Sauve qui peut.

Why should it matter to the average Canadian, or Mexican, or anyone else, whether their currency goes down? First of all, higher interest rates are a cost of doing business, and so are bad for the economy, creating a recession and all the layoffs and salary cuts that that entails. Furthermore, vacations to countries with so-called "hard currencies" will be more expensive in terms of the local currency, so that a Canadian's vacation to Florida or California would be less likely; illegal Mexican immigration into the US will be enhanced because of the incentive that each dollar will equal even more pesos. And what about the intangible subtlety of confidence, how do citizens feel knowing that their currency is dropping against others, and what effect would this have on the national psyche? How will patriotic Canadians react to foreigners with hard currencies buying their land out from under them, while their loonie is on the bargain counter? Devaluation's impact on specific industries will differ, but with the US buying 80% of Canada's exports, a loonie crash will benefit exporters and harm importers, which Canadian TDLrs are again advised to consider. Perhaps get into a business serving increasing numbers of tourists; Canadian and Mexican border towns will benefit at the expense of US border towns because of bargain-hunting border hoppers. Canadians, prepay your foreign expenses now, in advance, as far as they will let you get away with, and buy imported goods immediately if you are going to buy them anyway. Most menacing of all are "exchange controls," where the government seizes your bank accounts and does not allow you to remove your wealth from the country, as in Russia today. Fortunately, TDLrs have been apprised of these dangers for several years, and a word to the wise was sufficient. Is it too late now? Not at all. Other natural-resource countries such as Australia and New Zealand, whose economies are likewise based largely on exporting commodities, have seen their currencies plummet over 20%, whereas Canada has been cushioned to some extent by having been able to export into the strong American market rather than Asia's devastated economies. As pointed out in your editor's second book The Invisible Crash, devaluations also unleash inflations that sometimes end in hyperinflations that always end with the proverbial "man on a white horse. "Consider the danger of what is daintily referred to as "civil unrest" but which Karl Marx called "revolution," the first example of which has already occurred in Indonesia. If people really profited from their mistakes, all people would be rich by now.

One of the more serious effects of devaluations is that devaluing countries with corporations and banks that have borrowed in a hard currency (such as in US dollars, Swiss francs, Hong Kong dollars) find that they suddenly owe much more than that in terms of local currencies. If they can't scrape up the extra money, they go bankrupt, banks close, corporations lay off people, shortages of goods appear as people rush out of devaluing paper money into goods, while borrowing becomes almost impossible, especially since interest rates go sky-high in order to attract capital already occuring in Russia and heading our way. One bullish factor for the US economy is that a flood of frightened capital into the US has pushed interest rates down, reducing an American cost of doing business.

Fortunately for our TDLrs in Hong Kong, we turned bearish in mid-1997. Under their currency-board system linking the Hong Kong dollar to the US dollar, when TDLrs sell local dollars in order to buy US dollars, interest rates go up to attract funds back into the Hong Kong dollar. Higher interest rates will cause a terrible recession there. Embarrassed Hong Kong authorities are now actually buying stocks on the open market to soften an impending crash, and their temptation is simply to run the printing presses. Since living well is becoming impossible in devaluing nations, more people are discovering that revenge is the best revenge.

We lament the tragedy that so many new nations trying the capitalist system for the first time will blame these currency upheavals on capitalism. In fact, they are not now experiencing capitalism at all, which would have relied on a sound and honest currency in which government officials did not have the right to run the printing presses so that they could spend enough money to buy their own re-elections. When we started the Hard Money Movement in 1960, this currency crisis was precisely what we had hoped to have helped avoid. Apparently, in vain. The shortest distance between two points can be between a central-banker's ears.

The monetary system needs to be privatized, as governmental control of currencies is being proven to have been inherently untrustworthy.

1. The "northern peso" has lost 5% of its value in a slow but relentless decline over the past three months. So stubborn is the trend that aggressive buying of Canadian dollars by the central bank in the past few days has produced a rebound of less than half a cent. Ottawa has turned a budget deficit into a small surplus and total debt is shrinking as a percentage of Gross Domestic Product. The possibility of Quebec separating from the rest of Canada, often blamed for the currency's weakness, now appears remote. The currency has fallen 10% over the past year. What lies behind this weakness? The most obvious weakness is the country's persistent dependence on commodities, which account for nearly 40% of merchandise export earnings. This alone cannot explain its fall from grace. Australia and New Zealand rely much more on resource exports, especially to Asia, which absorbs only 9% of Canadian exports. Yet their currencies have not suffered any more than Canada's. A second, and more serious, weakness is lagging productivity. Corporate and personal tax rates are higher than in the US and may have discouraged investment. Mr Thiessen appears to have made things worse this summer by saying he did not think an interest-rate increase would be necessary. With the Asian crisis hitting more deeply than expected and growth slowing in the US, which accounts for more than 80% of Canada's merchandise exports, the Canadian economy is starting to wane. Moreover, recent surveys show consumer confidence falling along with the dollar. Edward Alden, FINANCIAL TIMES, (London), 12 Aug 98 Ed: Every excuse considered, except the true cause having sold the gold behind the currency.

2. Sergei Dubinin, head of the central bank was refusing to admit the gravity of the situation yesterday. "What is happening on the markets belongs in the realms of psychology," he said. "There are at present no financial grounds for a deterioration in the situation." Objectively, Mr Kiriyenko may be right. Russian markets appear to have been the victim of negative investor sentiment about the Japanese yen, the recent slide on Wall Street, further falls in the international oil price and fears of a Chinese devaluation. Mr Soros argued the only way out was to introduce a currency board backed by $50bn of reserves after a 15-25% devaluation of the rouble. Such currency boards, which fix the local currency to a hard currency and ensure that domestic money supply expands or contracts in line with hard currency reserves, have brought financial stability to countries as diverse as Argentina, Estonia and Singapore. But the Russian government has long argued it would be impractical to introduce a currency board in such a big and complex country. Besides, where would the $50bn come from? A growing part of the Russian industrial establishment appears to favor evaluation. They believe this would make their exports more competitive and lower their domestic cost base. John Thornhill, FINANCIAL TIMES (London), 14 Aug 98 Ed: "No financial grounds'? Why not stop running the printing presses, then? A currency board would be better than what exists now.

3. Russian President Boris Yeltsin and other top officials cut short their vacations to address a financial crisis that has begun to pinch ordinary people for the first time. Over the weekend in Moscow, some banks refused withdrawals and many automatic teller machines ran out of cash. Mr Yeltsin made the move after a long telephone conversation with President Bill Clinton, in which Mr Clinton expressed concern over Russia's financial ills. Investors have all but stopped trading Russian securities. A solution is vital because leading Russian banks have begun to default on obligations to each other, Western creditors and their depositors. "Right now, the main devaluation pressure is coming from the banking system," said a research note by United Financial Group. "Banks are desperate for liquidity and are selling all available assets to meet cash calls. If the central bank bails out the banks, the resulting higher money supply will generate inflationary pressure and drive the ruble down faster." Sharp drops in stock and bond prices have depreciated the banks' large portfolios of Russian securities, leaving them without sources of ready cash. Some banks have also written billions of dollars in forward contracts, promising to sell dollars at a fixed rate to investors wanting to hedge against a ruble devaluation. Many of those contracts are coming due. International credit-rating agency Fitch IBCA said: "We expect further payment defaults to take place, and there are significant concerns that defaults by particular banks will have a knock-on effect on their counterparties, thereby bringing down much of the Russian banking system." At one SBS-Argo branch in central Moscow, a manager told worried customers Saturday morning than an armored truck would soon arrive with cash. But when the truck came, it was nearly empty. Some customers managed to make partial withdrawals in rubles; those who wanted dollars were told to come back tomorrow. Mark Whitehouse, WALL STREET JOURNAL, 17 Aug 98 Ed: TDL has been bearish on the ruble for years. After the last one, we predicted more would follow. No change yet. A preview of "The Coming Gold Crisis" in North America.

4. Last week's global market sell-off hurt stocks and bonds from Russia to Hong Kong but the pain in Latin America's bond markets stands out. The financial crisis dealt a beating to Latin bonds, which suffered some of the quickest and biggest price drops ever seen by traders. The unraveling of the market and resulting high interest rates will make it difficult for companies and nations of Latin America to borrow money on international markets in the near term. And the lack of investor interest in emerging-market assets of any type means the market isn't likely to make a speedy recovery. Says Hari Hariharan, head of Banco Santander New World Investments Group, "There's no appetite for virtually any kind of paper anywhere." Governments will be forced to cut spending while companies will have to hold back on new investment projects. It is too early to tell how economic growth will suffer but easy access to credit was a key factor in the strong growth in Latin America in the past two years. Venezuela needs cash to finance a gaping budget deficit and ease pressures to devalue its currency after a sharp drop in world oil prices, the country's main export. Venezuela filed plans last month to sell more than $1 billion of bonds to foreign investors. Now those plans are likely to be shelved and the government is scrambling to find other ways to narrow the deficit, such as further budget cuts or expensive local bond issues. The lack of credit could eventually force Venezuela to devalue its currency, something the government has sworn not to do. On Friday, Venezuela said it would allow more flexibility in the trading band it uses to control its foreign-exchange rate but stood by its promise not to devalue. Thomas T Vogel Jr & Pamela Druckerman, WALL STREET JOURNAL, 24 Aug 98 Ed: Denials tend to precede devaluations. Watch for TDL's Major "Sell" on the US bond market some day.

5. Stepping away from a longstanding commitment to unhindered markets, monetary authorities undertook a major and unprecedented intervention in Hong Kong's stock and futures markets Friday to hurt speculators who are trying to force a devaluation of the Hong Kong dollar. Finance Secretary Donald Tsang, accused speculators of attacking Hong Kong's currency with a "whole host of improper measures," including the spreading of "vicious rumors" about a devaluation of Hong Kong's currency and the stability of its banks. The Hang Seng index is almost two-thirds off its peak of a year ago. Said Donald Hanna, an economist at Goldman, Sachs & Co. By making "speculative profits more uncertain," he said, the move should "reduce the number of attacks." G Bruce Knecht, Erik Guyot, Henry Sender & Bill Spindle, WALL STREET JOURNAL, 17 Aug 98 Ed: They try to "hurt speculators" instead of smashing their own printing presses.

6. Two months ago there was some concern about whether Japan's troubled Long Term Credit Bank was destined to be the next victim of the country's financial turmoil. Yesterday, however, a new and more dangerous question hung in the markets: whether LTCB's fate could instead provoke a broader banking crisis with international repercussions. The government hoped to tackle the problem by using a "bridge bank" scheme for state-run bodies to run temporarily the operations of failed banks. But this scheme will not be ready until the autumn at the earliest. Gillian Tett, FINANCIAL TIMES, (London), 18 Aug 98 Ed: Dawdle, dither and delay. Meanwhile, the Titanic takes on more water.

Gold is impervious to rust.