Keep
your eyes open!...Keep
your eyes open!...
(Rev 6:5) When the Lamb
opened the third
seal, I heard the third living creature say, "Come!" I looked, and
there
before me was a black horse! Its rider was holding a pair of scales in
his hand.
(Rev 6:6) Then I heard what sounded like a voice among the four living creatures, saying, "A quart of wheat for a day's wages, and three quarts of barley for a day's wages, and do not damage the oil and the wine!"
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The following article was forwarded by Yossi Regev:
The Crash of 1998 and The Jewish People
In a July 1994 interview
with the Star Tribune,
Federal Reserve Chairman
Allan Greenspan said the following
with regard
to the October 1987 crash:
"We were closer to a
monetary collapse than we
would like to believe... We
would have had all of these crazy
horrible events
that none of us thinks
can happen until we see them. We
would get into
the types of problems
that historic monetary collapses
always create.
We are far from that at
this stage but I suspect a lot nearer
than we
would like to believe."
What exactly are these
"crazy horrible events"
alluded to by Chairman
Greenspan and how far are we from
them in January
1998? In the following
article we intend to evaluate the
current state
of the global financial
and monetary system from as a
detached view as
possible in order to
ascertain how far we really are from
a "historic
monetary collapse".
While we recognize there are
differences, as Mark
Twain put it history may
not repeat itself, but it does
rhyme". From such
an historical
perspective, the risk of a global
financial meltdown
would appear to be
greater today than at any time in
modern financial
history. Perhaps more
frightening than this risk are
certain unique
aspects of both, the current
unipolar International Political
System, and the
state of today’s capital
markets, which have the potential to
dramatically
exacerbate the "crazy,
horrible" social and political
fallout, alluded
to by Chairman Greenspan.
The focus of our analysis
will be centered on the
US. This US centered
approach is, we believe justified, as
the US is
much more than the
preeminent global economic power. US
economic
power is reinforced by the
ideological clout it carries. Since
the emergence
of the US as the
"victor" in the Cold War, America and
particularly
its economic system has
become the model aspired to by
virtually the entire
world. Communism as an
economic system is bankrupt. Free
markets and
capitalism have won out.
Growth is now the over-arching goal.
Capitalism
is the underlying
structure albeit at times reined in
by certain
welfare principles while
technology is the high octane fuel
spurring ever
more rapid growth with
low inflation. First Japan
and Western Europe
and more recently the Asian
and Latin tigers along Eastern Europe
were perfect
examples of this US
inspired approach.
The significance of the near
deification of the
American system has
created a situation where the world
is much too
complacent and
overconfident in its sustainability.
We are ignoring
all the danger signs
and we are failing to implement the
necessary
corrective measures and
consequently we are exacerbating and
deepening
the problem. Moreover, with
regard to the issue of greatest
concern to our
readers the potential
"crazy, horrible and ugly" political
and social
fallout from a monetary
collapse - the excess ideological
baggage and
expectations attached to the
current US dominated and inspired
system can only
serve to exacerbate the
sense of despair and frustration in
the wake of
its collapse.
While Marx was clearly wrong
about Communism his
critique of Capitalism,
particularly the "crisis of
overproduction and
concentration of capital"
were right on the mark. As Capitalism
marched
on triumphantly and
Communism was pronounced dead the
Marxian critique
was unjustifiably
buried as well. To what
ever extent the
structural deficiencies of
Capitalism identified by Marx were
given any credit,
Keynsian inspired
welfare state solutions were assumed
to have put
them behind us. While the
welfare state has smoothed over the
sharper edges
of Capitalism it has not
solved its fundamental structural
deficiencies.
It should be recalled that
the depression of 1929 ended only
after the onset
of World War II which
dramatically increased demand as well
as absorbing
excess Labor. Years
after Roosevelt’s New Deal Reforms
the country
was still gripped by the
Depression which dragged on until
WWII. In the
aftermath of the war while
welfare state reforms may have
prevented the slide
from some post war
recessions into what might otherwise
have been
full blown depressions
these reforms have not fundamentally
altered the
inherent structural
weaknesses of Capitalism.
Probably of greater
significance than the
Keynsian inspired reforms in putting
off the crisis
of Capitalism were a
number of unique historical
developments. First
we had the Marshall plan
and the rebuilding of Europe which
absorbed excess
US capital and
productive capacity. Then
we had the military
buildup, the Korean War and
the rearming of Europe as we fought
the Cold War.
The Vietnam war and the
arms race no doubt played a role in
staving off
the consequences of the
tendency toward overproduction and
inadequate
demand.
The dramatic rise
in the price of oil in
1974 and 1979 and the consequent
redistribution of wealth and
recycling of petrodollars
into the massive
development and arming of Middle
Eastern and Latin
American states played
its role in the balancing act. After
Europe and
Japan were rebuilt and
began competing seriously with the US
for markets
and the oil boon had run
its course it was only a matter of
time before
the bipolar world structure
of two competing blocs lost its
functional value
for the US.
As the Iron
Curtain came down new markets
for our capital and outlets for
our excess capacity opened up,
pushing off once
again the day of
reckoning. Only 7 years later the US,
Japan and
West Europeans have run
out of rope. China, Eastern Europe,
Russia and
the Asian and Latin Tigers
rather than continuing to absorb our
excess capacity
are faced with their
own severe crisis of overcapacity. We
have reached
the end of the line.
Our powerful capitalist locomotive is
approaching
the cliff at 200 miles
per hour but no one seems to see the
fall ahead
of us. For the sake of
brevity we are obviously
oversimplifying here
but the point is we believe
substantively correct.
In recent months we have
witnessed frightening
competitive currency
depreciation's throughout Asia, 60%
plus declines
in most Asian stock
markets, the near daily collapse of
one Asian
financial institution after
another, severe worldwide
deflationary pressures
in key economic sectors
and daily profit warnings from US
multinationals
as a result of these
deflationary pressures. Despite short
term negative
reactions in the US
market to these adverse developments,
the news
is quickly shrugged off as
US investors in an almost Pavlovian
like response
jump in to buy every
dip. Meanwhile the Federal Reserve is
still looking
over its shoulder for
the enemy of the last war - inflation
- as the
global economy is heading
into a massive deflationary pit.
If Roosevelt's New Deal
proved inadequate to pull
us out of the 1929
depression it is difficult to see how
the current
welfare state system can
stave off the coming broader global
crash let
alone pull us out of the
mess. But we are getting ahead of our
story. Before
we can appreciate the
vulnerability of the capital and
financial markets,
we need to place it,
in the proper historical perspective.
The Great Depression which
began with the Market
crash of October 19, 1929
was the single most important
development in conditioning
market
psychology in the 20th century. The
sheer magnitude
and depth of pain it
inflicted for so many years made
indelible marks
on those who lived
through it as well as those who
learned of it
second hand. Many began to
doubt the very viability of
Capitalism. The euphoria
that existed
immediately prior to the crash and
level of confidence
in the markets
would not be restored for many years.
At some
level the very fact that the
crash occurred at all would serve
throughout the
century as a barrier to
investors and potential spark for
their fears.
It took until 1954 for the
Dow to regain its pre crash highs but
the public
did not really join the
party until the mid 1960s. By 1968,
Wall Street's
mood was euphoric albeit
still somewhat tainted by background
fears of
1929 and like today,
corrections were seized upon by
bullish investors
as buying opportunities.
As a result of this positive
psychology the market
continued to set new
highs approaching the 1000 mark in
1968. Newton
Zinder, of E.F. Hutton,
reflecting the bullishness of the
times was uneasy,
but guardedly
optimistic, and his evaluation sounds
eerily familiar:
"From the technical
point of view, the market continues
to be in overbought
territory,
suggesting a period of some
consolidation may
not be far away". How about
another 1929? "Not a chance," said
Zinder. The
correction "should be
followed by further upside progress".
(quoted in Barrons, Dec 7, 1997)
"Despite clear signs of
economic troubles on the
horizon the party
mentality continued. New
issues with high
hopes but few assets were
well-received. Mergers and
Acquisition activity
was raging on Wall Street.
Mutual-fund sales soared, with new
ones starting
at the rate of one per
week.." By early November, the funds
industry
was managing more than $51
billion in assets, with $8 billion
having come
in during the previous
half-year alone. Volume was high on
the exchanges,
with the NYSE regularly
posting 15-million-share days with
increasing
volatility. The Jingle is
beginning to take its form.
The euphoric bubble began to
burst with the Fed
discount rate of Dec 18.
Psychology had quickly shifted.
Analysts began
speaking of another 1929
style crash. Many of the same
analysts so euphoric
in November were now
anticipating disaster. There was no
crash, and
while 1969 was not a great
year it was not a disaster either.
By 1973 the market was
setting new highs. It was
party time again. Most
analysts had turned bullish and
investors began
to jump in again. Just as
investor's confidence was restored
the markets
began a sharp decline
falling 40% in 18 months. This was
the worst bear
market since the 1930s.
After adjusting for inflation, the
entire stock
market advance since 1954
had been wiped out. The market
quickly recovered
in 1976 only to be
followed by another sharp decline 2
years later
leaving investors reeling.
By the summer of 1981 with the Dow at
750 poised
for what can certainly be
characterized as the greatest bull
market in history,
analysts, so wildly
bullish in late 1968, were
frighteningly pessimistic.
Just as extreme
optimism proved to be a sign the
party was about
to end in 1968, extreme
pessimism in 1980 proved to be a
signal that the
bear market was ending.
There goes that Jingle again.
Obviously none of this
suggests that history has
to repeat. Still, the
mood in recent months has been far
closer to that
of late 1968 than to
1981. But again we are
jumping ahead of
ourselves. In the summer of 1987
with the market at all time highs up
nearly 2000
points from its 1981 lows
a sense of euphoria was once again
raging on Wall
Street. Despite signs of
economic troubles ahead, the market
continued
to rally. Merger activity
and new offerings were again setting
new records.
Speculative fever was
everywhere, public participation was
still way
bellow what it had been in
the 60s but clearly investors were
returning.
Stocks and mutual fund
participation as a % of households
liquid financial
assets had risen from
a low of 7% in 1981 to 34% in
September 1987.
Once again the experts were
for the most part,
wildly bullish. Yet Between
October 16th and October 20th the Dow
plunged
nearly 900 points a decline
of close to 40% in a matter of days.
It was October
1929 all over again,
or so the analysts were telling
us. We were
about to embark on a
protracted and very painful bear
market.
Once again the analysts proved
wrong as the market quickly
stabilized and began
to head back up. Those
who panicked and sold would soon
regret their
decision as they saw their
former holdings quickly recover. By
the end of
the year the market had
recovered most of its losses.
This pattern of
sharp declines and quick
recoveries was the new pattern.
In 1990 with the collapse of the UAL
takeover
the market again suffered
steep losses only to recover weeks
later. Sadaam
Hussein made his
contribution to reinforcing this new
lesson in
the Fall of 1991. Those who
failed to draw the appropriate lesson
got burned
quickly. In late 1994 the
Mexican Crisis temporarily shook up
the market,
but that too was a short
lived scare. Rumors of coups in
Russia and presidential
assassinations
would momentarily disrupt the bulls
advance with
steep declines. But again
the markets rapidly recovered.
The lessons often painfully
drawn after each of
these brief selloffs was,
first, Don’t panic, and second, Buy
the dip.
The great bull had
momentary shakeouts as
certain market leaders
particularly in Technology suffered
bad quarters
but again the market
would quickly recover. By the summer
of 1997 the
US stock market was
arguably the most richly valued in
history.
On virtually every historical
measure of valuation the market was
overvalued
while all the classic signs
of a market top appear to be in place.
The yield on the
Dow Jones Industrials in
September 1987 just prior to
the '87 crash was 2.6% as opposed to
today’s historic
low of 1.7%. In
September '87 some analysts were
concerned about
the Dow selling at a
lofty 2.5x book value. Today analysts
do not seem
to be at all perturbed
by a Dow selling at over 5.5x book
value. Just
prior to the '87 crash the
S&P 500 was trading at 20x
earnings. Today
the S&P 500 trades at over 23x
earnings. The valuation of the stock
market in
October '87 was the
equivalent of 70% of GDP versus 120%
of GDP in
October '97. Public
participation in the markets has
reached record
highs. In 1987, 25 million
households owned $270 billion in
stock mutual
funds. At present, 45
million households own $2.4 trillion
worth with
over 1 trillion coming
into the market in the last 2 years
alone. Today,
stocks and mutual funds
comprise about 58% of households'
liquid financial
assets, while in 1987,
the figure was about 35%. Private
pension fund
exposure to equities is
over 60%, the highest level since
just before
the big bear market of 1972.
Mutual fund cash levels are at 5%.
In $ terms 1997 has been the
biggest year ever
for takeovers and mergers
while IPO activity is
raging. Volatility
and volume in recent months have
reached extremely high levels,
another classic
characteristic of market
tops. Assuming history does indeed
rhyme based
on stock valuations, the
bull move's duration and extent, and
the trading
volume and massive public
participation that have been evident,
it would
certainly appear that the
bull market is approaching its final
days. If
all this was not enough
insider selling according to the
latest Vickers
release has reached truly
frightening levels. While insider
buying has almost
completely dried up .
Even as the market sold off sharply
in October
insiders failed to step in.
Yet none of these
traditional signs of trouble
seemed to be of any real
concern to most analysts and
investors. After
all the market had been
richly valued for quite some time
now. Many a
bear had learned the hard
way not to sell this market-pricey as
it might
appear to be short. The
longevity of the bull market had led
many to posit
new paradigms. We were
told "it is different this time". The
market could
continue rising
indefinitely along with the economy.
We had found
the answer to the
vagaries of the business cycle.
Advances in technology
were facilitating
dramatic increases in productivity.
These productivity
increases made
possible sustained economic growth
that would
not lead to inflation. In
turn economies would not overheat and
the Fed
would not need to take away
the punch bowl by raising rates.
Even the otherwise cautious
Fed Chairman Allan
Greenspan seemed to be
buying into this rather dubious
scenario. In his
Testimony to Congress
this past fall. What keynsian style
welfare state
reforms left unsettled
technology now resolved . The
business cycle had
been repealed for good
and so investors could truly party on
forever.
After 68 years the damage
of the 1929 Crash was finally behind
us, confidence
had truly been
restored. After all, if this benign
view was correct,
why worry? Corporate
earnings should have no problem
reaching their
growth targets and with
inflation out of the way current
valuations were
reasonable.
This perfect world was
certainly not pricing in
the debacle that recently
engulfed much of Asia nor did it
anticipate it.
This was totally ignored
as investors quickly swooped in to
buy the late
October dip pouring in
over 15 billion into US equities in
November.
A little more than a month
later the market was setting new
highs Our panglossian
analysts wasted no
time telling us all the reasons why
Asia was not
a problem for the US
economy and investors apparently
concurred.
If we were to take a little
step back and view
the situation objectively
Asian developments not only appear
quite frightening
but they go along way
to discrediting both the new paradigm
growth without
inflation scenario -
as well as the broader general sense
of a triumphant
capitalism dancing on
Marx’s grave. It is readily
apparent that
the competitive currency
depreciation's of the past year is
but the latest
step in the attempt of
the Asian tigers to protect their
market share
in industries where massive
overcapacity has been driving prices
ever lower.
Is it not much more
reasonable that the low inflation we
find globally
has more to do with the
fairly concrete and measurable
disinflationary
pressures of the Asian
export machines than the rather vague
and diffuse
impact of technology?
I have no doubt
that the CEO’s of leading
US electronics, steel, auto,
and semiconductor companies could
provide rather
graphic evidence of the
disinflationary pressures exported by
Asia. (See
for example statements in
Buisness Week Dec 18 1997)- While
these disinflationary
pressures were
helpful in sustaining US growth with
low inflation
in recent years at some
point these pressures can become
contractionary.
Such a deflationary
inspired recession more akin to the
busts of the
late 19th and early 20th
century can easily spiral into a
depression. This
risk is further
heightened by the Fed’s insistence on
fighting
the last war.
Most of the "experts" are
busy telling us why Asia
will have little impact
on the US economy. Secretary of the
Treasury Robert
Rubin was the first to
reassure us as he told investors not
to panic
on Oct. 28th because as both
he and President Clinton put it "the
US economy
is fundamentally sound".
(Quoted in Business week Nov 10 1997)
Chairman Greenspan took this
confidence even one
step further when he told
Congress we can see the events in
Asia and the
October decline in the US
market as salutary events.
These remarks
sound eerily like statements
made in 1929. After the
initial collapse
on Oct 29, John Meynard Keynes
told investors the collapse should be
seen as
a beneficial rather than an
evil event which would contribute to
the long
term health of the world
economy. President Hoover
like Clinton and
Rubin reassured the public
that there was no reason to panic as
the underlying
fundamentals of the US
economy were quite strong. Just as
the IMF is
scrambling to put packages
together to bail out the falling
Tigers in 1998,
back in 1929 JP Morgan
led other leading Banks in trying to
put together
a stabilization package.
Despite all the assurances and the
confidence
of the experts JP Morgan’s
package failed to stabilize the
markets and the
decline that began on Oct
29th 1929 proved to be the beginning
of a severe
world wide depression. To
ascertain whether there is something
to these
rhymes we need to evaluate a
little more closely the nature of the
Asian crisis.
Asia today is caught in a
classic deflationary
trap of too much productive
capacity and too many goods chasing
too few consumers.
This type of
malignant deflation can and is
getting quite ugly.
Economic growth wilts
as some consumers postpone purchases
out of concern
about the future, and
other would-be buyers hold off in the
expectation
that prices will
continue to fall. Deflation and
falling unit-sales
depress profits. As a
result, companies retrench by firing
workers and
chopping capital
investments further weakening demand.
This is
the stuff of what Marx
referred to as the Bust Cycle of
Capitalism.
What is going on in Asia
today appears to be following
the Marxian
paradigm perfectly. The East Asian
crisis is directly
traceable to the
late 1980s when Japan experienced a
classic investment
led expansion which
kicked off an investment binge
throughout the
region. Back in the 80s
Japan dramatically added to its
industrial capacity
at a rate that far
exceeded demand growth which led to
price cutting
and instances of dumping
on world markets. This in
turn discouraged
new investments in plant
capacity at home and encouraged
excess capital
to seek out new targets.
These conditions fed a financial
market and real
estate bubble in Japan on
the one hand and on the other to the
export of
excess capital into the
rest of Asia. This investment in Asia
absorbed
the capital that was
blocked up in Japan and fueled
dramatic growth
which created markets to
absorb at least in the short run much
of Japan’s
excess capacity. As Marx
would have predicted the
"miraculous" growth
that swept through Asia was
not shared equally and in fact led to
tremendous
disparities in wealth.
While every one's standard of living
improved,
the billion plus army of
new consumers and low-cost workers
who unlike
the capitalist elite only
shared a very small portion of the
fruits of their
labor could not provide
the necessary demand to continue
fueling the global
economic boom.
Meanwhile, the rich elites were
getting richer
and squandering their
wealth on feckless, unproductive,
conspicuous
consumption, not to mention
all the speculation in the stock and
real-estate
markets.
While the Japanese financial
bubble burst at home,
investments in Asia
continued in an even more reckless
and indiscriminate
fashion than was the
case earlier in its home
market. With easy
access to capital, the large
Asian conglomerates just kept
building and expanding
hoping sales and
profits would follow. The result has
been the
creation of an industrial
monster. Massive global inventory and
capacity
overhangs were created in
many key industrial sectors leading
to falling
prices and profits.
In recent months, one after
another of the once
mighty Korean Chaebols
along with their smaller Asian peers
have been
lining up to seek court
protection from creditors, setting
off an Asian
if not global debt crisis.
Desperate for cash, Korea
along with China and
the other Asian tigers have
gotten into beggar thy neighbor
currency depreciation's,
in an attempt to
make their exports more competitive.
The Asian
tigers find themselves not
only in desperate competition with
one another
but with their one time
Japanese benefactors. In short, Japan
has exported
its excess capital and
productive capacity to its Asian
sisters in such
an utterly reckless
fashion, that it now faces along with
the rest
of the global economy a
problem of truly apocalyptic
proportions. There
goes that jingle again,
this sounds a great deal like 1929.
The bursting of the Japanese
bubble combined with
the more recent crises
of the Asian Tigers has sapped up the
excess capital
of the 80s and
created in the words of Japan’s
finance ministry
"a severe liquidity
crunch." While the Japanese
are still reeling
from the collapse of their
financial markets and 7 year
recession, their
crippled banks now face
losses from their massive lending
spree too Asia,
their investments in
Asia, as well as the fallout from
further declines
in the Nikkei. In the
last 6 months 11 major Japanese
financial institutions
have already
failed. Japan appears to be in a
spiraling recession
headed for
depression. Japan’s interest rate on
their 10
year bond has sunk from 8%
in 1990 to 1.4% today, yet its
economy continues
to decline. (So much for
the notion that we have nothing to
worry about
with such low US rates.)
The problems in Southeast
Asia promise only to
exacerbate Japan's woes.
Exports have been leading Japan's
ill-starred
attempts at economic
recovery, and Southeast Asia was
Japan's largest
market, accounting for
over 40% of its total
exports. Not only
have those exports fallen off the
cliff as the Tigers retrench sharply
but Japanese
companies are being
squeezed by the deflationary
pressures being exerted
on their pricing
power by their Asian
competitors. At a minimum,
Japan may have to devalue
the yen to compete, raising the
specter for the
global economy of another
round of competitive devaluation's
among the formidable
trade partners in
Asia. This will in turn further erode
corporate
profits, push more
companies into bankruptcy, create
more bad debt,
drive down demand even
further and deepen the crisis.
The situation in Asia is
indeed rather frightening.
The turmoil that came
to the surface last summer in
Thailand and spread
quickly to Indonesia,
the Philippines and Malaysia has
since moved north
to Hong Kong and Korea
and now, as we have shown, threatens
to unravel
Japan as well. These
markets are off anywhere between 50%
and 75% the
debt of many of these
nations has been reduced to Junk
status. Bankruptcies
and bank failures
are announced on an almost daily
basis while the
IMF and its more powerful
members are being called on to
participate in
massive bailout and
stabilization projects. The
new Korean President
has already admitted his
country is bankrupt and that the 60
billion dollar
stabilization package
is not nearly enough. This
is no minor development,
after all Korea is
the worlds 11th largest economy.
After rather extensive
research I have reached
the conclusion that
virtually all of Japan’s key
financial institutions
- specifically its
Banks and Large life insurers are on
the verge
of insolvency. Japanese
Banks are reportedly sitting on over
one trillion
dollars in bad debt.
This insolvency will be increasingly
difficult
to cover up as the Asian
crisis deepens. Who will provide the
trillions
needed for an Asian wide
bailout which already shows signs of
spreading
to other developing export
led economies in Eastern Europe and
South America?
Can anyone really take
seriously the initial response
that the US would
not be affected in any significant
way. The analogies
to the 1994 Mexican
situation or the 1982 Latin American
crisis constantly
drawn as proof of
America’s power to whether the storm
only shows
how out of touch these
analysts really are.
In 1994 the US allowed
Mexico and earlier Latin
America to export their
way out of their crisis as Washington
provided
emergency capital and the
market for their cheap imports. Does
anyone believe
the US is capable of
providing the 100’s of billions if
not trillions
necessary to bail out the
world while buying up all of the
global excess
capacity? Even if the US
had the capability and the will to do
so, the
ultimate effect on the US
economy, particularly on jobs, and
corporate profits
would push us into
depression anyway.
Congress' recent denial
of fast track authority for
the White House to negotiate trade
agreements
along with its refusal to
increase funding for the IMF would
tend to indicate
that even at this
early stage the US lacks the will to
fill the
role of lender and buyer of
last resort. In short,
recent trends would
seem to indicate the triad of
conditions deflation, competitive
devaluations
and rising protectionism
that characterized the Great
Depression are coming
to characterize the
current global situation. History
does indeed
seem to rhyme.
We do not believe we our
overestimating the dangers
of the Asian contagion
on the US and the evidence that has
begun to flow
in recent weeks appears
to validate our thesis. While it is
true as Wall
Street’s ever optimistic
analysts continue to remind us, that
South East
Asia buys a mere 6% of US
exports it is quite irrelevant to the
issues we
have raised here. To begin
with, as we have shown, this is not a
problem
limited to the Asian tigers
but has spread to encompass most of
Asia, including
Japan and China. Asia
absorbs over 30% of America’s exports
and accounts
for 38% of our imports.
Perhaps of even greater significance
is Asia’s
share of the global economy
which exceeds 34%, the biggest of any
region.
By comparison North America
has a 22% share and Western Europe
has 20%.
If the essential dilemma
posed for the global economy
by the Asian crisis
is its deflationary pressures than
these percentages
carry great
significance and drawing analogies to
Mexico,
are to put it mildly,
absurd. That US exports to the region
will decline
is obvious and not
insignificant. However the larger
threat is that
of a desperate Asia
dumping its excess capacity on global
markets.
This will squeeze competing
US corporate profit margins, forcing
cut backs
and layoffs on the one hand
and encourage protectionism on the
other.
In recent weeks, numerous
major US corporations
have stunned Wall Street
with profit warnings as well as
cutbacks due to
these Asian deflationary
pressures. First came Eastman Kodak
in early November.
Facing serious
pressure from Fuji, Kodak cut their
forecasts
and announced 10,000
layoffs. Caterpillar, Boeing,
International Paper,
Tenneco, Avon Products,
Union Carbide, Minnesota Mining and
Manufacturing,
Coca Cola, Seagate,
Read Rite, Micron, Nike and Reebok to
cite just
a few, made similar
announcements. Western Digital and
Micron Technology
coupled their
warnings with cries that Asian rivals
were, could
you believe it, selling
below cost. Hewlett Packard pointed
to the Cannon
and NEC printers that
are being given away free in PC
packages. Compaq
has complained that
Toshiba’s aggressive pricing has
begun to take
its toll. The list goes on
and on, but the point has been made.
The real collapse in Asia
has just begun to gain
momentum in the last two
months and we are already seeing
serious negative
fallout for US earnings.
Yet Wall street analysts have not yet
revised
their forecast of 14.5%
earnings growth next year.
Despite all this the US
markets shrugged off the
initial swoon and drove
the markets to new highs in December
as if nothing
at all had happened.
Most US money center banks who stand
to be one
of the biggest losers in
all this, even after warning
investors, actually
hit new highs in mid
December. In a recent Montgomery
Asset Management
survey 750 investors,
out of 1000 polled, said they're
looking for 20%+
average annualized
returns over the next decade. That's
tantamount
to saying: "This market is
never going down again. I don't have
to worry
about it. I have to invest
in it. I'll borrow money to invest".
As usual,
investors are extrapolating
the recent past into the indefinite
future.
Just as in 1982 when the dow
had gone nowhere for 17 years and
multiples contracted
to extremely low
levels, investors assumed equities
would continue
to remain depressed
indefinitely, so to today we are
blithely assuming
15% per annum growth as
a given. It would appear
that we have indeed
become quite "giddy" over
the sustainability of this bull
market specifically
and in a more general
sense, the impact on global economic
growth of
the "triumph of
Capitalism".
The only thing this market
has going for it today
are low interest rates
and low inflation. If the threat
facing continued
growth was the classic
postwar Fed rate hike slowing down an
overheating
economy, these two
factors would indeed be positives.
However, since
the threat we face today
is a Classic Marxian deflationary
bust cycle these
two factors should be
seen as warnings. During the
depression, rates
remained low for many years
with 0 inflation but the economy
still did not
recover. The problem during
the depression as it has been for
Japan in recent
years is earnings or the
lack thereof in a deflationary
environment.
Withdraw the pillar that has
sustained the markets
high multiples in the
last few years, namely earnings
growth, which
is only now being ratcheted
sharply lower in the wake of the
Asian crisis
and there is obviously a
problem. It is only a matter of time
before our
market heads sharply
lower. In this regard it is much more
than the
intrinsic impact of
earnings disappointments on stock
valuations.
Ultimately the volatility
of earnings and increasing frequency
of disappointments
will lead to a
high premium being placed on risk as
opposed to
the recent premiums placed
on growth. Consequently
multiples will begin
reflecting the perceived
risk of plunging profits. In time we
will see
a change in psychology and
the overall attitude toward equities
as we have
seen after every major
market shift.
As we saw in the 30s and the
early 50s equities
as an asset class will
derate relative to debt instruments.
In the early
50s, US equity yields
were significantly higher than bonds
as the memory
of the 30s and the
perceived risk in equities remained
the predominant
determinants of
investor psychology. Today,
yields are scoffed
at as investors have
learned for the past 15 years to
focus on growth
and capital gains. When
we consider the fact that partly due
to these
psychological influences
markets tend to overdo it at both
extremes the
withdrawal of the earnings
pillar from our currently overvalued
market is
rather scary. Lets not
forget that at the end of secular
bear markets,
equities trade at levels
closer to 6x earnings than the
current 23 x earnings
and with yields
closer to 7% than the current
1.5%. Even
assuming current earnings
levels, the market would have to
decline about
65% to be consistent with
post bear market valuation levels. If
you add
to that calculation a period
of contracting earnings the potential
decline
is mind boggling. Such a
decline when considering the extent
of public
participation particularly
the extent of retirement money in
today’s market
carries with it serious
economic as well as socio-political
risk.
To better appreciate the
decline we are probably
heading for, a closer
look at the decline in the Nikkei
since 1990 might
be helpful The Nikkei
approaching 40,000, in 1989 was very
similar.
The Japanese had become so
confident in themselves and their
market they
believed it would never go
down. The Japanese were all powerful
they were
buying up everything, even
America. They bought Pebble Beach,
Rockefellor
Center, Hollywood studios
and every painting they could get
their hands
on from Christie's and
Sotheby's. Writing in the Atlantic
Monthly in
May 1989, days before
Japan’s market began to crack, James
Fallows a
respected economic
columnist wrote, "No symptom of
slowdown can yet
be observed. By every
measurable indication -- corporate
profit, personal
savings, industrial
productivity -- Japan is distinctly
on the rise."
(Atlantic Monthly May
1989)
Essentially, you
had the same tone of overconfidence
there that you have
here today. And what happened in that
market?
As the market began to crack
they bought the dips. They didn't
have a crash.
The market would fall
sharply and then rally back almost as
sharply
as confident Japanese
investors jumped at the opportunity
to buy the
dips. The long awaited
correction had finally materialized.
Investors
guided by knowledgeable
analysts saw the decline as healthy.
"We haven't
had a 10% correction, in
some time", they tell each other.
"This is no
big deal, I'm going to buy
this dip. I'm not going to worry
about it. Besides,
I'm essentially locked
into my long position. I can't sell
because I
know the market will come
right back. After all over time
equities have
proven to be the best
investment". Then the market bounces
and everyone
feels great. Then the
market plummets another time, (can
you hear that
jingle) as Japan was now
in a Bear market each wave down
invariably set
lower lows. This rather
painful process went on for a while.
It took some
time for investors to
unlearn their earlier lessons until
stocks get
to the point where
investors couldn’t take it anymore.
By that point,
many were wiped out. In
fact, it wasn't until the Nikkei
broke 20,000
that people began to realize
that there was something very wrong.
The Nikkei went on to fall
another 7000 points
and 6 years later the
Nikkei is still down over 60% from
its highs.
Imagine such a fall here.
Imagine how painful buying those dips
will become
when the market keeps
breaking down to new lows. Imagine
wiping out
peoples life savings. Of
course this can not possibly happen
here.
America is the strongest
economy in the world. We won the Cold
War the
whole world is striving to
follow our example. I would not
entirely rule
out the possibility of a
1929 type crash despite the tendency
to buy the
dips.
Should the markets decline
too sharply in a short
period of time the
specific nature of certain
derivatives particularly
the popularity of put
options as a post 87 form of
Portfolio insurance
could trigger a sharp
downward spiral that gets completely
out of control.
Since this is a
rather complicated technical issue I
will spare
you the gory details.
Suffice it to say that while in this
scenario
the small investor is spared
the heart wrenching Chinese water
torture type
of decline the final result
is much bloodier for the overall
system.
In the latter scenario the
decline is likely to be steeper and
lead too the
collapse of more
financial institutions.
Of course all this seems
unfathomable, we have
learned the lessons of the
recent past well. We have been
trained to buy
the dips. We have grown
quite confident in the strength of
our economic
system and the US economy.
This confidence, as we have shown, is
totally
unfounded. We should not
allow the current complacency to
confuse our analysis.
Prior to every
major market break, be it 1929, 1968,
1976, 1987,
or Japan in 1990,
complacency reigned.
Yet prior to all those
declines the warnings were
readily apparent to
those who took a detached view. We
have proven
that today’s complacency is
not justified by reality. We have
demonstrated
the extent to which the US
market is overvalued even in the best
of worlds.
We have made a strong
case for the argument that
developments in Asia
are of grave significance
to the US. We are convinced
the great bull
cycle that enriched so many in
recent years is about to be undone in
a very painful
bear market that may
rival the Great Depression in its
impact. We are
also convinced that the
world will be a very different place
when it is
over. The pain,
frustration and disillusionment will
be enormous
and widespread. We will
see violence on the streets of Korea
and other
Asian, Latin and Eastern
European countries. We will likely
see revolutionary
change in many of
these countries. The impact of this
global finacial
collapse on the
already shaky move toward European
Union will
certainly not be a salutary
one. We will also no doubt witness
serious social
and political unrest in
the US. The question for Jews must be
what all
this means for American
Jewry, Jews around the world, and
US-Israel relations.
Debt,
Deflation, and Hyperinflation
The Coming Economic Collapse
Lance Owen has posted yet
further supporting evidence
of an impending economic
crisis. It can be found at:
http://home.istar.ca/~lowen/
