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/
