• Global Review
  • Wednesday June 17
  • Week starting July 13
  • Conclusions

• Canuck's Corner
• The United States

So, are we at a turning point, or is this only a false dawn ? That is the question for this month's Issue.

The event that, at least chronologically, marked the beginning of this new wave of optimism was a joint American-Japanese intervention in the forex market on Wednesday June 17. This is convenient because it means we can look at what is going on by starting from the three 'pointers' [LINK] that were the conclusions I drew from the global trends assessment in the last Issue [LINK] Skeptical Investor No. 11. June 14 1998). Because the following is based on the same overall assessment, it may be a good idea for readers to review the June Issue before continuing.

The anticipated international intervention in the Yen:USD exchange rate happened very quickly - on June 17 - and must have already been planned and agreed in principle between the USA and Japan before that weekend (June 13/14). In a joint action starting at 0800 EDT (12.00 GMT) an estimated US$2 bn were sold for Yen, pushing it up by nearly 5% against the dollar within hours. This big response shows that the intervention took a lot of currency traders completely off guard, which of course is exactly what it was intended to do. But apparently not all:the Yen had already climbed from its low of 146.75 (June 16) to 143.22 before 0800 EDT June 17, so someone was already being cautious.

The reason for the surprise - and for the strong effect of the action -was not so much that it was a joint effort, but that the USA was a participant at all. The credibility of unilateral action by the Bank of Japan had been damaged a couple of months earlier when it spent what is estimated to be ten times as much - US$20 bn - in what proved to be ineffective support of the Yen. Few currency traders believed they had much fear from further BoJ intervention. But the participation of the USA ... this was something new, and a shock to many. This was the first time since the"reverse Plaza Accord" that the United States had intervened directly in the foreign exchange markets in support of the Japanese currency unit. Further, US Treasury Secretary Rubin has consistently, and sucessfully, followed an unambiguous "very strong" dollar policy so an action that involved reducing the value of the USD was at odds with all recent precedent.

Were this to represent a fundamental shift in policy, it would be the most internationally significant such shift in a decade. But it is extremely unlikely that it does signal any change of direction, and I do not think many analysts would disagree. The United States embarked upon it very reluctantly indeed, and only because things were spinning out of control (the Yen was in danger of plummeting) and because they were backed into a corner by the Chinese who made it very clear indeed that if something was not done they were going to devalue their currency.

What it has done however is, for now at least, to stabilize the Yen by putting a cap on it of perhaps 145 Yen to the dollar, or thereabouts. Currency traders will no doubt now get very nervous if that level is approached. And it stopped a possible slide into a new round of severe currency chaos: thus buying some time during which, those concerned hope, the global economy can be repaired. What it did not do though is change anything fundamental. The underlying reasons for the weakening Yen and the surging dollar remain as they were. The United States still has a strong dollar policy and, at about 140, the Yen is still internationally weak. Thus the capital flows that have distorted the global markets may be expected to continue as before.

(It has also demonstrated that the People's Republic of China now has enormous economic power, and prestige, throughout Asia. Expect China to play an increasingly important role from now on.)

Then, early last week, there were two events that have been interpreted very optimistically, boosting stock markets around the world. Ryutaro Hashimoto, Japan's sixth Prime Minister in five years, tendered his resignation in response to bad losses by his party (Liberal Democratic Party) in elections to the Upper House on Sunday. And, on Tuesday, under great pressure from the USA, the International Monetary Fund announced it had agreed a financial assistance package with Russia which would give it an extra $17.7 billion in IMF loans this year, plus an extra $2.5 billion in loans from the World Bank and from Japan. With further assistance agreed for 1999 the total package for Russia has reached $35.8 billion.

The basis for investors' delight at the resignation of Hashimoto seems to be that they many have come to believe that he bears much of the responsibility for the financial mess that Japan is now in: thus they see the prospect that he may be replaced by a man who will fix it.

But such optimism is extremely premature. The problems in Japan's economy are extensive and severe: cleaning up the estimated $600 billion (probably much larger) of bad loans owed to Japanese banks is itself a huge and difficult task that will take a tough and strong-willed leader, but is a 'necessary but not sufficient' requirement to get the economy growing again. The essential fixes will involve many bankruptcies and a period of high unemployment, and none of the candidates for the prime ministers job is proposing to undertake all of the drastic measures that are clearly needed. And some of the proposed measures involve Keynesian pump priming which will do more harm than good: government debt is already $2.8 trillion - 75% of a fallingGDP. For comparison the US national debt is 68% of its growingGDP.

I believe that even using the most optimistic scenario that can sensibly be constructed for Japan, it would take two years before the economy could turn around and start growing again. Obviously, during these two years, Japan is unlikely to be able to be the engine of growth for the rest of Asia.

As for the financial aid to Russia " ...the consensus of Western experts is that the rescue package provides Russia with a breathing space, rather than a solution to its chronic economic problems." (Sydney Morning Herald, July 17). I can only agree.

I do not believe that any of these recent events has changed anything fundamentally: the Yen intervention and the Russian "bailout" are both best interpreted as stopgap measures that have bought some time, as has the probably unwarranted optimism for a new man at the helm in Japan.

It is difficult to assess however how far optimism alone will drive international markets up. I do believe though that the global economic forces (capital flows, over investment, bad debt loads, etc.) that are at play are so powerful that the negative fundamentals will reassert themselves, and, in my opinion (not to be taken as a recommendation) buying back into the Asian markets at this stage would be best contemplated as merely a short-term speculative play. I do not see,yet, a turning point.

Canucks' Corner

The United States