Looking for the Bottom Jude Wanniski January 13, 1998

Since the slide began in Asia early last year, with Thailand chained to the deflating dollar/gold price, we have been repeatedly asked when we think it is again safe to invest in the region. We hear the Templeton Fund, which has had success in “buying low,” is now buying  Korea on the guess that it has hit bottom. Templeton may well be right. In any case, we never recommend one investment over another, but rather present the political analysis which makes us more or less comfortable with a country or a region, equities or debt.

Investors recall how the Mexican Bolsa finally began to recover in dollar terms after falling by half in the early months of 1995, following the halving of the peso’s dollar value. Even when we observed the Bolsa inching its way up in 1996 on Wall Street’s coattails, we did not mask our wariness about putting money into a place where the culprits were still in power. Mexican President Ernesto Zedillo is not one bit wiser today than he was in December 1994, when he let the International Monetary Fund push him over the edge into the peso devaluation -- just after he won the presidency by vowing he would never do so. The fact that the Mexican people turned the Congress over to the opposition party is the one good thing that has happened since. Even this was offset when Zedillo announced last month that he was promoting Finance Minister Guillermo Ortiz to the directorship of Mexico’s central bank. Ortiz, who had worked at the IMF in Washington during the Salinas administration, was its agent inside the Zedillo government at the time of the devaluation. The one solid man at the Bank of Mexico who knew what he was doing, Francisco Gil Diaz, resigned the moment he learned he would have to work for Ortiz. The new finance minister, Angel Gurria, is an expert in public relations.

We have the same problem in Asia. There are surely people in the Asian governments who have a good idea what is happening to them, but not enough of them are in positions to do anything about the central problems that are sinking the Titanic. The rescue has to come from outside, from a power strong enough to throw out life preservers and haul them to safety. Instead, we have the IMF drilling holes in the lifeboats. IMF director Michel Camdessus and his deputy, former MIT economist Stanley Fischer, are in the region this week urging the victims to balance their budgets so their foreign creditors can be paid! The IMF thinks in terms of external debt, because it represents foreign banks. It cares nothing about a nation’s internal debt, which is why it is so casual about recommending devaluation. Remember, when a country devalues its currency, it repudiates that part of its national debt denominated in its currency by the amount of the devaluation. In Indonesia, for example, the 75% devaluation of the rupiah in real terms has wiped out 75% of the nation’s wealth held by the private sector in the form of government debt. The debt burden shifts from the state to the citizenry. 

When the United States devalued against gold in the 1970s, it essentially repudiated 90% of its publicly held national debt. Wealth shifted from the people to the state by that process. By 1980, the IMF was urging the United States to raise taxes and cut spending to balance the budget, which would have utterly destroyed our economy. Instead, President Reagan cut tax rates and allowed spending to rise to levels necessary to 1) win the Cold War and 2) finance the welfare costs associated with the mangled U.S. economy. The economy we have now is the result of the supply-side actions taken by Reagan, his tax cuts and Fed appointees, who were repelled by the devaluation idea.

In looking for a bottom in Asia, we can take some satisfaction in noting that Harvard’s Jeffrey Sachs, an economist we listed last year as one of the most dangerous on earth, has been speaking out aggressively against the IMF austerity programs. We can also note that after Deputy Treasury Secretary Lawrence Summers stopped in Jakarta to urge President Suharto to accept the IMF loan conditions, the “budget surplus” part of the package was dropped. As usual, there are no public specifics on what the package contains, either in Indonesia or Korea, but it would be nice to think that Summers -- who has accepted an invitation to attend the Polyconomics annual client conference in Florida at the end of February -- is now doing more good than harm. Since Sen. Bob Torricelli [D-NJ] last summer urged the White House to meet with me to hear my deflation warnings, I’ve met twice with Summers. I’ve sent him dozens of memos on the cause of the problem having emanated with the Fed and specifically discussed the deflationary problems in Japan. At the very least, he has not been ignorant of this perspective.

The Wall Street Journal, which should have been on top of the deflation story months ago, has begun to make strides in the right direction. Its editorial Monday, “Saving Asia, 101,” is the best we have seen in the public prints, especially this single argument: “Devaluation of the won or baht or whatever can be stopped by restricting the supply of them. That is, instead of sterilizing currency inflows and outflows, the central bank should let redemptions of its currency reduce its supply.” The Journal still argues without foundation that: “Doing this will of course increase internal interest rates, slow the internal economy, and endanger tottering banking systems. But these costs are likely to be much cheaper than the costs Korea, let alone Indonesia, suffers already.” If the Indonesian central bank today purposely reduced the supply of rupiah beyond the demand for won, the markets would drive up its value, interest rates would fall, and the tottering banks would no longer totter. In other words, the medicine the Journal prescribes is far better than it advertises.

As the world’s second biggest economy, Japan is still an enormous drag on Asia because of its monetary deflation. Neither the Clinton Treasury or WSJ realize Japan cannot be cured by prescribing tax cuts or spending increases when only massive injections of yen liquidity into the banking system will reverse the deflation. Banks totter both because of inflation and deflation, because they are intermediaries between debtors and creditors. In Japan now, the citizens are so worried about tottering banks they are withdrawing yen deposits and converting to dollars, helping drive down the dollar price of gold and creating bankruptcies here and there.

The most powerful man in the world could fix all of this up in a jiffy, but Fed Chairman Alan Greenspan is still playing his cards close to the vest. We gave him 2½ cheers for talking about the possibility we are now deflating, when he should have known that all last year. Unless he finds a way to add dollar liquidity to reverse the dollar deflation and drive the gold price up, we can not feel confident we have reached a bottom. He should also know better than to back the IMF austerity schemes in Asia. We should not have to rely on Larry Summers and Jeffrey Sachs to be rescuing the Asians from Michel Camdessus and Stanley Fischer. The most promising straw in the wind is a little story in today’s NYTimes on page D3. “Greenspan Heckled.” We think this was the first time Greenspan has been jeered publicly, in his presence. At a community financing meeting in L.A., someone shouted at him for promoting an Asian bailout while they need the help. “It’s a disgrace...You should be ashamed of yourself.”