Lethal Stage
Here it comes, says David Hale
Review1 | Preview2
Follow-Up: Brave New World
Few economists grasped the implications of the economic bust in Asia as
quickly or surely as Zurich Insurance's David Hale. Last December, he was
right on the money when he stated in a Barron's interview that the collapse of
Asian currency and stock values would inevitably mutate into a full-bore
economic crisis in the region ("This Is Different3," Dec. 22, 1997). Nor was
Hale any more sanguine in an article in the July 27 issue of Barron's ("No
Relief4"). He saw the so-called Asian contagion as intensifying and spreading
over the globe.
We decided to put in a follow-up call to Hale late last week in light of the
recent intensification of global financial problems in the wake of the Russian
ruble devaluation and debt default. Hale, indeed, sees the latest mishap, which
has sent currency values and stock markets crashing as far away from Russia
as Brazil, as the latest and most lethal stage of an economic drama that began
innocently enough a year ago in July with the collapse of the Thai currency, the
baht. First, of course, the economic crisis in Asia led to reduced demand in
world commodities markets, which, in turn, has blighted the trade balances and
therefore the currencies of key commodity-producing nations like Australia,
Canada, New Zealand, Norway and, of course, Russia.
In Hale's view, last month's ruble
devaluation and concomitant debt
default were the most ominous
developments. For the moves
shattered several key illusions
held by international bankers and
investors about emerging
markets. For one thing, Russia
has called into question the very
credibility of the International
Monetary Fund and, by
implication, the U.S. in being able
to fashion effective bailout
programs. Clearly if the IMF and
U.S. Treasury failed to arrest the
downward spiral of financial
events in Russia -- the country
supposedly deemed too nuclear
to go bust -- what assurance could investors and lenders have of a modicum of
asset protection in other precincts of the emerging and developing world?
Likewise, says Hale, Russia shocked the international financial community by
its almost unprecedented willingness to default on its domestic debt. "Normally
countries, when they take the fateful step of debt default, only welsh on their
foreign currency debt," he averred. "That's because domestic debt can always
be paid back with a cheapened currency merely by running the printing
presses. But Russia instead resorted to de facto devaluation and, in the
process, destroyed their banking system along with their standing with the
international financial community. For while hedge funds and other international
investors own some $10 billion of the ruble debt, the Russian banks hold some
$22 billion of it. The move was totally mad."
He sees no early solution to the Russian crisis even with a weakened Yeltsin
finally succeeding in nominating a prime minister, Yevgeny Primakov, who's
acceptable to the Russian Duma after two false starts. The stabilization of the
ruble will depend on a concerted international effort, which isn't likely to come
for some months. Clinton, at the moment, is obviously preoccupied with
surviving the Lewinsky scandals. In the meantime, taxes will go uncollected and
the ruble will continue to fall and destroy domestic purchasing power.
According to Hale, the global ripple effect of the ruble crisis is even graver. By
casting doubt on the integrity of all emerging and developing debt, it has
triggered a global margin call and credit crunch. As a result, interest rates have
soared in places like Brazil, Mexico and Venezuela, raising the specter of
recession in 1999 in a continent which is a major trading partner of the U.S.
"Brazil alone has suffered a quintupling in their interest rates to nearly 50% as a
result of Russia, which has obviously hit the Brazilian economy like a tornado,"
Hale observed. "The currency and debt of any country with budget or current
account deficits is now vulnerable to attack by both hedge funds and worried
businessmen trying to convert funds into safer currencies. Likewise, a banking
crisis impends in much of the developed world because of the heavy exposure
of banks in Japan, Germany, the U.K. and France to emerging-market debt
with as much as 100% of their systemwide bank capital on the line."
Other signs of current international financial distress abound. Intelligence
sources tell Hale that Chinese authorities have already expended nearly half of
their $150 billion in foreign currency reserves to defend the Hong Kong dollar
peg against speculative attack. That's in addition to the estimated $15-$20
billion spent in recent interventions into the Hong Kong stock market in the
attempt to punish international short-sellers banking on the deleterious effect
that rising interest rates would continue to have on stock prices. To little avail,
however.
Nor are things going well in the rest of Asia, in Hale's opinion. The Obuchi
government in Japan is proving as feckless as most observers feared. Its key
bank-rescue bill remains bottled up in the upper house of the Japanese
parliament while the country's financial health deteriorates further. Fears are
beginning to surface over the very ability of major Japanese banks to roll over
their certificates of deposit in light of their exposure to deteriorating domestic
and foreign loan portfolios. Several recent bankruptcy filings by Japanese
corporations have only fanned these fears.
Hale also claims that the corporate restructuring of Korea is now foundering.
Indonesia remains mired in what he describes as a "terrible" recession, despite
a recent rally in the rupiah. No political solution to the country's economic
woes is likely until scheduled national elections next year. A new bankruptcy
law may ultimately help Thailand's recovery, but the process will take years.
Malaysia's recent decision to institute draconian capital or exchange controls
constitutes a huge risk in Hale's estimation. Effectively, foreign investors in
Malaysian stocks and enterprises will be unable to get their assets out of the
country for at least a year. Among other things, exchange controls typically
lead to a misallocation of capital and corruption. Some controls may make
sense, he concedes, to prevent banks' short-term dollar lending from
destabilizing developing economies by the institutions levering up borrowers
and then abandoning them at the first sign of trouble. But Hale feels equity
investors shouldn't be similarly hamstrung. Highly placed sources in Brazil tell
him that selective exchange controls may be imposed shortly.
As a result of all these developments, Hale is less than upbeat about the
prospects for the U.S. stock market. Yet he sees no impending crash. Lower
interest rates led by a drop in the U.S. long bond to 5% should prevent any
free fall in stocks. Moreover, he expects the Fed to "confirm" this drop in long
rates by lowering short-term rates in the not too distant future. Yet these
moves won't deter continued erosion in U.S. stock prices.
Jonathan R. Laing
Brave New World
A sea of troubles clobbers global satellite-phone stocks
Better put off your plans to take a cell phone on your next trip to the middle of
nowhere. The dream of being able to reach out and touch someone from
anyplace on the planet has launched a myriad of multi-billion-dollar satellite
projects ("Crowded Skies5," June 15). But recent events involving the two
leaders in the field, Globalstar and Iridium, illustrate the immense risks in
these massive projects.
Iridium, which is closer than any of its rivals to going live with global mobile
telephone, saw its stock price close at 35 3/8 Friday -- up 2 3/4 on the week
but still well below the $72 it fetched in May -- and its bonds go into free fall.
The company postponed until November 1 its planned September 23 startup
of its system. Standard & Poor's revised its outlook on Iridium debt to
"negative" from "stable," and said further delays could lead to ratings
downgrades. Although Iridium now has 79 satellites in the sky, seven of them
have failed and another is having problems. Its supplier Kyocera, which is
making handsets for the service, has been running behind schedule because of
delays in completing some key software. Iridium said it also needs extra time
for testing the system.
As for Globalstar, Iridium's top
rival, last week a Ukrainian
Zenit rocket launched from
Kazakhstan with the first 12 of
the network's planned 48
satellites failed a few minutes
after liftoff and had to be
destroyed, sprinkling Siberia
with pieces of rocket and
satellite debris. It was the
eighth time in 31 launches that
a Zenit has been blown to bits.
Globalstar shares last week
plunged by 6 7/16, to 10 1/4,
compared with about $37 in March. Stock in Loral, which built the satellites
and holds a 42% stake in Globalstar, fell by two points on the week, to 13
7/8; QualComm, which helped develop the project, rose by 2 15/16, to 45
1/2 .
In fact, the entire satellite industry has big headaches, technical and otherwise.
Multimillion-dollar satellites have been destroyed in several launch accidents,
and the industry has been hurt, too, by political problems. First, Loral was
accused of improperly providing sensitive information to China. Not long after,
the State Department suspended SeaLaunch, a Boeing-led joint venture to
launch rockets from floating platforms in the ocean, citing concerns about
information passed from Boeing to its Russian and Ukrainian partners.
Another company hurt by these problems is ICO Global Communications. The
third big player in the telephone space race, which came public last month at
$12, last week fell by 7/32, to 8 13/16. ICO, it seems, has been planning to
launch three of its planned 12 satellites from SeaLaunch platforms using Zenit
rockets.
Eric J. Savitz |
