from - stratfor.com
STRATFOR.COM Weekly Global Intelligence Update
17 April 2000
Forecast for the Second Quarter of 2000: The Global Economy
Summary
Today we launch our forecast for the second quarter of 2000. The dominant theme in the world in the coming three months will be the economy. This year the United States will experience not just turmoil in the markets but a short, sharp recession that will serve to strengthen the economy over the long term. The effects of this abroad, however, will be less healthy - particularly in Asia. Europe will seek to maintain its business interests in Russia, even as the government there puts a strong hand over the economy and the oligarchs. Latin America will likely escape serious repercussions.
Analysis
For years, our view of the U.S. economy has been intensely
optimistic. More recently, though, we have argued that the robust economy has been due for a short, sharp recession led by a market sell-off. In February, we published "Recession Time?" predicting not only a sell-off but also a recession in the summer and fall of 2000.
The markets have clearly begun the sell-off. But the consequences will not be limited to either the markets or the United States. The shake-out in the U.S. economy will only help strengthen its long-term prospects but will reverberate elsewhere. Asia will struggle. Effects will be as political in nature as they are economic, particularly in Beijing. Russia's new president will move to quickly establish control over the economy; thus, a confrontation with the country's oligarchs is likely to happen quite soon. Latin America will likely ride out significant economic turmoil.
United States
In the United States, the markets have clearly begun the sell-off. The sell-off of Internet stocks is triggered by the fact that too many of the business plans for publicly traded Internet companies make them dependent on subsequent rounds of financing; they are not self-sustaining. As they have launched their plans, though, they have found the markets cool to more rounds of financing.
Investors are diving for cover after realizing that many of these companies cannot survive. But the problem is not confined to the Internet stocks. Inefficiencies and irrationalities have crept into other sectors of the U.S. economy. Now, with the interest rate hikes of the Federal Reserve and the increasing conservatism of the markets, the supply of money is becoming relatively tighter, even as the values of both corporate and individual portfolios decline.
We don't expect a recession to start in the second quarter - but we do expect the rate of growth to decline. Actual contractions in the economy will occur in the follow-on quarters. Further market declines will follow. Consider that the S&P 500 has risen in nearly a straight line from around 500 to around 1500 in five years. A fall to 1000, retracing half of the rise, would not be unthinkable and would not break the long-term bull market that began in 1982.
Asia
All of this is bad news for the rest of the world economies,
particularly for Asia. The greatest problem facing Asia is its inability to form capital. First, Asian speculative money fled to the United States seeking higher returns. Now, as U.S. interest rates rise, a second round of outflow can be expected as Asians take advantage of more conservative investments. This will drive the dollar higher.
In a sense, there will be an immediate benefit to the region, as the rising dollar makes exports bound for the United States cheaper. This will have an interesting political effect. An underlying protectionist sentiment has been masked by the prosperity of recent years. But as the economy weakens, the pain of imports will rise - and so will protectionist politics in the presidential elections. Both George W. Bush and Vice President Al Gore are free traders, but the export surge will likely prove too much for Gore - who has strong trade union support - to resist.
In turn, this will intensify Washington's problems in Asia. It will make already difficult relations with Beijing even harder. It will also create problems with Japan, where nationalist sentiment in the figure of Tokyo Governor Shintaro Ishihara is rearing its head. A recession in the United States will not only weaken Asian economies but also create significant opportunities for trade friction between the United States and a large portion of Asia.
Viewed on its own terms, Asia remains susceptible to a relapse of the economic collapse of 1997. Its export-based economies are still dependent on U.S. consumption and need further foreign investment. Higher U.S. interest rates will draw from that pool of investment; a slower U.S. economy will reduce the consumption of Asian products. A downturn in the U.S. economy generally means that inefficient enterprises are weeded out; in Asia, however, it will mean another crisis.
While the Asian economies are no longer in free fall, they
generally have not made the structural adjustments necessary to prevent another economic slide. Banking systems are still a mess and companies are far too bloated with middle management. Homegrown solutions like Malaysian-style restrictions to control capital flight still don't make up for decreased investment. The self- proclaimed recovery is little more than a cyclical uptick in a downward trend.
Some countries, however, will be better off than others. Out of all the Asian economies, South Korea, Singapore and perhaps Thailand are somewhat prepared to deal with another downturn. South Korea and Thailand have implemented a measure of International Monetary Fund (IMF)-prescribed reform. Singapore at least understands the region's tenuous economic position and is doing what it can to insulate itself.
A downturn will bring about two contradictory effects. Attempts by regional governments at increased economic cooperation will be undercut by an export war. Asia still smarts at the social cost of the IMF-prescribed remedies. Therefore, the region will likely try to pull together to solve its own problems. It can use its own money and own economic policies to attempt to remedy the situation, perhaps resulting in the realization of rhetoric-heavy but capital- poor institutions - such as the Asian Monetary Fund.
However, these cooperative efforts will be undercut by regional competition over trade. The increased strength of the U.S. dollar will trigger an Asian export race as the countries desperately attempt to build up their reserves. Regional cooperation is likely in the mid-term, but trade wars will slow the process.
Weak economies will increase domestic political unrest in some nations - particularly Indonesia and China. Indonesia's democratic government, which is already in a precarious position, will be further strained as foreign investment falls. Indonesia will face a chicken-and-egg dilemma. It needs a cash influx to stave off social instability and separatism. Despite the best efforts of neighboring Singapore and Malaysia to encourage investment, foreign investors will stay away as long as there remains a threat of instability. Unable to attract outside funding, Indonesia's central regions will concentrate on securing the country's remaining wealth - thus fueling the fires in resource-rich separatist regions.
China will be unable to hide its own economic downturn, causing more Western investors to cut their losses and leave. This will prove to be the decisive point in the political struggle between advocates of Western-style economics and the old guard. As foreign capital flees the country the winners will be the hard-liners opposed to Western investment and involvement in the economy. The economic malaise will breed domestic dissent and unrest, potentially requiring a widespread security crackdown that may surpass what China experienced in 1999.
Shutting China's economic doors brings further problems. Many regional leaders are getting rich off local, foreign-run operations. A central government effort to expel these companies might provoke a backlash from regional power brokers. In time, the resulting rifts between the central government and the provincial leaders could lead to serious fractures within China - and the more distant threat of armed conflict.
Europe
Europe's economy is more diversified and self-sustaining and as such will not be severely affected by the American hiccup.
A large chunk of Europe's trade and investment stays within the region, which gives it a measure of economic insulation in the same way the size of the U.S. economy allows it to sustain itself. The European Union's largest foreign capital investments are in Eastern Europe and Russia, and Europe will focus on ensuring a return on its money.
For example, Russia owes the German government nearly $16 billion in loans - about the same amount as Germany's defense budget. Russia doesn't have cash to pay the loans, but neither can Berlin simply write them off. A Russian default would cripple its ability to borrow, but would also hurt the financial standings of the creditor nations and banks that loaned Russia the money in the first place. A partial solution was the appointment of a German to head the International Monetary Fund - with the implicit understanding that he could grease the wheels for loans with which Russia could repay Germany. Instead, Europe will continue to look for business opportunities within Russia as it attempts to recover a portion of its investment.
The major foreign policy story in Europe will be in Kosovo, as NATO reins in the ethnic Albanian militants who have been raiding southern Serbia. These militants, the Liberation Army of Presevo, Bujanovac and Medvedja (UCPBM) take refuge in the three-mile buffer zone surrounding the border between Kosovo and Serbia, where they are relatively safe from NATO peacekeepers and Serb interior police. This group must be reined in to keep the peace. The likely triggering event for this will be the transfer of command over the peacekeeping mission from NATO to the European-led Eurocorps.
At the same time, the West will begin to rebuild Kosovo's political structure. Even though peacekeepers have been in Kosovo for almost 10 months, the United Nations has been surprisingly slow at creating governmental institutions of any sort. But international support for Kosovo Liberation Army leader Hashim Thaci dwindles as his group continues to ignore the rules imposed on them at the end of the war. The moderate and malleable ethnic Albanian leader Ibrahim Rugova is the logical choice for UN support.
Russia
The Russian economy is not only of concern to Europe but is an absolute priority for President-elect Vladimir Putin.
It approaches the point of cliche to say that the Russian economy is in shambles and that something must be done. In this quarter Putin will focus on Russia's internal situation. First, Putin will begin repairing the economic and financial institutions necessary for basic commercial life. He has already begun to restructure the banking system and will continue with relatively simple steps such as modernizing the tax code - a reform that is also supported by the Communist majority in the legislature.
Putin's plan, thus far, involves strengthening the economic
policing bodies, like the Federal Security Service (FSB) and tax police, while pulling layers of meddlesome and counterproductive bureaucracy out of the daily operations of business. Success here can pave the way for less popular reforms like the eventual nationalization of major industries.
However, any real economic progress will be incomplete unless Putin can sweep out the oligarchs, a small group of robber barons who direct major segments of the Russian economy. Putin must end the government's dependence on oligarch-controlled industries. Three of them - gas, electricity and railways - provide nearly 35 percent of Russia's budget revenues. Taming the oligarchs will also keep industrial profits within Russia, rather than in the Swiss bank accounts of tycoons like Boris Berezovsky. Publicly attacking a major source of corruption is the best way for Putin to lure Western investment back into Russia.
Putin will make a very public, very decisive move against the oligarchs - most likely a series of raids, arrests and open trials - perhaps as early as the first week after his May 7 inauguration. Putin has already begun reinforcing the Moscow tax police with FSB leadership. The charges will be corruption and tax fraud.
This purge will have several effects. It will nurture the
nationalist sentiments Putin has stoked with the war against
Chechnya. The oligarchs are a symbol of the corruption and
bureaucracy that Russians believe has kept them in the dirt.
Purging them will feed the nationalism and demonstrate the strength of central power in Russia. As oligarchs depart their posts, Putin will gain control of moneymaking industries such as gas, oil and weapons exports. He will install his own loyalists and channel the money back into government coffers.
An unintended consequence of this housecleaning will be that the outside world will perceive Putin as a pro-Western reformer. Putin won't resist the label as it will likely encourage investor confidence in Russian markets. The label will be correct in light of Putin's anti-corruption drive and tax reforms, but does not take into account future moves such as nationalization of key industries and tight economic controls.
Latin America
The increasingly dollarized Latin American economies will escape the economic correction relatively unscathed. For instance, the Argentine peso is pegged to the dollar. The effect will be minimal because most of their trade flows among themselves and the United States - all of which will be raising rates. Increased foreign investment should make up for any decrease in exports to Asia and Europe. |
