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Asia Nikkei Business – February 27, 1995

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February 27, 1995

After Mexico, Canada Might be, Same Thing Perceived among G-7 Countries

Interview with Martin A. Armstrong, Chairman of PEI

Many people think that Latin America and other developing countries might fall into debt crisis following Mexico. But I don’t think so, but possible default might occur in Canada and it might go into default next year, even if temporarily.

Since the beginning of last year, 40% of its total government expenditure spent for interest payments. Half of the rest went to social security payments. This means that it invested little money into real economy development. 40% of the government bonds will come due within this year, and it’s clear that lack of deposit will reveal soon. Whenever government debt becomes excessive, private capital should go away in search for more sound place to invest.

Currently we had seminars in Canada and over 4,000 people attended. And the number one question was how to invest money outside Canada. This shall be evidenced by the fact that one US$ against Canadian dollar was CAN$1.15 in early 1992, and currently it’s some CAN$1.4, and further more it dropped sharply since last third quarter, further 25% down would be possible.

Heavy Social Welfare and High-Developed Countries are to be in Trouble

About five years ago, New Zealand and Australia were attacked first and followed by Italy and Sweden. Next year Canada might be faced with the same problem, and then people shall recognize how serious these two big issues are. As Canada is one of the seven advanced countries, we cannot take it as special phenomenon that happens in such a small country as Mexico. People might be able to understand how seriously heavy social-welfare and high leverage are damaging and having the country’s confidence when Canada is in trouble.

Unexpectedly, the US seems safe, because the economy size is huge and only 15% of the government expenditures is applied for interest payments. As the other countries are losing confidence, in a short term the US will be attracting would capital. However, it would like to warn that even the US shall be involved in the same problem until 1998 or so, because its structure is very vulnerable to fluctuation of interest rate.

The Clinton Administration demonstrated loudly the deficit reduction program of US$500 bil, however, when we checked the details, the real story shall be revealed.

Out of $500 bil, $250 bil was prepared artificially by shifting ones. For the first year term of the Clinton Administration, 33.49% of the government bonds was within one year maturities, and if we included 1 – 5 years maturities bond, the percentage was more than 70% the situation of which is quite opposite to 10 years ago.

When it made the program, the short term rate was only 3% p.a., although the long one was 6%, therefore shifting to the shorter term was supposed to contribute $50 bil interest savings per annum and for five years it should amount to $250 bil. In addition to this $250 bil saving, tax increase of $250 bil should have helped $500 bil government debt reduction program that ought to be the historical greatest maneuvers.

To the contrary to the expectation, the program proved to be just a dream last year, because interest rates were hiked sharply, which means that the government burden of interest payments will increase steadily. Everybody will realize it when Canada becomes the next Mexico.

Nevertheless, for the time being bull stock market backed by flourishing business results of American companies will be successful in attracting world capital.

Political uncertainties in Russia and China help the US assets be attractive and make the capital in the emerging countries back to the US.

The Japanese institutional investor also seem to resume investments in the US, because they think J.YEN exchange rate against US has almost peaked out and the higher yield of the US financial products. And reduction of capital gains might attract them also.

Anyhow, all these factors might conceal the problems behind, and J.YEN is expected to be down to 120 – 130 yen per US$ in due course.

Lack of confidence should happen all of a sudden as we experience Mexico case, and once it should happen, we won’t be able to stop the outflow of capital even if overnight rate is increased by 100%, which is evidenced by the situation of Sweden.

Even Japan, which cannot stop the increase of government depths, shall face the same problems as other G-7 countries by 1998.

Investments in the US stocks, corporate bonds, and in gold for long term are recommended. Which is smart investment? US stocks and corporate bonds in terms of short period and gold from long term investment strategy are recommended.

Quite different from copper or nickel, gold price is hitting the bottom and under the up trend. From demand and supply, gold bar marked by the Russia has almost sold out the gold reserve. New expectation of gold is becoming difficult, because the privilege of the native residents tends to be preserved and environmental issue is highly regarded, new gold mining is now almost impossible. There is little hope that shortage of gold supply will be eased.

It should be noted that lack of confidence in the government and gold prices tend to go opposite. I am of opinion that by 1998 gold prices might go up to $1,000 per ounce.