By Martin A. Armstrong
© June 1st, 1998
Princeton Economic Institute
Capital is currently fleeing from emerging markets on a wide scale basis. The immediate problems that are surfacing in Russia should come as no surprise. Russia has been unable to collect taxes; unable to make payroll for months; unable to control its local governments and unable to control even its nuclear weapons, since a few missiles remain missing at this time. The government has been taken over by the Mafia and it is unable even to meet interest payments on the last few rounds of IMF injections.
The Russian crisis will become much worse should something happen to Yeltsin. The fate of Europe and indeed perhaps the global economy rests on the shoulders of one man. Without Yeltsin, Russia will swing back to the communists. The average man on the street is beginning to sense that at least things functioned better under the communists than they are currently. Russia has turned off all the hot water throughout the country in an effort to conserve energy in order to export more crude oil for hard needed cash.
We are living in the last throws of the collapse in Communistic/Socialistic economic systems. Over the next 4 years, we expect this crisis to become much worse before it will be better, All highly socialistic systems are collapsing from their own internal inefficiencies and this includes Europe and Japan. The greater the central-control mechanism, the greater the economic difficulties ahead. We also see a continued economic contraction in China that will UNQUESTIONABLY lead to a devaluation in the RMB.
These severe economic pressures are the primary cause behind the dollar’s strength. With or without the Euro, turmoil in Russia will provide yet another bullish stimulus for the dollar and a further decline in commodities at least for the next two months. Russia itself is starting to sell whatever it can get its hands on. Those who think that Russia would not sell its gold, silver, palladium and platinum reserves fail to understand the point. Unless the government can lay its hands on as much cash at this time – there is a risk that it could fall taking Yeltsin with it. Therefore, there is no strategic plan here at work. Russia is in a crisis mode for its survival.
Even former Russian states are coming under significant pressure. Uzbekistan has already sold 120 tones of its silver reserves just recently, which has contributed to the recent decline. More is likely to appear since Uzbekistan is a net silver producer. Russian banks are now allowed to sell precious metals directly under the new deregulation and the first sales are starting to hit the marketplace. Russia itself has yet another $4 billion in gold and 300+ million ounces of silver, according to our sources. The more deflationary things appear in emerging markets, the more selling of precious metals we expect to see over the next two months.
While gold mines banned together to lift their hedges a few months ago in an attempt to support the gold price, now these same parties risk being downgraded by the credit agencies since they are exposed to the market forces. Should gold break below the $280 level, everything the mines bought back may return to the market in the form of new hedge positions. Those mines that do not protect themselves, could be forced to close this summer.
In Japan, the politicians still fail to understand the crisis they have created in their own economy. The politicians have spent more than 10% of Japan’s reserves in a futile attempt to support their currency. From the politician’s perspective, a weak yen means they have failed. While the political forces in Japan keep crying to the G7 for help, there will be NO coordinated effort at intervention. The G7 is fully aware that Japan has spent more than $25 billion on its intervention without success. The G7 has Asia and Russia to be concerned about – not supporting the yen just because the LDP elections are in July.
At this time, 1998 is starting to resemble 1931 as one nation after another was forced into default. Not even the gold standard prevented the economic collapse of the Great Depression. In fact, it probably made things worse insofar as when a nation didn’t have the gold, there were no bailout packages that could be floated on a new paper scheme in order to keep the game afloat. When government ran out of gold – they defaulted on their bonds. Today – the game is extended merely do to the current floating exchange rate system. However, at some point the untinkable does happen.
With chaos in the Indian subcontinent causing tensions to rise and sanctions to be imposed, this is the last thing South East Asia needed at this time. New lows throughout the region cannot be ruled out. Even Hong Kong can be expect to see its share market tumble to the 6,000 area before a bottom comes into play. Latin America is now coming under attack and countries such as Australia are being hard hit due to their high commodity oriented economy and proximity to South East Asia. Even the Mexico bailout is starting to look like it could be in trouble once again. The truth behind the Rubin/IMF bailout for Mexico is simple. When things died down and the press wasn’t watching, Mexico issued bonds backed by oil in the European markets. The proceeds from that bond issue were then applied to pay off the US Treasury ahead of schedule making Rubin look like a hero when in fact it only moved the debt back to the private sector. As Crude oil dropped by more than 40%, Mexico’s debt could come under pressure once again if the currency slips further.
The share markets around the world are being hit. We would be MOST concerned about the European market with close attention being paid to Germany and France. The greatest exposure to Russian defaults remains Germany who by some accounts has more than 50% of the debt.
As we head into the July period, we must warn all clients that we may see some very extreme swings in all markets from FX and commodities to shares and bonds. The best investment on the board appears to be none other than US bonds, which still remain poised for new highs perhaps going into even 1999.
In summary, the situation is becoming critical. If the dollar yen closes ABOVE 140, this may signal that an explosive move for the dollar is unfolding even against the European currencies. A closing BELOW the $280 spot level in gold could send this market down to the $250-$225 area even by July perhaps bringing an end to the bear market. Palladium and Platinum could go into a free-fall and a closing for silver under $5 will spark a drop back to the low to mid $4 range with a risk of dropping to $3.25 moving into next year. A weekly closing below the 1078 level on the S&P500 may spark a panic sell-off back down to the 1032 area. A weekly closing BELOW 5258 on the DAX and we will see a very significant decline becoming possible. In the end, US bonds may prove to be the only investment short-term.
For now, the future is a bit more cloudy than just the Y2K problem. We suggest CAUTION in just about everything. The period ahead into 1999 will be a rough ride to say the least.