A Registered Investment Advisor
GLOBAL STRUCTURAL TRANSITIONS
December, 1994 GLOBAL STRUCTURAL TRANSITIONS
Nineteen ninety four was a year of "leaving the past behind." It marked 50 years since the D-day invasion of Normandy, which turned the tide of World War II. This past year was also the 50th anniversary of the World Bank and the International Monetary Fund (IMF) which were created at the United Nations-sponsored International and Financial Monetary Conference in Bretton Woods, New Hampshire (referred to as "Bretton Woods") only three weeks after the Allied landings in Normandy. "As much of the world lay in ruins, monetary experts could not help but be aware of the cataclysmic costs of political and economic nationalism. Against this background, delegates from 45 countries that were allied to win the war were eager to try also to work together to 'win the peace'" (The IMF in a Changing World 1945-85, Margaret Garritsen de Vries).
There were a number of other milestones in 1994 as well: 46 years of war between Jordan and Israel ended with the signing of a peace treaty, 40 years of Democratic control of the U.S. House and Senate ended, we marked the 25th anniversary of Woodstock and the death of Mary Jo Kopechne and 25 years of British military presence in Northern Ireland and celebrated 17 years since I married my husband, Rod!
All in all, I believe we are in a very pivotal time, a time of continued structural transition. In 1995, the United Nations celebrates its 50th anniversary and as Sir Sidrah Ramphal, cochairman of the Commission on Global Governance stated in a press briefing in Cairo, it is "a time which begs the question 'Did we get it right in San Francisco (first conference to create the United Nations)?'" The Commission on Global Governance is in the process of completing a study to determine how to change the UN in order to for it to meet the demands of the "post-cold war era". These recommendations are to be made public in 1995.
The November newsletter discussed the fact that the UN is looking to empower itself as a permanent worldgovernment to meet on a year round basis and raise revenues through a number of suggested world taxes--one of these days you and I may get a tax bill from the UN along with our U.S. federal tax bill!
In the December 1993 newsletter, I observed that we appear to be going through a time of "structural transition" and wrote about a number of structural transition components as I saw them. They were:
The Federal Deficit
North American Free Trade Agreement
The New Tax Law (1993)
U.S. Interest Rates and the Federal Reserve
The Proposed Health Care Bill
The Stock Market
As we review 1994, we will see that we are still in a time of structural transition and probably will be for the next several years. The components are the same, with the exception of the New Tax Law, which is renamed Taxes, the Federal Deficit, which is renamed Deficits--Federal and Trade, NAFTA to which we add General Agreement of Trade and Tariffs and The Stock Market to which we add bonds, and several new entries: Inflation, Derivatives, and the United Nations/World Bank/IMF. A follow-up question is: "Will we be better off after the transition?"
The events that made the news in 1994 might provide us with an understanding of what "structural transition" may mean. In January, Los Angeles was hit by a 6.7 earthquake which devastated the city and sent shock waves throughout the country. The year continued with events surrounding skaters Nancy Kerrigan and Tonya Harding, O. J. Simpson, porn actor John Bobbit, Erik and Lyle Menendez, Charles and Di, as well as Internet, Whitewater, Paula Jones and healthcare, not to mention Rwanda, Somalia, South Africa, and Haiti.
In the area of the economy, finances, and money, the same kind of diversity and tempo followed with the Federal Reserve, interest rates, GATT/WTO, the dollar, derivatives, and hedge funds. The tempo was fast and furious, with each event sending its own shock waves through the economy. . . .only time will determine the magnitude.
As always, in order to see where we may be headed, we need
to look at the past, consider the present, and project what may be in the future in order to determine our course of action.
Two major newsletters were written in May and June detailing the actions and history of the Federal Reserve over the past seven years as it relates to the dollar and interest rates. What we concluded in the June letter is that the Fed's actions to raise interest rates have nothing to do with inflation but are taken to curb the outflow of capital leaving America. On April 29, we were told that "we came to the brink of a dollar crisis," according to David Jones from Aubrey G. Lanston & Company, NY. The Baltimore Sun reported the rescue of the dollar as follows: "The United States teamed up with the central banks of 16 nations yesterday to buy billions of dollars in a global campaign designed to show investors that the Clinton administration is serious about maintaining the value of the AILING (emphasis added) U.S. currency. . . . Besides dealing a blow to U.S. prestige, a weaker dollar fuels inflation by making imports more expensive, and it forces the Treasury to raise interest rates to keep attracting foreigners to buy the Treasury bonds needed to finance the deficit" (Baltimore Sun, 5/4/94, A1).
However, I believe the following articles paint the current picture. "The dollar's fate rests primarily on the performance of U.S. bonds and stocks" (Financial Times, 5/9/94). As long as U.S. financial markets are weak, capital will continue to flow out of dollars into foreign currencies, they say. To this we add a more recent article from the October 24 Wall Street Journal. According to David Abramson, managing editor of ForexCast, a Bank Credit Analyst Research Group publication in Montreal, "Until short-term interest rates favor the dollar over the mark . . . . the U.S. currency is doomed to decline . . . . Many analysts believe that until the Federal Reserve raises interest rates for a sixth time this year, the dollar probably will slide further . . . . We need tighter monetary policy to suck in capital flows from abroad . . . . Once the Fed moves, the money will come into the U.S. and the dollar will go up because real interest rates will be more attractive."
On November 15, the Federal Reserve raised short- term interest rates for the sixth time by a larger-than- predicted 3/4 percentage point, which was the biggest increase in the discount rate since May 5, 1981. Major banks were quick to react by raising the prime rate by the same amount to 8.5%. Protestors gathered outside of theFederal Reserve Building that day to hear Senator Byron Dorgan of North Dakota say, "Behind a locked door, the Fed is making decisions that represent tax increases 20 times the size of a tax increase contemplated by Congress."
At the December 20 Federal Open Market Committee meeting, the Fed chose not to raise interest rates for the seventh time as Federal Reserve Chairman Alan Greenspan "wants to give November's rate hike a chance to work first" (Washington Times, 12/20/94). In response, Sung Won Sohn, economist at Norwest Economics, said, "We know the Fed is going to raise rates again. That's as clear as the pope's religious affiliation." David Wyss, an economist at DRI-MCGraw Hill Inc. in Lexington, Massachusetts told The Wall Street Journal (12/20), "I think they will move in January and it will have to be a big move. They can't do less than last time." He predicted an increase of either another 3/4 of one percent or perhaps a full percentage point at the late January meeting.
"Inflation is in no danger of rising . . . . The Fed is fundamentally misreading the economy. A 'sea change in pricing practices' in recent years, caused by consumer resistance to higher prices, has forced companies to 'control costs by engineering them out,'" said Jerry Jasinowski, president of the National Association of Manufacturers. This includes widespread use of part-time and contingent workers and the "out-sourcing" of work for flat fees, which holds employment costs down dramatically and increases the pool of workers competing for full-time jobs, he went on to say in the article "Despite Fed fears, prices barely increase" (Washington Times, 11/17/94). It should be noted that if the Federal Reserve raises interest rates high enough, that, in and of itself, will produce inflation as it will cost more to buy since it costs more to borrow. Also, a lower dollar increases the costs of importing, which means foreign made goods will be more expensive to us. In summary, the writer contends that the Federal Reserve will create the inflation that it is trying to prevent.
After passing the second largest tax bill in history in 1993, the Clinton Administration is not done with us yet! As stated in the June newsletter, there are a number of areas that are up for grabs which will cost us more money. With the unexpected shift to Republican leadership in the House and Senate, no 1994 tax law was passed. Both the Democrats and Republicans are trying to find a way to pay for a reduction in the capital gains tax. In 1994 we were given a reprieve from higher taxation, not an exemption.
Although there was no healthcare bill in 1994, thatdoes not preclude a revised healthcare bill being introduced in 1995. Let us not forget what Hillary Clinton told the Senate Finance Committee in 1993: "The people will know that they are not being denied treatment for any reason other than it is not appropriate--[it] will not enhance or save the quality of life." The Crimes Bill was passed, legislation that has enough pork in it to feed the entire nation.
NAFTA and GATT
In 1993, under Republican leadership, NAFTA was passed under the leadership of Newt Gingrich. In 1994, history repeated itself as Republicans, under the leadership of Senator Bob Dole, clinched the GATT vote. The General Agreement of Trade and Tariffs is a global trade agreement between 124 countries in which trade barriers will be reduced in order to allow "free trade." Instead of using two sentences to complete the contractual agreement to lower tariffs, 24,000 pages were used. There is one vot per country. In order to see if the U.S. will get fair treatment, we must remember that "eighty-three percent of the nations who would be members of the WTO are developing countries and over two-thirds have received foreign aid from the United States in the last decade." (Source: Ronald D. Ray Legal Update on GATT/WTO)
The writer had grave concerns over NAFTA with regard to sovereignty and domestic economics, and continues to have those same concerns with regard to GATT. On January 1, GATT will turn into the World Trade Organization, which comes under the jurisdiction of the United Nations.
In the GATT newsletter, a diagram was provided showing the establishment of the United Nations and the creation of the World Bank, International Monetary Fund, and the International Trade Organization (ITO). Congress did not give its consent to the ITO in 1948 and therefore it was "spun off" on its own. It took 46 years to change the mind of Capitol Hill in order to pass GATT/WTO. This is the last brick that completes the economic foundation for the United Nations to function as a world government.
Deficits -- Federal and Trade
After the passage of President Clinton's deficit- reduction bill last year, news about the deficit dropped off editorial radar screens. The federal budget deficit for 1994 is estimated to be about $200 billion. The total amount that the federal government owes is $4,692,973,000,000, and your share is $17,950. It is projected by the time President Clinton leaves office, he will have added $1T more to the current deficit. It has been suggested that the way to deal with this problem is to cut the budget and increase taxes, including a 5% national tax on consumption, higher Medicare premiums, and a cut in all federal benefits (whichincludes Social Security), for well-off Americans (Business Week, 8/ 22/94).
Through September, 1994, the trade deficit in goods and services increased for six months in a row, with the October trade deficit up 7.5% from September's figures. Overall, the deficit totaled $90.5 billion, surpassing the $75.7 billion deficit for all of 1993. The largest trade deficit America experienced was in 1987 with $152 billion.
In an article entitled "It's Harder to Hit the Brakes", Business Week (11/21/94) discusses the fact that the Federal Reserve's influence has "structurally changed" with the loss of national boundaries and globalism. The Fed has to fight the global economy on another front, too. America's ever-growing appetite for imports has created a structural trade deficit that is sinking the dollar, a decline compounded by the growing demand by American investors for higher- yielding foreign assets . . . . The resulting net outflow of capital from the U.S. means that America is not generating the funds necessary to finance its trade gap. "Last year, we transferred financial resources abroad equal to 3% of GDP," says William Sterling, an international researcher at Merrill. "That's nearly twice the size of the Marshall Plan after World War II."
What can we say except long before Orange County filed bankruptcy, Alan Greenspan, chairman of the Federal Reserve Board, brushed off calls for new legislation to control derivative financial instruments and warned that intervention could increase risks to the US financial system. Mr. Greenspan said there was a pressing need to overhaul the entire U.S. regulatory structure, but he warned that reforms aimed solely at derivatives could be counterproductive (Financial Times, 5/26/94).
Derivatives, such as swaps and options, are instruments derived from other financial assets, i.e., stocks or bonds. For example, you buy 100 shares of ATT at 50. If you "call it right," you can turn your $5,000 into $7,000 or $10,000 by buying an option on the stock. On the other hand, if you don't "call it right," depending on market circumstances, you can lose up to all of it. In 1994, close to a dozen large corporations and entities suffered huge losses as a result of rising interest rates that affected the value of derivatives.
Orange County, CA, which has the highest income per capita in the U.S., filed for bankruptcy protection in early December. Specifically, Orange County got into trouble by borrowing to build a $7.5 billion investment pool into a $20 billion bond portfolio. (Do you realize that they borrowed almost $3 for every $1 in the investment pool? That is very, very high leverage and extremely imprudent.) Then as interest rates started to rise, bond prices fell, creating the huge paper losses that the county now is facing in theirportfolio. Orange County is now caught in a trap: If they sell, they'll face huge losses. If they don't, they'll have to keep paying interest on the money they've borrowed, which could also mean huge losses (USA Today, 12/8/94 and 12/23/94).
According to the December 22 New York Times, , the hedge funds were the first to disclose losses amid rising interest rates and lower bond values, then came Piper Jaffray and others who run mutual funds, followed by several municipalities, most notably Orange County, California. Now it's the bank's turn. According to figures available from among 24 regional banks' studied by Morgan Stanley & Company, PNC Bank has the largest number of bonds that must be held to maturity along with the largest number of derivatives. We can see the effect rising interest rates are having on the bond market.
The stock market reached a new high on January 31 of 3978, only to drop over 300 points to 3675 by May. Since then, it has gone up 50 and down 90 according to the activity that prompts it, i.e., rising interest rates, the loss in hedge funds, or the Orange County situation , etc. Last year, we saw impressive gains as precious metals were up over 70% for the year with international stocks up 28% and Pacific Rim stocks up 44%. U.S. stocks lagged behind with technology up 20% and aggressive growth up 15%.
So far this year, the writer counted all Morningstar funds up greater than 4% only to find 20 out of 1260. The winner was technology, that category was up 3.49%. All other categories had losses, domestic stocks, aggressive and growth stocks were down 5-8%, Pacific stocks down 11%, precious metals down 16%, and bonds down 3 - 8% as a category.
Bond funds varied as to losses and not just the 3 - 8% loss by category. Some individual global bond funds dropped as much as 15% along with some individual U.S. Government bonds funds dropping anywhere from 5% to 12%. In 1987, due to rising interest rates, the stock market dropped up to 33%. In 1994, due to rising interest rates, the bond market dropped anywhere from 3% to 15%, depending on the type of bond and portfolio structure. It would be accurate, in the writer's opinion, to say that 1994 was a year in which the bond market crashed.
In the December 1993 newsletter, we revisited the book Euroquake by Daniel Burstein, who in 1991, wrote the dollar would come into parity with the Japanese yen and German deutsche mark between 1995 and 1997 when a "new global currency agreement will be hammered out . . . ." He said, "Although the system itself will be intricate, the bottom line will be a massive devaluation of Americanassets roughly analogous to fixing today's exchange rates at $1.00 =1.05 yen and $1.00 = 1.20 deutsche marks."
The dollar fell below 1.00 on the yen for the first time in history on June 29. Shortly thereafter, President Clinton attended the G-7 Finance Ministers' Summit where the world's seven major industrial countries failed to produce a dollar support strategy. Without clear direction from the U.S. in support of the dollar, it continued to fall to a post- World War II low of 96.08 yen in November before the Fed intervened.
According to the November 4 Wall Street Journal, traders estimate the Fed, acting alone, spent an estimated $1.5 to $2 billion to support the dollar by buying it back from foreign banks over a two- day period. Earlier in the year, in April and May, the Fed, along with the help of the world's central banks, propped up the dollar. Commenting on the November drop, David DeRosa, a director of foreign exchange at Swiss Bank Corp. in New York, said, "It didn't go down to 96.08 yen for nothing." He added that unless the Fed moves aggressively to increase U.S. interest rates, the dollar is likely to head south once again."
After the sixth interest rate rise in November, the dollar strengthened to 1.5833 marks and 100.45 yen as of December 23. While this is the last interest rate increase for 1994, it appears that it won't be the last as there is already talk of another rate increase at the end of January.
In light of the above, it appears that there are strains in the economy or perhaps "economic aftershocks." After five years of lower interest rates, the economy was doing everything it should do--- expanding. Now the Federal Reserve tells us we headed for inflation (something they say they wish to prevent but will create), and therefore, must increase interest rates. As we have seen, the problem is not inflation but a flight of capital out of the United States. The only way to prevent a continual flow is to raise interest rates to the point where investors feel adequately compensated for their investment. Although the dollar has strengthened somewhat, it appears that another interest rate increase will occur in 1995.
The economy is in a lull. The stock and bond market did not post gains this year because of higher interest rates, GATT was passed, which will lead to a greater influx of foreign goods, which in turn may lead to a second downsizing of American firms, resulting in unemployment and a reduction in the standard of living. Consumer debt is at an all time high. (USA Today, 12/ 28/94) reports that total household debt (including mortgage and auto) as a percentage of after-tax income, is at an all time high of 91%, versus 64% in 1974. Credit card issuers made it easier to borrow and increased creditcard limits by 23%. Lastly, in 1994, median family income fell by 1.9%. When adjusted for inflation, it dropped from $37,668 in 1992 to $36,959 in1993. Commenting on this, Christopher Frenze, senior economist for the Republicans on the Joint Economic Committee, said "It's very unusual to see declines in median family income during an expansion phase of the business cycle."
The United Nations/World Bank and IMF
A year ago, I would have never thought to add this to the list of structural adjustment components. However, as indicated in the November newsletter, I attended the UN International Conference on Population and Development in September. What I saw there was quite unexpected. I had never considered the UN as a world government but that appears to be what is on its agenda. In doing some research on the UN, I found a book called Human Development Report, 1994, written and published by the United Nations. Its 200-plus pages contain a rather detailed account of how the UN perceives it needs to change in order to become a world government and thereby preserve the earth's resources and global human security. These recommendations include changing the UN charter to allow them to meet on a permanent basis, creating an Economic Security Council responsible for the collection of world taxes, and establishing a permanent UN volunteer army. In addition, the UN wishes to create a permanent criminal court. For those of you who are interested, you can send for a copy of this book by calling the UN publications line at 1-800-253-9646. It is yours for $18.00 plus postage or, if you prefer, for a small handling fee, you can call me and I will send you a copy of the first chapter, which outlines a number of these "revolutionary" ideas.
Earlier in the year, the new currency was discussed. In the May newsletter edition, I reported that it would be in circulation by the end of this year. However, the December 26 U.S. News & World Report states that the first revamped $100 bills should appear in 1996 and all other denominations should be in circulation by the year 2000. The writer would like to mention that the new configuration is like that of the currency used by all of Europe, the Middle East and Asia. Perhaps it is a "global currency."
This past year, bonds dropped substantially in value. A number of you moved from bonds to money market funds in an effort to keep the principal safe. Although you have been there for about 7 months now. Because the Federal Reserve may, and most probably will, raise interest rates for a seventh time, I would ask you to be patient. During the year, in an effort to keep money safe, other money management techniques such as bond timing and dollar cost averaging were used. A number of you have invested overseas, which the writer feels is an important form of diversification.
Many of the structural adjustment components appear to be leading us into inflation. With inflation comes a downturn in the economy. With regard to inflation, the "hard" assets, i.e. gold, silver, rare gold/silver coins and oil and gas do extremely well. As stated before, "He who owns the gold makes the rules." While it may not appear to hold its value in the financial marketplace, there are other markets in which it goes for top dollar.
My concern has always been for your well being. While I do not know all the answers, I know when to ask for wisdom. The investment recommendations have not changed since the May newsletter.
For this new, fresh year and , I leave you with part of an admonishment which King Solomon gave to his son :
My son, if you accept my words and store up my commands within, turning your ear to wisdom and applying your heart to understanding, and if you call out for insight and cry aloud for understanding, and if you look for it as for silver and search for it as for hidden treasurer, THEN you will understand the fear of the Lord and find the Knowledge of God. Proverbs 2:1-5