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The Widening World Crisis

by Andrew Rothovius / The Washington Global Letter

[Editor's Note: Andrew Rothovius was one of the first to understand the wider implications of the Asian crisis when it first surfaced in Thailand in mid-1997. Now he's saying that the Asian Tigers and Japan might be in the beginning stages of a recovery. The reasons for his optimism might surprise you. We think you will find his analysis enlightening. For gold investors, such a recovery would be welcome news as it very well could revive strong demand for the yellow from that part of the world. Asian investors are unlikely to be caught again without sufficient gold holdings, hence our interest in publishing this important discussion from one of America's top political analysts. Subscription information follows below.]

The financial and monetary crisis that began in Southeastern Asia at the beginning of July last year, with the collapse of the Thai currency, has now after devastating the other Far Eastern "Tiger" economies, spread to enmesh Japan and Russia in its grip, and is starting to extend its ravages across Latin America. We do not however see this crisis as necessarily putting the affected countries beyond any prospect of saving or recovery. On the contrary, we discern several indications that Japan and Russia can surmount their present difficulties, and again become prime factors and movers in the market places of the world. Also, that the worst may be over for the "tigers", except Indonesia where the economic disaster has ignited long-smoldering ethnic unrest.

Nevertheless, at the moment the situations in both Russia and Japan continue critical. Over the last several weeks, both have installed new prime ministers who have promised far-reaching measures to reverse the growing disasters of their economies, but not enough time has yet elapsed to determine whether or not they can achieve the required results. We discussed the political background of the Japanese crisis in our July Letter, and further on in this one we'll review how the situation is evolving there. It is Russia though where matters may be at the verge of bringing about the break-up of the country, with consequences that would deeply affect other nations and their economies. The four months' experiment of President Boris Yeltsin with the untried, 35-year-old Sergei Kiriyenko as Prime Minister came to a crashing end in mid- August, as the ruble was devalued despite repeated official assurances that this would not be done. A week later, Yeltsin fired his entire cabinet and tried to reinstall Viktor Chernomyrdin as Prime Minister, a post he had twice previously held.

IMF BILLIONS DISAPPEAR IN RUSSIA

Behind these moves lay the collapse of the Russian state finances, as a result of the continuing failure to collect desperately needed tax revenues from the mafia oligarchs who have come to control all aspects of the Russian economy, and have sent their vast takings out of the country to foreign havens. The Russian Central Bank over the summer spent half its hard currency and foreign exchange reserves in a vain attempt to defend the ruble. A $4.8 billion infusion of credit from the International Monetary Fund was promptly spent - and the IMF said there was no more it could give, what with the U.S., Congress failing to vote $18 billion to replenish the Fund's depleted coffers.

The re-appointment of Chernomyrdin met with an immediate storm of opposition from the Communists who control 35 % of the seats in the Duma (lower house of the Russian Parliament), though they won only 2l% of the vote in the last elections. This time the communists were joined by a wide spectrum of the other parties in the Duma, in a shared alarm over what might be the nature of the "economic dictatorship" that Chernomyrdin said he would install to resolve the economic crisis. If there was any sort of dictatorship in the offing, the Communists wanted to be the ones running it.

The details of just what Chernomyrdin had in mind never did get disclosed to the Russian public, but from our sources we have obtained an outline of what was discussed behind the scenes in the Duma as Yeltsin vainly tried to gain support for Chernomyrdin. In short, the "economic dictatorship" would have taken the form of a IMF-sponsored "currency board", in function if not in name, that would after an initial burst of hyperinflation from printing rubles to pay the piled-up back wages and benefits of millions of workers and pensioners, contract the money supply by a third to a half, with resulting 30 to 35% unemployment and devaluation to worthlessness of any remaining savings, Supposedly this would then attract foreign investment in the bankrupt industrial sector.

It is hardly surprising that such a prospect failed to win any backers for Chernomyrdin - and it is saddening to see Yeltsin, only seven years after he climbed up onto a tank in a Moscow street and broke the Communist coup and in fact the whole Soviet system, descending to such depths of economic lunacy. By close to 3 to 1 votes, the Duma twice rejected Chernomyrdin and the "economic dictatorship", forcing Yeltsin to choose some one else with a better understanding of what has brought Russia to its present desperate plight - and of what might still be done to save it.

There was general agreement among the non-Communist factions in the Duma, that the best available man was Yegor Stroyev, governor of Orel Province south of Moscow. He is the chairman of the parliament's upper house, the Federation Council, in which the provincial governors sit by virtue of their office, and in that capacity has repeatedly spoken out on Russia's need for an industrial policy that furthers the development of commercial and manufacturing enterprises within the country, and not what has been the rule -- the wholesale dumping of Russian assets abroad, to the enrichment of a few speculators, while opening the gates to cheap imports that have bankrupted inefficient domestic industries and thrown millions out of work.

Communists Hope To Get It ALL Back

Stroyev, however, was not acceptable to the Communists as his program was not statist enough for them. The choice narrowed down to two men -- the flashy mayor of Moscow, Yuri Luzhkov, and the Foreign Minister, Yevgeny Primakov, an old Communist Party apparatchik. Lushkov was seen by many if not most of the Duma members as not - at least not yet - really a national figure. In addition, Yeltsin was said to object to him as a likely.seeker of the Presidency in 2000. That left only Priniakov, who at 68 is probably truthful in saying he has no ambition to become President. His nomination by Yeltsin was quickly confirmed by the Duma.

Primakov is a more complex figure than most Western observers have so far made him out to be. He has been known in the West primarily as a hard-line nationalist, still following many of the Soviet Cold War foreign policy. A graduate of the Russian Science Academy's course in Oriental Studies, he is fluent in Arabic and Georgian in addition to his native Russian, and speaks English without the need of an interpreter. He has a long record of working for Soviet interests in the invasion of Afghanistan in 1979, in the arming of Saddam Hussein's Iraq with Russian weaponry before Desert Storm, and of trying to work out a deal that would have left Saddam in control of Kuwait. There is ample evidence for his involvement in and backing of Soviet spy activities within the United States.

Russia Arms Yugoslavia Vs. America

As Yeltsin's Foreign Minister, Prirnakov has consistently followed an anti-American line, repeatedly advocating the lifting of sanctions on Iraq, where he has continued to make frequent visits to Saddam; and has supported (even armed) the Serbian (Yugoslav) dictator Milosevic in the wars in Bosnia and Kosovo, while opposing the admission into NATO of former Soviet satellites in eastern Europe. (Editor's Note: On October 11th, GOP Senator McCain of Arizona, who as a Navy pilot was shot down over Vietnam and spent 5 years in a communist prison in Hanoi, warned that Serbia is well-armed with Russian anti-aircraft missiles and that American pilots could die in a war over Kosovo.) Yet despite having supplied Serbia with these missiles, Russia's Primakov has tried to present an illusion of reasonability in his dealings with Western diplomats, especially U.S. Secretary of State Madeleine Albright. who appears at times to practically have a crush on him, even dancing with him at a party. Primakov in this mode seeks to come across as one who must try to preserve the status of Russia as the great power it no longer actually is, while being at the same time open to friendly advances from all, whether of the West or the East. He is probably too intelligent to expect that anything like the Soviet command economy can ever be restored in its full rigor; and in tackling the task that has been thrust upon him, of restoring Russia to some semblance of a healthily functioning society, he is unlikely to resort to measures too overtly statist. The West need not be under any illusions about Prirnakov as a late-comer convert to democracy and free-market reforms; but neither, we think, need there be undue fears about him as a reviver of the Cold War, which today's Russia is in no sort of shape to resume.

Little known in the West. and not very widely known even in Russia, was that Prirnakov had been trained as an economist at the Russian Institute of the World Economy and International Relations, and was elected as an economist to membership in the Russian Academy of Sciences in 1985. He has thus some back-ground in the subject, with which to approach his daunting assignment of restoring an economy done almost to death through seven years of assault by some of the most rapacious profiteers ever seen.

(Editor's note: IT HAS TO BE ASSUMED THAT HIS EDUCATION IN ECONOMICS UNDER THE COMMUNISTS DID NOT PREPARE HIM FOR A TRANSITION TO A MARKET ECONOMY, BUT IT WOULD GIVE HIM TOOLS TO UNDERSTAND THE PROCESS.)

Lebed Looms Large Looking At 2000

It was probably the perception by all parties, whether or not they were aware of his economic expertise, that Primakov was a forceful enough character to stand up to the robber-baron Russian Mafioso, which accounted for his swift acceptance by the Duma. The only other public figure in Russia, with a personality of a forcefulness matching or surpassing that of Prirnakov, is Gen. Alexander Lebed, the recently elected governor of the huge (one-fourth the size of the continental United States) Krasnoyarsk province in central Siberia, Lebed is believed to be holding back from any deep involvement in the crisis at this time, having set his sights on running for the Presidency in the election in 2000. He is said to be getting financial backing for his prospective presidential run from the biggest mafia baron, Boris Berezovsky, a bankroller until now of both Yeltsin and Chernomyrdin. At any rate, Lebed - though stealing the show at Clinton's meeting with Russian opposition figures, by drawing ominous parallels between Russia today and in 1917 just before the Bolshevik Revolution - has accepted Primakov quietly and gone back to Krasnoyarsk to impose local price controls, the coast of food and other necessities having risen sharply there, as all through Russia, following the collapse of the ruble. Local controls however, as Lebed is quickly finding out, are ineffective because available goods tend to flow to areas where prices are uncapped.

It is still a very open question, whether Primakov can put together an economic program that will save Russia - more correctly, the Russian Federation, composed of some 90 separate provinces and "republics", many populated by non-Russian nationalities - as a viable political entity. Nearly three weeks after taking office, he still had not been able to complete a cabinet - except for some second-level posts, that he filled with former Communists who had last served in government under Gorbachev, nearly a decade ago. The Communists of today may have voted to accept him as Prime Minister, but they have balked at taking posts in a cabinet where they would not be a majority.

Whatever his own past communist affiliations, and his clear affinity yet with some of the party line, Primakov again is, we suspect, too smart to let the Communists take full control of the government. He realizes that Russia cannot go back to the eras of either Stalin or Brezhnev.

But it is equally clear, at least to him and to others in Russia, if not to the Western governments who keep repeating their calls for adherence to the IMF's "conditionalities" which have already reduced the economy to chaos, that the arrears of pay and pensions have to be made up as fully and as quickly as possible. That means either the West puts up the money or Russia will print rubles, at the same time imposing national price controls to prevent any runaway inflation. That this is what Primakov will be attempting to do, was indicated by the printing of $70 million worth of rubles on Sept. 21, a very limited amount in relation to the totality of the need, but a cautious one with respect to the hyperinflation danger. If this approach toward a solution of the crisis fails of its intended effect, the tendency already clearly evident for the fragmentation of the Russian Federation will become unstoppable.

Russian Breakup Real Possibility.

The growing incapacity of the central government to meet its responsibilities is pointed up in daily in scores of news items from Russia. Only a few need be cited to attest the extent of the disintegration in process.

The Baltic fleet's base in the Kaliningrad enclave is down to less than forty days' food supply for its personnel, and the civil administration there has halted tax remittances to Moscow, in order to have some funds for buying food in Poland and Lithuania. The Arctic Fleet's base port of Murmansk is in a condition of near starvation and is asking for aid from the Scandinavian countries. Russia has had to give up its early warning radar station in Latvia, because it can no longer pay the rent. The Moscow Mafioso, who must be faced down by Primakov if he is to achieve anything, have under Yeltsin kept 84% of the entire finance capital of the Russian Federation within their local control.

As a result, scores of cities outside Moscow are in situations similar to that in the Far Eastern metropolis of Vladivostok, where water and electric power are available only a few hours per day. In such a state of affairs, more and more of the local administrations are starting to take matters into their own hands. Locally elected assemblies and officials are enacting and enforcing laws to meet their particular situations. The decrees of Moscow are being ignored, or observed only in lip service.

A more or less de- facto independence already exists in probably close to half the Russian Federation's provinces and "republics." We will not be surprised if protests lead to an accelerated break-up of this far-flung nation. And it is in this that we see a real hope for Russia's future. In all of its long past, Russia has never known a truly federative structure such as that in the United States. A revised Russian Federation, in actuality and not just in name, would be a powerful force for economic growth and peaceful development of the still largely untapped mineral and timber resources of Siberia. It would be easier for American business and industry, and for that matter the U.S. Government itself, to deal with local sovereignties, many of which would be bigger than most European countries. The central regime in such a new Russian Federation would be limited to handling national defense, foreign relations of broad scope, and providing a single currency. Who can bring such a Russian Federation into real existence? Not, we think, Primakov; he is still too tied to a past Russia, to great-power imperialist posturings, from which he cannot free himself even if he would.

THE REAL TEST WILL BE IN HOW FAR PRIMAKOV GOES IN OPPOSING U.S./ NATO INTERVENTION IN KOSOVO, AGAINST RUSSIA'S SERBIAN CLIENTS.

Primakov may, however, be a necessary transition figure, who can bring Russia through the present crisis. Alexander Lebed, we feel, is far more likely to be the catalyst for real and lasting change, if his administration of Krasnoyarsk is a success and he wins the Presidency in 2000. A question may be whether he can shake loose of his present ties with the mafia capo Berezovsky. Our impression is that Lebed is using him and not the other way around. What we are foreseeing for Russia is a mainly peaceful rather than violent break-up, leading to a truly federative recombining, whether under Lebed or some other leader not yet emerged. And that is why despite the present trauma of Russia, and the certainty of painful weeks and months ahead in the near-term, our long-term outlook for Russia, and for American investment there, is bullish.

Light Ahead in the Japanese Tunnel

The media have been uniformly gloomy about the new Japanese government of Prime Minister Keizo Obuchi and its attempts to agree with its opponents on measures to solve the debt crisis besetting all that nation's major banks. Two months after taking office, Obuchi and the opposition - mainly composed of the leftist and reformist parties - are still arguing over the details of legislation that was supposed to have been enacted weeks ago.

THE OPPOSITION HAS APPARENTLY DEFEATED ALL ATTEMPTS IN THE LOWER HOUSE TO COMMIT GOVERNMENT FUNDS TO BAIL OUT SALVAGEABLE BANKS.

News reports described Obuchi's much heralded meeting with President Clinton at the United Nations General Assembly in New York on Sept. 22 as a disappointing failure; The Prime Minister at that time could give Clinton no assurances of any early resolution of the impasse in Tokyo, which - it was said - threatened the entire world financial structure, through the trillion-dollars-plus debt exposure of the Japanese banks.

We didn't share this pessimism. Long, arduous negotiations are the traditional Japanese way of arriving at agreement on any subject. Eventually, we said, there would be enacted the necessary legislation to resolve the banking crisis and to get the Japanese consumers in a mood to start buying. (Editor's Note: As we go to press with this Letter, reports are streaming in from Tokyo that seem to suggest we have been correct in our optimism about Japan all along. Details are too fuzzy to report here. But in our next Letter we will analyze the likely impact of Japan's new moves.) Japan certainly does not lack the money to turn things around. They have the Yen equivalent of six trillion Dollars in liquid funds in the postal savings system and in sound savings banks. No other country in the world has that kind of reserve of ready cash. We can't see how Japan can possibly go broke, OR EVEN CLOSE TO IT.

ALL THAT JAPAN HAS LACKED UNTIL NOW WAS THE WILL TO USE JUST 10% OF ITS LIQUID CASH RESOURCES TO CURE ITS PROBLEMS.

But a little noticed recent news story indicates that Japan is ready to start lending and spending billions to help the Southeast Asian "'tigers" get back on their feet. A Japanese finance office for this purpose has been opened in Singapore, now rapidly replacing Hong Kong as the financial capital of the Orient. Reports are that Japan will aim first at assisting Malaysia, which on Sept. 1 instituted currency controls to prevent the sort of hedge fund speculation that caused the Southeast Asian melt-down in the first place and has until recently kept any significant recovery from getting started.

The decree of Malaysian President Mahathir revokes the validity of the country's currency abroad, forcing the return to productive use within Malaysia of large sums that had been placed speculatively in Singapore and Hong Kong. Foreign money in portfolio investments in Malaysia must be held there at least one year. The immediate result has been a halving of domestic interest rates, from 16% to 8%.

Asian Tigers Seem Ready To Turn Up

If similar steps are taken, as we expect they will be, by the other "Tigers", with modifications to fit their individual cases, and Japanese funding helps ravaged regional businesses to resume productive activity, the area could within a few months be on its way to regaining growth and prosperity.

This recovery can only be done without any further IMF "bail-outs," which invariably sink their recipients deeper into debt they can never fully pay, and inflict misery on their populations. Two years ago, Japan proposed an East Asian trade agreement, with currencies to be kept stable against each other, and Japanese investment providing motive power for continuing growth. Pressure from Western banking and financial groups, swayed by the hedge funds preparing their speculative assault on the area, blocked this proposal. The situation is different now, with the hedge funds having taken severe losses in the Russian crisis and having reduced leverage in the Far East. We look for Japan to take the lead in bringing to early actuality this East Asian mutual trading area, this time very likely with U.S. support.

America and Japan are in fact coming into a closer and deeper relationship of shared responsibility for the security and prosperity of East Asia. The recent North Korean test of a long-range ballistic missile that passed across Japan, has resulted in a U.S. -Japanese agreement to mutually develop an antimissile defensive shield for Japan.

The real problem in the Far East is not Japan, but China, which has been hit with floods on a massive scale, with damage to farms, homes and industries that will take years and untold billions to restore. In addition, China is believed to have spent a fair chunk of its estimated $160 billion foreign reserves in defending the Hong Kong dollar and its own renmimbi currency from the attacks of the hedge funds and other Western "traders." The Chinese banking system is even more deeply mired in debt than Japan's, and its collapse could come at any time. That could even lead to a possible eventual break-up of the country, with the "special economic zones" of the coastal South, where a partial capitalism was introduced a decade ago, throwing off the rule of the Communist North altogether - and perhaps joining up with Taiwan, which has continued to prosper amid the economic storms raging around it on every side. Taiwan's currency has fallen only 15% in value since the Far East crisis began, its stock market has fallen only 9%, and this year has seen its economy growing by 6%.

Ninety-eight per cent of Taiwan's businesses are small or medium-sized; and strict controls have prevented them from taking the cheap speculative millions from foreign sources that proved so fatal to the economies of Thailand and Indonesia, Taiwan has now also banned the foreign hedge funds from operating in its financial markets, with good results.

Meantime back at Rancho Europa:

The crisis in Russia has come as an unwelcome added interruption to the finance ministries and central banks of the European Union, who have been busy all summer on getting the nine separate currencies that will merge on January 1, 1999 into a stable alignment with each other. Britain which for now is not joining, and whose overvalued pound sterling and overly high interest rates have sent its recently prosperous economy skidding into a tailspin, had already been a distracting annoyance to the Euro ministers, forcing them to also think of how to relate the pound and the Euro on a stable basis.

Germany's Winners Are Disorganized

The German national election campaign, running at full blast since March, has been a further source of distraction. Through the first several months, all the polls gave a huge lead to the Social Democratic candidate for Chancellor, Gerhard Schroeder, the popular governor of Lower Saxony, riding high on his smashing re-election triumph. The German public, the polls showed, had tired of Chancellor Helmut Kohl, who had held the office for sixteen years. A new face was wanted, and Schroeder - who exudes the same sort of crowd-pleasing charisma as Tony Blair - seemed to be fitting the bill. Then came the rumble of the crashing ruble, across the Russian plains to the east; and hundreds, perhaps thousands, of German holders of Russian state bonds quaked in fear of heavy losses of their money, as Moscow announced a moratorium on payment on the bonds, with no indication how long the suspension would last, or perhaps never be lifted and the bonds be repudiated. Suddenly Kohl looked the old reliable leader, who could be trusted to somehow save the situation and the German investments in Russia.

Within days, the race became too close for the polls to call. A fifth of the voters were, however, still undecided the day before the election, And enough of them made a last-minute decision that it was indeed time for a change, to give Schroeder a 4l% to 35%win over Kohl. But Schroeder was left with a difficult task in finding partners from either the losing Christian Democrats, the flighty Greens, and various splinter parties, to form a governing coalition that can steer Germany through the initial phases of the Euro and the still exploding Russian crisis. But as of October 12th, the Greens were proving difficult in what they were demanding and the leaders of the winning Party were fighting over how to share the spoils. More on this in our next Letter.

by Andrew Rothovius / The Washington Global Letter
October 27, 1998

Editor's Note: If you are looking for a newsletter that will give you a bottom-line, no-nonsense look behind the scenes of international politics and finance, we highly recommend the U.S.A./Washington Global Letter. To subscribe, call 1-800-219-1333

The U.S.A. / Washington Global Letter
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Naple, ME 04055

E-mail: JonVanEck@aol.com

Copyright © 1998 by The Washington Global Letter. All Rights Reserved.

Reprinted by USAGOLD with permission of The Author. No further reproduction without permission.

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