---------- Forwarded message ---------- Date: Sun, 23 Aug 1998 23:50:44 -0500 (CDT) From: [EMAIL PROTECTED] To: [EMAIL PROTECTED] Subject: Weekly Analysis -- August 24, 1998 __________________________________ Computer professionals can unearth deleted files in seconds. What is on your hard drive? http://www.shredder.com/ __________________________________ Global Intelligence Update Red Alert August 24, 1998 A Tale of Two Cities: Moscow and Caracas Face Different Realities In a week dominated by advanced weaponry, primitive hideouts, stained dresses and something about dogs, tails and wagging, it's probably time for all of us to come back to something resembling reality. Last week, reality was resident in two cities -- Moscow and Caracas -- playing very different games in each. In Moscow, reality was showing its brute strength, brushing aside wishful and sloppy economic thinking. In Caracas, reality was playing hide-and-seek, as rumors of devaluation triggered massive dislocations in Latin America's markets. We were driven once again to reflect on what has, at least for us, become obvious: regional thinking trumps global thinking every time. While everyone was thinking in terms of Asia, Russia was playing out its already lost hand, while Venezuela was having the deck shuffled for it once again, possibly with some cards missing. Russia's problems are unique and insoluble. Latin America's problems are also unique but much less dangerous than they appear. As usual, the world is heading in many different directions at the same time. * The End of the Westernizers in Russia Moscow was hit hardest by reality. As we predicted at the time, the IMF bailout lasted weeks rather than months. We wrote on July 13 that, "The bright young men governing Russia do passably well at meetings at Harvard and with Western bankers. But they are, by definition, incapable of coping with the brutal realities of Russian society. Russia today reminds us increasingly of Iran in the last days of the Shah of Iran, as Western bankers conduct negotiations with Westernized technocrats, sublimely oblivious to the volcano building beneath them. A Russian default is now, we believe, a given. The timing depends entirely on the IMF, and timing, to be sure, is the only option left open." The timing of the Russian default has now been announced. It happened last week. Russia announced unilaterally that it was imposing a 90-day moratorium on all foreign debt payments by commercial banks. Because nothing is going to happen in the next 90 days that will allow them to resume payments, we are now in a full default period. Interestingly, Western bankers and journalists let the Russians get away with the claim that this was not an actual default. The bankers, of course, have a vested interest in pretending that nothing major happened last week, because they will be forced to write off the debts if they admit the obvious. Since bankers' bonuses tend to run on an annual basis, we would expect this nonsense to be allowed to continue until after the end of the year. Since journalists who have covered Russia have done an abominable job, they will be prone not to press the issue either. Nevertheless, the reality is simple. Russia has stopped paying a huge segment of its foreign debt and will never repay the entire amount. Unless the West is prepared to extend substantial new loans far in excess of the last IMF bailout, Russia will not be repaying any of these loans. One measure: Russia's stock market is at about 25 percent of its peak. The economy has also contracted almost that dramatically. Loans extended on the expectation that Russia will blossom can never be repaid. German banks in particular are in trouble over these loans. Anyone holding Russian receivables as well as financial instruments should consider storing them alongside their Czarist railroad bonds. In the meantime, Russia's brightest young man was dumped by Boris Yeltsin. Prime Minister Sergei Kirienko, hand-picked by Yeltsin to take the blame, left office after about one hundred days on the job, to be replaced by Viktor Chernomyrdin. The problem with Chernomyrdin, of course, is that he was the one Yeltsin fired because of his mismanagement of the Russian economy. Chernomyrdin, who is by no means a bright young man, apparently extracted a guarantee from Yeltsin, that he would have complete control over all appointees to his cabinet. In effect, Chernomyrdin, the man most responsible for the current desperate state of the Russian economy and someone without any real support in the Duma or in the nation, has just been handed complete control over the government by Yeltsin. We always assume that there is a reasonable explanation for most events, but we must admit that this appointment has us baffled. We see two possible explanations. First, Yeltsin knows that there is no escape from financial calamity. By pushing all possible power onto Chernomyrdin's shoulders, Yeltsin is shifting responsibility to him as well. Chernomyrdin, not Yeltsin, will be blamed. Because that's not likely to work, another explanation is that Yeltsin is simply out of ideas. Having no choice but to fire Kirienko, Yeltsin couldn't find anyone else willing to be his fall guy except for Chernomyrdin. It really doesn't matter very much. A coalition of Communists and nationalists is going to take over Russia and there is almost nothing that anyone can do to stop it. Yeltsin is completely discredited in Russia, along with his Western-oriented technocrats. New investment and loans are useless, because the economy itself has effectively stopped functioning. Investments are simply dissipated without any hope for returns to the investors. That means that the post-Yeltsin governments will not have much hope of attracting new investment or loans. Therefore, they will have little reason to repay old ones. Yeltsin's half-hearted attempts to maintain Russia's international financial standing by at least paying back some debts will be met with a very reasonable counterpoint from the Communists: why throw good money after bad? Refusing to repay loans and permit repatriation of investments to Western imperialists who have devastated Russia's economy not only makes good politics, it also makes good economic sense. The damage of default having already been done, what is the advantage of repayment? Well, at least they saved money by not moving Lenin's body from Red Square. They'll be needing him again. * Latin America Shaken by Local Concerns On the other side of the world, the Latin American markets shuddered last week. Part of the cause was periodic concern that the Asian crisis is going to spread. Another part had to do with events in Venezuela. Venezuela's economy is not like the rest of Latin America's. Venezuela is one of the world's major oil exporters. It is the largest source of oil imported by the United States. During the first half of 1998, oil prices crumbled. This created substantial problems for all oil exporters and particularly for those whose economies were built primarily on oil production and exports. Venezuela is one of those. Although Venezuela maintained a fairly conservative projection on oil prices, compared to some of the wilder estimates maintained by other oil companies and analysts, even its conservative estimate proved too optimistic. As a result, the flow of cash into Venezuela was substantially less than expected and the flow of money into government coffers was also less. The government has now gone through several rounds of budget cutting. So has the national oil company, Petroleos de Venezuela (PDVSA). Declining oil prices have naturally shifted the national financial picture, putting pressure on the Bolivar. The Bolivar is permitted to float by the government, with a bracket on either side. However, lack of foreign reserves may make it impossible for the Venezuelan central bank to move in to shore up the Bolivar as it moves to its limits. Therefore, the brackets may not hold. Last week, it began to appear that the Bolivar would have to be devalued, or more precisely, would fall to a new level without the national bank being able to intervene. As news of a possible Venezuelan devaluation spread, speculators began hitting other Latin American currencies and stock markets, taking a chunk out of the Mexican, Brazilian and other markets. Panic spread amid fear that the Asian disease and/or the Russian crisis were spreading to Latin America. Latin America was being seen as the next domino to fall. In spite of the fact that U.S. stock markets stabilized in the midst of the Russian debacle and continued bad news from Asia, the assumption spread that Latin America took its bearings from Asia or Russia and that, therefore, another blood bath was imminent. We have rarely been accused of being optimists, but we do not see the Latin American case as really analogous to either Russia or Asia. Let's begin with the trigger, Venezuela. There is really nothing new here. Venezuela has been in economic crisis since the spring, when it became clear that attempts to raise oil prices in concert with Mexico and Saudi Arabia had failed. A liquidity crisis had hit Venezuela at the beginning of August, through which the Finance Ministry and Central Bank had managed to navigate. The bad economic news has been discounted by the markets. So has the bad political news. Hugo Chavez, who tried to stage a coup a few years ago, is favored to be elected President in next December's elections. Chavez, who had already tried to make his peace with the international financial community, if not with the Clinton administration, was not new news. Therefore, the pressure on the Bolivar at this time seems strange. The numbers have not shifted materially. There have been rumors of new negotiations with Saudi Arabia on another round of oil production cuts designed to raise prices. Saudi Arabia, heavily focused on Asia, needs Venezuelan concessions on market share in the United States as much as it needs production cuts. The Venezuelans are not about to make concessions like that. We wonder whether the source of speculation on the Bolivar might not have more to do with Saudi negotiators needing increased leverage with the Venezuelans than with any current macroeconomic problem. We concede that this is a conspiratorial view of the situation, but we find it very difficult to understand why the Bolivar, which survived a much more serious crisis in early August, should be hammered again with little genuinely new information available. * Latin America -- No Asia or Russia The point is this. Because Venezuela triggered concerns regarding the rest of Latin America, it is noteworthy that there might be non-economic explanations for Venezuela's problems, explanations that neither transfer to the rest of Latin America nor justify the degree of concern. Moreover, there are fundamental differences between Latin America and Asia. Latin America is in the early stage of its expansion. Asia is a generation into its cycle. Asia has been able to generate most of its investment capital internally. Many of Asia's problems derive from this. Because it has been generating capital internally, Asia's economy has not been subject to genuine external scrutiny. Moreover, the economic strategy pursued by Asia was designed to avoid recessions by surging profitless exports overseas. As a result of its lax banking regulations and its avoidance of recessions, Asia failed to impose either regulatory or fiscal disciplines that would weed out inefficient businesses. The result is the current meltdown. Latin America's banking system is not nearly as opaque as Asia's. Since it generates a smaller proportion of its investment capital internally, Latin America is forced into a higher level of transparency than Asia. Most importantly, Latin America enjoys (if that is the word) a normal business cycle. It suffers through recessions with some regularity. It does not have the multi-generational bloat of Asia to deal with. Latin America differs from Russia as well. The Russian economy is contracting dramatically. Investments into a contracting economy usually don't work. Latin America is growing. Its growth rate might be less than hoped for because of Asian problems and commodity price declines, but it is still growing, on the whole. Put simply, whatever its problems, Latin America's economy works. Russia's doesn't. Returns on Latin American investments may vary in the short run, but unlike Russia, they will not be total losses. Having been wrong on Asia and Russia, investors are now going to the other extreme and seeing Asias and Russias everywhere. We have been arguing here that what we are seeing is a regionalization of the global system, and that the stock markets are pointing the way. Last week, while the rest of the world's markets shuddered, the U.S. markets stabilized. The Latin American markets should, we believe, be read more in the context of their North American counterparts than as an adjunct to the Russian and Asian systems. As the American market moves up, more capital becomes available for investment in Latin America. Money that used to go to Asia and Russia is still being produced in the United States and to a lesser extent in Europe. We expect its target increasingly to be Latin America. We like to be realists. Our realism has led us to call both the Asian and Russian meltdowns accurately. But being realists does not mean that we are perpetual pessimists. We are in the midst of the normal economic process that has dominated the world ever since European conquerors created a global economy. Global economy does not mean homogeneous economy. Some parts of the world rise, some parts fall. Some parts do each more consistently than others. Asia and Russia are falling. The United States is rising. We think that Latin America will continue to trail the American track during the next generation. We don't know what will happen next week or next month in the Latin American markets. But we do believe that expectations that Latin America will follow Asia and Russia are as unrealistic as the assumption that Chernomyrdin can solve Russia's economic problems. The key is to read the markets regionally rather than globally. The world is dividing into three great regions (Asia, North America, Europe) with North America being both the most prosperous and secure. Latin America has the good fortune to be more closely linked to North America and Europe than to Asia. In particular, close links to the United States will be invaluable during this next generation. That holds true regardless of who did what to whose dress in the oval office. The United States will prosper in spite of its truly bizarre national politics. So will Latin America, although their ride will be more, shall we say, exhilarating. ___________________________________________________ To receive free daily Global Intelligence Updates or Computer Security Alerts, sign up on the web at http://www.stratfor.com/mail/, or send your name, organization, position, mailing address, phone number, and e-mail address to [EMAIL PROTECTED] ___________________________________________________ STRATFOR Systems, Inc. 3301 Northland Drive, Suite 500 Austin, TX 78731-4939 Phone: 512-454-3626 Fax: 512-454-1614 Internet: http://www.stratfor.com/ Email: [EMAIL PROTECTED]
