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Thursday, June 27, 2002


Every day the Financial Times gets nearer and nearer to fathoming just how problematic the global position really is. The point about yesterdays WorldCom revelations was not their gravity - they were, after all, the worst accounting fraud in US history - but their timing. The US is facing a total crisis of institutional confidence with everything from the Catholic Church to the CIA under the magnifying glass, passing, on the way of course, through Wall Street and all its works. Euphoria about super profitability is in danger of becoming its opposite. And just as we overshot on the way up, it looks like we're in danger of overshoot on the way down. Of course non of this is helped at all by the chorus of well-meaning (or are they really not so well-meaning?) economic 'experts' who don their best rose-tinged spectacles before venturing into the hot American sun.

The whole problem with the overvalued dollar thesis, as I don't tire of pointing out, is overvalued with regards to what? Gold? The Chinese Yuan (sure but its early to be recognising this)? For the dollar to come down something must go up. The Japanese government hasn't stopped intervening all week to prevent the Yen rising above US$120, and something around US$140 would probably be much better for them (and if you're among those who think that there's a big danger from the backwash if Japan falls, then for everyone else too). So the Euro has started its climb. This reminds me of that old fairground attraction where you take a big hammer to see how far up you can push the ball. Of course you never reach the bell at the top, but the most depressing part is watching the thing come down again. Well here we go with the Euro. The attitude of laissez faire we are exhibiting here really does seem irresponsible to me. Still as the late President Hoover had it 'if you can't stand the heat, then you shouldn't be in the kitchen'. Europe is about to feel the heat, and I just hope it isn't so macho as to not be able to recognise when it can't take any more. Because if it doesn't then it might just fall into such a big hole that its not going to climb out again.

Still, we were talking about America weren't we. The striking thing in todays press is the difference in tone between the UK and the US press on this one. Outside the US it seems the quality of credibility is somewhat strained, whilst back home they seem to feel it would be unpatriotic to engage in negative thinking. Take this from the Financial Times for example:

The equity bull market ended more than two years ago. But now it seems that bull market psychology is unravelling fast.

The WorldCom accounting scandal is an arrow at the heart of one of the standard bull market assumptions: that the US was the paragon of the world's financial markets, with the most dynamic economy, the most innovative companies and the highest accounting standards.

Overseas investors were happy to fund the US's substantial current account deficit because they wanted to have a stake in the great US boom. But they must now feel rather as emerging market investors did in the mid-1990s - that they were suckers in a game rigged in favour of insiders.

In Asia, the blame fell on cronyism and a banking system that allowed overinvestment in unprofitable projects; in the US, the blame is falling on corporate executives, who have taken excessive risks and distorted accounts in pursuit of lucrative share options.The disillusionment with the US has spread to the dollar, which on Wednesday slipped to within an ace of parity with the euro.

Of course, it is possible that the current plunge in shares represents the kind of climactic sell-off that often marks the bottom of a bear market. Equity markets have drifted back to the lows last seen after September's terrorist attacks on the US, which were followed by a rapid and substantial recovery. But these are dangerous times, not least because of the way that the global economy and financial system had adapted to the long bull market. There is leverage built into the system, not as extreme as the gearing that brought down Long-Term Capital Management, the US hedge fund, in 1998 but just as dangerous for being so widespread. That leverage shows up most obviously in the US corporate sector, where companies that had geared up their balance sheets during the boom years are now caught in the vice of falling revenues and the constant need to meet interest payments.
Source: Financial Times LINK

or this from this morning's Economist Global Agenda:

The world’s financial markets are in turmoil after the revelation of a massive accounting fraud at WorldCom. Is the collapse in share prices and the dollar a short-term reaction: or might policymakers now find themselves struggling to keep the economic recovery on track? The timing was impeccable. After several days of financial market turbulence, investors and traders had started to calm down on June 25th. Then WorldCom dropped its bombshell. Essentially, an accounting fiddle enabled the giant telecoms company to exaggerate its reported profits by close to $4 billion over the past five quarterly accounting periods. This spells disaster for WorldCom, which could now be forced to declare bankruptcy. But the consequences for the world economy could also be alarming.

While markets remain so volatile, it is futile to make any prediction about when, and where, they will stabilise. It is possible to take an overly pessimistic view of investors’ loss of nerve. Shares and currencies can often bounce back in the most unexpected way, and as the experience of recent years has shown, for the most insubstantial reasons. Even if such corrections are inevitable, there are dangers when adjustments take place in an atmosphere of near-hysteria in the markets. When investors and traders panic, they have a tendency to over-react—shares get dumped indiscriminately, for instance, without investors making judgments about the relative worth of individual shares. This is especially likely to happen when people realise that some firms are willing to pull the wool over their eyes, even to the extent of perpetrating accounting frauds. Investors are hardly inclined to try to decide on the merits of their investments when Rite Aid, Enron, WorldCom and many other companies have tried to disguise the true state of their finances. The typical shareholder is wondering who else is guilty.
Source: The Economist LINK

While the New York Times sullenly noted:

It was not just WorldCom that took a beating today. It was also the United States itself, and the American gospel of how business should be done.

After years of pumping billions of dollars into the United States because it seemed the land of opportunity, foreign investors are pulling back. And people around the world who for decades have looked to the United States as the model for openness and accountability in business have been sorely disillusioned by the mounting waves of scandal. "This is the most pessimistic sentiment against the United States that I have ever experienced in my career," said Wolfram Gerdes, chief investment officer for global equities at Dresdner Investment Trust in Frankfurt. "There is unanimous agreement that the U.S. is not the best place to invest anymore."

The loss of foreign confidence in the United States is important in itself, because of the huge deficit the United States runs in its trade with the world. To cover that deficit, America must attract a net inflow of $1.3 billion in foreign money every day. Even a modest decline in the flow can weaken the dollar and drive up the prices of imported goods. But the fall from grace is broader than just a turn in the monetary tide. The more enduring impact of the accounting and boardroom scandals may be the tarnish they spread on the "American model," a philosophy that emphasizes bare-knuckle competition, aggressive deal making, a high level of public disclosure and fantastic rewards for executives who deliver the goods.

Source: New York Times LINK

The net result of all this. I'm afraid we are going to have to wait and see, but the ending may not be 'Made In Holywood'.

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