A Look Back
For the past three years Ive written about nations beyond our borders for Worth, examining politics and economics from Arabia to Zambia. This month Ill revisit some of these exotic locales to see whats stayed the same, whats changed, and whats turned out differently than it appeared at the time.
My first article, in November of 1995, was about hydrocarbons and Saudi Arabia, which floats on a quarter of the worlds oil reserves. After two decades of living it up on profits from their vast supplies of oil, the country was nearly bankrupt. The House of Saud contained 6,000 princes, a quarter of whom were unemployed, all of whom received large stipends from the royal treasury. The Saudi populace seethed with anger that the royal family kept the bulk of the oil revenues for its own use. The GNP for each Saudi had been cut in half between 1981 and 1992, from $16,000 to about $8,000. Extremists inside and outside the Kingdom plotted to take over the country. Leveraging its enormous income, the country had borrowed fantastic sums. The king was aged and ill then, without a successor who had the political authority to keep the Kingdom together, and since then the king has only become more aged and more ill.
At that time a United Nations study assured us that oil prices would be flat for the next 15 years. This made no sense to me. Over the past 20 years, few resources have been invested into productive capacity for raw materials, and that certainly includes oil. You name it--mines, farms, drilling rigs, plantationsthere are fewer of them today than 20 years ago.
On a macro level oil had to go up. If oil went down, the Saudis would go bust and Islamic extremists would take over the country, which would curtail the worlds supply of oil and force its price higheror oil would go up, bailing out the Saudis. Either way, oil had to go up.
And go up it did, giving the Saudis breathing room. Recently, however, it has come down, but this has had more to do with the Asians temporary halt in buying of commodities of all sorts, which naturally includes oil, the prime commodity. The fall of the price of oil has thrown the debt-laden Saudis into a yet tougher bind. Their staggering debt has risen over the past three years, yet the income to service that debt has fallen. Thus the House of Saud is now even more vulnerable to political and military attacks from inside and outside the Kingdom. As before, if the price of oil doesnt rise over the mid-term, the Kingdom is likely to go bankrupt, which will push prices up.
At this point, world known reserves of oil are peaking and will soon begin to drop, adding pressure for a rise in price. Not much has been spent to develop the capacity to drill for oil over the last 17 years. As an example, all over the world drilling rigs have been cannibalized or become ancient. Fundamentally, even without enormous pressures from Saudi Arabia tumult, oil prices are set to rise.
My second Worth column, in late 1995, examined China. It looked to me then that as China continued to unleash itself from the yoke of communism, it would become the worlds next great country, a superpower with enormous influence. The Chinese had a tradition of entrepreneurship, they worked hard, and despite espousing communism, their leaders encouraged individual enterprise.
Today, competing fiercely with each other, most of Chinas neighbors have devalued their currencies. Blood has now flowed in the streets of Asia, and its markets have dropped 40% to 80%. While I dont expect such bloody events in China, I do expect turmoil, which could well be political in nature or involve labor strikes.
Before Asia can stabilize, however, the region must resolve its various troubles. As President Habibie has no political legitimacy, Indonesia will likely collapse as a single entity and split into several nations. Such turmoil can only put more economic pressure on China. The only way Asias vicious cycle of competitive devaluation can come to a halt is for China to become a major international player like the U. S., make its currency convertible, and allow it to float on world markets. China will never realize its economic potential until it takes such a step.
Asia still offers greateven fabulousinvestment opportunities; however, I will look to do my first round of investing in Asia only after turmoil strikes China. I will take that to be a bottom in Asias markets, especially if it leads collaterally to the disintegration of Indonesia.
My original thoughts about investing in China still seem right. However, it will be important not to invest directly in China, as foreigners will probably not be given the best shake, but to invest in overseas Chinese companies that are involved with the Chinese economy.
In early 1996 I wrote an article about the "new" Russia. Back then the world was bullish on Russia. Franklin Resources, one of the worlds largest fund companies, had started a Russian fund. Huge Western companies had rushed into Siberia to drill for oil, and others had formed to take out vast quantities of clear pine, minerals, and other commodities. "Smart" investors and American MBAs parachuted into Moscow, opening MacDonalds, exporting every sort of commodity, buying and selling telephones and telephone service, computers, and Western cars.
It made a kind of sense. Russia had been a superpower, held back by the leash of communism, a clumsy economic system, and appeared to be opening itself to democracy and capitalism. Surely the nation that had routinely flung the worlds most powerful rockets into orbit would be the emerging nation of all emerging nations.
It didnt look like it to me. Back in 1990 I had traveled across Russia by motorcycle, from Nakhodka in the far east across Siberia to Brest, on the western border, a three-month, 7,000-mile journey, examining the country with an ants eye view. It was easy enough to see that Russias roads, rail lines, bridges, factories, military installations, hospitals, and pipelines, were falling apart. Russia had no history of popular democratic capitalism; indeed its leaders had always been czars or warlords, and the political stance of its people a sort of sullen obedience. It looked to me as if Russia was more likely to be the worlds next great disaster rather than the worlds foremost economic tiger. Any rise in its markets looked to me as only an upward jiggle interrupting a long, long fall.
And indeed, Russia has become a disaster. Rather than take a position like Polandwhich allowed individual entrepreneurs to run small restaurants and factories and to manage kiosks, and which killed off subsidies to large, inefficient state factoriesRussia attempted to go both ways at once: to control the economy at the same time they freed it. Powerful Russian "oligarchs"who operate like financial warlords--took the place of the all-powerful state. Much of the hard currency "invested" in Russia scampered into private accounts in Swiss banks. The country came to depend on the dollar, not the ruble, even for interior trade.
Today the former Soviet Union--the largest contiguous empire the world has ever known--has flown apart into 15 separate states, and before the breakup of the empire is over, there will be 50 to 100 states. The ruble is on its way to becoming worthless.
As examples of how bad the situation is, the shares of Unified Energy Systems, Russias electricity network, have fallen 90%. Those of Surgutneftegaz, a Siberian oil company, have fallen by 84%, while those of Lukoil, which supposedly has more oil in the ground than Exxon, trades at a discount of 98% to the international majors in terms of its dollar value per barrel of proven reserves.
All too often we Americans think every problem has a solution, yet many problems have none. No one can put back together this gigantic Humpty Dumpty. Hard as it may be for IMF bankers to fathom, the only solution here is for the various parts of Russia to continue to break up into their natural states and rebuild their economies. Moscow cant stop this process, the United States cant stop it, and neither can the IMF or the World Bank.
As for investing in Russia? I suppose by now everyone knows to forget it. Despite outstanding bargains, its prudent to wait until the final break-up and emerging political stability, which may take decades.
Two years ago in an article here on Latin America I pointed out that the region had much the same potential as the United States back at the beginning of the century. Just now Latin America is in the middle of a periodic setback, such as we went through in 1907. For example, Brazil has only minor problems compared to its former major problems of hyper-inflation and military government. Today the Argentines currency has been set too high, but this will change, too. The problems Latin countries are now having are only normal setbacks to a long-term upward movement.
And just what did we look like at the end of the nineteenth century? First, we were a large debtor nation. Moreover, we had regular political assassinations, little rule of law, political corruption, politicians trifling with the currency, and frequent booms and busts. Still, over the next few decades we became the worlds richest country, albeit with setbacks in 1907, when we went bankrupt; in the early 1920s, when our economy went bust; and of course in the 1930s, when we suffered the Great Depression. Long term, as Latin America opens to the outside world, the region will blossom and become as successful as the United States is now.
Mexico, the perennial sick man of Latin American, is the chief exception to the bright future of Latin countries. I cant be optimistic about a country that hasnt made the full transition to economic independence. Time and time again weve bailed out the Mexicans, and they have come to rely on us. They need to learn not to borrow too much. As well, their politicians are still corrupt. Cronyism continues to run rampant, and in a crisis the Mexicans bail out their friends with our money rather than let the market do its cleansing work.
In mid-1996 I wrote about the United States, examining our situation with the same analysis I use overseas. While I quoted a learned professor who opined that our national debt-cutting caused our depressions and various national busts, and was therefore dangerous to our economic health, I didnt buy it at all.
History demonstrates that nations with huge foreign debts are at risk of foreigners pulling out of their investments and wrecking economies. Indeed, we see this now in Asia. I noted that 57% of the worlds foreign reserves were in dollars, and that if only a part of those central banks chose to sell their "investment" in dollar bonds, then the price of our T-bonds would fall, interest rates would shoot up, our stock market would fall, and we would enter hard economic times, as high interest rates beget recessions. Given the size of our debt, these hard times could go on for a long time, in the same way that Englands troubles after the fall of the pound went on for a long, long time.
As we were at the beginning of the century, the U. S. is once again a large debtor, now the worlds largest debtor nation. At the beginning of the century our debt financed productive capacityrailways, factories, mines. Today our debt finances transfer payments, social security payments, and welfare. For decades now weve been living off our reserves and the favors of friends, as nations around the world have purchased our Treasury bonds to use as their currency reserves, and these fresh funds have kept our economy liquid and buoyant.
As I predicted last year, foreigners are finally selling off our debt. So far this hasnt affected the value of the dollar very much or caused many problems, but the dollar is now beginning to show weakness. Foreigners appear to have cashed in $100 billion of U.S. bonds over the last year and a half, and luckily Americans have stepped up to take the place of these sellers. At the same time, the government has run a temporary surplus, which has also helped the dollar. Still, we havent addressed our root problems of over-spending; our debt continues to rise; and sooner or later if we dont pay down this massive debt, whats remaining of our investors will flee into sounder investments such as oil, European currencies, China, etc. This is a story as old as history, and it only ends one waywith the devaluation of a currency and more debt and huge economic problems. Almost nobody in this country recognizes that were living off our reserves, and no one is changing his ways.
Its important to realize that the countries today who are in economic distress are all debtor nations to whom foreigners have stopped loaning money. Were the last large debtor nation, and our turn will come unless we make fundamental changes. If we took the brand name of "the United States" or "America" off our country and presented just the raw statistics of our national situation to investorsour giant debt, bloated interest payments, transfer payments to tens of million dependent on them, and dependence upon overseas investors--few would invest with us. For well over a year and a half our stock market has been struggling, with many stocks down substantially, a sign that investors overseas and here may be leaving our markets.
The Europeans are struggling to put together a new currency, the euro, which I examined in early 1997. With Europes many borders, economies, languages, currencies, and cultures, its commercial markets suffer from cultural and monetary friction. While Denmark is closer to France than New Jersey is to New Mexico, there is still a greater cultural and economic difference between the two, one that inhibits trade. The euro was designed to mitigate that difference, to draw economies as diverse as Spain, Belgium, Ireland, and Italy together into a United States of Europe. Indeed, if this melding can occur, Europe will be the largest market in the world, and the euro will be the worlds largest and one of its soundest currencies, an ideal reserve currency. It still seems as true today as it did last year that the formation of the euro is the most important world event of the next five years.
It strikes me that only two paths are likely: one, that the euro succeeds. As a far sounder currencyEurope doesnt have the balance of payments problem we have or our gigantic debtthe euro begins to take the place of the dollar in the vaults of central bankers world-wide, causing sales of the dollar and its long-term slide. For the first time in a long time we wont be able to print money to get ourselves out of fiscal scrapes. Or two, that the euro will indeed collapse, probably due to European political discord, which will cause world-wide turmoil. Either way, theres trouble brewing.
However, while some European countries, such as Germany and Denmark, run reasonably sound governments, others, such as Italy and Belgium, are vastly more profligate. To tie all these diverse economies and fiscal and monetary cultures into one currency is a huge and incredibly difficult task.
My opinion hasnt changed. Just as I wrote last year, I still dont believe the euro as presently envisioned can or will come into existence. While some countries in Europe run a tight shipthe Netherlands, Ireland, and Denmarktoo many others are not fiscally sound. Even the Swiss and the Germans are starting to emulate the profligacy of the U.S.
On January 1, 1999, European banks and businesses will be obliged to keep two sets of books, one in their local currency and one in euros. This will begin a transition period, and on June 30, 2002, the conversion is supposed to be complete. From then on only the euro set of books will be kept.
However, Im still of the opinion that the euro wont make it to 2002, that it will collapse before then.
Indeed, when the savvy investor hunts around the entire world for a political regime that runs a tight ship in which to invest, he is hard pressed to find any sound currency other than perhaps that of Singapore or Luxembourg. Even the prudent New Zealanders have been whacked around by the Asians, who have stopped buying commodities they sell.
While I havent written an article that focused solely on commodities, I have frequently noted their importance to many countries. In 1996 I wrote about Canada and Australia, two countries struggling to keep their economies on a sound footing, both of whom depend upon the sale of commodities for national revenues. Just now, with their customers, the Asians, buying little, its been tough for them. However, with the bear market in commodities over they should do well in future years.
While commodities have been dropping lately, it still appears that 1992 to 1993 was a long-term bottom for them. They are now making a second bottom, and many will go up from here. Asian inventory in raw materials is now down, but the Asians must soon buy commodities to stay in business. As I note earlier, investors have put almost no money into new productive capacity in any commodity, all their money has gone into paper assets, bonds and stocks, which have inflated mightily. Driven by low supply, there is likely to be a big rally in oil and other commodities. Now is a great opportunity to buy them. Their rise in price wont come about because of a great boom and growing demand, but because of a lack of supply.
In April of this year I wrote about the IMF. It struck me that the IMF was a moral hazard for finance ministers around the world and an economic hazard for the rest of us, not a true savior or a fairy godmother. That is, the availability of easy money in times of monetary distress only encouraged profligacy and loose thinking about the unthinkabledevaluation, the inability to pay off hard-currency loans, the collapse of economies, riots in the streets, and the dissolution of normal society.
It would indeed be wonderful if the world had a fairy godmother who magically appeared when innocent nations were in financial trouble, waved a magic wand, and whisked away economic troubles. In fact, the IMF has come forth to aid nations dozens of times over the past decades, but rather than help troubled nations, its really only bailed out fat-cat investors. The IMF has only put off the day of reckoning of profligate nations, making their economic catastrophes worse in the long run, or allowed those who have mismanaged their national economy to escape with even fatter Swiss bank accounts.
Russia is a prime example. IMF money and the promise of more money has given the Russians the false hope that their economy can function like a Western economy without the hard choices and economic pain required. Russia, the Ukraine, Kazakhstan, and the rest of the world would be a better place without the hope of a fairy godmother. Not only are there no free lunches, there is no fairy dust, either. When human beings deal in reality, not fairy tales, false promises, and Ponzi schemes, they manage their affairs in a far shrewder and far sounder manner.
We Americans all too often think every difficulty has a quick and easy solution. While a can-do spirit is to be commended, many times an easy solution is not in the cards. In the real world often the only solution for an explosion is for it to complete its course, for the pieces to fall to earth where they will. Only then can something new, something substantial, be built on which we can go forward.
Updates are available at www.jimrogers.com.