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Written: July, 1998
The devaluation in Russia set in motion a chain of events tantamount to a global economic earthquake. The epicentre is in Moscow, but the tremors will be felt throughout the world and especially in Central Europe
Traders are betting on a future exchange rate of 20 Roubles to the greenback by the end of this year. Judging by the prices of financial options, futures and forwards, they also foresee a rate of 36 Ck to 1 USD in one month and up to 50 CK to the dollar by yearend (a rate of 41 features in the average transaction). Trading departments in all the major prime European banks, hedge funds, players in the financial futures and options markets – all believe not in a market meltdown – but in a meltdown of all markets. No one will say so openly – but this is what is implied by their trading strategies.
First to go will be the Russian banks. Devoid of liquidity, robbed by their own founders, with no access to retail banking (this is the almost exclusive territory of Sberbank, the Russian giant savings banks) – about 1,000 banks live off trading in Roubles and in shares. Following the deletion of the Russian capital markets in the last few months – a massive bloodbath will follow. We are not talking anything as orderly as consolidation – we are talking riots in the streets, violence, frozen accounts, hundreds of collapsing institutions and a frenzied run on the Rouble.
This will drive the remnants of the community of investors in emerging markets to the arms of the Czech, Polish and Hungarian capital markets. The Vysegrad safe haven – more identified with the EU than with Russia – will provide investors with the short-term illusion that they are protected.
But this self delusion will quickly evaporate as the Hong Kong Monetary Authority will lose the battle that it has waged in the last few days to defend its currency. The HK$ is bound to lose its USD peg any day now. China will then succumb to internal political pressures (mainly from the exporters lobby) and devalue the Yuan. This dual blow to regional stability will set off the worst round of currency devaluations and trade wars ever. The Central European currencies, stock markets (and economies) are likely to react to his bit of the drama very adversely. While largely decoupled from the Russian economy – the Czech economy, for instance, is sensitive to changes in global trade patterns.
The final blow will be delivered on October 1998. In the last few weeks, investors in the USA have been switching from equity positions to debt (bonds) positions to the tune of about 3 billion USD weekly. This is small change in Wall Street terms. But what is less known is that most of the bond purchases are not related to the scenario of a benevolent, interest rate reducing, Fed. Sophisticated investors are planning to short stocks and, in the meantime, are investing their liquidity in bonds. The plot is classic and in thickens by the hour : come September, a mountain of money, now invested in bonds will chase stocks up. This would be a bear trap. Many will be caught in this last rally. The sophisticated will then short stocks and revert to bonds. They will do so not only by selling physical stocks but by using highly leveraged instruments. This will be sufficient to crash Wall Street. A careful analysis of the figures shows that these people (who rarely fail to read the market correctly) believe in a minimum of 20% decline in the Dow Jones Industrials in the last two weeks of October alone. They also believe in a bear market with a decline of 50% in the index by June 1999.
No economy will survive this blow – not even the Czech Republic's.
Currencies: The DM will be demolished by Germany's closely knit contacts with the Russian economy. The Yen will react badly to the currency devaluations in South East Asia (and will probably reach 200 to the USD in 6 months time). The only safe haven will be the good old dollar. Probable target: 2.03 to the DM.
Stock Markets in emerging economies will not be spared by their previous falls. They will be hard hit. They will also become totally illiquid.
How is the Czech economy likely to react to all this mayhem?
The world economy will contract in 1999 and trade protectionism will flourish. It is not even certain that the IMF will retain its solvency, what with the recent fiascos in Russia and Indonesia. When the largest economies disengage themselves from the rest of the world, a Second Great Depression could start. Export economies, such as the Czech Republic's, will contract by double-digit numbers. Prices will spiral up uncontrollably as cheaper imports disappear from the markets. Inflation will bring in its wake further devaluations, which will fuel inflation further. Real income will b eroded, savings will vanish, people will cut savagely on their consumption. Only the legal and illegal professions will thrive. Defaults, bankruptcies, receiverships, insolvency and foreclosures will soar. Each such cycle will exacerbate the next one by spewing into the labour market its latest victims. As globalization trends are bucked and then reversed under the attack of economic reactionary forces, previous multilateral collaborative efforts will be actively or effectively dismantled.
Other emerging markets will endure an even worse fate:
Congress, for instance, is likely to refuse to approve any additional funding for the likes of the United Nations or the International Monetary Fund. The latter, teetering on the verge of insolvency itself, its last funds exhausted, will refuse to disburse additional loans to any country. Many a country will be thus reduced to begging in specially arranged donor conferences and, when no donors are left, to default on their debts, in droves. The confidence in the world monetary system and arrangements is bound to be irreparably shaken. The price of precious metals will skyrocket. People will buy land as both a hedge against the erosion of the value of their savings and as a source of food in case of "real trouble". A barter economy will flourish together with the official monetary one. As currencies lost their meaning, their convertibility greatly reduced, their value constantly eroded by inflation (the mirror side of the scarcity of goods) – people will regress to earlier methods of exchange and of storing value.
This will be the beginning of an end. Politicians will still bicker. The Internet will still be gathering pace. Some mergers will still be made. Trading in Wall Street may be brisk, though bearish. Diamonds could well be in vogue again. The monetary orchestra will be playing in full force as the Titanic ship of the world economy will sink, ever more deeply and inexorably.
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