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You Can't Become Rich In Your Pocket Until You Become Rich In Your Mind | ||||
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Infallible formulas for making investors richSome of these new weights on the dollars end of the teeter-totters came from currency panics and collapses in Asia that began in July 1997. While the worlds glitterati were gathering in Hong Kong to toast that tiny capitalist miracles ingestion into the maw of the reformed communism of China, Thailand was quietly removing the peg that had supported its currency, the baht. At the time, I was disgusted by the near-zero coverage in Western media of Thailands forced devaluation, and I warned clients that the real financial story was coming from Bangkok, not Beijing or Hong Kong. I cited a famous H. T. Webster cartoon that depicted farmers chatting in Hodgenville, Kentucky, February 12, 1809. One asked what was new, and the other said thered been a new baby, named Abraham, born at the Lincoln cabin, but Nothin much ever happens around here. If Thailand was unable to defend its currency, what about the other Asian tigers? As what would be called Asian flu (and I called Thai bahtulism and Malaysian ringgitworm) spread to the currencies in the region, Asian financial markets collapsed, unleashing the worst depression in the region since the 1930s. That fast-spreading panic moved money into the dollar on a big scale, so the dollars bull market accelerated. Currency markets tend to trade according to Newtonian physics: When a currency is moving in a given direction, it will continue to move that way until external forces compel it to change direction. As traders put it: The trend is your friend. So the dollars two-year bull market continued into 1998, at which time two more crises drove investors into the greenback. First came Russias default on its external obligations, a blow that the markets had inexplicably failed to anticipate. Financial markets worldwide slumped, as fears of financial collapses from institutions holding devalued Russian paper proliferated. The thermometer of global financial health, the TED spread (see The Ted Spread: Global Finances Thermometer, Chapter 7) leaped, but not into the crisis zone. The dollars role in times of trouble once again asserted itself. When a global crisis is unfolding, the greenback is a traditional haven. (Why do so many people call it a safe haven? That is an ignorant redundancy. Any unsafe place or market hardly qualifies as a haven.) Then came a made-in-America financial crisis that just might have broken the dollar bull market had the Fed not responded with such vigor. Long Term Capital Management (LTCM), a huge hedge fund based in Greenwich, Connecticut, had a galaxy of stars in its partnership, including two Nobel Economics laureates (Myron Scholes and Robert Merton) and elite alumni from Salomon Brothers from the era when its swaggering traders were Masters of the Universe (as described by Tom Wolfe in Bonfire of the Vanities and Michael Lewis in Liars Poker). It was supposed to have foolproof computer-based hedging strategies that profited from small distortions in the markets. What they were certainly expert at was in finding complex tax avoidanceor evasionstrategies with complexities beyond Enrons wildest dreams. (The Wall Street Journal quoted the esteemed Myron Scholes as saying, Nobody really pays taxes, a concept currently being tested in a suit brought by the Treasury against the partners. The previous member of the Greenwich glitterati who spoke similar words was Leona Helmsley, and she ultimately went to jail for tax dodging.) Then, as global markets were still reeling from the Russian default and from a major bank loan restructuring for IndonesiaLTCM began to crumble. Word spread that those supposedly fail-safe formulas had failed. (It would turn out later that the geniuses who worked out these programs only used trading data dating back to 1990. Thus, they had no precise information about how various kinds of financial assets had behaved during the major TED spread crises of the 1980s.) The partners at LTCM called on all their powerful friends in Wall Street and Washington to bail them out. They got by, with more than a little help from their friends. The Fed participated in a bailout package that wound LTCM down gradually and had the charming attribute of protecting much of the wealth of the key insiders who had claimed to possess infallible formulas for making investors rich. The Fed also injected massive liquidity into the system. But the most crucial help came from an unlikely source: The beleaguered Japanese revalued the yen upward, a move that ended what was potentially a bigger financial crisis than Russia and LTCM combined. As Chart 6-1 shows, the yen had been declining steadily, and there was widespread talk in currency desks that Japan was prepared to let the yen collapse as a means of kick-starting its economy out of a deflationary recession. This threat alarmed China, Japans biggest trade competitor. The Chinese let it be known that if the yen were to fall further, China would competitively devalue its currency, the renminbi or yuan. Given that China had already become the most formidable force in international trade, that was the equivalent, in trading terms, of threatening nuclear war. By its upward revaluation, Japan took pressure off all the Asian currencies and off the share prices of leading global banks that stood to lose heavily from a new wave of global deflation. Charts 6-1 through 6-4 illustrate the interrelationships among the Feds crisis management, the stock market, and the currency markets. The debate still continues about the Feds response to the LTCM collapse. Most observers believe it did the wise thing in helping to orchestrate a bailout that prevented a massive default. It eventually came out that LTCM was levered far beyond what the marketplace assumed. It may have been indebted to 50 times its equity, depending on which valuations one accepts. Some of Wall Streets biggest namesincluding Merrill Lynch Chairman David Komanskywere investors in LTCM, and at least one central bankthe Bank of Italyhad a large investment in the partnership. I argued then, and continue to believe, that the Fed should have let LTCM go down, relying on the beneficial effects of its massive monetary ease and the yen revaluation to carry financial markets through the crisis. The United Statesincluding Fed chairman Alan Greenspanhad long lectured Asians of the evils of crony capitalism. Those lectures had grown louder and longer after the 1997 Asian collapses disclosed webs of partnerships, deals, paybacks, and other sub-rosa arrangements that contributed to the depths of the disasters. So what was the bailout of LTCM if not crony capitalism? Moreover, by both bailing it out and embarking on a massive liquidity expansion, the Fed spawned a new monster that would dwarf LTCM, bahtulism, and ringgitworm: Nasdaq had been on a simmer through the summer of crises. It was trading in the 1600-1700 range, and it responded to the Feds furious monetary injections like Popeye to spinach. The rest of the world saw that breakout, and global investors rushed into American technology stocks. Nasdaqs nonstop run to 5048 was fueled by massive global inflows that also boosted the dollar. Those two bull markets moved in tandem: Through 1999, the weekly price changes of the euro against the dollar had a sustained, superb inverse correlation to the performance of Nasdaq in general and Cisco Systems in particular, as can be seen in Chart 6-5. Inverse correlations (see Analyzing Your Portfolio Risks, in Chapter 9) are assets that trade in opposite directions to each other: When the euro fell, for instance, which was most days during 1999 and early 2000, Nasdaq went up, usually led by Cisco. Positive correlationssuch as the share price of Cisco and the changes in Nasdaqs valueare, of course, more common: In a bull market, most stocks go up, and in a bear market, most stocks go down. That the value of a new foreign currency would trade inversely to a U.S. stock index was an important indicator of a major global trend. By this time, any discussion of the strength of the dollar was focused overwhelmingly on its strength against the euro. Japan was bogged down in another deflationary recession. The Canadian dollar was bedeviled by a global perception that the nation had poor politics and an overdependence on commodity exports at a time of long-term commodity deflation. The British pound was rising strongly, but this was really at the expense of the euro, not the dollar, and reflected Britains better economic performance under the enlightened, moderately leftist Blair government, at a time when Eurosclerotic policies on labor, regulation, and taxes were seen by investors globally as reasons to avoid investing in the Continent. Why was the currency of the region with the greatest reliance on red tape now trading inversely to the market value of a U.S. technology-heavy index, and to the share price of Cisco, one of the glamorous components of that index? To answer that trillion dollar question, we need to go back to 1991. |
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