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How the cookie crumbles --
the insight of economist Martin Armstrong

by Diana Holland

A summary of Armstrong's presentation to the World Economic Outlook Conference, forecasting the destabilizing effect of European Economic Union on the world economy. 

Martin Armstrong of Princeton Economics in the US is recognized as one of the world's top economists. His institute predicted the fall of the Nikkei average in Japan soon after it was announced in Share International in 1988, when the index was riding at an all-time high and the prospect of it falling was unthinkable. Armstrong spoke recently at a World Economic Outlook conference in Vancouver. The following summarizes some of his pronouncements.

Much attention has been paid to the turmoil in Asian markets recently, but a much more insidious factor in destabilizing the world economic situation now is Europe, and specifically the advent of the European Economic Union soon to be enacted.

Capital is now fleeing Europe at a phenomenal rate, says Armstrong, as no one can predict what individual currencies will be worth when the union comes into force, let alone several years into the future. A little-reported fact was that two days before the Asian debacle took hold in October 1997 the German long-term bond-market was not fully subscribed at one of its routine auctions. Why? Because in 30 years, the term of some of the bonds in question, the German mark may not even exist.

There is a cap of investment funds which constitute "hot money", explains Armstrong, "ready in the blip of a computer screen to move on to greener pastures. By and large up until now, however, a large number of investors have been content to make long-term bond placements and collect a partial return twice a year for 10, 20 or 30 years. With the advent of the European Economic Union, that horizon has now dwindled to six months. In sum, there is no way to plan for stability and a huge pool of capital is moving around the world looking for a safe place and never quite finding it."

The level of volatility in the markets is unprecedented, says Armstrong. The Asian economies peaked in 1994, but the South Asian economies insisted on pegging their currencies to the US dollar, letting the value of the US dollar determine the worth of their money. As a result, they have ended up squandering the country's assets to keep up with the rising US dollar. So dramatic has been this rise that one-third of the world's resources are now propping up the US dollar, and keeping the US interest rates about 50 per cent below where they would be on their own. Normally, a country has to raise interest rates to make bond purchases more attractive to foreign investors. But why bother when those foreigners are clamouring at the door, especially when domestic business can flourish when rates are low?

At the same time, there is a political band-wagon in Europe that wants to go ahead with unification at all costs. It has sought no advice and brooks no criticism from the banks. In fact, with its powers of moral suasion, it is forbidding them to speak up against the plan or point out its utopian nature. And yet, even in terms of comparing the internal worth of the various currencies, how can one establish relative currency levels when the supporting economic figures will always lag by six months?

The problem, says Armstrong, is that the union as now envisaged is a monetary one, not the fiscal and political union that it would have to be to succeed. Essentially, politicians foresee running the new Europe by "gentlemen's agreement", promising to keep their respective currencies within a 3 per cent range of one another. The plan is pure utopia, says Armstrong, and doomed to fail. He foresees three Big Bangs to come into effect between April and July of 1998.

First, on 1 April, comes the Japanese Big Bang, when the currency is somewhat liberalized. The Hashimoto Government is relying on Japanese citizens to bolster the lagging economy. However, one of the provisions is that Japanese investors will be allowed to have holdings off-shore, and since savings rates are much less than 1 per cent at the banks, Armstrong predicts that there will be a sizeable outflow of funds.

On 1 May, the European Big Bang kicks in, whereby the currencies of all the European nations can be swapped at par. This means that in preparation for the European Economic Union in 1999, the "ECU" or strong European currencies like the French franc or the German mark will be at par with the weaker "EURO" currencies of nations like Spain. The result? An automatic devaluation of 5-7 per cent to be imposed soon on the currency of the stronger nations, which is why German money and real-estate interests are now frantically buying up the Eastern Seaboard in Canada and the US.

Based on complicated technical analysis, Armstrong presages a third Big Bang upwards in American stocks and bonds before the dust settles: volatility is at an all-time high with so much money searching for a safe place. Armstrong is more optimistic about the longer term beginning in about 2003, when he thinks a measure of stability may have intervened. Till then, despite his wealth of expertise, he was hard-pressed to recommend any form of investment, and for very interesting reasons.

"The world is now truly a global place," he says. "What happens here has an impact there, and those impacts are real. One cannot plan one's investments on the vagaries of the local economy or even of the central government. All investments are likely to perform like a roller-coaster over the short term given the current level of volatility.

The IMF has no business lending money to troubled countries unless it does so in the local currency, stresses Armstrong. What has happened to date in countries like Russia or Thailand? The loans are made in US dollars and the local currency plummets because with the dollar as the new effective standard it soon takes more and more local currency to purchase it. Bad enough, but the problem does not end there: the loans were made in US dollars and have to be repaid in US dollars, which are now even more expensive to procure as the dollar continues to rise internationally. The situation is untenable, says Armstrong, and the IMF is not helping defaulting nations one bit with its measures.

Despite his many contacts in the world of high finance, Martin Armstrong has not heard of any blueprints for change and reconstruction, and doubts that sharing, in any form, would be high on the agenda of world leaders. Essentially, he claims, politicians look out for their own interests, and pretty much their own immediate interests at that. There is very little global cooperation, he states, and, as is the situation in Europe, transcending cultural differences is next to impossible in the short term. It would take something far larger than an economic catastrophe to bring about sharing. Historically, change of that magnitude has not taken place without pain, he muses, and it would take a colossal event 

 From the  April 1998 issue of Share International.

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First published April 1999, Last modified: 15-Oct-2005