News

Overview of financial and stock-market activity at world level on
31.12.2002

The month of December 2002 was characterized by:

• a retreat of the European markets, despite a few bright spots.
• considerable activity on Wall Street ending on a gloomy note and some nervousness.
• a general downwards trend on markets worldwide.

ECONOMY:

In Japan, the Government set in place a calendar for banking reforms intended to solve one of the most urgent problems faced by the country. New measures envisaged an injection of public funds into the capital of banks, with accounts currently weighed down by dubiously recoverable debts officially estimated at 50,000 billion (thousand million) yen, equivalent to 409 billion U.S. dollars.

The biggest banks in the world, including the Japanese banks, were in a bad way. Mizuho Financial Group, with its 50,000 employees (and CDN$1,916 billion) is the largest in the world, together with its peers. When they "catch a cold", it is the world's second biggest economy that risks pneumonia! (1)

The whole Japanese banking system has been "infected" for a decade and it can well be imagined that the banks' balance sheets are in a "mess". Another valid angle on the difficulties that Japanese banks are in could be an explanation based on the bursting of the property bubble in the 1990s. With a fall of 50% in property prices from their peak (and continuing falls), the situation can easily be grasped: thousands of Japanese businesses nearly moribund, incapable of paying off their debts, on "life support", and banks hard put to it to find fresh funds for innovatory enterprises.

Statistics confirmed the deterioration in the world's second largest economy, indicating an urgent need to clean up the Japanese banking sector. Moreover, in October 2002 the unemploment rate in Japan hit 5.5%, its highest level since the end of the Second World War, industrial production fell and households cut back on their spending. So, Japan has been losing momentum and its heavy-weight economy, second in the world, was out of condition, with:

• the country "groggy" from three recessions in 10 years
• the stock market back at 1983 levels
• its banking system undermined by hundreds of billions of U.S. dollars in bad debts
• the "giant" trying to recover its balance.

Nevertheless, the Japanese were "not short of a bob or two", supported by an exceptionally high propensity to save (10% of disposable income) and profiting from the huge gains accumulated over 50 years of prosperity. The Japanese had plenty of cash, but a system out of kilter, owing to:

• an obsolescent industrial structure
• a financial sector in deep trouble
• Government indebtedness
• an ageing population
• the necessity of economic and financial reforms
• the country's need to borrow

After having been the "Empire of the Rising Sun", Japan needed to make moves to avoid becoming the "land of the setting sun".

To sum up, could Japan be facing a repetition of a "speculative bubble"? Consider:

• the stock market crash of October 1987
• the "property bubble"
• the slowdown in the economy
• the greater decline in industrial production in 2002
• interest rates at 1%
• deflation.

Further, Japan expected growth in the 2003/2004 financial year, despite the recovery budget financed by record indebtedness, but this might be too optimistic, owing to:

• declining receipts from taxation
• the numerous uncertainties at world level
• the reduction in exports
• the record level of unemployment in the country
• the weight of bad and doubtful debts affecting Japanese banks
• Tokyo share prices at their lowest for 20 years, undermining investor confidence
• the growing level of public debt.

This Government debt already stands at nearly 140% of the Gross Domestic Product (G.D.P.), the highest level among industrialized countries.

Could the sequence of events undergone by Japan during the last decade be about to recur in America?

At the end of 1989, when Wall Street crashed, the NIKKEI index continued on the up and up:

• on 31 December 1989, it hit a peak of 38,915.90 points, then was affected by the slowdown of the economy
• by December 2002, it had collapsed to around 8,640 points, the lowest level in 20 years.

Thus, the Tokyo stock exchange ended the day with falls on 16 December 2002 for the ninth consecutive session, the longest series of closures with figures in the red for eleven years, affected by a sharp appreciation of the yen that would put a brake on exports. In addition, the problem of banks' bad debts was back in investors' thoughts.

The price of land, in scarce supply in Japan, kept climbing for two years after the stock exchange peak, up till 1991. The banks seem to have been in part responsible for property speculation.

Could the United States go down the same road? The answer to this question was still in the balance. In fact, the American economy seemed to be slowly pulling out of its doldrums. Investors received reasuring news suggesting an upward trend in the United States from the publication of data indicating:

• recovery in retail sales
• movement in the manufacturing sector according to some indicators
• improved consumer sentiment
• renewed consumption.

The American Federal Reserve (FED) left its standard rate unchanged at 1.25% on 10 December 2002. The Central Bank considered that risks were equally spread over a return to recession and renewed inflation. This was the stance also taken on 6 November 2002. Rates are now unlikely to be altered before the end of the summer of 2003.

The index of consumer confidence issued by the "Conference Board" showed a climb to 84.1 in November 2002, the first increase in six months, to be compared to the 79.6 of October 2002.

As for the University of Michigan consumer confidence index, it went from 80.6 in October 2002 to 84.2 in November 2002.

The level of unemployment in the United States went up to 6% of the active population in November 2002, as against 5.7% in October, with the American economy losing a net 40,000 jobs in November 2002. This was only the second time in eight years that the figures had gone this high. American growth, as previously noted, showed an increase in the Gross Domestic Product (G.D.P.) of 4.0% over the third quarter in comparison with the corresponding period of 2001.

For the second year running, 2002 was a record year for bankruptcies in the United States, following the accounting frauds and frantic spending of the last decade. The end is not yet in sight.

However, deflation could reappear in the near future in the United States and the American Federal Reserve (FED) might reduce its interest rates further, down to zero if necessary, to avoid a crisis like the situation Japan has been undergoing since 1995. In fact, for the first time in nearly 50 years prices in the private sector have been falling in real terms in the United States. The FED should take energetic steps to reverse this tendency. Deflation has economists worried and in such an environment consumers and entreprises put a brake on expenditure or even bring their spending to a complete halt. Since prices are falling, they hope to be able to buy the same for less at some later stage; but this drags the economy into recession.

The European Central Bank (ECB) reduced its interest rate by half a percentage point, in other words by 50 base points, on 5 December 2002, after a meeting of its Council of Governors. The base rate fell from 3.25% to 2.75% (this is the minimum rate applying to major refinancing operations).

Spain had a remarkable rate of economic growth and should show an increase in G.D.P. of around 2% in 2002 and 2.5% in 2003, according to the IMF.

Sweden is organizing a referendum on adoption of the euro on 14 September 2003 and Great Britain is at risk of finding itself more and more isolated in Europe.

In the Eurozone, unemployment rose to 8.4% (2) in October 2002, from 8.3% in September 2002 and 8.0% in October 2001.

In Germany, there were already over four million out of work. Confidence had never been at such a low point in Europe's number one economy, according to a survey undertaken by "Eurochambers", and recessionary trends cannot be ruled out for 2003.

It was in Belgium where entreprises were most preoccupied about the future.

In Denmark and Great Britain, the two other European Union countries that like Sweden have not adopted the euro, entreprises viewed 2003 with greater optimism.

Switzerland saw the greatest increase in unemployment for around six years during November 2002, with the number of unemployed pushing past the 120,000 mark.

STOCK MARKETS:

Recent gains on stock markets should not "pull the wool over investors' eyes", as markets face extreme volatility in coming months. The trend for December 2002 was generally downwards. In fact, risks of a world-wide collapse into recession seem high, owing to:

• weakness in consumer confidence
• stock markets still in a state of shock
• fears aroused by the Japanese banking system or debt in Latin America
• repercussions of crude oil prices
• the fear of armed intervention by the United States in Iraq

together darkening economic horizons and world prospects for 2003. (3)

Similarly, the International Monetary Fund (IMF) considered that there were major risks of a world-wide economic downturn, owing to the fragility of financial markets. It commented on the fact that there was uncertainty and disquiet about the solidity and durability of world economic recovery, company profit forecasts and geopolitical conditions. (4)

EURO:

The euro climbed to its highest value relative to the American dollar for three years on 13 December 2002. However, the European Commision believed that the Eurozone was lacking vigour, with continuing limited internal demand and repercussions for some exporters from the rise in the euro. The situation of the currency could be summed up as follows:

• internal demand in the Eurozone remained weak throughout 2002
• the zone was hit by drops in share prices
• international prospects were uncertain
• prospects for entreprises and for employment were fragile.

Although internal demand should be one of the main forces for growth, it was held back by worries linked to unemployment and recent bursts of inflation. Could the euro be acting as a braking force?

INSURANCE:

Increased insurance premiums were a world-wide phenomenon in the property insurance sector, with simultaneous upward movement in the amounts having to be paid out and disappearing revenue from stock market investments. In certains cases in Canada, premiums suddenly rose by 300%, 500%, or even 600% (Schools Commission)

CRUDE OIL:

Crude oil prices rose in a nervous market, but kept following a saw-tooth profile, after the publication of new figures on American reserves showed a drop in home heating oil stocks, with Iraq always in the forefront of market worries.

Saudi Arabia, world leader in crude oil exports, proposed to OPEC that there should be an increase in official production quotas set by the organization. OPEC decided to reduce production to a new ceiling of 23 million barrels per day, to come into force on 1 January 2003.

Prices of crude climbed, owing to the prospect of war in Iraq and to the strike affecting exports from Venezuela, fourth largest supplier of petroleum products to the United States, already more than five weeks old. On the New York Commodity Exchange a barrel stood at US$31.97 on 24 December 2002, after peaking at US$32.00 that same day, and on the NYMEX it hit US$32.50 on 26 December 2002 after a peak of US$32.55. On 30 December 2002, a barrel of crude was priced at US31.40 in New York for February 2003 delivery, after reaching a peak of US$33.00: a two-year high. Crude could reach US$40.00 a barrel or more in the event war starts in Iraq.

GOLD:

Gold was at its highest for five and a half years. (5) This significant rise could be explained by:

• fear of attacks by Islamic extremists
• a reduction in advance sales of gold not yet extracted
• tensions in the Middle East and the prospect of war in Iraq.

Over the course of 2002 the rise in the gold price was 23%. The chance of a war stimulated prices of gold and of crude oil. Prices for gold reflect its traditional role as a safe haven for investors in time of war; they climbed for a seventh consecutive session. Gold for February 2003 delivery was at US$346.60 an ounce on 20 December 2002 on the New York Commodities Exchange, after having leapt by US$13.00 an ounce as high as US$355.70!

In the "News" for 28 February 2002 it was noted that: while the price of gold showed a sudden jump at the start of February 2002, breaking through the US$300 per ounce barrier for the first time in two years, 2002 will show that this is anything but a "flash in the pan"..... In 2001, the average price of gold was US$271, but 2002 will see its price in the US$285 to US$350 bracket, if not indeed even higher..."

This has been borne out by events! Gold reached US$348.30 on 31 December 2002.

Gold stood at more than US$400.00 an ounce just before the Gulf War against Iraq in 1991.

A further factor of some weight: What if Islam adopted gold as a trading currency, restoring its prominence of yesteryear? An embryonic project of this nature might take concrete shape in mid-2003, and then how would Central Banks of various countries react? (6)

In conclusion, if recovery is dependent on tensions in the world as Alan GREENSPAN, President of the Federal Reserve Bank (FED), sees it, it is clear that risks of a geopolitical nature have become considerably more significant and have weakened demand. Nonetheless, he judged the danger of seeing the United States tumbling into a deflationary spiral as small. However, the American economy faces to changing factors:

• the hangover from the speculative bubble
• fears of deflation (similar to the slow but inexorable long-term decline in prices in Japan)

These two non-symmetrical phenomena are very rare: how might they be linked? So as not to see the economy overwhelmed by a major crisis, what measures, particularly what advance measures, should be adopted?

Governments, business circles, the general public, have come over the last 50 years to be accustomed to the dangers of inflation rather than of deflation. All the same, 2002 was the blackest year for decades for stock markets in the developed economies, seeing a third consecutive year of dropping prices: this had not happened since the Second World War or the crisis of the 1930s, depending on which country!

2003 will be the worst year for the world economy since 1945, as no country or region will experience enough of a "bounce back" to pull the rest of the world along with it. World stock markets will make no progress, but rather face further falls! None of the major imbalances such as excessive household indebtedness, or current account deficits will be corrected, and they may well get worse! However, the World Bank foresees a recovery in the world economy during 2003 with growth reaching as much as 2.5% according to its estimates! Has it kept in mind the developing conflicts in the offing?

Despite the rather discouraging (but realistic) tone of this issue of "News", we should like to wish the very best for the New Year 2003 to all our readers, and to thank them for the trust they have put in us!

31 December 2002

Marc LAMBINET, Ph.D