Benjamin C. Works, Executive Director

--Celebrating Chaos Theory Since 1990--

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WallSt 6-16; Tuesday June 16, 1998

On Monday, June 15^th Japan, Inc. fell out of bed as Tom Sparico and I watched and considered together. The Nikkei closed below 15,000 and that was the breakpoint where the all-but-insolvent Japanese banks lose money on their less-than-liquid stock holdings. The Yen flirted with 146.5 during the day and appears headed for 150 and beyond. An interesting indicator for the US market is that the Japanese banks must have been behind the forces driving the US Federal Funds rate from its usual target of 5.5% up to 6%, where trading closed Monday afternoon. Japan has admitted it is in recession, but it is a deep one with the GDP shrinking at a more-than 5% annualized rate.

A crisis deferred is a crisis that worsens and Japan has been dithering now for eight years. But help in the form of American financial expertise is on the way via the capital markets. Here is where Wall Street does conquer the world and this is the theory behind the giga-bucks financial mergers of Sandy Weill's Travelers-Citibank merger, the Goldman-Sachs initial public offering and other such mega-deals. These new giga-firms are too big to say "no" to, is the thinking.

The commercial banking industry is increasingly a marginal player as a lender and Alan Greenspan's influence on the US and world economy is substantially less than that of the Security and Exchange Commission's (SEC) influence: the future belongs to the stock, bond and money markets and to the fund managers, not to the commercial bankers. Mutual Fund and Pension Fund investment managers, insurance portfolio managers and other money managers make the decisions where money will be invested and they require a higher standard of rules from foreign markets than bankers could demand or even governments can negotiate. But JP Morgan can still get a deal poached at the last minute in Kazakhstan, where a major oilfield deal was stolen out from under it and given to China two years ago. Try that with a Citigroup commanded by Sanford Weill and see how far your emerging economy gets.

Notice the singular lack of "decade of greed" rhetoric now that Democrats are knocking down eight digit salaries and bonuses and kicking in to Party slush funds? I did not initially approve of the Travelers-Citibank merger and remain very apprehensive about the unchecked egoism of our Wall Street "Masters of the Universe." I think hubris will brush back many and that the majority of mega-mergers add nothing; further, 80% never work out in terms of financial success. But it is also true that these Giga-investment banks have a stronger chance of protecting investment dollars abroad and enforcing standards of transparent business practices, which reduce corruption, than the older mechanisms have. Wall Street and the Harvard Business School's experts have apparently agreed on this globalist strategy and the one thing that makes sense about it is that it is a free-enterprise regime that relies on the invisible hand, or laissez-faire to generate economic growth and rising standards of living. It is more powerful than all the ambitious regulatory regimes of the Euro-crats, the UN Globo-socialists or the Washington regulators "jointly and severally" as we used to say on the Street. Understand that US pension assets now exceed $10 Trillion and that Mutual Fund assets are also around $10 Trillion. Then there are those insurance portfolios and other investment pools. Money Talks. Enlightened self-interest is good and increasingly profitable; greed is still bad, except on Wall Street and at Clinton fund-raisers.

Another effect of the crash in the Yen on Monday is that in a flight to safety, the perceived crisis raised Treasury prices and drove the yield on the 30-year Treasury bond down to 5.57% and with the Federal budget in surplus, there is every prospect for a 5% long-bond yield before Jan 1, 2000. To Japanese selling US stocks, though, the mild decline in the Dow Jones is made up for by the greater decline in the Yen. At this stage, the Dow has near-term support at 8500, and today, resisted dipping below 8600. A full 10% correction sell-off from the April high would lead to a Dow of 8280 and greater support for the Dow lies at 7700. Ultimately, the Street's computers will see a buying opportunity. Early Tuesday, the Yen attempted a rally but the Nikkei closed down again at 14,720 and we shall see how it goes. The Japanese Treasury may try to buy in Yen, but unless international investors want Yen to buy into a Tokyo market with growth potential, Treasury efforts will fail.

With balanced budgets ahead as far as the eye can see, we are looking at a rate structure very similar to the Eisenhower years, where the prime rate and 20-year bond were as low as 3.5%. A trouble is, though, that Congress is getting too cozy with the heightened level of revenues and is not rebating tax cuts.

A further effect is cheap oil, the lowest US prices in 12 years and even prices in the US below the Brent Field price for Europe, while Saudi sweet crude traded down to $8.61/bbl. This indicates not just a glut in prices but a set of regional gluts that have all but wiped out shipping differentials between the Arabian Gulf, North Sea and the US East Coast and Gulf of Mexico. Refined gasoline prices have not fallen as much, indicating profitable margins for refiners in the summer driving season.

In the near term, Japan only gets out of its tailspin when it recognizes its losses, repackages its losers as "Brady Bonds," cuts taxes and "gets on with it," but their bureaucrats don't want to cut taxes in a meaningful way, either. One major effect of Japan's 8-year long melodrama of denial and negotiation is that China has filled the economic vacuum and has taken away future markets from Japan, now a high-cost producer. Only when those "Brady Bonds" start to move will we see an economic recovery that will attract foreign capital into the Yen and into the Japanese stock markets. Sandy Weill is making his bet by picking up one-third of the equity in Nikko Securities as Japan de-regulates its capital markets.

Nor do the Euro-crats want to cut tax rates and social spending. Another currently interesting question is the final arrangements concerning the Daimler-Chrysler deal. Chrysler has a well-funded pension plan and benefits better funded than the German workers have and it seems foolish to let American pension funds subsidize Daimler employees. Further, US tax rates are vastly lower than German rates; Daimler also has to help subsidize the European Union's expensive bureaucracy and social safety net agenda. Germany has been reluctant to lower tax rates or accomplish needed reform; thus, if the government does not move, Daimler's logical decision would be to re-incorporate in Delaware or Bermuda, trading its stock in New York and moving its executive suite out of Germany.

Short Cuts:

A few odds and ends have stacked up over the last three to four weeks and SIRIUS will address them in due course; hopefully I will have a piece on China late this week. In April, I mentioned the proposed May sale of the GM building in Manhattan as evidence of a real estate speculative bubble. On May 31, The New York Times reported that Donald Trump beat out the REITs and paid somewhere above $420 per square foot for a 30-year old building of middling quality, that has great retail space and deluxe tenants, including Revlon and Estee Lauder. Still, when the new rental leases come up, count on some prudent folks to move out. The REIT game remains vigorous and there is not much Alan Greenspan can do about it since these pirates are not borrowing from banks; this is SEC territory (more in section 3, below). Trump overpaid for the Plaza Hotel in the 1986-87 real estate frenzy and lost it to his bankers. The GM building sits across Fifth Avenue from the Plaza and seems an equally vainglorious acquisition, but "the Donald" can always try to sell off space as deluxe condos.

Per The Army Times, the US government announced it is coordinating with Moscow on a means of preventing accidental nuclear launches resulting from computer glitches generated by the "Year 2000" program glitch. It seems our technology Tsar, Al Gore, has a signal failure accumulating in this computer problem, while he entertains us with the Internet project. It also appears, an industry source has told us, that there may be a problem on 09-09-99 in the programs. COBOL, the program language in question, was a project and product of the US government.

© Copyright 1998 Benjamin C. Works-SIRIUS