Three negative economic forces

by | Jun 4, 2000 | Archives

A few weeks ago I shared how as a young man starting at age 21 I went to work for a firm with eight employees. Within four years they had over 2000 staff and at age 25 my stock options were worth one million dollars (a lot of money then). But by 1972 the U.S. stock market (after nearly 20 bull years) had collapsed along with the U.S. dollar and I lost everything. I am sending vital information about three negative economic forces now because though I lost my first fortune and that job, I have never lost the lesson which can turn today's potential problems into cash.

If the economic crash of the early 70s that wiped me out sounds familiar to many of today's financial stories it's because many factors are the same now in the and high tech industry as they were in the overseas fund business then. By spotting the similarities we can also spot where problems may rise and how to increase profits.

Cycle Repeats

Economic events I see now also took place 30 years ago. This means we can predict (to a degree) what is ahead. We can see a crash coming. This gives us time to prepare for rising danger from three negative economic forces that are building now. One danger is the downturn in the U.S. economic cycle. The second is falling stock prices which erode the U.S. dollar. Three, rising U.S. bank risks are made worse by a weak federally backed-home loan system.

These risks should not be ignored. Recently two of the world's top investors (Warren Buffet and George Soros) began to withdraw from equity markets. What do they know? The same thing I learned thirty years ago, that markets are dramatically affected by cycles that repeat themselves. The chart next page, highlights this incredibly important fact and shows the Dow Jones Index and how it has moved in very similar ways prior to, during and after the three major times of social conflict we call WWI, WWII and the time I call WWIII.

When was WWIII? This was the era beginning in 1980 when President Ronald Reagan and Prime Minister Margaret Thatcher fought the “Evil Empire”. Though no shooting took place, all the economic aspects of a military buildup (huge defense spending-research into new sciences, etc.) were similar to any other major war.

Since then we have basked in the warmth of a post war boom, just as our parents did after WWII and our grandparents after WWIII. This chart shows that we should not be surprised by the current market turmoil and suggests that this turmoil may last ten, fifteen or even more years. We can expect U.S. interest rates to rise, U.S. shares to yield less. It should not be unexpected for money in the bank to earn more than shares.

Chart 1

Yet the downturn in the U.S. economic cycle and falling stock markets are where our problems just begin. Economic history does repeat and the last era of stock market doldrums in the 70s and 80s was accompanied by inflation, high interest rates and a falling U.S. dollar. This cyclical pattern is reinforced now by weak the comparatively high U.S. interest rate.

There have also been huge, growing, record-breaking U.S. trade deficits over the last several years. This gigantic financial outflow has been offset until recently by foreign investments rushing into the hot U.S. stock market. But the bear on Wall Street is slowing this overseas inflow and will push the greenback down.

Plus U.S. bank risk has grown caused by the recent economic boom. When times are good, banks get loose. This looseness has grown so much that the Federal Reserve Bank openly admitted the problem in the May 2000 issue of “Monetary Trends”. An article entitled “Are Banks Making Riskier Loans?” points out that bank supervisors have been expressing concern about risk assumed by U.S banks, especially the large banks with assets over $10 billion. The article concludes by saying, “The increases in problem loan rates at large banks during recent years of rapid economic growth provide empirical support for the concerns expressed by supervisors.” The article included two charts, one on the rise of non performing loans, the other on the percentage of loans being charged off as losses. These charts are below so can see the problem for yourself.

Percentage of Commercial and Industrial loans that are Nonperforming
Total assets of banks, millions of dollars

Period Up to $300 $300 to $1,000 $1,000 to $10,000 $10,000 to $20,000 Over $20,000
1991 4.30% 3.24% 4.06% 5.02% 5.37%
1992 3.99% 2.85% 3.24% 4.01% 4.63%
1993 3.21% 2.13% 2.17% 2.52% 2.89%
1994 2.52% 1.35% 1.27% 1.36% 1.37%
1995 2.18% 1.05% 0.95% 1.15% 1.19%
1996 2.25% 1.16% 1.02% 0.87% 0.97%
1997 2.13% 1.12% 0.92% 0.72% 0.75%
1998 2.13% 1.01% 0.92% 0.78% 0.84%
1999 2.06% 0.99% 1.00% 1.15% 1.05%

Percentage of Commercial and Industrial loans that are charged off as losses
Total assets of banks, millions of dollars

Period Up to $300 $300 to $1,000 $1,000 to $10,000 $10,000 to $20,000 Over $20,000
1991 1.87% 1.75% 1.85% 1.71% 1.86%
1992 1.48% 1.42% 1.37% 1.11% 1.46%
1993 1.01% 0.70% 0.71% 0.72% 0.69%
1994 0.62% 0.31% 0.29% 0.26% 0.15%
1995 0.63% 0.35% 0.14% 0.33% 0.16%
1996 0.64% 0.35% 0.27% 0.20% 0.20%
1997 0.64% 0.35% 0.25% 0.34% 0.22%
1998 0.72% 0.37% 0.36% 0.39% 0.38%
1999 0.67% 0.35% 0.57% 0.50% 0.58%

Bigger Banking Risk

The problem runs deeper than just banks as well. There is a huge distortion that could create a scandal worse than the U.S. Savings and Loan disaster of the early 90s. America's booming housing market has swayed the government backed home loan agencies Fannie Mae and Freddie Mac to take greater and greater risks. U.S. house pricing is notoriously cyclical. The drop in Wall Street can push housing prices down. A recent article in The Economist magazine (April 15 -page 79) tells how the agencies have increased lending at a 20% per annum rate. They have 1.4 trillion of debt and at current expansion will bear risk on more than half of U.S. residences within three years. These agencies are listed on Wall Street and should be private companies. Yet they gain benefits from their quasi official state and have $32.00 of debt for only one dollar of capital whereas large banks have $11.50 of debt per dollar of capital. Their implicit government guarantee allows them to borrow cheaply, yet they are making the same mistakes savings and loans made in the 80s. They pay officials and staff way above public and most private sector rates. Even worse they are moving into “sub-prime” lending.

Bigger Risk

Now here is the crunch. A dangerous house of cards has been built because these agencies are exempt from rules which limit banks from holding too much exposure in any one company. Banks can hold all they want of this stuff. One third of total bank capital in the U.S. today is this federal agency debt and equity, a highly concentrated risk!

During the 80s housing bust, Fannie Mae became technically insolvent, though regulators allowed it to keep operating. Now the risk of a future default has grown and this risk filters through the entire U.S. financial and banking system and is still growing. The U.S. Treasury expects these agencies to soon issue more debt than the U.S. government. A crash of the agencies can affect the U.S. dollar, U.S. debt, U.S. budget, taxation, U.S. banks and Wall Street in a very negative way.

There is one more concern. The politicians already know this risk. Recently Congressman Richard Baker argued that this debacle may cost the U.S. taxpayer an amount that dwarfs the savings and loan cleanup. This is an election year in which a new President will be in his first term. New Presidents always let the public feel the pain in the first two years of a term hoping that memories will fade by the next election! If a crisis must unfold, the next administration may encourage it to happen in 2001.

The Good News

This seemingly bad news will be good for those who are ready because there really are no good and bad markets. There are only investors who are ready for events up or down and those that are not.

Fortunately we have time to react. We do not have to rush away from U.S. risk, though we should begin to prepare.

What to do?

First get ready to move into safer positions especially out of the U.S. dollar and U.S. banking system. Reduce equities and long bonds. Increase holdings in short term (up to three years) bonds and cash. Upgrade the quality of your investments. Use banks in more than one country.

Be smart about the higher risk investments you make. Aim for safety and take only smart risks. Get into high-potential deals that are at low ebbs. Then wait for them to rise. Avoid hot deals that have peaked and are likely to fall.

More Profit Potential

One great way to diversify is through a Multicurrency Sandwich (borrow low-deposit high tactic). This is a perfect time for such investments because they diversify currencies. There are also two added currency distortions now which enhance your chances to profit with low interest loans. The Japanese yen has risen too high and the euro has fallen too low. This creates instability which offers ideal conditions for a multicurrency sandwich in which you borrow the overly strong yen (which has a low interest rate) and redeposit the loan in the overly weak euro (or associated currencies) which have a higher interest rate.

Here is how such a Borrow Low investment can add 46.76% per annum to your earnings. This example shows how to use an existing asset (with 6% yield) worth US$100,000 to borrow US$400,000 of Japanese yen at 1.5% for investment in European and other currency CDs and bonds.

  Currency                    Investment                    Return     Yield
US$100K Original Asset earning 6% in AAA investment 6.00% US$6,000
US$ 50K General Electric Polish Zloty Bond AAA 11-2-02 17.06% US$8,530
US$ 50K Hungary Government Florin Bond A1/A 12-1-01 10.30% US$5,150
US$ 50K IFC Slovakian Kroner Bond AAA 10-8-01 8.72% US$4,360
US$ 50K Argentina Gvt Euro Bond B1/B+ 6-02-03 8.28% US$4,140
US$ 50K Brazil Government US$ Bond B1/B 5-11-01 8.39% US$4,195
US$ 50K Mexican Gvt 3 Month Peso Cetes Bond Baa3/BB+ 14.00% US$7,000
US$ 50K Norwegian Gvt NOK Kroner Bond AAA 31-05-01 6.77% US$3,385
US$ 50K Turkish Gvt Lira 3 Month Bond B1/B 32.00% US$16,000
US$400,000 Japanese yen loan interest 1.500% US$-6,000
Total return on initial $100,000 at risk 52.76%

This multicurrency portfolio is based on current bonds and interest rates available at the time of this writing and takes advantage of several principles. First is leverage. 46.76% of the profit earned is pure, extra profit above the 6% that the original asset earns. This works because existing assets are used as collateral. No additional cash or investment is required.

Second, the principle of positive carry means when you borrow money at 1.5% and earn an average return of 13.05% (the average return of the investments above before leverage) you have an 11.55% margin of error (the difference between the 13.05% and 1.5%). You have this much protection from fees, defaults and forex losses.

The next advantage is diversification into nine currencies, nine different investments of which more than half have strong A to AAA ratings. This reduces forex and default risk, but because five of the currencies are related to the euro, chances for forex profits are enhanced. The euro has fallen by 22% (as I write this report) since its launch in January 1999. Yet the entire euro economic area was growing at a robust rate of almost 4% in the second half of 1999. Because Europe is running behind the U.S. in the economic cycle, just as the U.S. dollar's fall is overdue, so too is the euro's rise. Plus the dollar's strength has been boosted by a hot U.S. stock market and a much higher interest rate than the euro.

None of this guarantees the euro will rise but these forces increase the likelihood it will. Plus because the loan is in an overvalued yen and Japan still has many economic challenges, there is an added chance the yen will fall versus the U.S. dollar as the dollar falls versus the euro. This means this portfolio has double, forex profit potential which can add profits above and the beyond the 52.76% shown above.

This tactic has worked for me (and my readers have reported great success as well) again and again. For example when I recommended taking yen loans to invest in U.S. dollar and Mexican peso CDs and bonds in the early 90s, profits exceeded 108%. Later when I recommended yen loans at 1.75% invested in Korean won AAA rated bonds paying 15%, the won immediately revalued and made 43% profit in two months (plus 53% on interest differentials or 96% in the year).

In 1998 one of my recommendations was to borrow Japanese yen and invest in Japanese stocks. This idea made triple sense…first, giving global diversification and second entering Japanese markets at decade low prices. (Japan was in its tenth year of recession.) Getting in at this bottom made more sense than staying in super inflated .coms, high tech and U.S. shares that had peaked in Wall Street's highest and longest bubble yet. Third, the risk was reduced because the investment was in yen, the currency borrowed. This tactic quadrupled profits and turned an astounding 1,315.5% gain in 1999 when invested in the Warburg Pincus Japan Small Company Fund (which rose 329.7%).

I lack space to explain the Borrow Low – Deposit High and other diversification tactics here, but feel these issues are so vital at this time I have listed some of my best banks, financial experts, publications, courses and seminars that can help you increase your knowledge now.


These contacts and sources of information below can help you diversify globally and organize strategies to profit during the U.S. economic downturn.

The Economist, My favorite news magazine offers a far more global perspective than its U.S. counterparts. Though conservative to excess (as I am) the editors and writers offer a deep perspective on global economic issues and the last three pages of each issue are full of useful economic indicators. The April 15, 2000 issue contains an article entitled “Homesick Blues” (page 79) that outlines the U.S. home loan risks. The April 29, 2000 issue contains an article “The Euro's Agony, Europe's Opportunity” (page 45) that will help investors interested in investing in euros.

Monetary Trends, Federal Reserve Bank of St. Louis, This periodical, published by the Federal Reserve, is full of dry statistics I rarely understand, but the front page article often provides deep insights into some aspect of the U.S. banking industry. Its May 2000 article “Are Banks Making Riskier Loans?” is a warning call.

Jyske Bank, Private Banking, Jyske is Denmark's fourth largest bank and has one of the most advanced Borrow Low – Deposit High programs I have ever seen called Invest Loan. I have used their system for more than a decade because they make the strategy so easy to use. Jyske also offers a complete range of private banking services including multicurrency demand deposits, CDs, bonds and stocks. There are no taxes charged in Denmark on interest and profits for non Danish accounts.

Jyske also offers an excellent diversified portfolio idea, which cannot lose which invests equally in NASDQ, Japanese and European Share Indexes for the next two and a half years without risk of losing your capital. These are currently downtrodden markets. Yet in this new tech age they each can have explosive upwards returns. Investing in such trouble spots while they are down is the best way to reap huge long term profits. But what about the risk?

Currently Jyske Bank currently offers a guaranteed Three Index (available until June 26). This account invests 1/3 in the NASDAQ index, 1/3 in Japan's Nikkei 225 Index and 1/3 in the European Euro Stoxx 50 index and is guaranteed. You cannot lose more than 3% of your investment over the 2.5 years. Yet you can make high returns if the indices rise. I have used guaranteed index accounts with Jyske and enjoyed great success. My first invested in the London Stock Index and rose 38%. The second (in the Japanese Nikkei Index) rose about 14%. Yet each was guaranteed just like a CD. Had those markets tanked, I would not have lost a cent. I am speaking at two Jyske conferences this year and invite yuo to join me.