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JoC Newspaper Tuesday, September 26, 1995 By: CHRISTOPHER WHALEN The most recent report on foreign exchange trading by the Bank for International Settlements shows the global currency market is continuing to expand rapidly, fueled in great part by the periodic surges in money growth in the United States and other industrialized nations. The fact that a 20 percent increase in trading occurred between 1992 and 1995 suggests that activity in the foreign exchange markets is more related to gaming than commerce or even traditional finance. Growing government intervention and public debt are the primary culprits in creating the volatile casino atmosphere that exists today throughout financial markets.The growth in speculative dealing in financial instruments that settle in cash should come as no surprise. Banks and broker-dealers alike find it hard to make an honest buck in today's transactiondominated markets. Large commercial companies and governments can borrow funds directly from investors at rates at or below cost for the biggest money center banks, thus begging the question of why many banks exist in the first place. The recent merger of Chase Manhattan with Chemical Bank, which itself still is not finished merging with Manufacturers Hanover, is a big example of an industry trend. In an environment where commercial banks are no longer needed to serve as a conduit to funnel savings to industry, the emphasis has gradually moved from making loans to taking speculative punts. The collapse of Baring Brothers earlier this year because of the speculative dealings of one man was an extreme case in point. Wall Street today is less about building industries over a period of years and more about betting which way a market will move over the next 10 minutes. So keen is the competition among financial institutions for profits that some commercial banks have even been lured into the game of lending to high- risk borrowers. In this business, the lender routinely writes off 8 percent to 10 percent of a loan portfolio each year due to defaults, yet can still make money by charging the remaining customers higher interest rates than for normal borrowers. Waving goodbye to 8 percent to 10 percent or more of a loan portfolio each year may seem extreme, but firms like The Money Store make a living doing just that. Yet just across the border in Mexico, local currency interest rates and the incidence of loan losses are even higher, grim evidence of the global phenomenon of deflation that is now threatening the stability of world markets. Since the 1982 debt crisis, Mexico's banks have operated in an environment of uncertainty and inflation that made it virtually impossible to predict, much less manage, a bank loan portfolio. Add bad credit practices and a tendency to roll overdue credits with new money loans and you have a situation where the real level of bad loans is well over half of total credit, not the 15 percent to 20 percent suggested by sanitized official figures. In order to make at least a paper profit, Mexican banks charge their customers very high real interest rates and fees, among the highest in the world at 20 percent to 25 percent above the visible inflation rate. The result is an economy that is congelado - frozen - where nobody is getting paid nor can pay debts and accounts receivable. The banks pretend to be profitable based upon accrual of usurious rates of interest, but the economic reality - insolvency - is unavoidable. Losses to date on bad bank loans already have cost the Mexican government more in subsidies than the total promised revenue from the privatization of the commercial banks just a couple of years ago. And the bill is still mounting.

Across the Pacific from Mexico is Japan, the most extreme case of the deflationary bubble of the 1990s. Yet the similarities to the situation in Mexico are significant. Throughout the 1980s, interest rates in Japan have been well below rates in the United States, allowing Japanese industry to raise capital and build capacity more cheaply than any other industrial nation. That same access to cheap capital, however, also created a financial ''black hole" that continues to widen, even with Japan's version of the U.S. Federal Reserve discount rate now at only 0.5 percent. The recent decision by the Bank of Japan to drop interest rates to such low levels is a reflection of the credit quality problems that continue to emerge even now, five years into Japan's asset price crash. Japanese banks have had bad loans of Mexican proportions, but less phony accounting and paper profits to disguise the true financial situation. Japan has now announced its third fiscal stimulus plan this year, some 15 trillion yen in new spending. But neither this nor a 0.5 percent rate for overnight loans will do anything in the near term to ameliorate the private asset price collapse that is slowly destroying Japan's once formidable wealth. Despite the recent, multibillion-dollar effort by the United States and especially the Bank of Japan to prop up the dollar vs. the yen, the Japanese currency already is beginning to rise again against the dollar as the deflation continues in Tokyo. The astounding $65 billion intervention by the Bank of Japan this year still is not nearly large enough to counter the combined effect of the U.S. current account deficit and the destruction of yen wealth that continues apace inside the Japanese financial community. The ongoing contraction of prices and liquidity in Japan is driving the downward trend in world interest rates. Even with interest rate spreads of more than four percentage points for U.S. government bonds, Japan remains a net buyer of yen because of the current account deficit with America and the need to repatriate hard cash capital to cover losses at Japanese banks and firms. The real dilemma lies with the value of the yen, which seems bound to appreciate again vs. the dollar. Not since the Louvre and Plaza agreements of the 1980s have world central banks so aggressively attempted to manipulate the value of the dollar vs. other currencies. This is precisely the problem. For more than two decades, the industrialized nations have accommodated the fiscal and monetary excesses of the U.S. economy with intervention and market manipulation. Rising market volatility and the gruesome financial troubles in Japan, Mexico and parts of the U.S. economy all result from such misguided policies.

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