JoC Newspaper
Tuesday, September 26, 1995

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 financ e. 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 transaction-
dominated 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 int o the game of lending to high - risk borrowers. In this business, the lender
routinely writes off 8 percent to 10 percent of a loan port folio each year due to defaults, yet can
still make money by charging the remaining customers higher interest rates than for normal

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 threat ening the stability of world

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 port folio. 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 perc ent to 25 percent above the
visible inflation rate. The res ult 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 rat e now at only 0.5

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. Japanes e 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 ameliorat e the private asset price collapse that is slowly destroying Japan's once
formidable wealt h.

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 cont raction of prices and liquidity in Japan is driving
the downward trend in world interest rates.

E ven with interest rate spreads of more than four perc entage points for U.S. government bonds,
Japan remains a net buy er of yen because of the current account deficit with America and the
need to repatriat e hard cash capital to cover losses at Japanese banks and firms. The real
dilemma lies wit h 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 accommodat ed the
fiscal and monet ary 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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