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How to Survive and Prosper in the World Financial Crisis An Adam Smith Nightly Business Report Special
If you would like to read the full transcript of one of the interviews excerpted in this show, please click on the appropriate link below: Domingo Cavallo, Dr. Mahathir bin Grigory Yavlinsky, Stanley Fischer, Robert Rubin, Lee Kuan Yew, Sachs SOT: The pain is very, very real Adam Smith voiceover: In Asia, and around the world, pain and trouble.. a third of the world in deep recession and social turmoil. A new kind of financial crisis. Linda O’Bryon voiceover: But here.. a booming economy and a roaring bull market. Soros SOT: We may be living in a fool’s paradise. Adam Smith voiceover: Could this crisis be a vision of the future? Rubin SOT: This was the first global financial crisis. Fischer SOT: It is certainly not the last crisis. Linda Linda O’Bryon voiceover: And is there a way to manage your money wisely in turbulent times? Are there opportunities as well as dangers? How does the investor prosper? Adam Smith: Find out–next! Announcer: From Adam Smith and Nightly Business Report... How to Survive and Prosper in the World Financial Crisis. Adam Smith: The President called it "the worst financial crisis in 50 years"- but where is it? We don’t seem to have caught the financial disease that has plunged one third of the people on the planet into misery in just under two years. Will we? Linda O’Bryon: And, later in the program, financial legend George Soros and Secretary of the Treasury Robert Rubin with their views. And what about your investments? Is there a path to safety, is there a path to opportunity in the crisis? But first, where did this begin. It began in world away from us in Thailand. ADAM SMITH: Thailand was one of the Asian Tigers in an emerging market that attracted billions of dollars of foreign investment for its real estate and industry. Thailand’s currency, the baht, was pegged to the US dollar. One of Thailand’s biggest customers was Japan - but Japan was deep in recession - Thailand’s sales to Japan fell and speculators began to bet the baht would have to be devalued. May, 1997 - speculators begin their attack and the Central Bank spends billions of dollars buying the baht to defend it. June - at a secret meeting at the Central Bank in Bangkok high financial leaders are told the country has no more reserves. July 2nd - the Central Bank announces to a stunned world that it has abandoned the struggle and will unpeg the baht from the dollar allowing it to float. That day as the baht’s value tumbled was the day the current global financial crisis began. SANYALAKSNA MANIBHANDU: Nobody really knew so much money had been thrown in to support the baht. That was something that was a shock - in August 1997 when we saw the amount of money that had been spent by the previous government on defending the baht I think most people were surprised to put it mildly. ADAM SMITH: The aftermath of the Crash was devastating. Exports continued to slide - banks were burdened by bad loans - property values plummeted. All over Bangkok are signs of a building boom that went bust. In the immediate wake of the currency crash prices on the Thai Stock Exchange fell 75%. That would be like the Dow Jones going to 2500. SANYALAKSNA MANIBHANDU: We have seen some very big names actually leave the industry - in other words, leave Thailand altogether after almost ten years of being here and that tells you that things have definitely changed. ADAM SMITH: One monument to the financial collapse in Thailand is in a barren area in Bangkok. This is an impressive complex of buildings, town houses, and shops but it is a ghost town. Unoccupied, unused. Built during the boom it was to be a satellite city of 700 thousand people. There is a business district called Bond Street, there are good roads but nobody lives there. From Thailand the crisis spread - economists and journalists used a medical term, contagion. Like some infectious plague the crisis spread to the rest of southeast Asia and then to the rest of the emerging markets - even though many of these countries have little in common. PAUL KRUGMAN: It’s like one of my favorite Dilbert cartons, as the pointy haired boss yelling at Dilbert "I am going to fire you and anybody who looks like you." You may know Indonesia and South Korea are very different places but to investors they looked enough alike that a crisis in one created a crisis in the other. ADAM SMITH: It was not poor or penniless countries like those in Africa that were hit with this financial malady but the previously promising rapidly growing markets - Malaysia, Hong Kong, Korea. In the fall of 1997, it struck Indonesia hard. As western investors pulled out of the emerging markets the Indonesia currency, the rupiah collapsed. Losing 80% of its value against the dollar. In dollar terms the Indonesian Stock Market crashed 90% an Indonesian version of the Great Depression of the 1930’s. Indonesia is a huge country - 211 million people. And millions of newly affluent Indonesians were pushed back into poverty. The long time leader, Suharto was forced into retirement and the new government took over amidst social turmoil and murderous racial strife. JEFFREY SACHS: This is a crisis hitting a lot of very vulnerable people - and it is causing a lot of suffering. Not everything should be viewed through the optic of the U.S. so it is not just a question what does this mean for us, and if it doesn’t mean much then there is no crisis. That is the kind of metaphysical view taken in American public discussion, but the pain is very, very real. ADAM SMITH: From Asia the Contagion spread in the summer of 1988 to Russia. The Russia currency the ruble, collapsed - losing 50% of its value in one week. The government defaulted on some of its bonds - sending shock waves around the world. JEFFREY SACHS: The Russians defaulted not just on their foreign debts but actually on their internal debts. That is that they defaulted out of ruble bonds. This is nearly unprecedented. ADAM SMITH: In Russia there was economic chaos and deepening poverty as President Yeltsin fired his reform minded ministers putting a stop to free market reforms. Gregory Yavlinsky is the last leader of a reform party left in Russian politics and he is a presidential candidate. He sees a stark choice ahead in the next election. G.YAVLINSKY: If the elections in ‘99 and 2000 would go badly Russia would go to the way of isolated country–country with the criminal environment. Almost a bandit situation inside with a nuclear, chemical and biological weapons. That will be real default. ADAM SMITH: Russia collapsed because its global market plunged. Suddenly the contagion seemed to reach us. The Dow Jones fell more than 500 points in one day - and the market dropped nearly 20% over time from its highs. The credit seemed to dry up. It took three rate cuts by the Federal Reserve to restore confidence. PAUL KRUGMAN: It was like an army that is starting, to starting to retreat - and the general rides out and waves his sword and shouts something incomprehensible and somehow rallies the troops - that is what Greenspan did. It didn’t have to work, it did work. Thank God. But now everybody is treating it as if the Fed can always deal with these things. When the lesson if there is any lesson over the last two years it’s that nobody is really safe. ADAM SMITH: Next the Contagion spread to Brazil. Even though there was some preparation for trouble and some efforts were made confidence disappeared, the Brazilian market and the Real, the Brazilian currency, tumbled and the Brazilian politicians squabbled about how to handle the pain. Domingo Cavallo is an adviser to the Brazilian government and a successful former Finance Minister in Argentina. Does he believe the Brazilian contagion could spread to the rest of Latin America? DOMINGO CAVALLO: If the Brazilian crisis deepens then the impact not only in Latin America but in the US and Europe could be fairly large. For sure, much larger than the impact of the Russian crisis because Brazilian economy is much bigger and particularly the total size of the Brazilian debt is much bigger than is the case of Russia. ADAM SMITH: flows from the of established centers of America and Europe and Japan to the higher returns in the booming periphery. But fear can cause that money to turn and roar out again. JEFFREY SACHS: This is a financial panic that we are watching. It is not the first time in history - this is a very characteristic feature of financial systems and financial markets. Especially characteristic of international capital flows. Linda O’Bryon: The contagion that affected a third of the world seems to most Americans to be far away. But it may be closer than they think, in ways they don’t even know. Darren Gersh of Nightly Business Report went to Baltimore for this report. DARREN GERSH: If an eagle, hawk or owl is injured in the state of Maryland, Corinne Parks often gets the call for help. She’s an expert in rehabilitating birds of prey. In her 22 years working for the city of Baltimore, she has saved hundreds of birds. Corinne Parks: "What are you doing yelling so much, your mommy’s here." GERSH: The world financial crisis seems a world away from here. Parks certainly isn’t worried. If any financial issue concerns her, its the year 2000 computer bug. Corinne Parks, Director, Carrie Murray Nature & Raptor Rehabilitation Center: "I think about the millenium, and I’ve talked to a lot of people who are worried more about that, than they do about what’s happening right now in Russia and Asia." Darren Gersh/NBR/Baltimore: But Corinne Parks and most Americans have good reason to pay more attention to what’s happening in Russia and Asia. Because, chances are, they are directly or indirectly invested in the global economy. Park’s Baltimore city pension fund ships 15 percent of it’s assets overseas, giving her an indirect interest in Russia’s Gazprom, a British bank, and Korean conglomerate Samsung until we spoke with her, Parks hadn’t realized how money set aside for her was spread around the world. Corinne Parks: I thought of it being right here in the United States, but I didn’t really think of it per se being all over the world. That’s a different aspect on it." Gersh: The money invested for Parks begins its global journey here at mutual fund giant T. Rowe Price. Bob Smith: "Ian, have we got you in Tokyo?" GERSH: Once a week, T. Rowe Price fund managers bring their coffee to this conference room. Here, they trade intelligence on global markets with their joint venture partners in London and around the world. The people on the other end of the line invest 120 million dollars in pension money on behalf of parks and other Baltimore city employees. Bob Smith: -- It seems with Europe slowing quite a bit more than people would have guessed. GERSH: Altogether, T. Rowe Price manages money for two million people. To see how the global financial crisis affects those investors, we spent the day with one fund manager, bob smith, he pilots the five billion dollar growth stock fund. The International meeting this morning, what did you glean from that. What do you get out of that meeting?" Bob Smith: "First is you realize that Japan is still very weak." GERSH: Smith says his job is to worry for his shareholders, so he’s roaming the halls, checking with firm analysts to gauge the impact the crisis will have on oil stocks and consumer multinationals. Bob Smith, Portfolio Manager, Growth Stock Fund: You read brazil as still a mess, its not getting any better, so for a company (EDIT) like Gillette who has a Brazilian business, Colgate Palmolive who have big Brazilian businesses, it will be worse than people think, so you figure it in in how you structure your portfolio. GERSH: Smith estimates 40% of his portfolio is exposed overseas Asia, and Brazil are key concerns because smith says much of the growth in growth stocks is coming from overseas. Bob Smith: "Does Japan make you feel more bearish?" GERSH: In the short run, smith says the financial crisis has been good news for the 95 thousand investors in his fund. Smith: Are your companies saying that the far east is getting better? GERSH: It’s kept inflation and interest rates low, helping stocks. The long run may be another story. Bob Smith: The reality is over time that crisis is a negative, on a short term basis its been a positice. Over time it has depleted the value of a lot of companies in the us, because if you take cash flows over the life of a company and you discount them, which is what a company is worth, those cash flows are less than they would have been, because Taiwan is not as strong as it would have been, because Indonesia never materialized because russia imploded. BOB SMITH: "Korea was actually the big story in Asia, up 6 1/4 percent. GERSH: "T. Rowe Price was one of the first companies to offer an international mutual fund. Making it part of a revolution in investing that began in the early 80s. Since then assets in all international mutual funds have soared from almost nothing to 230 billion dollars. David Testa, the company’s chief investment officer, helped start T. Rowe Price’s first international fund in 1980. Now he worries the average shareholder doesn’t understand how closely knit the world has become. David Testa, Chief Investment Officer, T. Rowe Price: If you look at a period like the fall or summer of last year, where they were confronted with what happened in Russia, they woke up and paid attention, but most of the time, people act as if these events occurring around them in the rest of the world, because their own circumstances are so good, they don’t want to be confused with the facts in a away. GERSH: Many T. Rowe Price investors have learned about the risks of the global economy the hard way. Since the crisis began, T. Rowe Price’s new Asia Fund has plunged an average 48% as of February. But so far, most U.S. investors have fared well. but the irony may be that just when the financial crisis is ending abroad, the average investor here may begin to feel the pinch. Testa: If you saw growth pick up dramatically overseas–at same time that we kept growing at a rapid pace here, then the risks of inflation, a spike up in interest rates would become quite suddenly a serious issue. GERSH: At first glance, the art of investing may seem like an exercise in abstract economics. But the decisions made as Bob Smith and his fellow money managers around the world react to the financial crisis, will influence investments worth hundreds of billions of dollars. Their choices sends money rocketing around the world affecting countless lives in Asia, Russia, Latin America and even Baltimore. PARKS: "That’s a bunch of bird here–now that’s a bird." GERSH: In Baltimore, this is Darren Gersh. Linda O’Bryon: We just heard that in a way people don’t want to be confused by the facts, because their circumstances are so good. Adam Smith: But just last summer many investment managers had the facts thrown in their faces. In particular the hedge funds... the unregulated pools of capital that roam around the world looking for maximum opportunity. Deeply involved in all the markets of the world, many were damaged by the crises in Asia and Russia. One of the biggest... long term capital management... nearly went under in the wake of the Russian default. The superstar of these investors is George Soros. His Quantum Fund has been for many years a leader among these funds. ADAM SMITH: Soros manages to be both a legendary investor and an influential critic of the very system from which he profits. Last year he published a book, The Crisis of Global Capitalism, in which he warns that free world markets have become increasingly unstable and that the current crisis could deepen. But why I asked him, should American investors be concerned when things here at home are going so well. GEORGE SOROS: Think of it this way - let’s say we are playing tennis - heavy tennis players. And we have a partner abroad, and and we are playing tennis, now that partner is suffering from some terrible disease, and is weakening. And we are winning. So it makes us feel very good. But unless we call in the doctor, we won’t have anybody to play tennis with. We may be living in a fool’s paradise... because if markets are unstable, we may now be in that boom phase that makes us feel good. And eventually when the price is paid, it would be too late to do anything about it. ADAM SMITH: Soros thinks we are in a fool’s paradise because we have done so well while so many countries are so damaged, and we have done so well because cheap imports from these countries keep our inflation down while our economy booms. So what I wondered could specifically go wrong for us? GEORGE SOROS: You could see our stock market after a long period of growth declining which will tend to make consumers less confident they would start pulling their money out of the stock market. They will find that their savings are eroding. They would have to start saving more. That could get you from this beautiful benign circle into a vicious circle - that’s one scenario. Another scenario, that as the economy begins to decline, you become resistant to imports. That will make it more difficult for the people over there to pay their debts, so you could have defaults. So there are many different ways that it Would happen. ADAM SMITH: People use a medical metaphor, they say ‘contagion’ as if it were a disease. Will this Contagion spread from the periphery, the emerging markets, to the center, that is Europe and the United States? GEORGE SOROS: I think that you have this sort of self- reinforcing process working in both the periphery and the center. It is in the long run unsustainable and it is liable to be reversed. But exactly how it is going to be reversed is really an open question. And I think that at this stage, you can’t make a clear prediction. Because it is conceivable let’s say that the periphery would recover before our economy turns down. It is also conceivable that our economy turns down which then puts pressure on rejecting or going the protectionist route, which will then reinforce the recession in the periphery, then you end up in a world depression. ADAM SMITH: You are a pioneer in the technique of investing, of looking at the entire globe and searching out opportunities wherever they might have existed. Unseen. Are there places where you now see opportunities from all of this turmoil? GEORGE SOROS: I do see great opportunities actually because stocks have become seriously undervalued, we have done it ourselves. We have bought into an Argentine bank for instance, into a dying stock brokerage and Korean stock brokerage because I think these opportunities are there. ADAM SMITH: How do you reconcile your role as a financial statesman and yet as a day to day operator in the financial world? GEORGE SOROS: Not very well actually. It is a conflict and it makes my life very difficult–as a hedge fund manager. Linda O’Bryon: As the contagion spread, different countries reacted in different ways. Some countries took the orthodox medicine prescribed by world leaders. Others... sometimes next-door neighbors... opted out of the mainstream, choosing alternative cures. ADAM SMITH: Singapore and Malaysia are neighbors–separated only by the Strait of Johore. Malaysia’s Prime Minister is Doctor Mahathir bin Mohamed - controversial for having jailed his potential successor, among other things. Lee Kuan Yew is Senior Minister and former Prime Minister of Singapore - his country weathered the crisis much better than Malaysia - its financial experience let it create a Singapore dollar that held up well. What does Lee Kuan Yew think created the financial turmoil? LEE KUAN YEW: Exuberance. The proliferation of new financial products in the last 20 years. Foreign exchange trading. Investment banks. Fund managers right across the globe including al the capitals of Southeast Asia and East Asia. And then the mania of participating in the boom in the emerging markets. Especially East Asia because it was so prolonged it seemed almost as if it would go on forever, and everybody wanted a piece of the action. ADAM SMITH: But Malaysia’s Mahathir sees a conspiracy to break Asia and buy it on the cheap. He has published this thesis and he describes western currency traders as bent on destruction for a profit. DR. MAHATHIR: Currency traders have been able to devalue or revalue the currency at will simply by selling or by buying the currency and when they devalue the currency they cause poverty. ADAM SMITH: Why would the currency traders pick on a particular country to cause this damage? DR. MAHATHIR: In the first place it is because they can make money out of these countries - of course they have a lot of countries that they can attack and it would seem that they move from country to country. They attack countries in Latin America. They make money there and having made money there and disrupted the economy of those countries they then move on to other countries and they attack those countries. In the meantime the first victims might recover and then they can go back again. ADAM SMITH: Who are these currency traders? DR. MAHATHIR: The problem is that we don’t really know who they are. ADAM SMITH: Is the financier George Soros the leader of this pack you describe? MAHATHIR: He was the most visible. GEORGE SOROS: Mahathir invented me because he needed somebody to blame and I was a very visible figure, so he kind of started using my name. I don’t know Mahathir, I don’t know Malaysia and I think that they had their own bubble which burst. It is difficult to accept that unpleasant things happen without anybody actually planning it. These conspiracy theories assume that there are some super minds with an incredible ability to predict and manipulate events. And markets behave in unpredictable ways. ADAM SMITH: You recently said a phrase that struck me - ‘Capitalism is not religion but some people treat it as though it were.’ Can you explain that? DR. MAHATHIR: We believe in Capitalism because we think that it is going to enrich us but when capital is used in such a way as to impoverish people then we should re-examine it. ADAM SMITH: Against all conventional advice, Mahathir imposed capital controls which basically opted his country out of the mainstream system. DR. MAHATHIR: There must be some regulation in the so- called free market - you know you can’t have freedom without some regulation on it. And the free market must have some regulations which will prevent abuses. At the moment we think it is too free and therefore it is subject to abuses by people who have a lot of money. ADAM SMITH: Lee Yuan Yew rejects that solution. LEE KUAN YEW: It would be ruinous to if we ever took that step. I mean, we lose all our credibility. ADAM SMITH: But even Lee Kuan Yew, the champion of free markets, sees some limits. LEE KUAN YEW: Free trade in goods, that is a plus for everybody. Free trade in services I think that is also a plus, but financial put a question mark,… I say, we don’t want too much of that. Adam Smith: Dr. Mahathir sees the crisis as the result of a kind of conspiracy, but it’s interesting to see that both he and George Soros agree on one thing... they both want more regulation. But what kind of regulation... and by whom? How do you fix a financial crisis? First you call a world agency... The International Monetary Fund. ADAM SMITH: Headquartered in Washington four blocks from the White House the International Monetary Fund has been both the Fire Station and Emergency Room of the World Financial Crisis. For 21 months it has struggled desperately to stop the contagion from spreading. Stanley Fischer is the Fund’s number two official. STANLEY FISCHER: The financial crisis has been around for at least 4 centuries and I imagine for all of recorded history and this is not the last crisis. Mr. Camdessus, the Managing Director of the Fund said of the Mexican crisis, that this is the first financial crisis of the 21st century. And by that he meant that the speed with which this situation turned around and the scale of the problem and the need for a loan in that case totaling close to 40 billion dollars, was completely different than anything we had seen before. Well we’ve had another 4 crises of the 21st century since then. ADAM SMITH: Tell me about Thailand. STANLEY FISCHER: It was not seen as an extraordinary crisis in July of ‘97. It was only seen as extraordinary by December of ‘97. When all the neighbors were in deep trouble as well and then the program began to change. ADAM SMITH: What makes contagion? STANLEY FISCHER: The difficulty with contagion is as follows: contagion as in disease will affect, will bring down the weakest - so there is no sort of innocent bystander in a contagion episode like this. Brazil did have problems - it probably would have avoided the crisis if Russia hadn’t got into the crisis. But it is not an accident say that it was one country rather than another. ADAM SMITH: The IMF was born half a century ago at a time when the US was on the gold standard and exchange rates were fixed. It was created to deal with the financial problems of trade imbalances of a different world. Many observers now think it is outdated. GEORGE SOROS: The IMF can only come in when it is called up on... when the crisis has already broken. It has absolutely no powers to have any, to exert any influence -to prevent a crisis from developing. Yet experience shows that the only way to prevent a bust is to moderate the boom that precedes it. And this could be done - it would require an increase in the capacity of the IMF - in the resources that it has - which it would make available to countries that meet the preconditions that the IMF sets. STANLEY FISCHER: We can not force a country to do things and countries basically have to be held responsible for what they do - that is where the source of problem lies. We will keep on nagging them to do better, but we have to recognize that the power of outsiders in these situations is bound to remain limited. I am not sure about this super IMF. Nor am I very enthusiastic about having an agency much larger than this one. We operate effectively despite views of many critics - in large part because we are a relatively small -we’re under 3,000 people - very focused, have a well defined task, teams more or less know what they are doing. I think the IMF on several occasions could have done better if they had more financial backing from its shareholders. But I would be very skeptical about a much larger agency and much more powerful one. ADAM SMITH: Since the Asian crisis broke in Thailand, the IMF has set aside 67 billion dollars to bail out countries caught by the contagion. Some economists argue that its approach and the conditions it imposes, have made a bad situation worse. JEFFREY SACHS: The IMF believes all sorts of things that are wrong, and one of the things that the IMF believes is that wherever interest rates are it is better that they be higher. The IMF has never seen an interest rate that it doesn’t want to raise further whereas I think that when you are in a situation as Brazil was last fall - before the collapse, or as Russia was in the summer of 1998 -before their collapse, that pushing up interest rates even higher was telling the investors this country is going into utter collapse - get out. STANLEY FISCHER: I don’t think the investors are so unsophisticated as to see a country with weaknesses there and to be reassured being told by the Finance Minister, Central Bank Governor, we are very strong and just to show it we are cutting interest rates and by the way, please put more money here because we are paying less on it. Linda O’Bryon: Despite attempts by the IMF and others to stop the contagion, fully one third of the world is in recession. Dozens of countries are actually experiencing negative growth... that is to say... their economies are shrinking. But not in America. Even though some sectors are down because of the crisis, others have taken up the slack.–Steven Aug went to find out what impact all of this has had on the people of a port city like Seattle. STEPHEN AUG: Ted Tanase rode the Northwest timber boom all the way up... exporting to Japan and Korea...even opening the first American home center in Japan in 1996 just outside Tokyo. Just a year later came the Asian currency crisis, plunging Japan and Korea-and much of the rest of Asia–into recession. Tanase’s business plunged with it...sales were only one-quarter of what he’d expected...and he was not alone: Ted Tanase, Four Motion LLC: "I belong to an associaiton of companies that do exporting in this business, and the membership of that organization has dropped from about 140 to 90 in just two years" AUG: Now, a year after closing his business, he’s organized a new company and he senses stability returning to parts of Asia...he’s already in talks with a firm in Korea about building a village of American-style houses there: Tanase: "We would be exporting all of the materials for the house, as well as the house design by some architects and even some of the labor to go over and not only construct the houses, but to teach Koreans how to build American-style housing." AUG: In fact, Tanase is emblematic of what’s been happening in the Pacific Northwest. With the economic decline in Asia, exports plunged...Asians stopped buying the lumber that went into their furniture and construction industries...so the region’s lumber business is down about 50 percent from 1996, the year before the Asian crisis...an estimated 10-15 percent of the region’s lumber distributors have gone out of business. The Asians also have stopped buying American farm products...that hit northwestern Apple growers... and wheat farmers...and they could not just turn around and sell into the domestic market. Patricia Davis, president of the Seattle Port Commission, says that’s because those products are made and grown specifically for the Asian market-whether wheat or lumber: Patricia Davis, President, Seattle Port Commission: "The taste or the qualifications of the building were Asia-specific. Metric. Certain types and varieties of products and wheat, which is soft white wheat which is made into noodles, we don’t sell in this market, in the domestic market. We sell hard red wheat to the Midwest, where we make our bread." AUG: Still...the port commission’s figures indicate parts of the Asian economy have shown signs of bottoming out...the drop in American exports has slowed down...But the problems are far from over. The Seattle area’s biggest employer-the Boeing Company-is still feeling them...as Asian airlines have cut back their aircraft purchases and delayed or canceled existing orders. Boeing’s chief executive, Phil Condit, says the Asian problem was one factor in Boeing’s first annual loss in 50 years: Phil Condit, CEO, The Boeing Co.: "We had some production problems that were fundamentally all of our own making. The decreases in production rates recently of the 747 are almost entirely Asian. So it’s sort of a shift from one set of problems to a different set, but the most recent ones are Asian-driven." Aug: And he’s not counting on any quick recovery in Asia-that’s in Boeing’s business plan...and that means fewer aircraft sales over the next couple of years...but he’s also worried about Latin America-because of recent problems in Brazil: Condit: "Asia represents something like a quarter of our commercial aircraft business, Latin America much less so. But then it does clearly bring the worry of will this spread further, and it’s that worry that’s probably the more serious of the...of the issues." AUG: And those worries are clearly reflected in Seattle. The city is a sort of national beachhead in the competitive battle over world trade...Its economy depends on trade. So, the region’s economic situation is reflected in the port Interestingly, the port was busier last year than the year before-but it was driven by imports. While exports were down 16 percent, imports rose 26 percent as Americans bought cheaper goods from overseas: Davis: "The imports were up, exports were down, but the containers have to keep moving. So we count containers as to how we are flourishing." AUG: And what has this meant to the Seattle economy? On the docks, the surge in imports–even though exports have fallen–has meant more jobs for longshoremen...but overall you’d hardly know the area’s biggest overseas customer, Asia, was in deep trouble. Dick Conway is a regional economist: Dick Conway, CEO, Conway Pedersen Economics: "What’s remarkable about the Asian crisis is that if you look at the numbers in general you don’t see it. You certainly see some sectors of the economy hurt by loss of exports, but by and large, our economy, the state economy is doing extremely well. That’s primarily because the consumer is doing well." AUG: Unemployment is a full percentage point lower than the already-low national average, but slightly higher than the 3.2 percent of early last year...business is good. The city’s famous coffee bars-and there must be one on every street corner downtown–are as busy as ever. Seattle streets are crowded and stores are doing well...retail sales continue to grow. And this despite massive layoffs under way in aerospace. At Boeing, the area’s biggest employer, about 29,000 of its 100,000 Seattle area workers are being laid off...Plus there have been huge job losses in timber and agriculture...all that must hurt the regional economy: Conway: "Well, it’s going to have a major impact. Our economy has been growing in terms of employment at a 4 percent annual rate. That was when Boeing was adding about 30,000 jobs. With the big turn around we’re going to slow down. We’re going to slow down to about a 1 percent growth rate." AUG: One reason is that salaries at Boeing are very high, and the layoffs will mean a substantial loss in regional spending power. But there’s a partial offset: Conway: "Aerospace salaries, $60,000 per year, roughly speaking, is about twice the average for the economy as a whole, but it’s just a fraction of what Microsoft workers are earning at this point in time. With stock option income, the average annual income of each Microsoft worker is about $300,000 per year." AUG: And those high salaries in software have meant lots of spendable income. According to Katherine James Schuitemaker of the Washington Software Alliance, that’s helped the kind of growth that has prevented regional recessions in the past when Boeing has laid off workers. Katherine James Schuitemaker, Chairperson, Washington Software Alliance: "One of the things we’re enjoying is an inflow of capital into the Pacific Northwest for companies who are just now forming and may be in fact the next Amazon.com and the next Microsoft. And as we see the influx of capital from venture capitalists, Microsoft millionaires, those who made the killing in the stock market, as it were, we’re seeing a tremendous fuel for growth here in the Pacific Northwest." AUG: And that’s one reason the Seattle region remains prosperous...it has enough industry-like software-that’s less dependent on exports. Much the same as the rest of America, where 90 percent of the economy is domestic. So, most Americans seem unaffected by the overseas financial crises which remain just that-crises overseas...and whether Americans are affected depends largely on what they do for a living and, to a lesser degree, where they do it. In Seattle, I’m Stephen Aug. Linda O’Bryon: How does all this affect YOUR investments? We’ll get to that in a moment. But first, if all this is going to be fixed, it’s going to be the U.S.–the last remaining superpower–that will provide the leadership to find the cure. We went to Washington for a wide-ranging discussion with the Secretary of the Treasury. Adam Smith: Mr. Secretary the President said this is the biggest financial crisis in 50 years. What made it such a terrific crisis? Robert Rubin: I think Adam it’s magnitude as a crisis is reflected both in the severity of the effect on the countries that were affected, but also the numbers of countries that were affected. This was in some ways the first crisis of the global financial markets, and it wasn’t just a single country having difficulty which would then remain isolated to that country. But rather it was a crisis that enveloped very large numbers of countries and I think basically affected pretty much every country in the world in one way or the other. Adam Smith: Is it over? Robert Rubin: Well, I would say this was a crisis that began well before Thailand in the sense of the problems that led to the crisis developed over many years. And I think that while a lot has happened, and some has been positive and some of course has been very difficult...that the world is going to take time to work through this. Linda O’Bryon: Take us through some of those tense moments. What did you do personally to try to stabilize the situation? Robert Rubin : I think a good example would be last week of December 1997 when the reserves, the foreign exchange reserves of Korea had gotten down to about $4 billion which is for practical purposes virtually nothing, and there were a lot of people who felt that we were less than a week away from a default in Korea which could have had enormous consequences for the rest of the world. The Chairman of the Federal Reserve Board, the appropriate people of the Treasury including myself, Deputy Larry Summers, and others from Treasury and the Fed got together and over the course of that last week of December, I was on vacation so for me it was all on the telephone, and that basically was what vacation became, was the telephone. We worked through what we thought we could do to help the IMF think through how to, what an effective program would be. And we concluded that in addition to everything that the International Monetary Fund needed to do, in addition to everything that Korea needed to do in terms of reform, it was also going to be necessary for the international banking system, the creditors, to support this program, and so we communicated with them. I did particularly, communicated with the bankers... Linda O’Bryon: You called these bankers directly on the phone.. Robert Rubin: I did indeed... Linda O’Bryon: Encouraging them to reschedule their ... Robert Rubin: Well, yes, encouraging them in the sense of explaining to them, although they really knew this, that Korea was on the verge of something that could affect all of us very substantially, and that it was in all of our interests for the banks to be supportive. And in the first instance to extend their loans and in the second instance to in affect enter...convert those loans into longer term credits. Adam Smith: What would have happened if Korea had defaulted? Robert Rubin: I think if you would have had a default in the private banking sector in Korea which would have quickly enveloped all of Korea, for practical purposes. I think you had a very real risk, a very serious risk, that initially other countries in the region and then very quickly I would say countries throughout the world would have had very serious financial instability. Adam Smith: This financial crisis seems to have touched Americans occasionally, but only occasionally. One time was just this past Fall when the American bond market went into a kind of cardiac arrest briefly. What happened then, and could it happen again? Robert Rubin : What you had in the August, September period that you’re talking about Adam was something approaching a gridlock of global financial markets. And you could debate exactly what it was a function of, but at the very least it was affected by Russia’s inability to make payments on the claims against Russia. And I think that came as something of a shock to the system. That in my judgment was the other, along with Korea..along with December ‘97, this was the other most dangerous period in this entire process. Adam Smith: Do you think this contagion could come and affect the United States specifically? On your own list, what could go wrong from here? Robert Rubin: Oh I think that what has happened over the last decade, maybe more at this point, is that the American economy has become part, the interdependent if you will of a global economy. And I think that’s been very much to our benefit. I think that we have benefited enormously in terms of job growth and standard of living, but a fact that we are part of a global economy. However, it also carries with it risks. And we have been focused on over...now almost two years, is helping to deal with those risks in global economy so to minimize the probability of it affecting our country. Linda O’Bryon: We have interviewed people in the pacific northwest, lumber distributors, their business is down 50%...10 to 15% of them have literally gone out of business. What do you say to them, what is their future in this kind of climate? Robert Rubin: I think the answer to those problems is for the international community and the United States really does provide the leadership in this and inevitably I think has to. The international community working around the IMF, to work with the countries that are suffering or experiencing financial instability, in order to help those countries do what they need to do in order to get back on track as quickly as possible. The key to this, the key to this whole thing is for these countries to deal with their problems to get back on track, and to once again then become help in the markets for us. Adam Smith: Do you have a sense that some of these countries have a kind of hostility to us, I mean here we are prosperous, mightily prosperous while a third of the world is really suffering. Do you get a sense of a kind of backlash at all? Robert Rubin: It’s a good question, and I think it really depends a little bit about which countries you’re talking about. I think ... believe we have been very sensitive in the way that we function so that on one hand we work to promote reform through the IMF, and the other hand we don’t engender or create the kind of backlash or hostility you’re talking about. Linda O’Bryon: While global trade opened up a lot of markets to the United States and created jobs, did the United States push too far, too fast, to countries that weren’t perhaps ready to have their markets opened.. that didn’t have the right regulations, the right legal reforms in place? Robert Rubin: I don’t think so Linda. We also talked about the absolute imperative to have sound financial systems, sound financial regulation, legal structures that were commensurate with the requirements of opening up the capital flows. But the other thing that we did, and I think these two somehow always get confused, is we very actively advocated opening up their market to foreign financial firms. Adam Smith: The Fed Chairman chief says we can’t be an oasis of prosperity and George Soros says we’re living in a fool’s paradise. Robert Rubin: I didn’t dispute both comments, an affect of the financial crisis abroad has been lower prices in this country. Linda O’Bryon: Taking a quick look at individual countries, Brazil had a crisis, where does it stand and how do you view Latin America has a whole? Robert Rubin: Brazil had been a country of hyperinflation for long back as one can remember. I did my honors thesis in college on hyperinflation in Brazil in place of economic development. And here we are today and only a few years ago that was still the case. That inflation was brought down to practically zero. So a great deal was accomplished. On the other hand, the fiscal issues in Brazil have not been dealt with and that’s really the problem that lies at the heart of the issues in Brazil today. Adam Smith: You just mentioned the International Monetary Fund.. It has been criticized about being too tough and maybe protecting the lenders more than trying to promote growth in each country. What’s your feeling? Robert Rubin: Oh it’s been criticized from all sides. The problem in these countries is not the program and the so-called austerity from the IMF, the problem is the crisis. Linda O’Bryon: As the United States faces a very large trade deficit, $168 billion expected to be $200 billion next year. Are you concerned that there may be a backlash now of protectionism or pressure on the dollar? Robert Rubin: I am deeply concerned about protectionism. And if we succumb to that pressure, I believe it has the potential for very badly damaging job growth and standards of living in this country.. I do believe should enforce our trade laws.... Linda O’Bryon: Since Alan Greenspan warned about irrational exuberance the stock market is up about 52 percent. How do you factor in the stock market in looking at the overall economic conditions as far as the way you look at it with risk and reward? Robert Rubin : Well as Secretary of the Treasury I always felt that we ought not to comment on the stock market, and I won’t. I believe markets over time affect underlying economic conditions and I do believe our economic conditions have been strong and I think are likely to continue to be strong although it’s certainly subject to risk such as the risk from abroad. But valuation of course another matter whether the market overvalues or undervalues those conditions are a different question. Adam Smith: Mr. Secretary, thank you very much. Adam Smith: It’s not surprising that the Treasury Secretary doesn’t want to talk about the stock market... but he certainly has a coherent view of the world as a whole and a sense of the risks. It’s clear he’s worried this crisis could strengthen the argument for protectionism... And if you look back at the 1929 crash and great depression, protectionism did push the world even deeper into trouble... Linda O’Bryon: But, what does all this mean to you the investor... I asked Ron Hill, strategist at Brown Brothers Harriman... why Washington and the administration clearly have taken this crisis seriously... But Wall Street has not. Ron Hill: Well we are taking it seriously whenever it threatens the well-being for the financial services system worldwide... which the russian default and the long term capital management crisis certainly did. But in some respects its as if the silver linings from the clouds of these developments came to our economy first... with Asia first and then Southeast Asia.. and Russia.. what we got were lower import prices.. a lower price for oil, which acts like a tax cut for the american consumer. So all of these have actually been beneficial. Linda O’Bryon:: As an investor, why should I care about the world financial crisis? Ron Hill: Well you should always care about the crises.. because they always have the way to get to you in ways you don’t expect. We certainly, my firm didn’t expect Russia would be the cause of a 20 percent correction in the stock market because we had forgotten the leverage back through the financial system.. when in fact Russia’s economy has very little impact on the U.S. economy. Linda O’Bryon: The title of this program is How to Survive and Prosper in the World Financial Crisis.. Number one.. How do i survive? Hill: Go back and ask yourself... Sustainable economic growth, low inflation, excess liquity, growing corporate profits... Are any of these likely to change in the near term because of the changes in the overseas markets. If your answer is "no"... all 4 remain in place, you probably stick with your investment program as it’s structured today. Linda O’Bryon: How does the investor prosper? Hill: The investor prospers by looking at each one of these selloffs as a buying opportunity so long as those 4 questions are still a yes. If in fact fundamentals change, then you’re going to prosper by moving away from some of your equity exposure but for now, the propserity comes in having the courage to buy when prices are down on psychologically driven dips in the market. Linda O’Bryon: And where are those prices down? Hill: The prices have been dropping on occasion, for example, in the healthcare sector, which we think is one of the strongest. They’re already still down a bit in the financial services sector from the fear that came through the russian crisis. Linda O’Bryon: Could the end of the crisis be the beginning of the troubles... as central bankers start pulling in? Hill: Absolutely. Once growth resumes globally at a faster and faster pace that pulls money automatically out of the financial markets into the real economy. Linda O’Bryon: What is the first or second sign that the investor should look for? Hill: When you start to see liquidity drained out of the market, the first and most sensitive sign will always be the bond market. Look at the long U.S. treasury. Look at the ten year bonds in germany or japan. When those start to fall in price, rise in yield, that’s telling you that there’s not as much money around as before and the bond market is the weathervane for the feeling of inflation in the markets. Linda O’Bryon: What about the so-called "bubble"? People are very worried that stocks are overvalued and especially in internet and some of the technology stocks. Hill: I lived through the bubble in Japan, so it was a very interesting time to be there. When all assets, especially real estate and equities were rising tremendously. I think the bubble in the united states is a much smaller bubble, if it’s a bubble at all. Because to compare what’s going on with a few internet stocks with a few billion dollars of market capitalization total to what happened in the Japanese real estate market levitated for awhile, I think is a bit of a overstatement. Linda O’Bryon: So the investor should...? Hill: The investor should right now stay with his or her invested positions if they’re comfortable with them. Continue to assess their risks as these changes occur globally. Not only declining economies, but also rebounding economies, which could hold more risk. And watch bonds to make sure that inflation’s not getting out of hand. Because that will be the worst enemy of the equity market in the long run. Linda O’Bryon: Thank you very much. Ron Hill. Linda O’Bryon: As Ron Hill and others have said... you have to be alert, watch for rise in interest rates... to prosper... you have to have the courage to go where it is unpopular and look for values. So crisises can produce value. Adam Smith: This time the crisis worked for the benefit of the American people... But as we heard, Stanley Fisher says this is merely the FIRST crisis of the 21st century... where globalization and technology come together with such speed and size that all the old standards evaporate. And it isn’t the last crisis. There will be more... It comes with the territory... the cyperspace and the global marketplace. Linda O’Bryon: But there have been some positives out of this crisis... there will be more disclosure... more transparency... and more attention to risk in the good times. Adam Smith: The fire department may get better at fire science, but fires will still break out... that’s the 21st century... I’m Adam Smith Linda O’Bryon: I’m Linda O’Bryon... Thank you for joining us.
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