The Johns Hopkins Gazette: January 11, 1999
Jan. 11, 1999
VOL. 28, NO. 17


Outlook: Hanke On The World Economy In 1999

First in a series in which faculty members examine issues facing the country

By Glenn Small

Johns Hopkins Gazette Online Edition

Steven H. Hanke, professor of applied economics in the Department of Geography and Environmental Engineering and in the Department of Economics, gives his views on the U.S. and world economies and what we might face as we approach the year 2000.

There's been a lot of volatility in the stock market in the last eight months. What do you foresee in 1999?

First of all, the volatility will continue because I think there will be periodic blowups that do occur in the emerging markets, most notably in Brazil and perhaps major problems again in places like Russia, Indonesia and Malaysia. And that will create volatility in the U.S. market. Also, I think the market will start heading south because the fundamentals that support it are shaky. You need strong earnings to support a strong stock market. And I think the earnings picture will continue to deteriorate in the U.S. this year. By my calculation, the market is probably overvalued by 35 percent.

The effects of economic turmoil in other areas of the world so far seem not to have affected the United States. Do you see this continuing?

No. Although the market went way down, came back up and is roughly where it was before the ruble collapsed, you have other more subtle things that have occurred. For example, the quality spread--or the interest rate spread between government bonds and corporate junk bonds--has deteriorated. The spread or differential between those interest rates has widened as risk has been repriced after all these foreign fiascos. Anything that's perceived as being a little risky is paying you a higher return now, relative to U.S. Treasury risk-free instruments, than it was before the crisis. Lots of things have been undermined. People just look at the Dow Jones. Well, that tells you something. But a lot more is going on. And it's not a particularly pretty picture.

Russia's economic woes have gotten a lot less attention recently. How is that country doing?

It's a complete disaster from the economic point of view. Contrary to the press reports, Russia never went through a transition moving from a communist/socialist system toward a market-oriented system. They kind of had a mutation. As a result, the economy is just completely dysfunctional and continues to go down. This year we'll see it decline another 10 percent, and it's already less than half the size it was in 1990. I can see nothing but a decline in economic activity, probably a very large increase in inflation and further devaluation of the value of the ruble.

Asia. Have we seen the worst there?

I don't think so because due to meddling in the region, primarily by the U.S., we have several countries that are very shaky, politically and economically. I think you've probably got the bright boys from the CIA fully engaged in the region. And these are the fellows who, according to Sen. Daniel Patrick Moynihan in his recent book, Secrets, were saying in 1989 that the standard of living in East Germany was higher than it was in West Germany. So we have a shaky situation, certainly in Indonesia. They really are in the middle of a revolution there. Malaysia, right next to it, is another fairly big country that may turn into a tinderbox and could blow up. In Korea, the reforms are running into a pretty strong head wind, and China is weakening. Japan is dramatically weakening. So [in] the whole region either you have political instability or economic decline, so I don't think we've seen the lows in the region. I'm not very optimistic about those markets.

How are emerging economies faring?

Some of them have taken fairly tough measures. For example, in Asia, Singapore really looks impressive to me. And Taiwan's been reasonably impressive. In Latin America the only one that's impressive is Argentina. Brazil's still very shaky. The exchange rate setup there is fatally flawed. And this year is probably going to be the year when the thing blows up, even though they've got $41.5 billion in credit lines arranged by the International Monetary Fund. I don't think that's going to be enough to do the trick. Eastern Europe? Really the only star performer is Poland. The rest are question marks, all of them. They're very small markets and aren't very liquid. They do plan a record number of initial public offerings of new stock in privatized companies for 1999. But the market environment in general is not too good.

Oil prices and other commodity prices continue to fall. Interest rates are being cut. At what point does a recession turn into a depression?

Russia is clearly in a depression; if you've been sinking about 10 percent a year for eight or nine years. ... I think the most constructive thing to say is that all the revisions and all the forecasts have been coming into line with what I've been forecasting for about 18 months now, which is much, much slower growth in the world. We still have positive growth in the U.S, by the way. But I think we're going to really start slowing down this year. So I see more downward revisions. The problem is that you've got 30 percent of the world's output produced by Asia, and they are in a serious depression in that region. To put things into perspective, in the Great Depression consumption went down about 14 percent in the United States, and in Korea consumption is down about 28 percent from where it was last year. Asia has really been hit, and there will continue to be a lot of collateral damage in 1999.

There's been a lot of doomsday talk about the Y2K computer problem and the potential for havoc. Do you have any thoughts on this?

I have talked to some of the experts and they do tell me that the private sector is in pretty good shape. The experts' view is that there [are] some holes in the government sector, and some real problems could spin out of that because a problem in the government sector can contaminate the private sector.

Economic union in Europe takes a step forward this month with the euro becoming the official currency for 11 of 15 EU countries. What impact do you foresee this having?

Asia is in a depression, there are lots of problems in the emerging markets in general and the U.S. will clearly slow down by the end of 1999. Now the greatest monetary experiment of the century started on Jan. 1; that throws additional uncertainty into the mix. Whether you like the idea of a euro or not, the Europeans couldn't have picked a worse time to start.

Do you have any advice for the small investor for 1999?

I'd do just what I've been recommending for a year and that is stay in relatively safe investments and overweight your portfolio toward government bonds and safe securities. To know whether you're overweighted or underweighted, you have to look at your age, and that should indicate the percentage of your portfolio that should be in fixed income securities, and then the remainder should be in stocks. So if you're 30 years old, you should have, normally, 30 percent of your portfolio in bonds and 70 percent of your portfolio in stocks.

Any final thoughts?

I think we're living in fairly dangerous times from the investor's point of view. And most people, particularly in the U.S., just don't have a clue--particularly younger people--of what could hit their assets in a hurry. They can really dissipate in no time. So I would just send out a wake-up call: Now is a time to be defensive with your assets. I think the U.S. foreign policy under the Clinton administration has been extremely adventurous and way overextended in their meddling and trying to micro-manage literally the world. It's not just Asia but the Middle East, the Balkans and Russia. So we have lots of potential major international problems that could come back to haunt us. If any of these regional problems blow up, they could trigger some bad news for the stock market because I think the stock market's quite vulnerable.