Grow Up To 1,000% Richer In The Great Stock Panic Of 2002

Chapter 6

The United States and North America
represent just one side of a
crumbling pyramid

The other two sides — Europe and Asia — began to break down around the same time. Plus, the oft-forgotten underside — South America, Africa, and Oceania — has already been in various stages of semi-collapse for quite some time.

Soon, they — and we — will be at each other's throats in one of the most devastating economic wars since the 1930s. In the mκlιe, nearly every one of the 191 nation-states that make up the modern world will scramble to protect its own people, maintain its own corporate profits, currency, stock market, jobs, and standard of living.

Most will be our allies in the war against terrorism. But that is totally separate and apart from the economic wars I will tell you about in this chapter.

Understanding this phenomenon is absolutely vital to your financial future. It is a major threat to your portfolio ... and an equally large source of potential profits. So don't let anyone confuse you with the intricacies of foreign exchange and international trade. It's actually quite simple:

FIRST, forget for a moment that each competitor in this global economic war is an independent nation. Instead, think of it as a "corporation." It competes directly with all the others in the same world marketplace. If it produces a good product at a low cost, it wins more market share. If not, it loses market share.

SECOND, cut through all the mumbo-jumbo about foreign exchange. Think of the exchange rates as a standard discount (or premium) that the "corporation" charges on every product it sells for export. When its currency is expensive, all its goods sell for a premium. When its currency is cheap, all its goods sell at a discount.

THIRD, don't let the term "reserves" throw you. They are simply the equivalent of a company's cash. When a country runs out of reserves, it's broke

FOURTH, join me on a tour overseas for a closer look at what's going on right now ...

Sneaky Tariffs, Ugly
Devaluations, Violent Interest
Rate Hikes, and Bloodthirsty
Capital Controls

We depart from Miami at 11 pm and wake up in Sγo Paulo the next morning. We grab a cab to a sprawling auto parts factory in the industrial "ABC" satellite cities — Santo Andrι, Sγo Bernardo, and Sγo Caetano. The owner makes you "Honorary CFO for the day."

He immediately gives you a quick briefing of your situation: You've got a huge debt. You owe US$10 million to foreign banks. And you owe the equivalent of another $10 million to Brazilian banks with floating interest rates. The monthly payments are strangling you. Earlier this year, they were eating up 50% of your cash flow. Now, they're close to 75%.

You figure the only way out is to somehow generate more sales revenue. But foreign suppliers are flooding the Brazilian market and taking over big chunks of your market share.

As you take a tour of the sprawling factory complex, you ask our host, "Why can't the Brazilian government get those darn foreigners off our backs? Make 'em pay through the nose in tariffs. Then imported goods will cost a mint in Brazil, and ours will be dirt-cheap by comparison. Everybody will buy from us."

His response: "No, please no. No more sneaky tariffs! Years ago, we used to think that was the way to go and we demanded the government do just that — to protect us from foreign industry.

The government levied huge tariffs, which practically doubled the cost of many imported goods. But we wound up paying through the nose for the parts, supplies, and oil we ourselves needed to import. In the end, both foreign goods and domestic goods were grossly overpriced. It was a disaster."

"OK," you respond. "Why don't we get the government to slash the value of the currency, the real? Instead of each real being worth, say, $1, it can be worth about 50 cents."

You pause to pick up a hubcap from a stack against the wall, and you ask: "How much does this cost, for example? Thirty reals? OK. If they cut the real in half, that's only $15. We could sell tons of these hubcaps in South America, the US, or Europe for just $15, couldn't we?"

"No, please no," responds our host again. "No more ugly devaluations! We tried that already — at the beginning of last year. The government devalued the real, and it fell, just as you said, from about one US dollar to about 50 cents."

"So what's wrong with that?" you query.

Our host shows signs of impatience. "It backfires! Aren't you forgetting the original reason you wanted to boost revenues? The debts — remember? Before the devaluation, to pay back $10 million in foreign debts, all we needed was 10 million in Brazilian reais. Then, after the devaluation, to pay back the same $10 million in foreign debts, we needed TWENTY million in Brazilian reais. Another disaster!

"And it gets worse," he continues. "Foreign investors are now starting to pull out of Brazil, mostly in response to the Argentina crisis. The real has plunged again, to nearly 40 cents. So to try to persuade foreign investors to stay in Brazil, the central bank has just jacked up interest rates. You know what that means? It means that, now, the amount we have to pay each month on our own 10 million reais in domestic debt is also rising rapidly."

"Heck!" you say softly, "then why can't the government just stop the flight of capital with capital controls? Why can't they pass a law that makes it illegal for everyone — foreigners or Brazilians — to pull their money out of this country?"

Our host's response is silence. He makes it clear that it's time to leave. As he bids us goodbye, he makes a comment that is a bit offensive, but still true: "We used to see America as different and special. But after your Twin Towers went down, we don't any more. Be careful, my friends. What's happened to us and our currency could happen to you, too."

Onboard our next flight, we review the key lessons: First, it should be obvious that there are actually two goodies at stake ...

1. Export markets. Each nation fights for access to the choice markets, while trying to defend its own turf for domestic producers.

2. Capital. There's a lot of hot investment money floating around. Nations want their share. And when they get it, they don't want to let it go.

Next, it should be clear that there are four weapons a country can use in the battle ...

Weapon #1 — tariffs and other trade barriers.

Weapon #2 — currency devaluations.

Weapon #3 — sky-high interest rates. That's when the government says "Oops. Currency devaluation has gone too far! Now it's chasing foreign investors away. We'd better jack up interest rates to keep them from running."

Weapon #4 — capital controls. This is the "nuke" of economic warfare. No one really wants to use it. But everyone stocks a complete arsenal just in case.

These are all big guns. And all it takes is a few major nations to deploy them to start a worldwide economic war.

In Argentina ...

We land in Buenos Aires in the late evening.

Argentina has refused to devalue, pegging its currency to the dollar. Because the dollar has been so strong, that means Argentina is selling all of its goods at a premium around the world.

Result: No one's buying. The country is near collapse after three years of recession. Foreign investors, terrified of a currency devaluation, are fleeing. And in a desperate attempt to lure them back, the government has let overnight interest rates skyrocket to 300%. But despite these astronomical rates, nearly $1 trillion worth of reserves have already escaped.

The country hopes and prays for a rescue from the International Monetary Fund (IMF). But instead, the IMF rushes to pour money into Brazil. Argentina, they figure, is pretty much a lost cause. Instead of saving Argentina, the IMF's primary strategy is to let Argentina go and just try to prevent the crisis from infecting Brazil and the rest of the world.

Investors hotfoot it for the exits. It's our cue to leave, too.

Next stop: Japan.

"Japan's Economy On Brink
of Collapse" — Former
Minister of Finance

In Japan, the situation is different from Latin America in two ways. Despite a 10-year slump, Japan is still the second largest economy in the world. And unlike Latin America, Japanese investors and institutions are owners or creditors of big chunks of US assets.

We have an appointment with an old friend of mine at the Japanese Ministry of Finance.

I immediately sense a dramatic mood change from my last visit some 10 years earlier. Back then, the atmosphere was both festive and affluent — $500 sashimi lunches with a private chef in Asakusa ... $50,000 sushi banquets with hundreds in attendance ... and everywhere, glorious forecasts of Japan's future. Today, the mood is so somber, even the most modest forecasts of a brighter tomorrow are greeted with disdain.

"We can't even talk about keiki kaifuku (economic recovery) any more," my friend bemoans. "When we use that term, the press and the market analysts attack us almost immediately. They assume we're just talking about more public works projects, more false recoveries in fits and starts, and bigger federal deficits.

"So what's the plan?" we ask.

"Saaaa," he says, sucking in air through clenched teeth, signaling the complexity of the answer. "What my younger and more vocal staffers want, strangely, is a real, unabashed crisis — a housecleaning ... even an outright depression if that's what it takes to break us out of this eerie, 10-year slump."

"Is this realistic?"

"Their proposals are radical, very radical. But what's more radical is the fact that Heizo Takenaka, the new minister in charge of economic and fiscal policy, is now spearheading this reform. What's even more shocking is that the new Prime Minister, Junichiro Koizumi, is demanding this reform."

My friend pauses for a moment, shakes his head, and continues. "Many Japanese are skeptical. They figure the new prime minister will make mostly cosmetic changes, and everything will continue as before. But I see something I've never seen before: A unity of purpose between the younger staffers here at the Ministry of Finance and the new political leaders."

"What does that mean?" we wonder out loud.

"It could mean an end to government bailouts of banks ... and a rash of bank failures like you had in America in the 1980s.

"It could mean big cutbacks in public works projects ... and later, a rash of failures of Japan's largest construction companies.

"It could mean an end to zero interest rates, which, in retrospect, have done nothing to stimulate consumer spending. But when interest rates go back up, I shudder to think what will happen to the thousands of Japanese small and medium-sized businesses mired in debt."

A uniformed office worker in her early twenties pours green tea while my friend rattles off Japan's economic woes, counting them on his fingers.

"Ichi. Public debt in Japan has topped $5.1 trillion — a whopping 118% of GDP.

"Ni. Retail sales have been falling for 44 straight months.

"San. Unemployment has gone through the roof. For two generations, young Japanese hires have been taught that once you're sha-in (a member of the company), you'll spend the rest of your working life at the same company. This is ending. And it's a deep psychological blow to Japanese households.

"Shi. Please don't quote me on this one. We've known all along that the bad debts at banks were far worse than our research departments were turning up; and these, in turn, were far worse than what we were publishing. Want the real grand total? It's $1.3 trillion in bad debts.

"Now listen carefully," he warns "because this is where our crisis is going to become your crisis.

"Go. We're letting the yen fall to boost exports. This is going to set off a whole new round of currency devaluations in Asia and around the world.

"Rokku. Our institutional investors — big banks, insurance companies, pension funds and trusts — are starting to dump US securities."

My friend pauses — forehead sweaty, hands shaking. "This monster crisis is Godzilla in the flesh. So far we've kept him offshore. But now he's in Tokyo Bay, and all our armor and ammunition are gone. What's worse, a whole new group of powerful people are now advocating that the only way to destroy Godzilla is to let him come ashore, even at the risk of trampling Japan's economy.

"But that's just the strategy that's being made public," he continues. "The hidden strategy is to protect Japan by launching several stealth attacks against foreign investments and markets — by dropping the yen and selling foreign securities."

To better understand what he's talking about, we take the subway to a major brokerage firm and visit another friend, head of institutional trading. The din of trading is all around us.

"Shikushou!" he curses in frustration and anger. "Everyone talks about 'bad loans' at the banks. But our biggest problem is their sick stocks. These aren't stocks they bought because they were great investments. They're stocks they bought over the years to help cement long-term inter-corporate relationships. They don't want to sell these stocks. If they did, they'd incur huge losses. They'd undermine those relationships. And they'd drive domestic stock prices down even further, sabotaging their own portfolios.

"So, how do they postpone the day of reckoning?" he asks, looking us squarely in the eye. "I'll tell you how. By dumping your securities — US bonds, US blue chips."

Even as he speaks, we hear a wave of shouting as sell orders hit the trading desk. Panicky traders lean over a round table and yell — at each other or into telephones.

"Hear that?" my friend explains. "That was just a big sell order coming from a major bank, to dump a large block of its US Treasuries. Its US blue chip holdings will probably be next."

The same is happening everywhere in Japan. Struggling or failing banks are no longer able to hand out credit to Japanese companies in desperate need of cash infusions. Without a ready source of cash, these companies are also forced to start dumping their overseas and domestic investments — stocks, bonds, real estate, business assets.

For US investors, the impact is potentially dramatic. About 27% — or more than one-quarter — of all US Treasuries holdings outside America are held by Japanese entities — some $330 billion worth. On top of that, they own about $350 billion of marketable corporate bonds and stocks.

Like pilots of a leaky balloon, Japanese investors begin to toss their foreign investments overboard in a desperate attempt to stay airborne.

Time for the final leg of our tour ...


Like in the US, thousands of European companies got caught up in the high-tech frenzy. And, as in Japan, the banks have been part and parcel of the mania. Now, it's obvious the party is over:
  • The German Neuer Markt, the equivalent of our Nasdaq, is down by over 90%. That's the same magnitude of decline as the great bear market of 1929-32.

  • High-fashion Internet retailer lost investors $185 million in 18 months ... lost $43.9 million ... and, the UK's largest failure to date with losses of up to $71.7 million, went bust for a second time — just months after Great Universal Stores (GUS) acquired it in bankruptcy court for $2 million.
All told, from their peaks in October 2000, the European markets lost a whopping $2.33 trillion by April 2001.

As in the US and Asia, the European economy recoiled from the blow: German-American automaker DaimlerChrysler announced layoffs of 26,000. Michigan-based Delphi Automotive Systems, the world's largest auto-parts maker, laid off 11,500 and shut down plants around the world, including a factory in England.

To the north, in Scotland, Motorola closed a factory and laid off 3,200 employees. Not to be outdone, Marconi Plc, the UK's biggest telephone equipment manufacturer, slashed 3,000 jobs.

Dutch electronics giant Philips laid off 7,000 workers, after posting an astounding 90% drop in quarterly profits ... Germany's industrial conglomerate Siemens cut 2,000 jobs ... Swedish mobile phone company Ericsson dropped 30,000 employees from its payroll.

Predictions for economic growth are slashed nearly every week. First, they were expecting 3.4%. Then it was 2.5%. By mid-2001, government economists said it would be more like 2%, and even that grossly underestimated the speed of the decline.

Already, the confidence level of European industry had plunged to a level that implied zero annual growth. Their strategy is the same as Brazil's and Japan's: Let the euro fall (despite lip service to the contrary). That's why the euro lost 25% of its value against the dollar since the European common currency was launched in January of 1999.

The crisis overseas
threatened to hit the US
directly and immediately

Even after the WTC attacks, most Americans are oblivious to the troubles overseas. They don't know much about it — and even those who do greatly underestimate how it can impact us. But there are five fundamental mechanisms through which the crisis overseas will strike America:

1. Mass psychology is international. A fundamental principal of financial markets is that selling begets selling. And in today's world of instant communication, the waves of selling can spread in seconds. We saw that in the days before the terrorist attacks and after. We will see it in the future as well.

2. Foreigners own massive amounts of US Treasury securities. After decades of trade deficits, foreign corporations and individuals have accumulated the largest stockpile of US investments in history. Of the total foreign holdings of $1,198.8 billion, Japan has $329.7 billion; the UK, $205.6 billion; Germany, $84.4 billion; OPEC, $53 billion; China, $51.6 billion; and Hong Kong, $45.5 billion.

3. US corporations depend on foreign sales. Every one of the 30 companies in the Dow is multinational. They rely heavily on foreign revenues. So as Asia and Europe fall, you will see gaping holes appear in US corporate earnings — especially in the largest blue chips. Indeed, the bigger they are ... the greater the vulnerability to recessions overseas!

4. Flight of capital from the US. We could find ourselves in a predicament that is not unlike Argentina's and Brazil's — desperate to prevent foreign investors from pulling out. Indeed, as you'll see in Chapter 13, the threat of foreign investors fleeing the United States will emerge as the force that paralyzes US government monetary and fiscal policy.

5. Trade wars! Sound unlikely? Well, simmering trade disputes are already erupting, and a united front against terrorism will not bring about a parallel unity on international trade.
  • The European Union (EU) is challenging a US law granting billions of dollars a year in tax breaks to more than 6,000 American companies, including major exporters such as ExxonMobil, Ford, Boeing Co., and Microsoft.

  • The World Trade Organization has ruled the US will be hit by as much as $4 billion in retaliatory sanctions. That, according to a statement by US Trade Representative Robert Zoellick, would be like a "nuclear weapon" on the global trade system.

  • The US Commerce Department imposed a 31% import duty on Japanese steel, accusing Japan of selling its steel at cut-throat prices. US steel companies have "won" more than 100 anti-dumping cases since 1998, but 18 US steel companies have gone into Chapter 11 in the same period.

  • The European Commission blocked a $42 billion merger between GE and Honeywell, fearing the company would hammer its European competition. Outraged, US Treasury Secretary Paul O'Neill called the rejection "off the wall."
Look: Politicians rarely sit idly by the sidelines, watching while their economies fall. When corporations lose money, their lobbyists clamor for retaliation against foreign corporations. When people lose their jobs, they blame foreigners, demand retaliation and, if they don't get what they want, they kick their leaders out of power.

But each economic action in one country leads to an unexpected and uncontrollable reaction by other countries. They devalue their currencies to make their goods cheaper. They jack up their interest rates. The sell their foreign securities. And in the worst case, they may erect their own massive walls to control the free flow of capital.

This is not a fleeting thunderbolt that will soon disappear like the crash of '87. Nor is it an economic virus that attacks just one vulnerable economy at a time like the Asian crisis of '97. It is economic war.

The euro has already plunged. This may be a booster shot for European exports, but it's a potential killer for the US. Trade between the European Union and the US generates $165 billion annually in export earnings for American business. It accounts for 38% of world trade in goods. It's 42% of our trade in services.

Plus, it has a dramatic impact on our corporate profits. Recently, DuPont, 3M, and Intel have all blamed their earnings troubles on the dismal slide of the euro and the dollar's rocket ride to ever-higher valuations.

Other US companies are also going to see their exports flattened by currency woes and then crushed by a trade war.

Urgent Action Needed

First and foremost, sell the shares in companies that will suffer the most in a worldwide trade and currency war. They did very well when international trade was expanding, but a trade war will hammer them mercilessly. Some prime examples:

US Based Company Foreign Sales
As a % of Total
Exxon Mobil Corp. 69.3%
McDonald's Co. 63.1%
Coca Cola Co. 61.2%
Intel Corp. 58.7%
IBM 57.9%
Eastman Kodak Co 51.4%
Oracle Corp. 48.0%
Boeing Co. 47.2%
Procter & Gamble Co. 46.2%
DuPont 42.5%

Second, get out of international mutual funds. These funds are going to suffer as the foreign companies they own are locked out by the tariff walls.

Also, some of your "non-international" mutual funds may have international holdings you are not aware of. Call your fund for a prospectus, or check out the major foreign holdings of your funds online at: or

Third, follow the Safe Money strategy. Keep the bulk of your funds invested according to our "Mr. Conservative" portfolio, which is highly insulated from the ravaging effects of a global trade war and economic slump. It will grow your money safely, letting you sleep at night. This includes the recommended gold shares, which thrive in a hostile international economic environment.

Fourth, use leverage for profit. A crisis of this magnitude is a gushing well of opportunities. For the portion of your assets you can allocate to more aggressive investments, it can be a profit bonanza.

But first, let's see how the events can unfold, and take a closer look at another key sector of the US economy will be hardest hit.

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