Where to look for structural weakness using Capital Flow Analysis Where to look for structural weakness : continued

Spotting Structural Weakness

Barriers to Seeing Structural Flaws

The 1997 Indonesian crisis was caused by structural weakness in the financial system that went unnoticed, even when the dangers should have been quite obvious:

Commonsense solutions, like a moratorium on payments or the issuance of Brady bonds, or even Steve Hanke's suggested currency board, were ignored or dismissed.

Commonsense solutions were ignored or dismissed.

The Clinton State Department, more interested in toppling the Soeharto regime than in saving the Indonesian people from economic hard times, added political intrigue to the poisonous atmosphere.

The initial lack of comprehension of the situation by economists was similar to the stock market crash of 1929, when Irving Fisher, 'America's greatest economist', expected the end of the economic crisis by mid-1930, never suspecting the disastrous political meddling of a new president, Franklin Roosevelt, who upturned capitalist economics, attacking businessmen as useless and un-needed, abandoning the gold standard, raising income taxes to incredible levels, and generally inviting socialism into the United States, thereby driving investors into hiding for a decade, until the Japanese got the economy going again by bombing Pearl Harbor. (See the essay: 'FDR and Worker's Capitalism')

Structural Weakness: Places To Look

If we are to be successful in spotting weaknesses in the economic system, we must be willing to look for trouble.

From Capital Flow Analysis of the U.S. economy, we note two outstanding forces that have driven a twenty-year rise in prices of bonds and equities:

The Trade Deficit: The massive accumulation of dollars in the hands of foreign exporters has created a steady increase in demand for dollar bonds.

The Buyback Movement: The over one trillion dollars of stock repurchases and cancellations by U.S. corporations has driven stock prices and price-earnings ratios upwards, and dividend yields down.

Anything that causes either of these trends to be reversed will almost certainly have an effect on prices in the stock and bond markets.

Reversal in the trade deficit or the buyback movement will effect prices of stocks and bonds.

In the case of the trade deficit, anything that closes U.S. ports would lead to a serious decline in bond prices.

In the case of the buyback movement, a sudden change seems less likely, although the unethical aspects of executive remuneration, the coming retirement of the baby boomers, and the countervailing force of foreign equity issues into the U.S. market are things to watch.

There are yet other kinds of structural weakness.

In the U.S., we might mention over-dependence of foreign oil and non-renewal energy sources in general.

Despite many books and articles about these vulnerabilities, not enough is done to ensure against disaster.

Historian Barbara Tuchman's 'The March of Folly' is an description of how governments throughout history have ignored commonsense solutions and have sat by helplessly as debacles have unfolded.


Before proceeding, check your progress:


Impending crises are sometimes hard to predict because we tend to:
Choice 1 Mind our own business.
Choice 2 Misinterpret econometric models.
Choice 3 Assume others will take action.
Choice 4 Be unaware of government plots.
Governor Djiwandono was shocked to discover that:
Choice 1 Dollar loans were not hedged.
Choice 2 Banking statistics were not consolidated.
Choice 3 The IMF refused to offer advice.
Choice 4 Banks charged interest to Muslims.
Which would have the least effect on the market value of U.S. financial assets?
Choice 2 Increased buybacks by closed-end funds.
Choice 3 Elimination of the trade deficit.
Choice 1 Prohibition of corporate buybacks.
Choice 4 Closing of American ports.

Investment Tutorial: Capital Flow Analysis   structural weakness : continued >

copyright | privacy | home