Global Economy Prospect

STRATFOR.COM's Weekly Global Intelligence Update - 17 April 2000

__________________________________________

By The Internet's Most Intelligent Source of International News &
Analysis http://www.stratfor.com/
__________________________________________

Have you visited our web site recently? We've made some new changes
that make using the site more efficient, allowing greater access to
thousands of reports. Visit http://www.stratfor.com today.
__________________________________________

OTHER FEATURES ON STRATFOR.COM

New South Korean Parliament Presents Challenge for President Kim
http://www.stratfor.com/asia/commentary/0004150030.htm

Georgian Troops Cuts Possible NATO Lure
http://www.stratfor.com/CIS/commentary/0004152325.htm

Kazak Locust Infestation Exacerbates Russia's Looming Food Shortage
http://www.stratfor.com/CIS/commentary/0004152357.htm
__________________________________________

STRATFOR.COM Weekly Global Intelligence Update
17 April 2000

Forecast for the Second Quarter of 2000: The Global Economy

Summary

Today we launch our forecast for the second quarter of 2000. The
dominant theme in the world in the coming three months will be the
economy. This year the United States will experience not just
turmoil in the markets but a short, sharp recession that will serve
to strengthen the economy over the long term. The effects of this
abroad, however, will be less healthy - particularly in Asia.
Europe will seek to maintain its business interests in Russia, even
as the government there puts a strong hand over the economy and the
oligarchs. Latin America will likely escape serious repercussions.

Analysis

For years, our view of the U.S. economy has been intensely
optimistic. More recently, though, we have argued that the robust
economy has been due for a short, sharp recession led by a market
sell-off. In February, we published "Recession Time?" predicting
not only a sell-off but also a recession in the summer and fall of
2000.

The markets have clearly begun the sell-off. But the consequences
will not be limited to either the markets or the United States. The
shake-out in the U.S. economy will only help strengthen its long-
term prospects but will reverberate elsewhere. Asia will struggle.
Effects will be as political in nature as they are economic,
particularly in Beijing. Russia's new president will move to
quickly establish control over the economy; thus, a confrontation
with the country's oligarchs is likely to happen quite soon. Latin
America will likely ride out significant economic turmoil.

United States

In the United States, the markets have clearly begun the sell-off.
The sell-off of Internet stocks is triggered by the fact that too
many of the business plans for publicly traded Internet companies
make them dependent on subsequent rounds of financing; they are not
self-sustaining. As they have launched their plans, though, they
have found the markets cool to more rounds of financing.

Investors are diving for cover after realizing that many of these
companies cannot survive. But the problem is not confined to the
Internet stocks. Inefficiencies and irrationalities have crept into
other sectors of the U.S. economy. Now, with the interest rate
hikes of the Federal Reserve and the increasing conservatism of the
markets, the supply of money is becoming relatively tighter, even
as the values of both corporate and individual portfolios decline.

We don't expect a recession to start in the second quarter - but we
do expect the rate of growth to decline. Actual contractions in the
economy will occur in the follow-on quarters. Further market
declines will follow. Consider that the S&P 500 has risen in nearly
a straight line from around 500 to around 1500 in five years. A
fall to 1000, retracing half of the rise, would not be unthinkable
and would not break the long-term bull market that began in 1982.

Asia

All of this is bad news for the rest of the world economies,
particularly for Asia. The greatest problem facing Asia is its
inability to form capital. First, Asian speculative money fled to
the United States seeking higher returns. Now, as U.S. interest
rates rise, a second round of outflow can be expected as Asians
take advantage of more conservative investments. This will drive
the dollar higher.

In a sense, there will be an immediate benefit to the region, as
the rising dollar makes exports bound for the United States
cheaper. This will have an interesting political effect. An
underlying protectionist sentiment has been masked by the
prosperity of recent years. But as the economy weakens, the pain of
imports will rise - and so will protectionist politics in the
presidential elections. Both George W. Bush and Vice President Al
Gore are free traders, but the export surge will likely prove too
much for Gore - who has strong trade union support - to resist.

In turn, this will intensify Washington's problems in Asia. It will
make already difficult relations with Beijing even harder. It will
also create problems with Japan, where nationalist sentiment in the
figure of Tokyo Governor Shintaro Ishihara is rearing its head. A
recession in the United States will not only weaken Asian economies
but also create significant opportunities for trade friction
between the United States and a large portion of Asia.

Viewed on its own terms, Asia remains susceptible to a relapse of
the economic collapse of 1997. Its export-based economies are still
dependent on U.S. consumption and need further foreign investment.
Higher U.S. interest rates will draw from that pool of investment;
a slower U.S. economy will reduce the consumption of Asian
products. A downturn in the U.S. economy generally means that
inefficient enterprises are weeded out; in Asia, however, it will
mean another crisis.

While the Asian economies are no longer in free fall, they
generally have not made the structural adjustments necessary to
prevent another economic slide. Banking systems are still a mess
and companies are far too bloated with middle management. Homegrown
solutions like Malaysian-style restrictions to control capital
flight still don't make up for decreased investment. The self-
proclaimed recovery is little more than a cyclical uptick in a
downward trend.

Some countries, however, will be better off than others. Out of all
the Asian economies, South Korea, Singapore and perhaps Thailand
are somewhat prepared to deal with another downturn. South Korea
and Thailand have implemented a measure of International Monetary
Fund (IMF)-prescribed reform. Singapore at least understands the
region's tenuous economic position and is doing what it can to
insulate itself.

A downturn will bring about two contradictory effects. Attempts by
regional governments at increased economic cooperation will be
undercut by an export war. Asia still smarts at the social cost of
the IMF-prescribed remedies. Therefore, the region will likely try
to pull together to solve its own problems. It can use its own
money and own economic policies to attempt to remedy the situation,
perhaps resulting in the realization of rhetoric-heavy but capital-
poor institutions - such as the Asian Monetary Fund.

However, these cooperative efforts will be undercut by regional
competition over trade. The increased strength of the U.S. dollar
will trigger an Asian export race as the countries desperately
attempt to build up their reserves. Regional cooperation is likely
in the mid-term, but trade wars will slow the process.

Weak economies will increase domestic political unrest in some
nations - particularly Indonesia and China. Indonesia's democratic
government, which is already in a precarious position, will be
further strained as foreign investment falls. Indonesia will face a
chicken-and-egg dilemma. It needs a cash influx to stave off social
instability and separatism. Despite the best efforts of neighboring
Singapore and Malaysia to encourage investment, foreign investors
will stay away as long as there remains a threat of instability.
Unable to attract outside funding, Indonesia's central regions will
concentrate on securing the country's remaining wealth - thus
fueling the fires in resource-rich separatist regions.

China will be unable to hide its own economic downturn, causing
more Western investors to cut their losses and leave. This will
prove to be the decisive point in the political struggle between
advocates of Western-style economics and the old guard. As foreign
capital flees the country the winners will be the hard-liners
opposed to Western investment and involvement in the economy. The
economic malaise will breed domestic dissent and unrest,
potentially requiring a widespread security crackdown that may
surpass what China experienced in 1999.

Shutting China's economic doors brings further problems. Many
regional leaders are getting rich off local, foreign-run
operations. A central government effort to expel these companies
might provoke a backlash from regional power brokers. In time, the
resulting rifts between the central government and the provincial
leaders could lead to serious fractures within China - and the more
distant threat of armed conflict.

Europe

Europe's economy is more diversified and self-sustaining and as
such will not be severely affected by the American hiccup.

A large chunk of Europe's trade and investment stays within the
region, which gives it a measure of economic insulation in the same
way the size of the U.S. economy allows it to sustain itself. The
European Union's largest foreign capital investments are in Eastern
Europe and Russia, and Europe will focus on ensuring a return on
its money.

For example, Russia owes the German government nearly $16 billion
in loans - about the same amount as Germany's defense budget.
Russia doesn't have cash to pay the loans, but neither can Berlin
simply write them off. A Russian default would cripple its ability
to borrow, but would also hurt the financial standings of the
creditor nations and banks that loaned Russia the money in the
first place. A partial solution was the appointment of a German to
head the International Monetary Fund - with the implicit
understanding that he could grease the wheels for loans with which
Russia could repay Germany. Instead, Europe will continue to look
for business opportunities within Russia as it attempts to recover
a portion of its investment.

The major foreign policy story in Europe will be in Kosovo, as NATO
reins in the ethnic Albanian militants who have been raiding
southern Serbia. These militants, the Liberation Army of Presevo,
Bujanovac and Medvedja (UCPBM) take refuge in the three-mile buffer
zone surrounding the border between Kosovo and Serbia, where they
are relatively safe from NATO peacekeepers and Serb interior
police. This group must be reined in to keep the peace. The likely
triggering event for this will be the transfer of command over the
peacekeeping mission from NATO to the European-led Eurocorps.

At the same time, the West will begin to rebuild Kosovo's political
structure. Even though peacekeepers have been in Kosovo for almost
10 months, the United Nations has been surprisingly slow at
creating governmental institutions of any sort. But international
support for Kosovo Liberation Army leader Hashim Thaci dwindles as
his group continues to ignore the rules imposed on them at the end
of the war. The moderate and malleable ethnic Albanian leader
Ibrahim Rugova is the logical choice for UN support.

Russia

The Russian economy is not only of concern to Europe but is an
absolute priority for President-elect Vladimir Putin.

It approaches the point of cliche to say that the Russian economy
is in shambles and that something must be done. In this quarter
Putin will focus on Russia's internal situation. First, Putin will
begin repairing the economic and financial institutions necessary
for basic commercial life. He has already begun to restructure the
banking system and will continue with relatively simple steps such
as modernizing the tax code - a reform that is also supported by
the Communist majority in the legislature.

Putin's plan, thus far, involves strengthening the economic
policing bodies, like the Federal Security Service (FSB) and tax
police, while pulling layers of meddlesome and counterproductive
bureaucracy out of the daily operations of business. Success here
can pave the way for less popular reforms like the eventual
nationalization of major industries.

However, any real economic progress will be incomplete unless Putin
can sweep out the oligarchs, a small group of robber barons who
direct major segments of the Russian economy. Putin must end the
government's dependence on oligarch-controlled industries. Three of
them - gas, electricity and railways - provide nearly 35 percent of
Russia's budget revenues. Taming the oligarchs will also keep
industrial profits within Russia, rather than in the Swiss bank
accounts of tycoons like Boris Berezovsky. Publicly attacking a
major source of corruption is the best way for Putin to lure
Western investment back into Russia.

Putin will make a very public, very decisive move against the
oligarchs - most likely a series of raids, arrests and open trials
- perhaps as early as the first week after his May 7 inauguration.
Putin has already begun reinforcing the Moscow tax police with FSB
leadership. The charges will be corruption and tax fraud.

This purge will have several effects. It will nurture the
nationalist sentiments Putin has stoked with the war against
Chechnya. The oligarchs are a symbol of the corruption and
bureaucracy that Russians believe has kept them in the dirt.
Purging them will feed the nationalism and demonstrate the strength
of central power in Russia. As oligarchs depart their posts, Putin
will gain control of moneymaking industries such as gas, oil and
weapons exports. He will install his own loyalists and channel the
money back into government coffers.

An unintended consequence of this housecleaning will be that the
outside world will perceive Putin as a pro-Western reformer. Putin
won't resist the label as it will likely encourage investor
confidence in Russian markets. The label will be correct in light
of Putin's anti-corruption drive and tax reforms, but does not take
into account future moves such as nationalization of key industries
and tight economic controls.

Latin America

The increasingly dollarized Latin American economies will escape
the economic correction relatively unscathed. For instance, the
Argentine peso is pegged to the dollar. The effect will be minimal
because most of their trade flows among themselves and the United
States - all of which will be raising rates. Increased foreign
investment should make up for any decrease in exports to Asia and
Europe.