Global economy subject to winds of change

The past 12 months will figure prominently in history books. The momentous changes that have swept through Europe will alter the political face of the world as much as Saddam Hussein’s brazen invasion of Kuwait. As always, political transformation of such magnitude will, in turn, cause shifts in the global economy. To investors, the new realities are as fraught with danger as they are heaped with opportunity. At first, the downfall of Marxism brought hope for freedom and expectations for quick financial gain to the millions looking forward to the opening up of Eastern Europe and the Soviet Union.

Yet the ambitions of many have already been cut down: it turns out that adjusting to capitalism is a more difficult process than initially thought.

This realization is starting to sorely test the determination, not only of those most affected, but also of foreign investors. Disappointments also lie ahead for those who promise themselves instant success from a unified Germany or, for that matter, a United Europe.

It’s much the same with the Middle East. Quick money was easily made during the days immediately following Saddam’s move as was lost again a few days later. The more difficult part will be to identify and exploit the longer-term trends that have been unleashed by the latest events in the Gulf and to put into place timely strategies.

The implications for investors are most significant. Both the changes in Europe and the Middle East will fundamentally alter the world order. The 1980s were a decade of unprecedented change and the 1990s will move at an even faster pace.

Last year, we predicted that 1990 would be remembered as a year of declining stock markets, spreading credit risks and growing deflationary momentum. In retrospect, that is more or less what characterized this past year. But the events in the Gulf have now superimposed other, equally consequential realities, which make predicting what will happen in 1991 a hazardous task.

Four key problems dominate and have the potential to dramatically change the global economic environment:

— After 50 years of progressive debt buildup and 10 years of record borrowing at the government and corporate levels, the debt pyramid is crumbling. The impact on the economy and the banking system is traumatic and could lead to disastrous results.

— The banking crisis is spreading. In the U.S., the savings and loans debacle is now no longer the only problem area. Money centre banks and insurance companies are in trouble, too. But even though most attention is focused on America, the chance of a serious calamity is nowhere more pronounced than in Japan. Banks were aggressive players in the stock market and carry heavy exposures to real estate, which is still dramatically overvalued.

— With the North American economies in recession and other industrialized nations caught in a slowdown, the Middle East crisis has the potential to quickly derail economic stability.

— The spreading chaos in the Soviet Union could lead to an overthrow of Mikhail Gorbachev. In that event, Soviet economic and political attitudes toward Europe and the Middle East could rapidly change.

The unfortunate thing for investors is that a more serious problem in each of these areas would affect financial markets quite differently. That is why a highly disciplined and defensive strategy is still in order. Cash and Treasury Bills, in fact, should make up an even greater part of your portfolio now, than a year ago. At some point in 1991, however, a shift to a more aggressive investment stance will be called for.005 0000,0606 Peter Cavelti’s “Preview of 1991” appeared in the December edition of Market Report, a monthly publication of Cavelti Capital Market, Toronto.