17 February 1999 - Blizzards and the Dogs of War

Here in Istanbul, jumpy-looking Turkish soldiers, automatic weapons at the ready, stand everywhere, while Turkish tanks and armored carriers patrol the streets, ready to spring into action at any sign of a Kurdish demonstration. It’s now a few days after the kidnapping capture of Abdullah Ocalan, the Kurdish rebel leader and hero to Turkey’s 20% Kurdish population. The government claims he is the leader of a terrorist force that’s killed 37,000 people.

As Paige and I continue our three-year millennium odyssey, we’re moving through one of the world’s most troubled hot spots–Eastern Europe–much of which was the former Soviet Union. On top of weather problems-this seems to be the year of the blizzard in this part of the world with avalanches wreaking havoc here weekly -in Istanbul we’re in the middle of yet another blizzard, which has stunned the Istanbul’s with its novelty.

It will come as no surprise to readers of the chief American papers to learn that Yugoslavia is in political and economic turmoil. We planned to drive through Romania to avoid the war in Serbia and Kosovo, but learned that in Romania the roads are little more than muddy ruts, difficult to drive through in the depths in winter. In addition, Romania is full of internal strife. Desperate workers have closed highways, overrun government offices, and occupied towns, mines, and factories. We were faced with the sort of choice that all too often confronts travelers in the so-called emerging countries of (a) driving through bad roads and minor civil strife or (b) driving through good roads and a shooting war. It’s a measure of how important roads are — back home, of course, we take good roads for granted — that we chose to dash through the war zone along the good roads. Luckily, we had no war-zone adventures, or misadventures, I should say.

Before we reached Yugoslavia we were told that their currency was only good in Yugoslavia, but it turns out that the country is such a basket case that it’s not much good inside Yugoslavia either, no matter whether you’re passing through a government toll station, staying in a hotel, or using the official currency-exchange booth. The government is printing money to support the war, and naturally the currency depreciates at a rapid rate. The political and economic situation deteriorates every day.

A few weeks back we crossed Europe, staying for a while in Frankfurt to figure out our next moves. We pressed forward through winter storms into Austria, measuring Austria’s economy against Germany’s, as the two economies have always been closely linked.

As I poke around here, I’ve become more and more disappointed in the German economy, and thus its stock market. While Germany has always been the economic locomotive of this part of the world — what California is to the United States, Brazil is to South America, and South Africa is to Sub-Saharan Africa — with the collapse of the Soviet Union in 1989 and then the collapse of Russia this past August, Germany’s become even more important.

Both the Austrian and the German left-leaning governments are now ready to award labor some of the riches they see the capitalists having sequestered during the prosperity of the nineties. After all, we’ve had the longest bull market in history; the rich have gotten richer; and the workers-who have the votes-have not become rich. The way is clear. The form of this sequestration appears to be to tax and/or burden the ownership of equity shares. History is clear about the effect of such actions by government: Shares will not rise. It’s right out of Econ 101: you get less of what you tax. As labor gets the bit in its teeth, labor strife in Europe is rising. What left-leaning governments are too short-sighted to see is that by putting the pursuit of jobs, or worker welfare, before sound currency and general prosperity, they’re killing the goose that laid the golden egg.

The economic and policy strains on Germany-and thus the euro and this entire region-can only intensify. The German economy shrank in the final three months of 1998. Employers attack the governments’ tax policy and the trade unions’ demands for excessive wages. Indexes of confidence are dropping. Economists are predicting that Germany will price itself out of world markets. The complexity of the challenges to Germany are on par with the Impact of re-unification-in 1989 or the first oil shock in 1973, and it must figure out a faster, more flexible response to its difficulties or suffer severe consequences.

While the Austrian government isn’t as militantly leftist as the German government and its stock market is cheaper, Austria is too closely tied to the German state economically to escape the consequences of its giant neighbor’s foolish actions. While over the decades I’ve made a lot of money in both countries, I’m presently selling equities in Germany and ignoring the Austrian equity market.

All this confirms what I’ve been saying all along: that strains are developing on the euro, and that while long-term the euro may do well for a while, I’m not surprised that it’s weakened against the dollar since inception. [$1.10 vs.$1.175] Both France and Germany, who’s economics together constitute the lion’s share of the European Union, have intractable structural problems with double-digit unemployment. Lafontaine, the finance minister of Germany, has put demands on the European Central Bank to lower interest rates, which will further weaken the Euro, and tension continues to develop. Win Dulsenberg, ECB president, declared in response to labor’s recent victories, “My preliminary impression is that this is a wage rise that may exceed productivity growth, and we fear that could give a signal for the rest of Europe, which would not be welcome.” In response, Mr. Lafontaine threatens to borrow and spend, using fiscal policy to solve the unemployment problem. These are only the early days. Imagine the strains on the euro when real financial and economic problems hit Europe.

Germany and France might look across the English Channel to obtain clues about much needed changes. Germany’s combined income, corporate, and social-security taxes are some 40 percent higher than Britain’s, while France’s tax burden is 80 percent higher.

This euro-trend to make equity shares less attractive is spreading — monkey see, monkey do. Romania has also decided it’s a bright idea to tax foreigners on their investments in Romania, and labor is in the street egging on its political leaders to tax the rich. It’s not as if Romania is doing as well as, say, Ireland, and has decided to skim off some of the profits. This is Romania, a former communist state, where it’s hard to keep an enterprise together much less to make a profit. Average monthly wages of less than $1OO are widely resented, and recent economic growth has been negative. The effect of such new taxes will be devastating, and when Germany, its giant neighbor, catches a nasty cold, Romania will come down with double pneumonia.

I know it’s a terrible temptation for left-leaning politicians to make workers happy by “taxing the rich,” but what they must come to understand or fail is that capital–especially today–will not sit by passively. For those who do not invest or lend, it may appear easy to invest and make a profit. The bull market has spoiled millions, but it’s actually a difficult and risky feat. Those countries around the world that conspire to make obtaining a profit yet harder must lose in the global competition, even though it might appear in the short run as if such taxes are easy solutions to complex social and economic problems. They never are.

For all these reasons I can see no reason for anyone to invest here, and by here I mean Romania, Hungary, Bulgaria, Austria, and Turkey. The strains produced by the slow-down of the German economy and the Y2K problem in Europe will make these economies worsen before they become better. Eastern Europeans had big hopes after 1989. However, unemployment and inflation were twin shocks to a population for 40 years shielded by the communist cocoon. Many who had never paid taxes before are supposed to pay 400% of their incomes to the government and face a high value-added tax at the market.

But what about Hungary, you might ask. Hasn’t it in a few years brought down its foreign debt and current-account and budget deficits from untenable levels? Isn’t its Socialist-led government, which was dangerously divided over economy policy only a few years ago, now headed toward its general elections with some confidence, having presided over one of the former east bloc’s most remarkable turnarounds? Hasn’t it positioned itself well to be the first ex-communist country to join the European Union?

All this is true, and a credit the country’s leadership, but in Hungary the bloom appears to be off the rose. It did take a rigorous and smart approach to macro-economic policy and a tough approach to privatization and restructuring, which is a good reason why it’s fared better than Russia. It even privatized its banks, a real step forward in building a solid financial infrastructure. However, where a few years ago real estate was up strongly, now it’s down and new buildings sit vacant. New manufacturing plants haven’t proved as efficient as everyone hoped. The country’s current-account deficit may well prompt its central bank to slow the pace of interest rate cuts despite slowing growth and slowing inflations.

Despite the prior euphoria over economic prospects, inflation is still in the double digits. The tax reform that was hoped for didn’t happen, and tax evasion is both the cause and the effect of very high marginal rates. A cut in high payroll taxes is needed, as they raise labor costs by some 50 percent and are used to fund the bloated and troubled Hungarian social-security system. (Can you imagine what a FICA tax — now 13.2% — of 50% would do to our economy?)

It’s easy to see how the economies of Central Europe can slide into the same morass as have those in Latin America and Asia. In addition to the tension stemming from these economies’ histories as Soviet client states, there’s the natural confusion and fumbling in execution that comes from so many new governments. Even in more mature societies, inexperienced new political leaders make false starts and backtrack because they’ve been shadow governments so long that they have little experience leading. As an example, the new German government renounced its contracts with France and Britain to take in the atomic waste from the closure of their nuclear reactors. An uproar ensued, as these weren’t contracts with mere private companies but with sovereign governments. The new German government has sort of backed down and sort of not backed down while they study the situation, but such backing and filling is typical of these new leaders.

Bulgaria, which hard as it might be to believe was once the economic engine of this area, has restructured itself but is still mired in the statist ideas of yore. Once it could obtain all the oil and gas it wanted from the Soviets, who bought its wine and agricultural products, but today its economy has collapsed to one quarter of its former self.

Turkey, where we are as I write this, is divided between Europe and Asia. To its west are the problems I discussed above, and to the east lie Syria, Iraq, Georgia, and Azerbaijan — that is to say, all its neighbors are either suffering or not dynamic. Given Turkey’s stable foreign-exchange reserves, it won’t have problems rolling over its debt. While it’s feeling a slowdown, the economy should perform reasonably well.

However, remember that twenty percent of Turkey’s population is Kurdish, who are pushing for their own homeland and will likely keep creating disturbances until they obtain some satisfaction.

The Turkish banking system is still a mess, without transparency, That is, a depositor, who is no more than an unsecured creditor, is owed money by an institution about which he has no reliable figures. I wouldn’t deposit my money in such a system; would you? Not only does neither political party have a commitment to sound money, but Turkey has a long history of debasing its currency, which means it’s likely to continue to do so. Making a modern currency hard is a cultural affair; it doesn’t happen because some one leader decides it’s a good idea. New Zealand, which for years and years was a statist mess, with the government printing money to buy up farmers’ surplus fleeces and mutton, only turned around when its people became fed up and instructed the government to do something, anything, to make their currency keep its value. It took 70 years, but finally many Latin Americans became so fed up with their economies’ constant inflation and devaluations that thev forced their governments to make their currencies have long-term value. It will be a long time before Turkey reaches this point.

Over decades of investing I’ve noticed that some countries are not likely to become models of economic development, and Turkey is one of them. I play Turkey for rallies, not for the long haul. I buy only when there’s a complete and utter collapse of its public markets and I buy in the expectation of selling at a profit into the first decent rally. However, I can’t see buying Turkey yet. Part of waiting is the unrest that pervades this area over the capture of Abdullah Ocalan, and part of the waiting is to see what happens in the national elections in April. Another part of being cautious about Turkey is my experience with its dreadful regulations. I received a lesson in Byzantine complexity when I went to redeem a new tarpaulin cover for our car at Turkish customs. To retrieve this prosaic rubberized cloth worth $150 I was forced to visit 10 offices over several hours where I had to purchase a dozen stamps and permits for $75. My second Byzantine experience, retrieving my battered laptop computer from customs bureaucrats shipped to me from my New York office, proved more demanding. This time I had to see 22 separate officials, some three and four times, and obtain several dozen documents. Whenever I’m forced to endure this much bureaucratic bloody-mindedness I conclude the country is so hidebound, so anti-business, and so anti- individual as to be a menace to investors.

The only possible investment I can think of in Turkey today is the purchase of land in the east near where the Kurdish people are centered, where an adventurous investor might take advantage of the Kurdish unrest to buy while prices are understandably depressed. That investor may have to wait five to ten years, but his return will likely be enormous.

I should also add, however, that Turkey does have things going for it, certainly more than the countries of East Europe. It has one of the youngest populations in Europe. which is a strong economic positive in these days of over-extended social-security systems. The youth in Turkey are getting fed up with the old games. I am watching closely because a real secular change may be developing. Turkey may become a superb place for long-term investors within the next two to three years.

As we make our way east, it’s fun to see how different things are here from back home. As we traveled across Bulgaria we discovered that the head gestures for yes and no are the direct opposite of ours; nodding up and down means no, shaking your head sideways means yes. Bring your own sink plug: Bulgarian inns would no more furnish a room with one than an American motel would furnish a toothbrush. Truckers refer to Bulgaria as Marlboro Country, as packages of cigarettes are ideal for obtaining favors from uniformed Bulgarian officials. No traveler should miss the Bulgarian folk-singing and church-choir concerts, which are as haunting in their way as Southern gospel singing in the United States.

We visited Nevsehir, the underground Turkish city in the east. Built under the ground to house several thousand people against marauding armies, such old Turkish cities extend as far as eight stories deep into the earth, a testament to mankind’s indomitable spirit of survival. We’d urge driving enthusiasts — motorcyclists or sportscar drivers — to make a special effort to hit the glorious Erzurum to Artvin route, several hundred kilometers long, a fabulous stretch through gorgeous scenery, over sparkling streams, and up and around challenging hills and tight turns. Not to be missed.

Out here there’s a lot of barbecue, wonderful for a couple of Southerners. Paige misses the glorious English breakfasts, those hearty feasts of eggs, sausages, and bitter marmalade, and we both miss the wonderful German beer, justifiably called the best in the world. In Hungry, we indeed ate our fill of goulash, which has a richer, more satisfying taste than anywhere else. Here in Istanbul the papers are in an uproar over Turkish coffee. Espresso machines have begun to pop up around town, and there’s the sort of fierce cultural debate raging here as in France over the introduction of American fast food and in Germany over the widespread introduction of English into advertising copy. Espresso coffee is too watery, Turkish pundits declare; real coffee should be as dark and thick as molasses, with a proper silt of ground coffee in the bottom of the cup.

For the time being we’re parked here in Istanbul waiting for our Iranian visas to be stamped, which are supposed to allow us into Iran in a few days. The Iranians keep giving us the excuse that the right paperwork hasn’t arrived from Tehran, which we take to mean that they’re holding us up because they don’t want a couple of Americans riding around Iran when the Kurds are so upset over the capture of the Ocalan. This is par for the course on a long trip like this; you have to take these interruptions as they come and work each one through. We expect shortly to push off to Ankara, in the center of Turkey, and on to Georgia and Azerbaijan and Iran, but maybe instead we’ll have to take a boat across the Caspian Sea. Tune in next month and we’ll let you know.