TIME Asia | Learning Some Lessons

ANATOMY OF A CRISIS: With no end in sight to the region's financial meltdown, the devastation so far offers up some crucial lessons for the future FREE MARKETS: Chris Patten on the need for democracy NO WAY OUT: David Roche defends IMF prescriptions	ASIA	February 2, 1998 VOL. 151 NO. 4
Learning Some Lessons The region's economic woes bring a search for explanations that can help the rest of the world avoid making the same mistakes By ADI IGNATIUS Hong Kong sia's financial markets may be unstable, but they aren't crazy. Just watch them operate in Indonesia, ground zero in the region's crisis, where $43 billion in International Monetary Fund aid has spectacularly failed to restore confidence. President Suharto, 76, who has ruled the sprawling archipelago for 32 years, officially announced last Tuesday that he would stick around for another five-year term. And he hinted that his heir-apparent would be a bureaucrat-crony with a weakness for pricey state projects. The market's views couldn't have been plainer: within 48 hours, the rupiah had fallen 72% to its all-time low against the dollar. And that was on top of a 70% slide since July. Says Eugene Galbraith of abn amro Hoare Govett in Hong Kong: "This is no longer a crisis of the economy but a crisis of confidence in the system." The market's the message, and the message is: there's no end in sight for Asia's financial debacle, now dragging into its seventh month. In Thailand, the stock market is down nearly 40% since July; South Korea's has fallen 36%; Malaysia's 48%. Currencies have tumbled even faster. Daily market swings of 5%, once the stuff of front-page headlines, no longer raise an eyebrow. What's especially worrisome is that the $100 billion-plus the IMF has pledged across the region to set things right hasn't done the trick. Meanwhile, Japan, which should be pulling the region out of its slump, is foundering. After seven years in the doldrums, the world's second-largest economy has slipped into recession. What's next is anybody's guess. The crisis is rapidly moving from the boardrooms and stock-market floors to the streets, and the specter of large-scale social unrest grows by the day. Indonesia has seen food riots in several cities, and last week Bangkok police clashed with factory workers protesting wage and bonus cuts. How did we get here? A year ago we were supposed to be on the eve of the Pacific Century. The Asian miracle--rapid growth, social stability--was the envy of developing nations everywhere. Suddenly in July it all began to unravel. The catalyst seems almost incredible now: the unexpected weakness of the baht (the baht!). But the Thai currency's fall under speculative pressure set off a domino effect that has exposed a regionwide financial system so shaky that optimists now forecast a recession for most of Southeast Asia for the next year or two. Pessimists see a more apocalyptic denouement, in which markets in Japan, China and, finally, the U.S. come crashing down. At the least, the pain in Asia will intensify. "A lot of losses have to be taken," says Marc Faber, who heads his own investment firm in Hong Kong. "The big wave of bankruptcies normally comes one or two years after a big fall in stocks." The search to explain the crisis often points to the hubris of Asia's business leaders, who borrowed recklessly and diversified into virtually anything that promised even faint returns (one now-bankrupt South Korean conglomerate diversified out of underwear and into construction). And they erected monuments to their own vanity--high-rise towers, state-of-the-art chipmaking plants--that couldn't possibly all make economic sense. The evidence is there for all to see: vast expanses of abandoned, unfinished towers in Bangkok or warehouses of slow-selling semiconductors in South Korea. But surely the hubris explanation is too easy. For one thing, there were legions of co-conspirators, like the foreign bankers who were impressed enough by Asia's "values" and profit margins to lend the region billions. For a better, one-size-fits-all explanation, a simplistic, but appealing analogy has been made with Speed, the 1994 Hollywood thriller about a runaway public bus. In the film, a terrorist tampers with the vehicle, placing in it a bomb that will explode if the bus slows to less than 80 km/h. The heroes struggle against all odds to keep it forever charging safely along at that pace. The bus, of course, represents Asia. The region's "miracle" worked as long as things--inflows of capital and cheap labor and outflows of exports--were perpetually moving at a breakneck pace. In this sense, the crisis that has swamped Asia wasn't exactly unforeseen. A year ago, a chorus of voices began sounding the alarm when gdp growth dropped slightly from the 8% to 10% annual rates the region had come to expect. Said a Seoul economist at the time: "If South Korean gdp growth falls below 6%, we'll face widespread bankruptcies." A Kuala Lumpur government minister: "If Malaysia's economy grows less than 6%, we could face race riots." But almost no one predicted the meltdown that actually transpired. It would be a mistake, of course, to count Asia out. In many ways its miracle was real, produced with authentic toil and innovation and enviable economic tendencies, like the region's fabled high savings rates. But a miracle is a tough thing to sustain. To try another analogy, Asia's fast-growth economies became something of a Ponzi or pyramid scheme. Rapid expansion depended on big infusions of capital, which meant building up large debts. As long as mega-growth continued, profits were high and companies could repay their obligations. Further loans were issued and the cycle continued. But when the system showed even the slightest signs of cracking (the baht!), it all crumbled. As in a Ponzi scheme, once the system breaks the game is up. Asia now is struggling to reform its economies, even as its markets continue to tumble. Some of what's happening is fairly encouraging, as a few corporations restructure themselves and as leaders push reforms that had been delayed for too long. In South Korea, the government has relaxed regulations on foreign ownership of companies. In Thailand, the government has forced several rotten lending companies to shut down. And in Indonesia, President Suharto has even agreed to strip some--though not all--of the special business concessions his children enjoy. The light at the end of the tunnel hasn't appeared, however. And it isn't clear whether the IMF and its prescriptions are making things better or worse. The consensus view is that Asia's woes will knock a percentage point off global growth this year. And things could get worse, much worse, if the contagion spreads north from Hong Kong. China has been mostly unaffected by the crisis to date, in part because its currency isn't fully convertible. But China's banking system shares some of the rot evident elsewhere, so it may be only a matter of time before the world's most populous nation gets dragged down too. And if China decides to hone its export competitiveness by devaluing the yuan, the crisis will enter a new, devastating second round. There are a few lessons to be drawn: WHAT GOES UP COMES DOWN This is so obvious it's almost ridiculous to note. But Asia was truly intoxicated with yearly gdp growth levels that until recently approached double-digit levels consistently. Malaysia, which had enjoyed nine straight years of at least 7% growth, thought it could sustain that rate until the year 2020. And almost no one thought they were crazy. Job creation was viewed as a given. Says Thierry Poux, Singapore-based regional head of a worldwide job-search agency: "To some in this region, unemployment is something they have never known." IT'S ONE WORLD, BABY The laws of economics apply to Asia too. Here's where the hubris argument fits. There was a sense that somehow Asia had discovered a magic formula: the perpetual growth machine. True, the governments were often authoritarian, but they offered their citizens what seemed to be a winning deal: "We'll make you rich as long as you shut up." Now the deal is in pieces. The political systems in, say, Indonesia and Singapore still won't tolerate much dissent. But the payoff is no longer there. In Indonesia, suddenly, calls are being heard for Suharto to step down. BAD CONNECTIONS When in doubt, go for clout. Billions of dollars changed hands based less on fundamentals than on personal contacts. But even that once-sure bet is unraveling. Asia' s biggest investment bank outside Japan, Peregrine Investments, was tight with some of the region's fattest cats. It gambled heavily on an Indonesian company with connections to the Suharto family. The sure thing went sour, however, and Peregrine went bust. Guanxi, as the Chinese call connections, ain't what they used to be. LOOKING THROUGH YOU How important is openness? Just ask Thailand. The baht crisis might have been manageable had Bangkok come clean early about its true financial state. But it took the Thai government several weeks to admit that it had committed $23 billion more to defend the baht than it had originally indicated. Result: the currency tanked and the regional rout was on. Investors hate surprises. TIME IS WASTING There's little to gain by delaying reforms, even if they cause short-term pain. Just look at Japan. The economy has been stagnant for seven years and is slipping into recession. There is a consensus that things need to change, but no one has the political will to push hard reforms. "There is no easy way out," says Simon Ogus, chief economist in Asia for sbc Warburg Dillon Read. "Do you deal with it quickly as the U.S. did [during the 1980s savings-and-loan crisis]? Or do you let it fester as Japan has done?" HEDGE YOUR RISK Even as the baht faced relentless pressure, Peregrine bet big-time that Indonesia's rupiah wouldn't follow suit. It lent heavily to an Indonesian taxicab company, hoping to issue Yankee bonds to spread the risk. But the currency collapsed before it could do so, and Peregrine went down. Its co-founder, Philip Tose, later said, "No one in his right mind would have even factored in" a collapse as dramatic as the rupiah's. Expect far more cautious lending in the future. DO IT RIGHT Asia's problems also trace to a fatal mismatch of financial flows. Many corporations unwisely borrowed short-term and then lent long-term. For the most part, they borrowed short-term dollars and yen and then lent out local currency long-term. Faltering economies and drastic currency devaluations made it impossible to repay those foreign-currency loans falling due. South Korea, for example, has $80.2 billion in short-term loans, including $25 billion coming due by the end of March. Many of these lessons seem obvious now. So why didn't the experts sound the alarm sooner? In part because many of the analysts who bet on Asia live in the region and have become boosters for it. More broadly, it's hard to foresee doom and gloom when the profits are rolling in. That's true with any heady price buildup: one never really anticipates the crash until it happens, despite history's plentiful warnings (think tulip bulbs and the crash of 1637). Who wants to get out of a market while it's still soaring? The Grinch who called it right early was Paul Krugman, the man Asians love to hate. Krugman, an M.I.T. economist, upset the "Asia is No. 1" school a few years ago with a brilliantly controversial essay that dismissed the idea of an Asian miracle. High growth rates weren't some inscrutable product of uniquely Asian values, he said, simply the predictable result of what happens if you throw in enough capital and cheap labor. At some point, though, the supply of those "inputs" is sure to run out. His most delicious passage compared Singapore, which views itself as a bastion of the free market, to the Soviet Union. Sure, Singapore recorded heady growth rates. But, as in the Soviet model, there were no gains in efficiency to match what the West was achieving through constant technological innovation. Funnily, one other group called it right: Peregrine. Not the investment house that went belly-up but its analytical arm, Peregrine Research (don't they talk?). A year and a half ago, experts across Asia were confronted with data showing a drop in the region's exports. Almost to a person, boosterish analysts dismissed the numbers as a mere cyclical triviality. Not Peregrine's team, which warned that a fundamental and negative shift had taken place. The yen's fall (from 80 to the dollar to about 110 at the time) had rearranged the playing field and was battering Southeast Asia's exporters. The region's glory days, Peregrine warned, could be over. Indeed, the yen's decline pushed up Asia's dollar-linked currencies, making them ripe for the devastating speculative attacks that began last summer. Asia will bounce back, of course. Picture a miracle, or more easily a tiger, in middle age--still some bounce to the step but not as fleet as before. With some luck, the economies will be revamped: bad loans written off, bad banks closed, bad projects killed. The crisis, after all, occurred because corporations and bureaucratic institutions couldn't keep up with the region's rapid change. "This is not some divine punishment for our over-indulgence, but institution-made disasters," says University of Chicago economist Merton Miller. "Until fundamental change is made in financial institutions, we are in danger of more of the same." There are plenty of lessons to be learned out there--if anyone is listening. With reporting by Rahul Jacob/Hong Kong and Ravi Velloor/Singapore
time-webmaster@pathfinder.com

The region's economic woes bring a search for explanations that can help the rest of the world avoid making the same mistakes

By ADI IGNATIUS Hong Kong

sia's financial markets may be unstable, but they aren't crazy. Just watch them operate in Indonesia, ground zero in the region's crisis, where $43 billion in International Monetary Fund aid has spectacularly failed to restore confidence. President Suharto, 76, who has ruled the sprawling archipelago for 32 years, officially announced last Tuesday that he would stick around for another five-year term. And he hinted that his heir-apparent would be a bureaucrat-crony with a weakness for pricey state projects. The market's views couldn't have been plainer: within 48 hours, the rupiah had fallen 72% to its all-time low against the dollar. And that was on top of a 70% slide since July. Says Eugene Galbraith of abn amro Hoare Govett in Hong Kong: "This is no longer a crisis of the economy but a crisis of confidence in the system."

The market's the message, and the message is: there's no end in sight for Asia's financial debacle, now dragging into its seventh month. In Thailand, the stock market is down nearly 40% since July; South Korea's has fallen 36%; Malaysia's 48%. Currencies have tumbled even faster. Daily market swings of 5%, once the stuff of front-page headlines, no longer raise an eyebrow. What's especially worrisome is that the $100 billion-plus the IMF has pledged across the region to set things right hasn't done the trick. Meanwhile, Japan, which should be pulling the region out of its slump, is foundering. After seven years in the doldrums, the world's second-largest economy has slipped into recession.

What's next is anybody's guess. The crisis is rapidly moving from the boardrooms and stock-market floors to the streets, and the specter of large-scale social unrest grows by the day. Indonesia has seen food riots in several cities, and last week Bangkok police clashed with factory workers protesting wage and bonus cuts.

How did we get here? A year ago we were supposed to be on the eve of the Pacific Century. The Asian miracle--rapid growth, social stability--was the envy of developing nations everywhere. Suddenly in July it all began to unravel. The catalyst seems almost incredible now: the unexpected weakness of the baht (the baht!). But the Thai currency's fall under speculative pressure set off a domino effect that has exposed a regionwide financial system so shaky that optimists now forecast a recession for most of Southeast Asia for the next year or two. Pessimists see a more apocalyptic denouement, in which markets in Japan, China and, finally, the U.S. come crashing down. At the least, the pain in Asia will intensify. "A lot of losses have to be taken," says Marc Faber, who heads his own investment firm in Hong Kong. "The big wave of bankruptcies normally comes one or two years after a big fall in stocks."

The search to explain the crisis often points to the hubris of Asia's business leaders, who borrowed recklessly and diversified into virtually anything that promised even faint returns (one now-bankrupt South Korean conglomerate diversified out of underwear and into construction). And they erected monuments to their own vanity--high-rise towers, state-of-the-art chipmaking plants--that couldn't possibly all make economic sense. The evidence is there for all to see: vast expanses of abandoned, unfinished towers in Bangkok or warehouses of slow-selling semiconductors in South Korea. But surely the hubris explanation is too easy. For one thing, there were legions of co-conspirators, like the foreign bankers who were impressed enough by Asia's "values" and profit margins to lend the region billions.

For a better, one-size-fits-all explanation, a simplistic, but appealing analogy has been made with Speed, the 1994 Hollywood thriller about a runaway public bus. In the film, a terrorist tampers with the vehicle, placing in it a bomb that will explode if the bus slows to less than 80 km/h. The heroes struggle against all odds to keep it forever charging safely along at that pace. The bus, of course, represents Asia. The region's "miracle" worked as long as things--inflows of capital and cheap labor and outflows of exports--were perpetually moving at a breakneck pace. In this sense, the crisis that has swamped Asia wasn't exactly unforeseen. A year ago, a chorus of voices began sounding the alarm when gdp growth dropped slightly from the 8% to 10% annual rates the region had come to expect. Said a Seoul economist at the time: "If South Korean gdp growth falls below 6%, we'll face widespread bankruptcies." A Kuala Lumpur government minister: "If Malaysia's economy grows less than 6%, we could face race riots." But almost no one predicted the meltdown that actually transpired.

It would be a mistake, of course, to count Asia out. In many ways its miracle was real, produced with authentic toil and innovation and enviable economic tendencies, like the region's fabled high savings rates. But a miracle is a tough thing to sustain. To try another analogy, Asia's fast-growth economies became something of a Ponzi or pyramid scheme. Rapid expansion depended on big infusions of capital, which meant building up large debts. As long as mega-growth continued, profits were high and companies could repay their obligations. Further loans were issued and the cycle continued. But when the system showed even the slightest signs of cracking (the baht!), it all crumbled. As in a Ponzi scheme, once the system breaks the game is up.

Asia now is struggling to reform its economies, even as its markets continue to tumble. Some of what's happening is fairly encouraging, as a few corporations restructure themselves and as leaders push reforms that had been delayed for too long. In South Korea, the government has relaxed regulations on foreign ownership of companies. In Thailand, the government has forced several rotten lending companies to shut down. And in Indonesia, President Suharto has even agreed to strip some--though not all--of the special business concessions his children enjoy.

The light at the end of the tunnel hasn't appeared, however. And it isn't clear whether the IMF and its prescriptions are making things better or worse. The consensus view is that Asia's woes will knock a percentage point off global growth this year. And things could get worse, much worse, if the contagion spreads north from Hong Kong. China has been mostly unaffected by the crisis to date, in part because its currency isn't fully convertible. But China's banking system shares some of the rot evident elsewhere, so it may be only a matter of time before the world's most populous nation gets dragged down too. And if China decides to hone its export competitiveness by devaluing the yuan, the crisis will enter a new, devastating second round.

There are a few lessons to be drawn:

WHAT GOES UP COMES DOWN This is so obvious it's almost ridiculous to note. But Asia was truly intoxicated with yearly gdp growth levels that until recently approached double-digit levels consistently. Malaysia, which had enjoyed nine straight years of at least 7% growth, thought it could sustain that rate until the year 2020. And almost no one thought they were crazy. Job creation was viewed as a given. Says Thierry Poux, Singapore-based regional head of a worldwide job-search agency: "To some in this region, unemployment is something they have never known."

IT'S ONE WORLD, BABY The laws of economics apply to Asia too. Here's where the hubris argument fits. There was a sense that somehow Asia had discovered a magic formula: the perpetual growth machine. True, the governments were often authoritarian, but they offered their citizens what seemed to be a winning deal: "We'll make you rich as long as you shut up." Now the deal is in pieces. The political systems in, say, Indonesia and Singapore still won't tolerate much dissent. But the payoff is no longer there. In Indonesia, suddenly, calls are being heard for Suharto to step down.

BAD CONNECTIONS When in doubt, go for clout. Billions of dollars changed hands based less on fundamentals than on personal contacts. But even that once-sure bet is unraveling. Asia' s biggest investment bank outside Japan, Peregrine Investments, was tight with some of the region's fattest cats. It gambled heavily on an Indonesian company with connections to the Suharto family. The sure thing went sour, however, and Peregrine went bust. Guanxi, as the Chinese call connections, ain't what they used to be.

LOOKING THROUGH YOU How important is openness? Just ask Thailand. The baht crisis might have been manageable had Bangkok come clean early about its true financial state. But it took the Thai government several weeks to admit that it had committed $23 billion more to defend the baht than it had originally indicated. Result: the currency tanked and the regional rout was on. Investors hate surprises.

TIME IS WASTING There's little to gain by delaying reforms, even if they cause short-term pain. Just look at Japan. The economy has been stagnant for seven years and is slipping into recession. There is a consensus that things need to change, but no one has the political will to push hard reforms. "There is no easy way out," says Simon Ogus, chief economist in Asia for sbc Warburg Dillon Read. "Do you deal with it quickly as the U.S. did [during the 1980s savings-and-loan crisis]? Or do you let it fester as Japan has done?"

HEDGE YOUR RISK Even as the baht faced relentless pressure, Peregrine bet big-time that Indonesia's rupiah wouldn't follow suit. It lent heavily to an Indonesian taxicab company, hoping to issue Yankee bonds to spread the risk. But the currency collapsed before it could do so, and Peregrine went down. Its co-founder, Philip Tose, later said, "No one in his right mind would have even factored in" a collapse as dramatic as the rupiah's. Expect far more cautious lending in the future.

DO IT RIGHT Asia's problems also trace to a fatal mismatch of financial flows. Many corporations unwisely borrowed short-term and then lent long-term. For the most part, they borrowed short-term dollars and yen and then lent out local currency long-term. Faltering economies and drastic currency devaluations made it impossible to repay those foreign-currency loans falling due. South Korea, for example, has $80.2 billion in short-term loans, including $25 billion coming due by the end of March.

Many of these lessons seem obvious now. So why didn't the experts sound the alarm sooner? In part because many of the analysts who bet on Asia live in the region and have become boosters for it. More broadly, it's hard to foresee doom and gloom when the profits are rolling in. That's true with any heady price buildup: one never really anticipates the crash until it happens, despite history's plentiful warnings (think tulip bulbs and the crash of 1637). Who wants to get out of a market while it's still soaring?

The Grinch who called it right early was Paul Krugman, the man Asians love to hate. Krugman, an M.I.T. economist, upset the "Asia is No. 1" school a few years ago with a brilliantly controversial essay that dismissed the idea of an Asian miracle. High growth rates weren't some inscrutable product of uniquely Asian values, he said, simply the predictable result of what happens if you throw in enough capital and cheap labor. At some point, though, the supply of those "inputs" is sure to run out. His most delicious passage compared Singapore, which views itself as a bastion of the free market, to the Soviet Union. Sure, Singapore recorded heady growth rates. But, as in the Soviet model, there were no gains in efficiency to match what the West was achieving through constant technological innovation.

Funnily, one other group called it right: Peregrine. Not the investment house that went belly-up but its analytical arm, Peregrine Research (don't they talk?). A year and a half ago, experts across Asia were confronted with data showing a drop in the region's exports. Almost to a person, boosterish analysts dismissed the numbers as a mere cyclical triviality. Not Peregrine's team, which warned that a fundamental and negative shift had taken place. The yen's fall (from 80 to the dollar to about 110 at the time) had rearranged the playing field and was battering Southeast Asia's exporters. The region's glory days, Peregrine warned, could be over. Indeed, the yen's decline pushed up Asia's dollar-linked currencies, making them ripe for the devastating speculative attacks that began last summer.

Asia will bounce back, of course. Picture a miracle, or more easily a tiger, in middle age--still some bounce to the step but not as fleet as before. With some luck, the economies will be revamped: bad loans written off, bad banks closed, bad projects killed. The crisis, after all, occurred because corporations and bureaucratic institutions couldn't keep up with the region's rapid change. "This is not some divine punishment for our over-indulgence, but institution-made disasters," says University of Chicago economist Merton Miller. "Until fundamental change is made in financial institutions, we are in danger of more of the same." There are plenty of lessons to be learned out there--if anyone is listening.

With reporting by Rahul Jacob/Hong Kong and Ravi Velloor/Singapore