From Asian to Global Financial Crisis: An Asian Regulator's View of Unfettered Finance in the 1990s and 2000s

When I choose a particular book to read, I usually make sure the Author really knows his subject. For example, I try to pick books written by Warren Buffet himself rather than someone who is interpreting his thoughts. Similarly, the last few books which I have posted are something like autobiography. Therefore, when I was interested to read about the Asian financial crisis and how it relates to the crisis of 2007/2008, I was hoping to read the experience of someone in the eye of the storm rather than some academics or critics who may not understand the uniqueness of Asians. I believe we are always biased by our upbringing, education background, families, friends, etc. As such, I was very happy when Andrew Sheng decided to write about the Asian financial crisis. Andrew Sheng is the ideal candidate to write about it given his experience in Hong Kong, China and Malaysia and the book will be handy as a source of reference and also to remind us not to keep repeating history itself.

Some of the key points which I gathered from the book are briefly summarised below:

1) Ultimate test of economic success is not natural resource endowment or geography, but the quality of governance (The turmoil experienced in some of the richest natural resource countries such as the middle east highlights this point. In fact, there is a term for such a situation, the resource curse).

2) The stronger the yen, the more Japan would transfer production to its cheaper neighbours and lend or invest in the region to prevent further yen appreciation. The more liquidity and investment inflows, the more the Asian economies boomed, because they were on a 'soft peg' to the U.S. dollar. On the other hand, the reverse situation would occur if the yen were to depreciate.

3) The Japanese asset bubbles were identical to other asset bubbles in the sense that they were essentially inflated by credit. (This is an important lesson. Bottomline is, whenever, there is easy money, there will be bubbles. In layman's term, if we start hearing mega projects or billion dollar seems like spare change, it means that there is easy money everywhere. You think it is easy to finance billion dollar projects if there is no easy money?)

4) ........potential volatility due to sudden swings in the reversal of the carry trade would remain one of the key vulnerabilities of the Asian global supply chain.

5) ......beam in our eyes, seeing what we choose to see or what we are trained to see, and we may ignore the most important details. (One of our major weaknesses. I would recommend mixing with people of different background and perspective in order to reduce the effect of "beam in our eyes").

6) 'Never let monkeys look after bananas'

7) The other problem with modern education and technical training is that we have created silos of specialists, each arguing with each other from their own specialization and narrow points of view.

8) The Asian crises followed the topography of a Minsky-Kindleberger model of financial crisis that goes through roughly five stages - displacement, monetary expansion, overtrading, revulsion and discredit.

9) The irony is that at or near the top of the boom, irrational exuberance and greed are such that hardly anyone questions Ponzi financing behaviour when it emerges.

10) ......loose monetary policies, excessive global liquidity and low interest rates create bubble conditions. (I have highlighted in a few previous postings that I believe Malaysia is currently experiencing a property bubble. We certainly have the ingredients where banks are aggressively marketing housing loans coupled with low interest rates two years ago. But now, we are seeing a steady rise of interest rates and the next stage will see the euphoria slowing down before a painful plunge. Well, that is my opinion)

11) The Thai explanation of the crisis may be centred on two broad areas - excessive private sector debt and mistaken policy decisions, the former somewhat encouraged by the latter.

12) In a financial panic the central bank must lend freely at penalty interest rates against good collateral. But the central bank cannot exercise the role of lending freely during a currency attack, particularly in trying to defend a fixed exchange rate. In a situation of open capital flows, the only defence of a fixed exchange rate is through higher interest rates. However, if the corporate sector is already overleveraged and the banking system fragile, then raising interest rates is in fact no defence. Higher interst rates would only worsen the financial position of the corporate sector and the banking system, leading also to bank runs.

13) .......central bank cannot defend both a currency attack and a bank panic at the same time.

14) Clean politics is wise politics.

15) To avert a crisis, monetary policy must strike a correct balance between these three elements [exchange rate regime, domestic interest rates and the control of capital flows into and out of a country]. (Easier said than done. One of the biggest obstacles for regulators is the interference of politics. As we know, once politics interfere, whether it is in public governance, education or finance, the results are usually disastrous).

16) Pride comes before a fall.

17) For nations to grow stably, their industrial base must be supported by a sophisticated financial system with good risk management and strong governance.

18) Amongst investors familiar with Asian markets, two important indicators point to irrational exuberance. The first is the amah (domestic maid) syndrome. When amahs get into the market, that is the time to get out.

19) The second systemic indicator is when businessmen begin to neglect their businesses and begin to punt heavily in the market.

20) Tan Sri Noordin: "During a crisis, don't deal with all problems. Deal only with the top three".

21) Walter Bagehot's dictum states that in a banking crisis the central bank must lend freely against good collateral.

22) China's rapid growth in the last 25 years is a demographic endowment, with a large increase in the working age population. (Can this last forever? Refers to China's working age population chart below).

23) If their (China) nominal exchange rate remains unchanged, then there will be a danger of asset bubbles forming in the stock and real estate markets.

24) .........from historical experience that all crises are inevitable - it is a matter of when and how serious. (My personal opinion is that an asset bubble crisis would hit Asian countries soon starting from China).

25) A fundamental problem with the world of financial derivatives is that neither regulators nor market participants have a good handle on how much true leverage exists in the system and consequently how much capital is necessary. The embedded leverage in many derivative products magnified the impact on market volatility.

26) Keynes: 'A conventional valuation which is established as the outcome of the mass psychology of a large number of ignorant individuals is liable to change violently as the result of a sudden fluctuation of opinion due to factors which do not really make much difference to the prospective yield; since there will be no strong roots of conviction to hold it steady'.

27) Minsky's Financial Instability Hypothesis holds that over a run of good times the financial structure evolves from being robust to being fragile.

28) The fallacy of composition, by which market participants erroneously assume that what they believe is true based on partial information is true for the market as a whole, was prevalent in both the Asian and current crises. Market participants acted on partial information, and their collective herd behaviour created market overshooting or undershooting.

29) Military strategists appreciate that ground conditions are continually changing and that strategic resources cannot be stretched too thinly. For best effect, they must be concentrated and used against a chosen sector with the greatest effect. They remember all too clearly that it is most dangerous when all is quiet on the Western Front. Likewise, financial regulators have to learn to recognize that dangerously low-risk spreads and low volatilities, coupled with fast-rising markets, are usually precursors to crisis.

30) A routine execution of current processes without examining outcomes is likely to lead to process for process' sake.

31) ......no financial structure is strong unless the real economy is strong.

32) .......crisis is ultimately political in nature.

33) Ultimately, all financial crises are crisis of governance.

In summary, this book is a good source of reference for an overview of the Asian Financial Crisis and how it relates to the 2007/2008 global financial crisis. Andrew Sheng's in-depth knowledge of Asian financial system has enabled him to analyse each countries' weaknesses from South Korea to Malaysia.

Here, to support my opinion that Malaysia and China is on the verge of another crisis which will be triggered by collapse of the property sector, I would like to offer my two-cents worth of opinion. First, I would like to draw the readers' attention to the first figure below:

From the figure above which was sourced from the National Property Information Centre (NAPIC), it shows that the total value of property transactions in Malaysia reached a record of RM107.44 billion in 2010. From the chart above, doesn't it look like it is due for a correction sometimes in 2012?

The next figure is on the working-age population (ages between 15 and 64) as a percentage of total population which was shown by Andrew Sheng in his book. What I find interesting is the good correlation between Japan's stock market reaching its peak on Dec. 1989 and the subsequent property collapse with the decline of Japan's working-age population. Based on UN's projections, will we see similar problems with China soon? Looks like 2012 may be an important year but I certainly hope it is not apocalypse. How about Malaysia? Looks like 2020 is a very important year for Malaysia after all.

Have a good weekend and for those celebrating Duanwu festival, enjoy your dumplings!