Wanna Buy A Miracle?
20 October 1997
It's about time that we recognized that the real fools this year have been western investors

The reasons for the crash of Southeast Asian currencies and stock markets, by now, are well understood. Asians are paying the price for their mistakes learning their lessons. But what about the movers and shakers of the global financial markets? They too have lost a great deal of money, but one doubts if they even know they have lessons to learn.

In December 1996, when Alan Greenspan spoke of "irrational exuberance," he was referring to American equity markets. He should have been talking about the stubborn fascination of Western investors in the so-called "emerging markets", especially Asian ones. In 1996 one third of all foreign direct investment went to the developing world, two-thirds ($81 billion) of which went to Asia. While American and West European markets have risen 20-25 percent in the past year, Southeast Asian markets are down 30-35 percent and their currencies are some 20 percent lower against leading European and American ones. We know why Asians were so enthusiastic about their own markets, but why were foreigners even more foolish in not keeping their money at home?

There is something frighteningly herd-like in the behaviour of markets. Stampedes tend to gather unthinking cattle when the destination is something alluring like an "Asian miracle". It is not surprising that officials should hype their countries* prospects in order to attract foreign investment. What is persistently astounding is the ability of bright minds in New York, London and Frankfurt not only to believe the hype, but to inject even more hot air. Proof? On April Fools Day in 1994 one joker in the Hong Kong stockmarket was swamped with offers from clients wanting his shares in Bhutan Dry Docks. (Bhutan is a landlocked statelet without a stock exchange.)

Fund managers, instead, might remember some unspectacular truths. There is no such thing as a *miracle* economy, or even an "emerging market." There are just specific countries with good policies and specific companies with good prospects. Some countries succeed because they adopt good policies and invest wisely (Singapore, Taiwan). Some succeed for a while because their less effective policies are obscured by hype about miracles (Thailand, Malaysia, and Indonesia). Markets, in the past, have treated authoritarian and closed countries with the same respect as the liberal democracies of the Atlantic world. That makes no sense. Senior analysts with the IMF as well as American and European investment companies in Southeast Asia will tell you (privately) that they knew that Thailand, Malaysia and Indonesia were risky bets, but to speak publicly would be to lose access to corrupt and autocratic rulers.

The failure of Westerners to demand greater transparency in emerging markets still hampers a full assessment of what went wrong this year. The IMF rescue package for Thailand, for example, should require far more openness about the cronyism and catastrophic investments that sparked the crisis. Providing similar support for Indonesia will also need to be accompanied by far tougher rules unless someone still believes the once-trendy Asian mantra about "Asian solutions to Asian problems."

Perhaps above all, those in the markets need to learn a little patience. There's not much to be said for dashing from one disaster to another. Barely three years after the Mexican crash, the same people who lost money in Southeast Asia are now turning their attention to Latin America. For the first time in more than a decade, emerging market funds now hold less money in Asia than in Latin America. Don't expect the Western market mavens to be any more successful there--Latin America, after all, is where they used to lose their money before they discovered Asia. Autocratic behaviour, crony-capitalism, opaque markets and rapidly inflating hubris are all in place in Latin America markets just as they were in Asian ones.

It should not be very hard to draw lessons from these trends. Malaysia's Prime Minister Mohamad Mahathir may be going too far when he describes George Soros and other Western financial gurus as "morons." But Mahathir is right to identify irrational aspects of market mechanisms. This is probably an incurable but not fatal illness in the global economy. Coping with it, at least in the short term, has three specific implications.

First, watch out for China hype. With Japan still in the recovery ward and Southeast Asians still among the walking wounded, "Asian miracle" folk will turn to China's supposed ability to defy economic laws. For the record, few Western companies make money in China. There is even less credibility in Chinese economic statistics than there was in the now discredited Thai, Malaysian and Indonesian numbers. Second, distrust those who think in terms of regions and regional prospects. Asia exists neither as an economic unit nor as a source of *solutions* to "problems." As a corollary, don't believe South Americans who hype the management skills of Mercosur or Europeans who tell you they know what they are doing in creating a single currency.

Third, take another look at European and North American markets, however irrationally exuberant they sometimes seem. Ask the sobersides who look after our pensions. Some 97 percent of investments by American and European pension funds are in their own markets. If everyone else paid 3 percent of their attention to emerging markets, the hype might deflate enough for those countries to grow more securely.


Segal is the Director of Studies at the International Institute for Strategic Studies in London.