The Great Taiwan Bubble Chapter 2

The Great Taiwan Bubble By Steven R. Champion Chapter 2:Bull Market Dilemmas

People

in

educational

Taiwan

system

are

churns

not

out

fools.

literate

The and

country's technically

competent graduates many of whom go on to study business or engineering at graduate school in the United States and then stock the Research & Development staffs at places like the Bell Labs, Hewlett Packard, and Intel.

This first

class educational system, the native intelligence of the people, and the country's dependence on export markets for revenues

has

led

to

the

development

a

surprisingly

sophisticated and internationally minded population. As stocks continued to roar upward, some of the more detached

and

reflective

members

of

the

country's

cosmopolitan elite began to sense that the massive bull market was starting to have a profound effect on society. All the new wealth and unrestrained animal spirits that the market generated were blinding the vast majority of players to

the

risk

that

the

bubble

would

burst

and

that

the

valuation of Taiwan assets would decline to somewhere near those levels common in the rest of the world.

It was

obvious to many that the effects of the bubble's bursting could

lead

down

some

very

unpleasant

roads,

drastically

altering the comfortable lives that people were becoming accustomed. Perhaps the people most acutely aware of the dilemma created

by

the

market

bubble

were

the

generally

knowledgeable and prudent government officials assigned to the

Central

Securities

Bank, and

the

Ministry

Exchange

of

Finance,

Commission.

and

the

by

the

Guided

Confucian ideal, Chinese society accords great prestige to a career in government service, and, despite the relatively low wages, many extremely able professionals work in these government agencies. exclusively universities,

These powerful bureaucrats are almost

graduates and

a

of

Taiwan's

majority

holds

top, advanced

meritocratic degrees

in

economics or finance from American graduate schools. Many of the older, more senior officials witnessed the economic and military disaster in Mainland China in the late 1940's when the Kuomintang government was forced to retreat to Taiwan.

In their last years on the Mainland the

economy was out of control and the currency was debased by one of history's great runaway inflations.

The lessons

learned

controllable

in

this

debacle,

the

much

more

situation in Taiwan, and forty years of one party (some might have said one family) control of the government had created a favorable situation for a conservative national financial policy, with a preference for equity investments rather than borrowing at the macro level, and had laid the foundations for Taiwan's economic miracle. A senior government official might have thought but not dared to publicly express himself as follows with the market run amok: "The stock market is wildly overvalued by world standards and must inevitably crash. The people who will be hurt the most are the unsophisticated, small investors who have gotten in late and who won't get out soon enough. It is my duty to protect these people. A market crash may ignite a liquidity crisis and even bank runs causing major

damage to the economy that we have worked so hard to develop. This will harm the country, and it is my duty to prevent this from happening. Securities regulations are being routinely broken every day, and these abuses are contributing to the berserk results of the bubble market. It is my duty to enforce the law." "On the other hand, any actions I take may effect investor confidence and hasten the inevitable crash.

Then, investors and the pesky opposition will blame the

government, the Kuomintang, and me, personally, for the disastrous results. Mobs of ruined speculators have rioted in the streets before, and I don't want them rioting in front of my house. Maybe I shouldn't be too hasty. Also, if we start to enforce the law now, I'll be stepping on the toes of important people, legislators and senior party officials, who are in the securities business or who have leveraged plays in the market. Besides, the stock transaction tax is now the government's most important source of revenue, and, without it, we would be running a bigger deficit. I'd better be careful what I say. I want to get promoted and to eventually enjoy a sinecure as the chairman of a government controlled bank. I can't afford to make waves." However

profound

the

misgivings

of

government

officials may have been, people with their own money on the line sensed the dangers posed by the bubble market in a less detached, more personal way.

They had to balance

their

of

detailed,

companies

objective

were

knowledge

really

worth

just

against

what

the

their

personal

consequences of a rational decision to sell out and go lie on the beach somewhere until things returned to normal. My

old

Horace's

friend

father

had

Horace come

had to

a

very

Taiwan

personal

as

a

dilemma.

refugee

from

Shanghai just before it fell to the advancing Red Army in the late '40's. and

excellent

In Taiwan, he put his commercial knowledge connections

to

work

and

founded

several

important companies in league with some of his old pals from

the

mainland.

No

expense

was

spared

in

Horace's

upbringing,

and

he

received

a

first

rate

education

in

Taiwan and later at graduate school in the United States. Following his father's death, Horace returned to Taiwan to run the largest of the family companies and serve on the boards of a few of the smaller investments.

He ran the

business well, and, although he would be the first to admit that he was more than a little henpecked by his overly Americanized Tai-Tai hsiao

hsing

hostesses

2

1

wine

and

, he enjoyed the dinners laced with

and

Madam

the

flirtations

Boom-Boom's

slim,

with chi

wine pao

house

3

clad

“assistant managers” that were the lot of a privileged lao ban 4 . Horace was sophisticated and internationally minded, and

well

barrier,

before he

knew

the he

market had

a

burst

problem

through on

his

the

12,000

hands.

His

company, a $50 million producer of electronic components, had a near monopoly position in its major market niche and was able to earn handsome financial returns by anyone's standards. from

He had recently obtained world-class technology

Europe,

and

there

seemed

to

be

no

clouds

on

his

financial horizons. Horace had no interest in setting the world on fire, and he was content to drift along with the serenity of his life only occasionally marred by brutal hsiao hsing induced hangovers and his wife's nagging about his late hours and the faint whiffs of sulfur fumes sometimes evident on his 1

Tai-Tai is a polite expression for one's wife.

2

Hsiao-shing wine is a popular rice wine in Taiwan. It is often served heated and flavored with lemon or plums.

3

A chi-pao is a form-fitting, high collared Chinese gown, which is often slit up the side.

4

A lao ban can be translated as "boss." In Taiwan, this term, rather than the "tai-pan" of potboiler fiction, is the preferred usage. Tai-pan (or da-ban in conventional Mandarin) is a title reserved for first level supervisors of taxi dancers.

undergarments. 5 company's

This idyll was interrupted one day when his

limited

share

float

and

relatively

low

market

capitalization attracted "Big Ears" Wu and his boys, who put the stock in play with predictable results. One

night

during

dinner

at

one

of

Taipei's

most

opulent Cantonese seafood restaurants, featuring expensive dishes like shark's fin, bird nest soup, abalone, bear's paw, and lots of XO brandy, Horace ran through his dilemma for me, which I will paraphrase. "My stock is selling at NT$250 per share, more than 200 times this year's earnings, and that means that, according to the market, the company is worth just about US$1 billion. This is crazy. I know what the company is worth. I know what our budget and order book look like. I know what our corporate assets are worth in the market. I may have slept through business school, but I know something is drastically wrong. I should sell every single share I own in the company right now and retire. Maybe I could use the proceeds from my shares to buy one of the smaller New England states or a county or two in California. Who needs to work! If I get bored, I can always buy the company back when the price comes back down out of the ionosphere." "On the other hand, my father did start this company and it meant a lot to him. We must have fifty of his old pals from Shanghai on the payroll, and, if I sell out, what happens to them? I guess, I'd have to resign from the company and the board. That would be the end of my excuses to go out on the town for "business" dinners with my friends. Who knows, my wife might even begin pestering me about moving back to the States. Maybe things are OK as they are. Even if my stock price drops back to where it was three years ago, I'll still be rich, and I'll still be able to gan bei 6 with Fei-Fei and Ping-Ping 7 as often as I want. I'd better think this through." 5

Certain of the famous hot springs in Peitou feature Japanese style group bathing facilities where the water has a high sulphur content.

6

Gan bei means "bottoms up !" and is a common toast at dinner parties.

7

Fei-Fei and Ping-Ping are common "flower names" in Taipei's willow world.

Horace, who saw it all coming and just dithered, was right. come

out

No matter what happened, he was likely to always without

major

problems.

His

company

was

un-

leveraged and liquid, and he personally stayed away from the market.

Sure, he might lose some paper profits, but

his financial and professional future was secure.

Others

were far more exposed financially and professionally. Driver Lu, who was seemingly at the opposite end of the financial spectrum from Horace, carried himself with the pride one usually associates with a Marine sergeant, and he had the spit-and-polish personal appearance and cando attitude that went along with the image.

Driver Lu's

chosen role in the world was to take our bank's manager to and from work each day, and do anything else the lao ban asked him to do, as quickly, efficiently, and safely as was possible under the circumstances. One morning shortly after my arrival in Taipei as a lowly lending officer, our branch manager, who was both a good banker and a nice guy, asked Driver Lu to pick me up at home in the morning and then to come get him at 8:00 a.m. for the ride into the office. Driver Lu showed up at my house with time to spare for the short ride over to pick up our boss, but an unexpected traffic jam 8 delayed us, and we were in danger of missing what to Lu was the sacrosanct eight o'clock deadline if things didn't improve quickly.

Sensing a stain on his

reputation was in the offing, Lu detoured down an obscure one lane country road which was elevated a foot or two above the flooded rice paddies that stretched out on either

8

Traffic jams in 1976 were unexpected !

side. 9 .

Lu pressed the accelerator of our mammoth American

car

the

to

floor,

and

I

noticed

that

the

speedometer

stabilized at seventy miles per hour as we roared down the narrow lane. Traveling at this speed on that road began to fill me with dread, which turned to alarm when I saw a huge German shepherd standing in the road about a quarter of a mile ahead of us.

The giant beast apparently sensed that we

were somehow or other encroaching on its territory and was aggressively pawing the pavement and snarling at us as we rapidly approached.

Quietly feeling around the naugahide

interior of the car for its non-existent seat belts, I waited for Lu to hit the brakes and hoped that we did not slide off the road into the fetid muck of the paddies, which could have had several possible results, all most unpleasant. Driver Lu, to my surprise, showed no signs of slowing down whatsoever, and the speedometer remained steady at 70. The dog was going berserk with rage as we continued to approach,

and

it

was

only

when

we

were

actually

close

enough for me to see the foam at the animal's mouth that it finally realizes that Lu was totally unimpressed with all the snarling and had no intention of slowing down, much less of stopping. Lu

accelerated

ever

so

slightly

just

before

the

impact, and I will never forget the bewildered expression on the German shepherd's face just before it was pulverized by the 5,000 pound Detroit behemoth.

The dog must have

finally flinched just before we struck it because it was 9

While much of the Taipei suburb of Tien-mu has changed beyond recognition, this one lane road can still be found.

dragged

under

the

speeding

auto,

and

I

heard

several

distinct bumps as its body was violently bounced between the

rock

hard

surface

of

the

road

unforgiving underside of our car.

and

the

equally

When we finally passed

over the unfortunate canine, its body was spun about twenty feet

into

the

air

before

the

gory

mass

of

blood,

fur,

gristle, and bone landed on the surface of the little lane with a splat. I was far too stunned to speak, and Driver Lu seemed not to have even noticed the collision due to his exclusive focus on picking up the lao ban at exactly the appointed hour.

As we approached our destination, Lu slowed down to

a dignified pace, turned around in his seat, and said to me with a pleasant smile, "Seventh one this year, Sir."

I

believe that it was early March at the time. After my promotion to branch manager, Lu became my driver, and I learned to appreciate his focused approach to life in many ways.

Fortune was good to Driver Lu, and he

was most surprised to inherit just under the equivalent of $1 million as his share of the disposition of some land held in his family for generations.

Following my move to

another company in Taipei, which already had a driver, Lu retired from the road. After experiencing a slight case of ennui, Lu teamed up with a former motorcycle messenger from the bank, who was now a senior brokerage official, and started play the market.

I saw Lu coming out of a VIP room of a decidedly

down-market brokerage house just after the TSE index had broken 11,000, and he invited me in for a chat.

The room

had a Japanese theme, and after we seated ourselves on the tatami mats and were served tea by a kimono clad attendant,

Lu gave me his current views on the market and on life in general. "The market is like magic! My grub stake of $1 million has grown to over $5 million thanks to the advice of our former colleague, Elbert. I've been to the States and Europe over the last few months with some great local tour groups. I just bought the TaiTai a diamond-encrusted Rolex, and I'm buying a small place in LA for my son to stay in while he studies taxidermy there. I know some people think the market might fall out of bed, but they just don't understand Taiwan. It's just like Japan, sir. I think the market's going to 20,000; after it does, I'll think about trimming my positions a bit. Right now I'm margined to the hilt and loving every minute of it." "On the other hand, I know that there are some people who have gone a bit overboard, and I've noticed that none of the companies whose stock I hold were clients of the bank. I've really just won a lottery, and maybe I should sell out and enjoy the rest of my life at ease. I've come a long was from being a driver, and I don't want to lose it all." One of those who knew that his professional life was at risk was my American friend, Irving, the highly regarded and

urbane

Taipei

branch

manager

of

a

New

York

based

international bank.

Traditionally, the way to the top in

Irving's

was

go-go

bank

lending

vast

sums

of

money

to

borrowers who could just barely pass the snicker test, book the profits through the magic of the accrual system of accounting, and then move on to a bigger, higher paying job before it all hit the fan.

Irving had worked this magic

several times before, barely missing the collapse in the international shipping business in his last assignment, and now knew that he only had to pull it off one more time before he landed what he hoped would be a secure senior job back in his head office. Swathed in his Hong Kong tailored suit which he had cut in a somewhat affected, vaguely British style, Irving

displayed all the outward trappings of success the day we met for lunch at the Bankers Club, but a closer inspection showed him to be pale, red-eyed, and seemingly hung-over. As he spoke, a slight facial tick appeared and became more pronounced as he continued.

His monologue went something

like this: "We had a customer dinner with Lucky Dragon Computer and Storm Door Co. last night. Man, "Big Boss" Hu can really knock back the hsiao hsing wine. He and his gorillas, whose only jobs seem to be getting their bankers drunk, must have toasted with me a hundred times. Today, I'm in real pain, but it's worth it. Lucky Dragon is our most profitable account, and I need to keep them happy. You know, they aren't making a cent in the computer business these days, and they phased out storm door production last year due to the appreciation of the NT dollar." "Luckily, they're redeveloping the old Tao Yuan plant into a theme park, and old Hu has been making a killing in the stock market. Our lines of credit, of course, are really supposed to be used to finance inventory and receivables. We all pretend that this is the case, but everyone knows that Hu uses the money in the market. Things are so crazy in the stock market now that I really should cut him off and get our money back. Any idiot can see that market's going to crash eventually, and, if it does, how will we get repaid? A bad loan now would ruin everything. I've got a lot riding on this." “On the other hand, if I'm going to make budget this year, I need the income from Lucky Dragon. The interest spreads are great. If I don't lend old Hu the money, he can get it just as easily from Crazy Lyonnais or one of the other banks. In fact, they only borrow from us because I go out drinking and carousing with them once a month. I'll talk to Hu and see if I can get him settled down a bit. I'm due for a transfer in another six months. Things should be all right that long. Look how long all this craziness has already been going on." I truly sympathized with Irving and knew that he was in a no-win situation.

Hoping to change the subject, I

asked him what time the dinner broke up and whether or not he was able to get a decent night's sleep the night before. While well intentioned, I had obviously asked the wrong question since Irving visibly winced, and I could tell that the bile was rising up in the back of his throat. closed

his

bloodshot

eyes,

for

a

minute

and

He asked

sheepishly, "Have you ever heard of Madam Boom-Boom...?" At this point, I think that I should concede that I was not merely a detached and somewhat amused observer of the bubble market and the problems it was causing, nor was I exempt from a certain amount of market induced anxiety. I had stumbled into Taiwan's stock market just as it sat at its then all-time high of 999 in late 1986 after working for several years as a banker in Taipei.

Even then, with

the wave of mid-'80's corporate bankruptcies still fresh in my mind, I suspected that the market rally had gone too far and had scoffed when my predecessor 10 had predicted that the market could rise another 20% in 1987. I was responsible for running he largest of the four investment trusts that had been originally set up to funnel foreign investments into the Taiwan market and which had by then

begun

market.

developing

investment

products

for

the

local

I was new to the investment management business,

but I sensed that, despite my doubts about the level of market prices, I was being paid to buy stocks not to hold cash.

It took a great intellectual leap to suppress my

native Midwestern financial conservatism, but I jumped into the market and soon found myself buying shares in companies that I would have been fired for lending money to only months 10

before.

Luckily,

as

The now famous Mark Mobius of the Templeton Group.

we

have

seen,

the

market

cooperated by going through the roof, and the net asset values of our funds ratcheted up with it. By early 1990, the market had reached heights that were unimagined a few years before, and I was acutely aware that the market was a house of cards that could collapse at any time. debates

As about this time, I was having daily mental

about

how

I

should

deal

with

this

very

touchy

problem, which went along the following lines: "The market has gone up by a factor of 12 in the last three years and is absurdly overvalued by all reasonable standards. There is no conceivable way that the underlying corporate cash flows associated with these shares can possibly support today's prices. No market in history has ever sustained this kind of a valuation level, and it's clear that sooner or later the market is going to crash. It's just a matter of time. We have more than $700 million invested in the Taiwan market, and this represents real money. Investors in our funds will see their capital destroyed when the crash finally comes, and my primary responsibility is the preservation of our clients' capital. I should sell stocks now for one hundred cents on the dollar and put the money into cash and top rate money market instruments. The yields are low, but safely of principal is the thing to focus on right now. It's time to ignore the crowd and do what I think is best." "On the other hand, if the market keeps going up while I have the portfolio in cash, investors in our funds will scream. I'm being paid to invest in the market, not hold cash. If our investors want cash, they can sell their shares. They are the ones who have decided to get into this crazy market, not me. Anyway, the market may go to 20,000 or 25,000. Once you're beyond the limits of logic, there's no telling where the market will go. I guess that 12,000 isn't really any crazier than 8,000 and that 20,000 wouldn't be any crazier than where we are today. A market is either crazy or not crazy; it can't be double or triple crazy. plugging."

I'd better take a few precautions, but basically just keep

I wasn't the only one who recognized that he had a problem, but we were a pretty small group. country's

financial

elite,

the

Even among the

conventional

wisdom

that

Taiwan was unique and that the market simply couldn't crash prevailed with a vengeance.

Most perverse of all, many of

Taipei's financial professionals were most nervous when the market bolted through the 1,500 and 2,000 levels, but got calmer and calmer as prices went into the stratosphere. Just as the market was precariously balanced at the 12,000 level, I was invited to a dinner party held in the private dining room of one of Taiwan's largest, government controlled banks.

The guest of honor was a very senior

American banker on one of his regular runs through Asia. As

the

twelve

course

meal

progressed

and

as

toasts

of

warmed hsiao hsing wine were ritually exchanged, several of the

stalwarts

basked

in

of

their

the good

country's fortune

financial

and

swapped

establishment stories

about

their recent market coups. The visiting American had been hearing about nothing other

than

how

the

stock

market

had

become

Taiwan's

infallible, unstoppable machine of wealth creation during his short stay on the island and really didn't know if he should be appalled or amused.

Having good manners and a

genuine regard for his hosts, some of whom he had known for thirty years, he made a few remarks suggesting that the market

seemed

overvaluation. outlandish

to

be

exhibiting

signs

of

extreme

He offered some amusing examples of the

valuations

of

several

listed

companies

and,

using great care in his choice of words suggested that the market might be in for a "correction."

Many of the local bankers exchanged pained looks, they

had

responded

heard with

all

this

polite

and

a

hundred

bland

times

before

generalities.

-

At

but this

point, a very senior and intellectually intimidating lady banker whispered dismissively in Chinese to a colleague who sat between us that "foreigners just can't understand our market!" That seemed to sum it all up.

The emperor wore no

clothes, and it was seemingly the height of bad manners to comment on it.

How had a country that had boot-strapped

itself out of nowhere allowed itself to risk its precarious success on the thin outer edge of a monstrous financial bubble?

To

get

a

better

grip

on

understanding

this

question, we need to step back a bit and look at events from a wider perspective and over a longer term.