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How the Asian financial crisis led to today’s debt binge

Former hedge fund analyst Steve Clapham on how today's problems were sown in Asia in the 1990s
How the Asian financial crisis led to today’s debt binge

I haven’t been writing for Investors' Chronicle for very long so to say it’s unusual to be reviewing a book would probably be a more accurate description in a year’s time (assuming I last that long). But I wanted to tell you about a book by my friend Russell Napier because its conclusions are important. I expect the book, The Asian Financial Crisis 1995–98: Birth of the Age of Debt, will appeal only to a minority of readers – it’s a serious book, weighing in at nearly 400 pages – but it’s a fascinating read for those interested in financial history (and all investors should be interested, because market cycles tend to repeat).

The book is framed around Napier’s contemporaneous writings as the Asian strategist for then top Asian broking firm CLSA. This was an unusual brokerage because for many years it acted as a pure research firm, without the bulge banks’ conflicts of interest: it had no corporate finance arm, no market makers and purely sought to help its end investment clients. Because of the lack of conflicts, its analysts were free, and were encouraged, to speak their minds.

This sometimes resulted in two analysts/economists from the firm coming up with different conclusions from the same data – I watched its economist and strategist at a conference presentation and was a little bemused; with one expecting the dollar to strengthen and the other suggesting it would weaken, it meant that one of them was bound to be right.

Napier was as outspoken as any, and in the book he uses his columns from the time to illustrate the contemporaneous reactions to events in Asia. Remember this was a period in which many of the region’s markets were to fall by 80 per cent or more, yet Napier’s early and sage advice often fell on deaf ears. Even after the start of the decline, many investors hoped that markets were cheap after a 50 per cent fall, only to see them halve again and then yet again. Countries such as Thailand and Malaysia were at one point valued at less than the capitalisation of British Telecom; but the equity value alone did not make them cheap – debt and currency risk had to be taken into account.

It’s this commentary that I think provides the most valuable lesson in the book – when you have a crisis, and particularly a crisis in which the banking system is intimately involved, bottom-fishers have to be very patient – it can take a long time for the selling to stop.

Another important lesson is the folly of benchmark weightings. Back then, Asia was a different place. The Indian economy was much smaller and China had yet to join the World Trade Organisation. Both countries’ stock markets were insignificant. To be an Asian investor meant having significant weightings in Thailand, Malaysia, Singapore and Hong Kong. Even if you had followed Napier’s advice and thought that the Chinese stock market would be largely untouched by the destruction elsewhere, as an investor in the region, China’s tiny weighting in the benchmark limited most funds’ exposure.

This is an area where the private investor has a major advantage over the professional. The private investor need pay no heed to benchmark weightings – if you don’t like a region, you can simply avoid investing there. For an Asian fund, in theory, a manager could have gone to 100 per cent cash, but in practice this is hugely risky for the manager’s career – if he or she is correct, and has his or her timing spot on, clients will be grateful. But if you are just a few months early, you will lose clients and likely your job.

The book is full of Napier’s personal experiences, many of them highly entertaining. He recalls a Malaysian security official asking him for a stock tip, Ian Botham nominating him for a parachute jump and my favourite, a rendition of Danny Boy on a New York bar. And importantly, the author is not afraid to admit he got things wrong. He initially missed the risk in South Korea, which had significant dollar earnings and a current account surplus but nevertheless came close to bankruptcy; and he underestimated the impact of the unleashing of liquidity post the LTCM crisis in supporting US markets.

And this is the important conclusion of the book. The Asian crisis, the Russian crisis and the failure of Long-Term Capital Management (LTCM) resulted in global non-financial debt rising from 191 per cent of gross domestic product (GDP) at the end of 2001 (the earliest available data) to 243 per cent by the end of 2019. Asian countries – notably China – kept their exchange rates low, accumulated US treasuries, and exported deflation to the developed world. In turn developed countries’ central bankers kept rates low, debt levels increased and asset prices rose on the back of low rates. Covid supercharged the debt situation. 

Napier believes that the only way this credit cycle will stop is when debt is so high it simply cannot be serviced. Napier believes that we are near this point now and the most likely solution is for central bankers to deploy inflation to reduce the real level of debt. Clearly, we are now in uncharted territory; this book is a useful reminder of one element of how we got here and is instructive on how to view the development of macro affairs.

Napier spent time studying US banks and reckons that an understanding of banks is essential training. I have never understood the intricacies of the banking system, but I found the book really interesting, as I had limited involvement in Asia at the time; and it’s helpful in understanding how to navigate a crisis. These seem to be a more regular occurrence in the 21st century.