Asian Tiger, Hidden Consumer

The Daily Reckoning PRESENTS: The combination of some financial and business reform among the Asian Tigers and more importantly, robust export-led economic growth, attracted foreign investment that hyped their equity markets last year. Gary Shilling explores…


Emerging stock markets did very well last year, with Morgan Stanley’s index gaining 30% as foreign investors piled in. Many of those economies were robust.

Conditions there were very reminiscent of the 1990s when the emerging economies of East Asia – including Thailand, Taiwan, South Korea, Indonesia, Malaysia, Singapore, the Philippines and Hong Kong – were the portrait of stunning economic growth. The region thrived by providing the West with cheap electronic components and other exports. As international capital markets opened up, foreign investors began pouring money into the East Asian countries to profit from the region’s growth. As subsequent events proved, however, much of that money was ill-spent.

The problems became clear with the currency crisis that began in Thailand in July 1997, when that country devalued its baht currency, and investors responded by pulling money out in a virtual stampede as the currency nosedived.

Beyond Thailand, South Korea and Malaysia also experienced rapid money depreciation as currencies fell in domino fashion. The withdrawal of capital led to significant retrenchments in other areas of those economies. Growth rates fell through the floor in 1998, especially in Indonesia, Thailand, Korea and Malaysia. The region’s stock indices plummeted.

Within a few short months, the emerging economies of East Asia, once heralded as shining examples of export-driven growth, offered newer lessons on the shortcomings of their development. Topping the list were cronyism, lack of transparency, undeveloped capital markets, inadequate banking regulation and plain old-fashioned graft and corruption.

The industrious Asians, however, did not remain depressed for long. Sure, nepotism and other unsound business practices, at least by Western standards, were eliminated more on paper than in fact, but economic growth revived and the region was depressed only to a limited extent by the U.S. dot-com collapse and 2001 recession.

Inflation has remained low, despite recent leaps in energy prices, in Hong Kong, Taiwan, South Korea, Malaysia and especially Singapore – while the Philippines, Thailand and notably, Indonesia have had meaningful inflation. Interestingly, these three countries have also suffered from political unrest in recent years. Not surprisingly, central-bank interest rates remain low in the low-inflation lands, but higher in the inflation-prone Philippines, Thailand and Indonesia.

These export-driven countries have also been aided by the collapse in their currencies in 1997-1998. Some of their currencies have subsequently gained against the dollar, but remain well below their pre-crash levels. Direct foreign investment has been returning to those lands, although collectively well below China’s, as nonperforming loans drop.

In the aftermath of the 1997-1998 collapses, a number of the Asian Tigers realized that part of their vulnerability lay in excessive dependence on exports for economic growth. Two of these countries – South Korea and Thailand – tried, without much success, to promote domestic growth to reduce that dependence.

I have long felt that probably the most important result of the Industrial Revolution was the development of the vast middle classes in Western economies. Before that, the agricultural societies concentrated wealth and income at the top of the economic spectrum. With the Industrial Revolution, the middle class grew huge, had significant income, and spent it on their kids’ education, the good life, etc. That created enough domestic demand to spawn largely self-sufficient economies.

I’ve argued, contrary to the views of many, that developing countries, including China, have not yet gained big enough middle classes to spawn domestically driven – as opposed to export-driven – economies. Despite all the cell phones and computers purchased by the Chinese of late, I believe those folks are simply spending the money coming from exports and direct foreign investment. With the next global recession, probably initiated by a U.S. house price collapse and fall in American consumer spending and imports, we’ll see who is right on the Chinese domestic-led growth argument.

In any event, the Asian Tigers remain dependent on exports, most of which, directly or indirectly, are bought by U.S. consumers who have been the world’s growth engine in recent years. American incomes have been insufficient to finance consumers’ robust spending, so they’ve relied on the equity in their houses to support higher borrowing and lower saving.

The combination of some financial and business reform among the Asian Tigers and more importantly, robust export-led economic growth, attracted foreign investment that hyped their equity markets, last year. That promoted more interest this year, when $20 billion flowed into emerging-market stock mutual funds in the first quarter. This is the same amount as entered in all of 2005 and many of those stock markets continue to do well.

U.S. institutional investors, such as pension and endowment funds, are also pouring money into emerging market hedge funds to the tune of $5.3 billion, last year. This is up 13% from 2004, and about $2 billion in the first quarter of this year. This money is in addition to institutional ownership of emerging-market stocks directly and through mutual funds.

As a result of all this foreign buying, Asian Tiger stocks are no longer cheap, given the historical volatility of those emerging markets. The export-led Asian Tiger economies will be especially vulnerable if the current softness in U.S. housing activity turns into a full-blown collapse. Then American consumers will have no other means of supporting their spending and will retrench to the considerable detriment of Tiger exports.

Furthermore, a strong dollar – which I forecast, on balance, for this year – can slash gains in foreign investments for Americans. Last year, the Morgan Stanley Capital International EAFE Index, a broad measure of stocks in Europe, Australia and developed Asia, rose 26% in local currency terms, but only 11% after accounting for the strong dollar.

Then there’s the threat of protectionism. Congressional ire is now focused on China, but history shows that any export-driven country is fair game when a weak U.S. economy spikes unemployment at home. Furthermore, rising global interest rates, as at present, have historically been punishing for stocks, especially in volatile emerging markets. Also, remember that small-country markets leap when foreign money floods in, but collapse even faster when it departs.

Why won’t we see a repeat of the 1997-1998 debacle among the Asia Tigers? They’re more export-dependent now than in 1996. Short-attention-span hedge funds are now involved in their markets. And, if things start to somehow unravel, foreign investors will recall their big 1997-1998 losses and want to beat the crowd out the door.

There is also the matter of correlation among stock markets. For years, I’ve analyzed the close correlations among stock markets around the world, most of which usually follow the U.S. These relationships are far from perfect. Last year, while foreign stocks rose 26%, the S&P 500 index of American equities advanced only 3%. Still, the evidence is that markets are moving more in sync now than earlier, not surprising in an increasingly interconnected global economy. It’s also true that the correlations of the S&P 500 index and its components have increased dramatically since the dot-com days of 2000 and even hedge fund returns now are closely linked to S&P performance.

From 1990 through March of this year, the correlations between Far East emerging markets, the total emerging market sector and emerging markets ex Asia, on the one hand; and those in developed Asian countries, the United States, and Europe on the other, were quite low, but the correlations have been much higher since 2004. Two factors are probably responsible for the higher interrelationships more recently. First, economies, and therefore stocks, are increasingly interrelated. Second, and probably more important, the Asian meltdown in 1997-1998 was a regional, not a global affair. The collapse in stocks in the Asian Tigers then did not spread worldwide.

This suggests that troubles in the U.S. economy and stocks cannot be sidestepped by emerging stock markets in Asia and elsewhere. At the same time, however, the history of the late 1990s indicates that troubles for the Asian Tigers don’t necessarily spread globally.

It’s possible, then, that the Asian Tigers could once again go their own way, but I suspect that their fates lie in the hands of U.S. consumers, who buy the exports that propel their economies. So, the softness in American consumer spending I expect to accompany a big house price drop, will weaken both the United States and Asian Tiger economies. In turn, that will logically sire synchronized declines in stock markets on both sides of the Pacific.


Gary Shilling
for The Daily Reckoning
May 16, 2006

Editor’s Note: Dr. Gary Shilling is president of A. Gary Shilling & Co. Inc., an investment advisory and economic consulting firm and publisher of the monthly INSIGHT newsletter.

Prescience has empowered Dr. Shilling to beat the stock market by a wide margin over many years while providing consistently accurate forecasts to his subscribers. Twice ranked as Wall Street’s top economist by polls in Institutional Investor, Dr. Shilling was also named the country’s No. 1 commodity trader adviser by Futures Magazine. And in 2004, MoneySense ranked him as the third best stock market forecaster, right behind Warren Buffett.

A regular columnist for Forbes magazine, Gary Shilling appears frequently on radio and television business shows and has written six books, including Is Inflation Ending? Are You Ready? in 1983, and more recently, two books detailing his forecast for the new world order and its consequences for your wallet. For his very latest research, see:


There have been some expensive cleanups in our world’s history. The most costly one was following the infamous Exxon Valdez disaster in Alaska in 1989. Cleanup alone cost in the region of $2.5 billion and total costs (including fines, penalties and claims settlements) are estimated at $9.5 billion. The Amoco Cadiz (France, 1978) reportedly cost about $282 million, of which about half was for legal fees and accrued interest. The Braer (UK, 1993) cost in the region of $83 million.

The second most costly cleanup, coming in right after the Exxon Valdez fiasco? Fannie Mae – and its counterpart Freddie Mac – at $800 million. We realize there was no oil to be sopped up, no wildlife to be saved – but it is certainly messy and unnerving…and costly.

And $800 million is just the “estimated” cost for 2006, earmarked for finding out to what extent the mortgage giants fudged their bookkeeping. On top of new computer programs and things of that nature, Fannie and Freddie had to hire 2,500 outside contractors to dedicate the next good chunk of their lives to poring over Fannie’s books.

Of course, in keeping with the general sentiment of our government whenever exorbitant sums of money are involved – no one batted an eye at this figure. The Washington Post reports:

“Contrast the $800 million cleanup cost with the $62 million annual budget of the Office of Federal Housing Enterprise Oversight, the agency in charge of ‘regulating’ Fannie and Freddie. That office, which plans to issue its final report on Fannie Mae by the end of the month, has a staff of 225 people, not one-tenth the number Fannie has hired for the cleanup.

“Congress dares not complain because it is culpable. Fannie Mae’s and Freddie Mac’s lobbyists have so totally ingratiated themselves with lawmakers that they’ve been able to fend off regulatory initiatives for the past two decades.”

So, not a word from the world improvers on the Hill, but surely Wall Street would have something to say, right?

Wrong. The Post continues, “Wall Street, like Washington, has no choice but to support Fannie Mae and Freddie Mac, no matter what. If they failed, they could take down the stock market, the bond market, the housing market and perhaps the entire U.S. economy because their stocks and bonds are so widely held and they are so essential to the mortgage market. No one can afford to let that happen. That’s why Congress is so afraid of grabbing the regulatory reins and why Wall Street keeps touting Fannie and Freddie as good investments.

“Today there are nine Wall Street analysts telling their clients to buy Fannie Mae stock and just two recommending they sell. The opinion on Freddie Mac is unanimous: 11 ‘buy’ recommendations.

“Fannie and Freddie aren’t going to fail. Wall Street and the government won’t let them. That’s the real tragedy. We’ve created a pair of mortgage monsters, and we can’t do anything about it.”

Now for other news, we turn to our team at The Rude Awakening…


James Boric, reporting from Baltimore:

“Imagine if every time you bought a stock, you knew exactly what the company’s CEO, CFO, board of directors and even its legal team thought about its future.”

For the rest of this story, and for more market insights, see today’s issue of The Rude Awakening.


Back over to Short Fuse, in Baltimore:

*** Our in-house small-cap superstar James Boric has been walking around the office with quite a smirk on his face for the last few week – which usually means one of two things: he’s beaten Addison in a conference room ping pong battle – or he’s got something good up his sleeve. Turns out, this time, it’s the latter.

“Insider buying (purchases made by corporate executives, officers, directors and beneficial shareholders) tends to correlate with the market’s rises and falls: when the market falls, insiders buy and when the market rises, insiders sell,” James explains.

“For instance, insider buying doubled just after the great crash of 1987 and declined severely between July 2001 and July 2003.

“More so than one else, insiders know when there stock is undervalued and when it is overvalued.

“With that in mind, Daily Reckoning readers should not be surprised at all that corporate insider buying these days is at six-year lows – far lower than in the bear market of 2001-02. Clearly the smart money doesn’t see much value in this over-heated market.

“Of course, there are stocks that insiders find attractive – even in today’s market. And those are the stocks I feature in the Small-Cap Insider. Historically these are the kinds of stocks that have outpaced the market by an exponential amount for decades. And for the first time ever, you are invited to join in on the action.

*** On the heels of the Fannie Mae undertaking, comes word that homebuilders’ sentiment has slumped its lowest level since mid-1995.

The Housing Market Index came in under 50, showing that the majority of builders view the market as unfavorable. This is only the second time that this has happened since 1995 – the other time being directly following the September 11 attacks.

“Based on historical experience, particularly the 1994-1995 episode, the pattern of movement in the HMI is not inconsistent with the orderly cooling-down process we’re projecting for home sales and single-family housing starts in 2006,” NAHB chief economist David Seiders said in a statement.

Oh, we’d say the housing market is definitely “cooling-off” – housing starts have fallen every month since January. And to think, people didn’t even believe there was a bubble.

*** During a time that international currency tensions are at their highest in 20 years, Japan’s Finance Minister Sadakazu Tanigaki has resisted American warnings to stop “jaw-boning” the dollar.

EverBank’s Chuck Butler reported that Tanigaki told Parliament that, in theory, it is possible that he would sell U.S. Treasuries to fund future currency intervention if necessary.

“The world financial markets are betting against the dollar and against Mr. Bernanke’s chances of correcting the imbalances caused by Alan Greenspan,” wrote Congressman Ron Paul recently.

“Our creditors, particularly Asian central banks, are losing their appetite for U.S. Treasuries. Our federal government’s huge debt and voracious appetite for deficit spending make our economy dependent on the actions of foreign governments and central bankers. Yet few Americans realize the extent to which their own government has sold out American sovereignty by borrowing money overseas.”

*** I always imagined Addison looked like Professor Caractacus Potts from Chitty, Chitty, Bang, Bang,” wrote in one reader this morning.

“Imagine my disappointment after seeing his visage at your site. Oh well – I’ll try to adjust.”

Sorry to disappoint you, dear reader, but Addison bears no resemblance to Dick Van Dyke in the original Chitty, Chitty, Bang Bang – not even a little bit. You can see for yourself.

The Daily Reckoning