This page intentionally left blank FROM ASIAN TO GLOBAL FINANCIAL CRISIS This is a unique insider account of the new world of unfettered finance. The author, an Asian regulator, examines how old mindsets, market fundamental- ism, loose monetary policy, carry trade, lax supervision, greed, cronyism, and financial engineering caused both the Asian crisis of the late 1990s and the cur- rent global crisis of 2007–2009. This book shows how the Japanese zero inter- est rate policy to fight deflation helped create the carry trade that generated bubbles in Asia whose effects brought Asian economies down. The study’s main purpose is to demonstrate that global finance is so interlinked and interactive that our current tools and institutional structure to deal with critical episodes are completely outdated. The book explains how current financial policies and regulation failed to deal with a global bubble and makes recommendations on what must change. Andrew Sheng is currently the Chief Adviser to the China Banking Regulatory Commission and a Board Member of the Qatar Financial Centre Regulatory Authority, Khazanah Nasional Berhad and Sime Darby Berhad, Malaysia. He is also Adjunct Professor at the Graduate School of Economics and Management, Tsinghua University, Beijing, and at the Faculty of Economics and Administration at the University of Malaya, Kuala Lumpur. Mr Sheng was Chairman of the Securities and Futures Commission of Hong Kong from 1998 to 2005. A former central banker with Bank Negara Malaysia and Hong Kong Monetary Authority, between 2003 and 2005 he was Chairman of the Technical Committee of IOSCO, the International Organization of Securities Commissions, the standard setter for securities regulation. He is a colum- nist for Caijing Magazine, the largest and most widely read finance journal in China. He edited Bank Restructuring: Lessons from the 1980s (1996) and holds an honorary doctorate from the University of Bristol. From Asian to Global Financial Crisis An Asian Regulator’s View of Unfettered Finance in the 1990s and 2000s ANDREW SHENG CAMBRIDGE UNIVERSITY PRESS Cambridge, New York, Melbourne, Madrid, Cape Town, Singapore, São Paulo, Delhi, Dubai, Tokyo Cambridge University Press The Edinburgh Building, Cambridge CB2 8RU, UK Published in the United States of America by Cambridge University Press, New York www.cambridge.org Information on this title: www.cambridge.org/9780521118644 © Andrew Sheng 2009 This publication is in copyright. Subject to statutory exception and to the provision of relevant collective licensing agreements, no reproduction of any part may take place without the written permission of Cambridge University Press. First published in print format 2009 ISBN-13 978-0-521-11864-4 Hardback ISBN-13 978-0-521-13415-6 Paperback Cambridge University Press has no responsibility for the persistence or accuracy of urls for external or third-party internet websites referred to in this publication, and does not guarantee that any content on such websites is, or will remain, accurate or appropriate. This book is dedicated to my mother, Chuen Mo Jhen, and my wife, Lim Suan Poh, whose infinite patience, encouragement and support made this work possible. Contents List of Figures page ix List of Tables x Acknowledgements xiii Introduction 1 1 Things Fall Apart 21 2 Japan and the Asian Crisis 44 3 The Beam in Our Eyes 71 4 Banking: The Weakest Link 86 5 Washington Consensus and the IMF 109 6 Thailand: The Karma of Globalization 126 7 South Korea: Strong Body, Weak Heart 159 8 Malaysia: The Country That Went Its Own Way 187 9 Indonesia: From Economic to Political Crisis 218 10 Hong Kong: Unusual Times Need Unusual Action 253 11 China: Rise of the Dragon 278 12 From Crisis to Integration 303 13 The New World of Financial Engineering 325 14 What’s Wrong with Financial Regulation? 350 15 The Global Financial Meltdown 375 vii viii Contents 16 A Crisis of Governance 396 From Asian to Global Crisis: Chronology of Notable Events 411 Abbreviations and Acronyms 429 Bibliography 433 Index 465 Figures A Institutional Tree of Life page 17 1.1 Asian Dragons and Tigers: Currency and Stock Exchange Indices, July–December 1997 42 2.1 Monthly Fluctuations in Yen–U.S. Dollar Exchange Rate, 1957–2007 50 2.2 Japanese Foreign Direct Investment to Asia, US$ billion, 1965–2004 52 2.3 Japan’s Net Financial Flows to Developing Countries, US$ billion, 1994–2004 53 2.4 Growth Rates of Asian Economies and Changes in the Yen–U.S. Dollar Exchange Rate, 1980–2007 54 2.5 Japanese Banks’ Consolidated Foreign Claims on Asian Economies, US$ billion, 1983–2007 60 2.6 Japan Debt Assets vs. the Rest of Asia Debt Liabilities 69 4.1 Stylised Model of Economic Growth and Demographic Transition in East Asia, 1945–2025 95 4.2 Emerging Market Credit Spreads, 1990–2006 100 9.1 Indonesia: Net Foreign Liabilities, 1970–2004 243 11.1 Working-Age Population as a Percentage of Total Population, 1950–2050 290 13.1 Global Leverage and Liquidity – The Unstable Pyramid 333 13.2 The Shadow Banking System: Securitizing and Moving Liabilities Off Balance Sheet, 1987 and 2007 337 13.3 Modelling of Financial Markets: Agent-Based Behaviour 344 15.1 Global Real Money and Credit Growth, 1984–2008 377 ix Tables 2.1 Selected Asian Economies: Net International Investment Positions page 68 4.1 Selected Asian Economies: Financial Structure (% of GDP) 92 4.2 Selected Asian Economies: Pre-crisis Conditions of Banking Sector, 1997 96 4.3 Selected Asian Economies: Cost of Crisis in the 1990s 98 4.4 Selected Asian Economies: Capitalization and Turnover of Stock Markets, July 2008 (US$ terms) 101 6.1 Thailand: Selected Real Economy Indicators 128 6.2 Thailand: Selected Currency and Current Account Indicators 129 6.3 Thailand: Selected Foreign Capital Indicators 134 6.4 Thailand: Selected Interest Rate Differentials (% per Annum) 137 6.5 Thailand: Financial Structure (% of GDP) 138 6.6 Thailand: Bangkok International Banking Facilities Credits (Billions of Baht) 139 6.7 Thailand: Selected Asset Prices 142 6.8 Thailand: Selected Financial Sector Indicators 143 6.9 Thailand: Selected Foreign Reserves and External Debt Indicators 144 6.10 Selected Asian Economies: Currency Composition of Long-Term External Debt, 1996 and 1997 (%) 146 7.1 South Korea: Selected Real Economy Indicators 160 7.2 South Korea: Financial Structure (% of GDP) 165 7.3 South Korea: Selected Financial Sector Indicators 167 x List of Tables xi 7.4 Selected Asian Economies: Inward Foreign Direct Investment Stock (% of GDP) 168 7.5 South Korea: Selected Interest Rate Differentials (% per Annum) 170 7.6 South Korea: Foreign Reserves and External Debt Indicators 172 7.7 South Korea: Selected Currency and Current Account Indicators 175 7.8 South Korea: Selected Foreign Capital Indicators 178 8.1 Malaysia: Selected Real Economy Indicators 188 8.2 Malaysia: Selected Currency and Current Account Indicators 190 8.3 Malaysia: Selected Foreign Capital Indicators 192 8.4 Malaysia: Selected Foreign Reserves and External Debt Indicators 195 8.5 Malaysia: Financial Structure (% of GDP) 196 8.6 Malaysia: Selected Financial Sector Indicators 200 8.7 Malaysia: Selected Asset Prices 201 8.8 Malaysia: Selected Banking System Loans by Type and Sector, End of June 1997 (% of Total Loans) 203 8.9 Crisis Economies: Net Portfolio Equity Liabilities 204 8.10 Malaysia: Foreign Direct Investment and Net Portfolio Investment (RM Billion) 208 8.11 Selected Asian Economies: Stock Market Collapse 209 9.1 Indonesia: Selected Real Economy Indicators 221 9.2 Indonesia: Selected Currency and Current Account Indicators 222 9.3 Indonesia: Stock Market Indicators 228 9.4 Indonesia: Financial Structure (% of GDP) 232 9.5 Indonesia: Selected Financial Sector Indicators 234 9.6 Selected Asian Economies: Average Corporate Leverage (% of Total Debt over Equity) 235 9.7 Indonesia: Selected Interest Rate Differentials (% per Annum) 244 9.8 Indonesia: Selected Foreign Reserves and External Debt Indicators 246 9.9 Indonesia: Selected Foreign Capital Indicators 247 10.1 Hong Kong: Exchange Rate Regimes 256 10.2 Hong Kong: Selected Real Economy Indicators 258 xii List of Tables 10.3 Hong Kong: Foreign Reserves and External Wealth Indicators 259 10.4 Hong Kong: Selected Financial Sector Indicators 261 10.5 Hong Kong: Selected Asset Prices 262 10.6 Hong Kong: Financial Structure (% of GDP) 267 10.7 Selected Asian Economies: Summary Measures of Bank Strength, 1997 268 11.1 China: Selected Real Economy Indicators 280 11.2 China: Financial Structure (% of GDP) 282 11.3 China: Foreign Reserves and External Debt Indicators 283 11.4 China: Selected Currency and Current Account Indicators 285 11.5 China: Stock Market Indicators 295 11.6 China: Selected Foreign Capital Indicators 298 12.1 Loss in Stock Market Capitalization from Peak to Trough during the Asian Financial Crisis 305 12.2 Japan: Loss in Stock Market Capitalization from 1998 Trough to 2003 Trough 306 12.3 Selected Asian Economies: Inflation (Annual % Change) 310 12.4 Crises Economies: Human Development Index, 1997–1999 312 13.1 Global Financial Assets, 2007 (US$ Trillion unless Noted Otherwise) 332 14.1 The SPISSPER Process Cycle of Financial Regulation 362 Acknowledgements This book could not have been written without acknowledging my huge debt to all my friends, colleagues, teachers and mentors, past and present, who are too numerous to mention. My time at Bank Negara Malaysia, World Bank, Hong Kong Monetary Authority, Hong Kong Securities and Futures Commission, IOSCO, and the China Banking Regulatory Commission (CBRC) all shaped my thinking and sharpened my analysis. Specific grati- tude must go to guidance and support by the late Tun Ismail Mohd Ali, Tan Sri Aziz Taha and Tan Sri Lin See Yan; Tan Sri Zeti Aziz in Bank Negara; Millard Long and Alan Gelb at the World Bank; Sir Donald Tsang, Rafael Hui, Joseph Yam and David Carse in Hong Kong; and Chairman Liu Mingkang and his colleagues in CBRC.