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Lessons Learned: Asia Narrowly Escapes
this Credit Crisis
Today's comment is by Eric Roseman, our Investment Director and editor of Commodity Trend Alert.
Dear A-Letter Reader,
Asia suffered a severe economic recession just 10 years ago. Capital markets hemorrhaged and some Asian countries even slipped into a depression after Thailand's collapse in July 1997.
After years of booming economic growth, markets from Singapore to Tokyo went through the ringer as stocks, real estate and currencies plunged. Like the Great Depression in the 1930s, asset values were purged across the region and fortunes were lost as the meltdown evaporated asset values.
But 10 years later, it's a whole other story. While Asia sails along at a breakneck pace, it's the major industrialized markets of the world that are plunging. The U.S., Canada, and Europe are experiencing the worst credit-crunch since the near demise of hedge fund Long Term Capital Management in August 1998.
The Tables Have Turned Against Us
The now notorious illiquid mortgage-backed securities are infecting the entire spectrum of commercial-backed paper. As a result, many banks and financial institutions in Canada, the United States and Europe are in the midst of a severe liquidity crisis.
Institutions are still largely reluctant to lend to one another, and that's exacerbating this credit crisis. This credit crunch refuses to subside, despite numerous cross-border central bank interventions. Commercial paper is often issued by special-purpose vehicles called conduits, which don't appear on bank balance sheets.
In Germany, two conduits collapsed in August and had to be rescued by their parent companies. And in the United States and Canada, several second-tier lenders also failed as the commercial paper market froze, and denied institutions their usual operational liquidity.
Asia Largely Escapes Sub-Prime Turmoil
For the most part, the sub-prime crisis has escaped Asian companies because private-equity deals in the region aren't typically financed by leverage. And leverage makes or breaks a deal.
Growth capital, which represents most investment structures, doesn't use leverage and thus has little or no direct exposure to changing market conditions. Asia has also been safeguarded because Asian lenders must ensure at least 75% of the current fund or deal to be funded before embarking on any new ventures.
That's not the case with private-equity deals in the United States and Europe. Their companies can initiate new projects and raise capital before the original deals are funded. With credit incredibly cheap in the post-2003 period, private-equity funds raised more than US$650 billion, mostly funded with leverage and high-yield securities.
Amazingly, despite the mayhem in credit markets since July, Asian companies are on course to finance a record year. Asian companies have raised US$24.6 billion thus far - almost the entire sum raised in 2006, according to the Centre for Asia Private Equity Research.
Of course, not all companies in Asia have remained completely unscathed by the sub-prime meltdown. On the contrary, Japan, Singapore and Australia have been hit by conduit failures this summer. Singapore-based DBS Group Holdings, a major Singapore bank, was forced to liquidate a conduit in August. In Australia, several banks have already injected billions of dollars to bailout conduits in mortgage-backed securities.
But overall, Asian banks have been relatively immune to the crisis because conduits are not a primary funding vehicle for parent companies, unlike European and American entities. That's good news for regional investors and capital markets.
Been There, Done That
On the macroeconomic level, Asia is also far healthier today compared to 10 years ago and especially compared to major market economies. Indeed, the economic tables have literally turned in a span of just 10 years.
In 1998, Asia was on the brink of the economic abyss as banks failed, governments faltered and capital markets collapsed. But that's not the case in late 2007.
Asia's Current Account Balances and Reserves Have Soared Since 1995!
Asia sports a small debt-to-GDP ratio while countries like the United States harbor a debt-to-GDP ratio approaching 6.5%. Other countries, like France and England, also have bulging deficits.
Current-account deficits and budget deficits are also negligible, if at all, in Asia. This compares to huge fiscal and budget imbalances in the United States and parts of Europe.
Some countries, including those in Eastern Europe and the Baltics are home to enormous budget deficits following years of booming economic growth. That's exactly what occurred in Asia in the 1990s as markets rapidly expanded and trade deficits accumulated, combined with overvalued currencies. Ultimately, high-speed growth smashed the economies in the region after years of rampant borrowing.
Don't forget: Asia is now the richest source of combined U.S. dollar foreign-exchange reserves at US$2.5 trillion. That's a testament to thriving international and regional trade.
There's no doubt about it: Asian currencies and investments denominated in those units will greatly reward long-term investors.
ERIC ROSEMAN, Investment Director
RosemanBlog.SovereignSociety.com
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