DR. JOHN RUTLEDGE
A Scam and its Victims
March 23, 1998

First stop: Seoul, South Korea, which is not a resort destination. I woke before dawn to see a heavy snowfall outside the hotel window and hundreds of men with brooms and shovels. These people are very tough, and they work very hard. Korean industrial assets are modern and efficient. Don't count them out.

Financially, things are a mess. The chaebols -- the giant Korean conglomerates that own most of the economy -- will need lots of restructuring. Western investors will force Korean companies to produce honest financial statements. But forget the idea that Korea will go broke. It still has the incredible Korean people. Its cheaper won -- down by about half in the past six months -- will enable the country to churn out boatloads of products for export. Watch for their products soon in a store near you.

Hong Kong looked a lot as it had before the boys from Beijing took over last summer. I did notice two important differences: The taxi drivers don't try to cheat you anymore; and some of the financial guys told me there are unofficial orders not to write articles critical of the government or of the property, security or currency markets. Both developments seem ominous to me.

The big question in Hong Kong was whether the government would maintain its commitment to low inflation and a strong Hong Kong dollar by supporting the currency board system. Some currency speculators reason that the dramatic drop in Southeast Asian currencies in recent months will put Chinese exports at a competitive disadvantage and force the authorities to devalue.

Singapore is much less affected by the financial meltdown than its neighbors because it is so tightly controlled. The government kept property prices fairly reasonable by maintaining controls on mortgage markets. Singapore has capital and financial know-how. It will play an important role in rebuilding the damaged economies of the region.

Malaysia is another matter. It has only 20 million people, and is rich in natural resources -- rubber, timber and palm oil. Property and financial markets were badly overinflated during the boom. Bank debt is 160% of GDP. Worst of all, the government is blaming the crisis on others.

For me, the best visual metaphor for the Asian crisis was the beach resort carved out of the jungle on the west coast of Malaysia, where we weekended. The hotel was small, with impeccable service and every luxury imaginable. The airport was new, with a modern concrete-and-glass terminal. We arrived and departed on a new Boeing 737. There were three other passengers on the plane.

The financial crisis in Asia is not being created today. It developed over the past 15 years, as investors' money was transformed into hotels, roads, airports and skyscrapers. What suddenly changed was that investors awakened to the fact that those assets are unlikely to generate the dollar cash flows to support their recent market values. It is a lot easier to get concrete into the jungle than to get it out again. Investors should forget about cost and book value when making Asian investments. And forget about historical P/Es. If you invest in Asia, don't pay more than you can justify based on the present value of projections of free cash flows -- in dollars, not local currencies.

This story is not going to end quickly. In Act I it plays out as a banking crisis. When banking has been repaired, the spotlight will shift to restructuring, as smart operators move in to redeploy assets. That's when the real money will be made, a lot of it by U.S. multinationals.

It's still some time off.

How did all this happen? Yes, Asian politicians allowed their cronies to build vast fortunes by deceiving foreign investors with poor accounting numbers and weak regulations. But scams require victims as well as perpetrators. Nobody held a gun to the heads of U.S. and European investors as they wrote their checks. The smell of all this easy money made people careless. Could the same thing be happening in the U.S. after 16 years of steadily rising stock markets?