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Teetering on the Rim

By Jock O'Connell

(This article originally appeared in the Forum section of the Sacramento Bee on Sunday, July 26, 1998.)

The sharp downturn in East Asia's economic fortunes that began a year ago this month with the collapse of the Thai currency has been affecting California in a number of ways, both good and bad. On the one hand, economic expansion throughout the U.S. has been fueled in part by investment capital that fled Asia for a safe haven here. Consumers have benefitted from cheaper import prices. Likewise, those borrowing funds to expand businesses or purchase new homes or cars have enjoyed lower interest rates that are partially attributable to the Asian crisis.

Others, however, have not fared nearly so well. California's exports to the Far East declined by 12%, with shipments to Japan and Korea falling by 12% and 42%, respectively. Declining sales in Asia by the state's electronics, aerospace, and agricultural industries are also starting to show up in the shape of lower corporate earnings reports and employee lay-offs.

And then there's singular case of the $141 billion California Public Employees Retirement System, which appears to have lost slightly more than $2.7 billion on its Far Eastern stock investments during the past year.

On the eve of the Asian economic crisis, the nation's largest public pension fund owned stock with a market value of approximately $7.5 billion in the ten principal economies of East Asia. (These economies --- we'll call them the Asia-10 for short — are China, Hong Kong, Indonesia, Japan, South Korea, Malaysia, Phillippines, Singapore, Taiwan and Thailand.) Since the cost of acquiring that stock --- what CalPERS calls its ‘book' value --- was $7.2 billion, CalPERS theoretically could have cashed out of its Asia-10 stock portfolio and pocketed a tidy $300 million gain (less transaction costs, of course).

Six months later, on December 31, 1997, things were very much different. According to a February 17, 1998, memo prepared by Sheryl Pressler, the pension fund's chief investment officer, the market value of the pension fund's Asia-10 stock holdings had dwindled to just under $5.2 billion. Meanwhile, CalPERS' money managers evidently had gone bargain hunting, snapping up additional shares at prices regarded as historically under-valued. As a result, the book value of the pension fund's Asia- 10 equity portfolio grew to nearly $7.5 billion by the last day of 1997. So at that point, CalPERS was in the hole to the tune of $2.3 billion.

By March 31 of this year, the situation showed some marginal improvement as some Asian nations began to show signs of making a fairly rapid turnaround. CalPERS' Asia-10 stock portfolio finished the quarter with a market value of $5.6 billion, still about $2.2 billion below its $7.8 billion book value but an improvement of $400 million over where it had stood at the end of last year.

Asia's first quarter stab at economic recovery proved to be a false dawn, however. As the spring proceeded, analysts became more and more convinced that Asia's economic woes would only continue to worsen. Indeed, by June 24, the day President Clinton left on his trip to China, The New York Times was reporting that, for the first time, administration officials had begun to consider the possibility of a full-scale depression in Asia.

The new round of bad news was reflected in unaudited figures supplied by CalPERS which show that, on June 30 of this year, the pension fund's Asia-10 stock portfolio -- with a book value of slightly more than $7.6 billion --- had a market value of $4.9 billion.

Only time will tell how much of that $2.7 billion "paper loss" will ultimately have to be written off as a real loss. CalPERS can hold stocks indefinitely until the market (not to mention currency values) recovers. Such favorable developments are likely to take some time, however. In the interim, like the dog that did not bark, a couple of billion dollars in pension fund money will not be earning any returns. Whenever the final accounting is made, chances are that CalPERS' real losses as a result of its equity investments in the Asia-10 economies will not be trivial.

For years, California has been at the right place at the right time in its own economic development to take advantage of one of the genuine miracles of the Twentieth Century — the emergence of the Far East from a collection of war-ravaged economic backwaters to models of efficiency and industry.

As America's window on the Pacific, California has a particularly high stake in what happens in the Far East. Not only do have we been shipping slightly more than half of our total export trade to customers in East Asia, our seaports and airports are the nation's primary conduits for trade with the Orient. No other state has gone so far in hitching its own economic destiny -- both materially and metaphorically -- to that of the Pacific Rim.

But what had once seemed a sound strategy appears to have become more of a commercial handicap as California industry copes with diminishing demand in Asia and the challenge of finding other new markets elsewhere in the world.

Computer chip and chip equipment producers have been hit especially hard by the Asian financial crisis, analysts said. Chip sales hit bottom in February, and equipment sales are expected to follow suit later this summer, according to the California Technology Stock Letter.

As Charles Geschke, president and chairman of Adobe Systems, wrote in the San Jose Mercury-News two Sundays ago: "The decline in the Asian economy, particularly in Japan, has had a major financial impact on Silicon Valley (and other) businesses over the past 12 months. The challenge is to accurately predict when it will recover."

The latest employment figures suggest the state's economy is starting to slow down, especially in Silicon Valley. Earlier this year, the San Jose area recorded year-to-year job gains of nearly 50,000. By June, however, job growth has tapered off to 27,600.

While it remains to be seen how much Sacramento's high-tech sector will be affected, Intel, Hewlett-Packard, Apple, and 3M — all of which have or are building manufacturing facilities in the Sacramento area — have all recently announced reduced revenues as a result of lower sales in the Far East.

Attempts to calculate the exact impact of the Asian crisis on California's agricultural economy are greatly complicated by what Anne Chadwick. a Sacramento-based farm trade consultant refers to as "that mother of all excuses and alibis, El Niño."

Trade, of course, is a matter of supply and demand, and El Niño has certainly dampened the former. According to the California Department of Food and Agriculture, the latest damage estimates from this year's wet and cool weather now stands at nearly $532 million. The state's almond crop, for example, is a third smaller than it was last year. It is this natural calamity, much more than the Asian economic crisis, that has California farmers and food processors fretting, says Louie Brown of the California Farm Bureau Federation.

Based on what she hears from growers and shippers, Anne Veneman, Secretary of the California Department of Food and Agriculture, concludes the effects of the Asian crisis on California farm exports has been very much mixed. "It really depends on the country and on the product. Many of our products seem unaffected. But, of course, we're not seeing the double-digit growth figures we've seen in the past."

Almond sales to the Far East by locally-based Blue Diamond Growers are "doing quite well, all things considered," reports the firm's vice president for exports, Ian Erridge. The countries most severely affected by the crisis -- South Korea, the Philippines, Indonesia, Malaysia and Thailand -- had not yet matured into major customers for California almonds and so only accounted for 3% of the company's exports. As for Japan, Erridge says exports thus far this year are actually up over last year.

Similarly varied has been the experience of cotton exports like Bakersfield's Calcot Ltd. which reports that, while California cotton shipments to Indonesia have been off, they have remained fairly steady to Japan and have increased to South Korea.

Views differ sharply about how long and how deep the Asian crisis will run and what its ultimate toll on California may be. So far, the mixed effects have led many observers to hope that California's economy may escape being badly gored by the Far East's current economic tribulations.

But with everybody's predictions there comes a major caveat. All bets are off if the current problems of Asia turn out to be more severe and long-lasting. The big wild card in everyone's hand is Japan, widely regarded as the linchpin of Asian economic recovery.

Yet Japan appears curiously powerless to save itself, let alone the rest of Asia.

Since its ‘bubble economy' burst eight years ago, Japan has launched as many economic stimulus packages as it had market opening initiatives during the 1980s, but with the same evident lack of effect. There is a possibility that Japan has seen its period of ascendancy pass. Not unlike Great Britain, it may find that its principal challenge in the future is sorting out a proper economic and political relationship with its continental neighbors.

A traditionally insular — even xenophobic -- culture, Japan is ill-positioned to cope with its own demographics. Today, there are more Japanese over 65 than under 15. The country's pension system is grossly underfunded and a rapidly aging and extraordinarily frugal population does not augur well for the country's future as a vigorous economic power.

A prolonged slump in Japan would stunt growth in Asia and also put a serious dent the U.S. economy. At the heart of the problem is the Japanese banking system. As The New York Times observed recently: "There is concern not simply about the collapse of any individual bank or the difficulties of its depositors, but rather about the consequences for the entire economic structure. In an increasingly globalized economy, there is a possibility that bank runs could trigger a liquidity crisis that could race around the world in minutes, sending markets plunging and ultimately provoking an international economic slowdown."

In light of such potential volatility, the Clinton administration has not surprisingly been lavishing considerable attention on cajoling Japan into a thorough reform of its financial sector coupled with a package of serious economic stimulus measures.

While Japan dithers, the other major imponderable in Asia is, of course, China.

China has long caught the fancy of foreign entrepreneurs whose schemes for vast riches are usually predicated on selling a product to just a sliver of a fraction of the nation's 1.2 billion souls. But here is a case where the focus of conventional economic analysis may prove too narrow to explain many phenomena. For example, China is often regarded as having a bright economic future. Why? The obvious size of the domestic market is the primary consideration but so too apparently is the stereotype of Chinese commercial prowess.

But what most analysts implicitly assume is that the exceptional entrepreneurial skills exhibited by overseas Chinese communities throughout the Pacific Rim are shared by the Chinese in China itself. The problem with this view is that it overlooks history.

Diaspora communities -- whether they be Chinese or Irish or Jewish — have typically outshone the accomplishments of their respective homelands. As economic historian David S. Landes observes in his current book, The Wealth and Poverty of Nations, China was a major technological, economic and military power at a time when Europe was still in the Dark Ages. Yet, since then, Chinese history has been a history of lost or squandered potential. What's to say that 1000 years of Chinese experience can be altered so quickly and easily?

In the here and now, Moody's this month issued a report that placed the rating for an average Chinese bank at "slightly less than" D -- right between India's and Russia's, hardly good company). Not surprisingly, the credit-rating agency is anticipating a wave of Chinese bank closures, and there are recurring expectations of an imminent devaluation of the Chinese currency.

Curiously, few market analysts recognize or appreciate the potential of internal strife in China. The dismantling and downsizing of state-owned enterprises will create considerable social strains as millions are forced to find new employment in a private sector which will be hard- pressed to grow fast enough to accommodate them. The Chinese government itself has said an 8% economic growth rate is essential to maintain social stability and continue ambitious reforms. And no one should underestimate the prospects of internal political friction as economically dynamic regions such as Shanghai or Guangzhou chafe under the dictates of Beijing's apparatchiks.

The future of California's economy is usually discussed in supply-side terms. To remain competitive, it is often argued, California must nurture leading edge industries by providing a favorable business environment that includes, among other things, an educated workforce and an efficient infrastructure.

Somewhat less frequently acknowledged are the demand-side requirements of economic prosperity. During the 1980s and early 1990s, California essentially fell under the thrall of Pacific Mania, a firm if myopic conviction that California's star would rise along with the economies of the Far East. Not surprisingly, we wound up shipping over half our total exports to the Far East.

The California Farm Bureau's Louie Brown says that one important effect of the Asian crisis will be to dramatize the value of global market diversification.

The lesson of avoiding excessive dependence on a single market or even region is as valid for agriculture as it is for another other industry. Even though California exports go everywhere in the world, the fact is that, in major overseas markets such as South America and India, California has a surprisingly modest share of total U.S. export trade. For example, on a world-wide basis, California accounts for about 15% of all U.S. exports. But we account for less than 8% of U.S. exports to South America.

Yet both Brown and Secretary Veneman point to a major obstacle to opening new markets, and this time it's not El Niño. It's the U.S. Congress. By refusing to grant fast-track negotiating authority to the administration, Congress, Veneman argued, "is depriving us of valuable tools in opening important new export markets for California agriculture." The state's top ag official also labeled as unhelpful congressional reluctance to support additional IMF funding to help stabilize troubled economies in Asia and Eastern Europe and its questioning of Most-Favored- Nation status for China. She could be speaking for most all of California industry.

Copyright © 1998 By J. A. O'Connell

CalPERS Asian Equity Investments 1997-98

(Millions of Dollars)

                          6/30/97       12/31/97        3/31/98         6/30/97
                        BV	MV      BV      MV      BV      MV      BV      MV
       China	        $1	$2	$4	$4	$5	$4	$4	$2                  
       Hong Kong	$601	$907	$619	$628	$709	$674	$698	$485
       Indonesia	$132	$150	$107	$37	$97	$31	$92	$15
       Japan	        $5,595	$5,609	$5,885	$4,098	$5,987	$4,336	$5,895	$4.045
       S. Korea 	$91	$67	$73	$21	$104	$48	$99	$31
       Malaysia    	$356	$374	$365	$127	$379	$179	$348	$90
       Philippines	$101	$97	$91	$45	$105	$64	$107	$48
       Singapore	$203	$239	$235	$164	$254	$181	$244	$116
       Taiwan	        $25	$41	$44	$58	$77	$82	$77	$63
       Thailand	        $70	$37	$46	$13	$61	$19	$61	$9
       Totals   	$7,175	$7,521	$7,469	$5,195	$7,777	$5,619	$7,626	$4,904
          (Losses)		  $346		($2,274)       ($2,158)		($2,722)

Source: California Public Employees Retirement System

BV = Book Value (Cost of Stock) MV = Market Value

June 30, 1997, figures are from CalPERS' Annual Investment Report of that date.

Other figures were provided by CalPERS in response to a specific request.

*The June 30, 1998, figures have not yet been audited.

Individual country figures have been rounded off and so may not add up to the totals in each column.

Copyright © 1998 By Jock O'Connell

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