The Great Taiwan Bubble

By Steven R. Champion

Chapter 2:Bull Market Dilemmas

People in Taiwan are not fools. The country's

educational system churns out literate and technically
competent graduates many of whom go on to study business or
engineering at graduate school in the United States and
then stock the Research & Development staffs at places like
the Bell Labs, Hewlett Packard, and Intel. This first
class educational system, the native intelligence of the
people, and the country's dependence on export markets for
revenues has led to the development a surprisingly
sophisticated and internationally minded population.

As stocks continued to roar upward, some of the more

detached and reflective members of the country's
cosmopolitan elite began to sense that the massive bull
market was starting to have a profound effect on society.
All the new wealth and unrestrained animal spirits that the
market generated were blinding the vast majority of players
to the risk that the bubble would burst and that the
valuation of Taiwan assets would decline to somewhere near
those levels common in the rest of the world. It was
obvious to many that the effects of the bubble's bursting
could lead down some very unpleasant roads, drastically
altering the comfortable lives that people were becoming
accustomed.

Perhaps the people most acutely aware of the dilemma

created by the market bubble were the generally
knowledgeable and prudent government officials assigned to
the Central Bank, the Ministry of Finance, and the
Securities and Exchange Commission. Guided by the
Confucian ideal, Chinese society accords great prestige to
a career in government service, and, despite the relatively
low wages, many extremely able professionals work in these
government agencies. These powerful bureaucrats are almost
exclusively graduates of Taiwan's top, meritocratic
universities, and a majority holds advanced degrees in
economics or finance from American graduate schools.

Many of the older, more senior officials witnessed the

economic and military disaster in Mainland China in the
late 1940's when the Kuomintang government was forced to
retreat to Taiwan. In their last years on the Mainland the
economy was out of control and the currency was debased by
one of history's great runaway inflations. The lessons
learned in this debacle, the much more controllable
situation in Taiwan, and forty years of one party (some
might have said one family) control of the government had
created a favorable situation for a conservative national
financial policy, with a preference for equity investments
rather than borrowing at the macro level, and had laid the
foundations for Taiwan's economic miracle.

A senior government official might have thought but

not dared to publicly express himself as follows with the
market run amok:

"The stock market is wildly overvalued by world standards and must inevitably
crash. The people who will be hurt the most are the unsophisticated, small investors who
have gotten in late and who won't get out soon enough. It is my duty to protect these
people. A market crash may ignite a liquidity crisis and even bank runs causing major
damage to the economy that we have worked so hard to develop. This will harm the
country, and it is my duty to prevent this from happening. Securities regulations are
being routinely broken every day, and these abuses are contributing to the berserk results
of the bubble market. It is my duty to enforce the law."

"On the other hand, any actions I take may effect investor confidence and hasten
the inevitable crash. Then, investors and the pesky opposition will blame the
government, the Kuomintang, and me, personally, for the disastrous results. Mobs of
ruined speculators have rioted in the streets before, and I don't want them rioting in
front of my house. Maybe I shouldn't be too hasty. Also, if we start to enforce the law
now, I'll be stepping on the toes of important people, legislators and senior party officials,
who are in the securities business or who have leveraged plays in the market. Besides, the
stock transaction tax is now the government's most important source of revenue, and,
without it, we would be running a bigger deficit. I'd better be careful what I say. I want
to get promoted and to eventually enjoy a sinecure as the chairman of a government
controlled bank. I can't afford to make waves."

However profound the misgivings of government

officials may have been, people with their own money on the
line sensed the dangers posed by the bubble market in a
less detached, more personal way. They had to balance
their detailed, objective knowledge of just what their
companies were really worth against the personal
consequences of a rational decision to sell out and go lie
on the beach somewhere until things returned to normal.

My old friend Horace had a very personal dilemma.

Horace's father had come to Taiwan as a refugee from
Shanghai just before it fell to the advancing Red Army in
the late '40's. In Taiwan, he put his commercial knowledge
and excellent connections to work and founded several
important companies in league with some of his old pals
from the mainland. No expense was spared in Horace's
upbringing, and he received a first rate education in
Taiwan and later at graduate school in the United States.
Following his father's death, Horace returned to Taiwan to
run the largest of the family companies and serve on the
boards of a few of the smaller investments. He ran the
business well, and, although he would be the first to admit
that he was more than a little henpecked by his overly
1
Americanized Tai-Tai , he enjoyed the dinners laced with
2
hsiao hsing wine and the flirtations with wine house
3
hostesses and Madam Boom-Boom's slim, chi pao clad
“assistant managers” that were the lot of a privileged lao
ban 4 .

Horace was sophisticated and internationally minded,

and well before the market burst through the 12,000
barrier, he knew he had a problem on his hands. His
company, a $50 million producer of electronic components,
had a near monopoly position in its major market niche and
was able to earn handsome financial returns by anyone's
standards. He had recently obtained world-class technology
from Europe, and there seemed to be no clouds on his
financial horizons.

Horace had no interest in setting the world on fire,

and he was content to drift along with the serenity of his
life only occasionally marred by brutal hsiao hsing induced
hangovers and his wife's nagging about his late hours and
the faint whiffs of sulfur fumes sometimes evident on his

1
Tai-Tai is a polite expression for one's wife.
2
Hsiao-shing wine is a popular rice wine in Taiwan. It is often served heated and flavored with lemon or plums.
3
A chi-pao is a form-fitting, high collared Chinese gown, which is often slit up the side.
4
A lao ban can be translated as "boss." In Taiwan, this term, rather than the "tai-pan" of potboiler fiction, is the
preferred usage. Tai-pan (or da-ban in conventional Mandarin) is a title reserved for first level supervisors of
taxi dancers.
undergarments. 5 This idyll was interrupted one day when his
company's limited share float and relatively low market
capitalization attracted "Big Ears" Wu and his boys, who
put the stock in play with predictable results.

One night during dinner at one of Taipei's most

opulent Cantonese seafood restaurants, featuring expensive
dishes like shark's fin, bird nest soup, abalone, bear's
paw, and lots of XO brandy, Horace ran through his dilemma
for me, which I will paraphrase.

"My stock is selling at NT$250 per share, more than 200 times this year's
earnings, and that means that, according to the market, the company is worth just about
US$1 billion. This is crazy. I know what the company is worth. I know what our
budget and order book look like. I know what our corporate assets are worth in the
market. I may have slept through business school, but I know something is drastically
wrong. I should sell every single share I own in the company right now and retire.
Maybe I could use the proceeds from my shares to buy one of the smaller New England
states or a county or two in California. Who needs to work! If I get bored, I can always
buy the company back when the price comes back down out of the ionosphere."

"On the other hand, my father did start this company and it meant a lot to him.
We must have fifty of his old pals from Shanghai on the payroll, and, if I sell out, what
happens to them? I guess, I'd have to resign from the company and the board. That
would be the end of my excuses to go out on the town for "business" dinners with my
friends. Who knows, my wife might even begin pestering me about moving back to the
States. Maybe things are OK as they are. Even if my stock price drops back to where it
was three years ago, I'll still be rich, and I'll still be able to gan bei 6 with Fei-Fei and
Ping-Ping 7 as often as I want. I'd better think this through."

5
Certain of the famous hot springs in Peitou feature Japanese style group bathing facilities where the water has a
high sulphur content.
6
Gan bei means "bottoms up !" and is a common toast at dinner parties.
7
Fei-Fei and Ping-Ping are common "flower names" in Taipei's willow world.
 Horace, who saw it all coming and just dithered, was
right. No matter what happened, he was likely to always
come out without major problems. His company was un-
leveraged and liquid, and he personally stayed away from
the market. Sure, he might lose some paper profits, but
his financial and professional future was secure. Others
were far more exposed financially and professionally.

Driver Lu, who was seemingly at the opposite end of

the financial spectrum from Horace, carried himself with
the pride one usually associates with a Marine sergeant,
and he had the spit-and-polish personal appearance and can-
do attitude that went along with the image. Driver Lu's
chosen role in the world was to take our bank's manager to
and from work each day, and do anything else the lao ban
asked him to do, as quickly, efficiently, and safely as was
possible under the circumstances.

One morning shortly after my arrival in Taipei as a

lowly lending officer, our branch manager, who was both a
good banker and a nice guy, asked Driver Lu to pick me up
at home in the morning and then to come get him at 8:00
a.m. for the ride into the office.

Driver Lu showed up at my house with time to spare for

the short ride over to pick up our boss, but an unexpected
traffic jam 8 delayed us, and we were in danger of missing
what to Lu was the sacrosanct eight o'clock deadline if
things didn't improve quickly. Sensing a stain on his
reputation was in the offing, Lu detoured down an obscure
one lane country road which was elevated a foot or two
above the flooded rice paddies that stretched out on either

8
Traffic jams in 1976 were unexpected !
side. 9 . Lu pressed the accelerator of our mammoth American
car to the floor, and I noticed that the speedometer
stabilized at seventy miles per hour as we roared down the
narrow lane.

Traveling at this speed on that road began to fill me

with dread, which turned to alarm when I saw a huge German
shepherd standing in the road about a quarter of a mile
ahead of us. The giant beast apparently sensed that we
were somehow or other encroaching on its territory and was
aggressively pawing the pavement and snarling at us as we
rapidly approached. Quietly feeling around the naugahide
interior of the car for its non-existent seat belts, I
waited for Lu to hit the brakes and hoped that we did not
slide off the road into the fetid muck of the paddies,
which could have had several possible results, all most
unpleasant.

Driver Lu, to my surprise, showed no signs of slowing

down whatsoever, and the speedometer remained steady at 70.
The dog was going berserk with rage as we continued to
approach, and it was only when we were actually close
enough for me to see the foam at the animal's mouth that it
finally realizes that Lu was totally unimpressed with all
the snarling and had no intention of slowing down, much
less of stopping.

Lu accelerated ever so slightly just before the

impact, and I will never forget the bewildered expression
on the German shepherd's face just before it was pulverized
by the 5,000 pound Detroit behemoth. The dog must have
finally flinched just before we struck it because it was

9
While much of the Taipei suburb of Tien-mu has changed beyond recognition, this one lane road can still be
found.
dragged under the speeding auto, and I heard several
distinct bumps as its body was violently bounced between
the rock hard surface of the road and the equally
unforgiving underside of our car. When we finally passed
over the unfortunate canine, its body was spun about twenty
feet into the air before the gory mass of blood, fur,
gristle, and bone landed on the surface of the little lane
with a splat.

I was far too stunned to speak, and Driver Lu seemed

not to have even noticed the collision due to his exclusive
focus on picking up the lao ban at exactly the appointed
hour. As we approached our destination, Lu slowed down to
a dignified pace, turned around in his seat, and said to me
with a pleasant smile, "Seventh one this year, Sir." I
believe that it was early March at the time.

After my promotion to branch manager, Lu became my

driver, and I learned to appreciate his focused approach to
life in many ways. Fortune was good to Driver Lu, and he
was most surprised to inherit just under the equivalent of
$1 million as his share of the disposition of some land
held in his family for generations. Following my move to
another company in Taipei, which already had a driver, Lu
retired from the road.

After experiencing a slight case of ennui, Lu teamed

up with a former motorcycle messenger from the bank, who
was now a senior brokerage official, and started play the
market. I saw Lu coming out of a VIP room of a decidedly
down-market brokerage house just after the TSE index had
broken 11,000, and he invited me in for a chat. The room
had a Japanese theme, and after we seated ourselves on the
tatami mats and were served tea by a kimono clad attendant,
Lu gave me his current views on the market and on life in
general.

"The market is like magic! My grub stake of $1 million has grown to over $5
million thanks to the advice of our former colleague, Elbert. I've been to the States and
Europe over the last few months with some great local tour groups. I just bought the Tai-
Tai a diamond-encrusted Rolex, and I'm buying a small place in LA for my son to stay in
while he studies taxidermy there. I know some people think the market might fall out of
bed, but they just don't understand Taiwan. It's just like Japan, sir. I think the market's
going to 20,000; after it does, I'll think about trimming my positions a bit. Right now
I'm margined to the hilt and loving every minute of it."

"On the other hand, I know that there are some people who have gone a bit
overboard, and I've noticed that none of the companies whose stock I hold were clients of
the bank. I've really just won a lottery, and maybe I should sell out and enjoy the rest of
my life at ease. I've come a long was from being a driver, and I don't want to lose it all."

One of those who knew that his professional life was

at risk was my American friend, Irving, the highly regarded
and urbane Taipei branch manager of a New York based
international bank. Traditionally, the way to the top in
Irving's go-go bank was lending vast sums of money to
borrowers who could just barely pass the snicker test, book
the profits through the magic of the accrual system of
accounting, and then move on to a bigger, higher paying job
before it all hit the fan. Irving had worked this magic
several times before, barely missing the collapse in the
international shipping business in his last assignment, and
now knew that he only had to pull it off one more time
before he landed what he hoped would be a secure senior job
back in his head office.

Swathed in his Hong Kong tailored suit which he had

cut in a somewhat affected, vaguely British style, Irving
displayed all the outward trappings of success the day we
met for lunch at the Bankers Club, but a closer inspection
showed him to be pale, red-eyed, and seemingly hung-over.
As he spoke, a slight facial tick appeared and became more
pronounced as he continued. His monologue went something
like this:

"We had a customer dinner with Lucky Dragon Computer and Storm Door Co.
last night. Man, "Big Boss" Hu can really knock back the hsiao hsing wine. He and his
gorillas, whose only jobs seem to be getting their bankers drunk, must have toasted with
me a hundred times. Today, I'm in real pain, but it's worth it. Lucky Dragon is our
most profitable account, and I need to keep them happy. You know, they aren't making a
cent in the computer business these days, and they phased out storm door production last
year due to the appreciation of the NT dollar."

"Luckily, they're redeveloping the old Tao Yuan plant into a theme park, and old
Hu has been making a killing in the stock market. Our lines of credit, of course, are
really supposed to be used to finance inventory and receivables. We all pretend that this
is the case, but everyone knows that Hu uses the money in the market. Things are so
crazy in the stock market now that I really should cut him off and get our money back.
Any idiot can see that market's going to crash eventually, and, if it does, how will we get
repaid? A bad loan now would ruin everything. I've got a lot riding on this."

“On the other hand, if I'm going to make budget this year, I need the income from
Lucky Dragon. The interest spreads are great. If I don't lend old Hu the money, he can
get it just as easily from Crazy Lyonnais or one of the other banks. In fact, they only
borrow from us because I go out drinking and carousing with them once a month. I'll
talk to Hu and see if I can get him settled down a bit. I'm due for a transfer in another
six months. Things should be all right that long. Look how long all this craziness has
already been going on."

I truly sympathized with Irving and knew that he was

in a no-win situation. Hoping to change the subject, I
asked him what time the dinner broke up and whether or not
he was able to get a decent night's sleep the night before.
While well intentioned, I had obviously asked the wrong
question since Irving visibly winced, and I could tell that
the bile was rising up in the back of his throat. He
closed his bloodshot eyes, for a minute and asked
sheepishly, "Have you ever heard of Madam Boom-Boom...?"

At this point, I think that I should concede that I

was not merely a detached and somewhat amused observer of
the bubble market and the problems it was causing, nor was
I exempt from a certain amount of market induced anxiety.
I had stumbled into Taiwan's stock market just as it sat at
its then all-time high of 999 in late 1986 after working
for several years as a banker in Taipei. Even then, with
the wave of mid-'80's corporate bankruptcies still fresh in
my mind, I suspected that the market rally had gone too far
and had scoffed when my predecessor 10 had predicted that the
market could rise another 20% in 1987.

I was responsible for running he largest of the four

investment trusts that had been originally set up to funnel
foreign investments into the Taiwan market and which had by
then begun developing investment products for the local
market. I was new to the investment management business,
but I sensed that, despite my doubts about the level of
market prices, I was being paid to buy stocks not to hold
cash. It took a great intellectual leap to suppress my
native Midwestern financial conservatism, but I jumped into
the market and soon found myself buying shares in companies
that I would have been fired for lending money to only
months before. Luckily, as we have seen, the market
10
The now famous Mark Mobius of the Templeton Group.
cooperated by going through the roof, and the net asset
values of our funds ratcheted up with it.

By early 1990, the market had reached heights that

were unimagined a few years before, and I was acutely aware
that the market was a house of cards that could collapse at
any time. As about this time, I was having daily mental
debates about how I should deal with this very touchy
problem, which went along the following lines:

"The market has gone up by a factor of 12 in the last three years and is absurdly
overvalued by all reasonable standards. There is no conceivable way that the underlying
corporate cash flows associated with these shares can possibly support today's prices. No
market in history has ever sustained this kind of a valuation level, and it's clear that
sooner or later the market is going to crash. It's just a matter of time. We have more
than $700 million invested in the Taiwan market, and this represents real money.
Investors in our funds will see their capital destroyed when the crash finally comes, and
my primary responsibility is the preservation of our clients' capital. I should sell stocks
now for one hundred cents on the dollar and put the money into cash and top rate money
market instruments. The yields are low, but safely of principal is the thing to focus on
right now. It's time to ignore the crowd and do what I think is best."

"On the other hand, if the market keeps going up while I have the portfolio in
cash, investors in our funds will scream. I'm being paid to invest in the market, not hold
cash. If our investors want cash, they can sell their shares. They are the ones who have
decided to get into this crazy market, not me. Anyway, the market may go to 20,000 or
25,000. Once you're beyond the limits of logic, there's no telling where the market will
go. I guess that 12,000 isn't really any crazier than 8,000 and that 20,000 wouldn't be
any crazier than where we are today. A market is either crazy or not crazy; it can't be
double or triple crazy. I'd better take a few precautions, but basically just keep
plugging."
 I wasn't the only one who recognized that he had a
problem, but we were a pretty small group. Even among the
country's financial elite, the conventional wisdom that
Taiwan was unique and that the market simply couldn't crash
prevailed with a vengeance. Most perverse of all, many of
Taipei's financial professionals were most nervous when the
market bolted through the 1,500 and 2,000 levels, but got
calmer and calmer as prices went into the stratosphere.

Just as the market was precariously balanced at the

12,000 level, I was invited to a dinner party held in the
private dining room of one of Taiwan's largest, government
controlled banks. The guest of honor was a very senior
American banker on one of his regular runs through Asia.
As the twelve course meal progressed and as toasts of
warmed hsiao hsing wine were ritually exchanged, several of
the stalwarts of the country's financial establishment
basked in their good fortune and swapped stories about
their recent market coups.

The visiting American had been hearing about nothing

other than how the stock market had become Taiwan's
infallible, unstoppable machine of wealth creation during
his short stay on the island and really didn't know if he
should be appalled or amused. Having good manners and a
genuine regard for his hosts, some of whom he had known for
thirty years, he made a few remarks suggesting that the
market seemed to be exhibiting signs of extreme
overvaluation. He offered some amusing examples of the
outlandish valuations of several listed companies and,
using great care in his choice of words suggested that the
market might be in for a "correction."
 Many of the local bankers exchanged pained looks, -
they had heard all this a hundred times before - but
responded with polite and bland generalities. At this
point, a very senior and intellectually intimidating lady
banker whispered dismissively in Chinese to a colleague who
sat between us that "foreigners just can't understand our
market!"

That seemed to sum it all up. The emperor wore no

clothes, and it was seemingly the height of bad manners to
comment on it. How had a country that had boot-strapped
itself out of nowhere allowed itself to risk its precarious
success on the thin outer edge of a monstrous financial
bubble? To get a better grip on understanding this
question, we need to step back a bit and look at events
from a wider perspective and over a longer term.