In Praise Of Investing Inertia

It turns out that doing nothing with your retirement portfolio was a pretty good way to ride out the financial crisis.

To channel Mark Twain, it appears that rumors of the death of buy-and-hold investing have been greatly exaggerated. Had you simply stayed put in a low-stress, completely pedestrian collection of equity and bond funds, including index funds, over the past few years and continued to contribute to them you would have actually outperformed the market. In other words, a little inertia can be a very good thing.

The obvious argument for buying and holding is that if you try to time the markets it's well nigh impossible that you will sell at the very top or buy back into the market at the very bottom. Blowing this timing can deliver more than a small, smarting tweak to your portfolio in our bubble-prone economy where highs can be dizzying and the lows crushing. A good chunk of the recovery will happen in its very first few days, and the crashes can be swift, too. Good luck trying to call these moves perfectly. You’ll need it.

Javier Estrada, professor at the IESE Business School in Barcelona, has proved just how much damage can be wrought by pulling out of the markets at the wrong time. Estrada analyzed the Dow Jones industrial average from 1900 through the end of 2007. He found that $100 invested in 1900 would have returned $25,746 by the end of his study. Yet if you missed just the 10 best days of that entire ride your total pot at the end would be $9,008, almost two-thirds less than maintaining constant market exposure. Had you missed the best 100 days you would have earned just $87 in that century-plus stretch.

The flip side, of course, is that if you avoid the worst days you also outperform. Had you missed the worst 10 days of Dow losses you would have seen your total rise to $78,781. The worst 100 would have earned you $11,198,734.

What this shows is that while timing the markets right can earn you a lot of money, you can also lose a lot. If you are investing for your retirement this is an awfully dangerous gamble. For many investors it may be a better idea to invest in a range of index funds, set it up so you dollar-cost average on a monthly basis, and basically forget about trying to micro-manage it.
Morningstar recently tabulated a decade's worth of data and compared how the average investor did vs. the average fund. The answer was that over the past 10 years investors did considerably worse, seeing returns of 1.68%, against 3.2% for all funds, meaning investors were generally off with how they timed their purchases and sales.

In addition Vanguard recently documented the benefits of standing pat in its study "Resilience in volatile markets: 401(k) participation behavior September 2007-December 2009." What the study found was that during a time of exceptional volatility the average defined contribution investor at Vanguard barely altered their saving and investment behavior. On the face of it this sounds like heresy: We are being told more than ever to keep a close eye on our money, and to, in essence, become our own investment managers. But this consistency yielded surprisingly good returns for Vanguard's retirement-centered investors, mitigating the downside of 2008 considerably.

In 2008 during the height of the credit crisis and the stock market meltdown, Vanguard found that traders shifted just 4% of their assets from equities to fixed income. In 2009 that number was 1%. Between September 2007 and December 2009 only 3% of participants abandoned equities.

This might sound like a recipe for financial suicide, but it was the opposite. Since most 401(k) investors at Vanguard kept up their contributions, the median participant account balance actually grew by 10%, vs. a 25% decline for the markets during the time above. The beauty of all this was during the worst financial crisis in several decades those who stayed put, whether by design or simple inertia, ended up buying a lot of securities at the bottom and making money.

What this means is that despite a hyperventilating financial media and daily reports of doom and gloom, most people who stuck with a plan of investing in a balanced portfolio of diversified equity, balanced and bond funds, including indexes, experienced far less volatility. They were able to build on their portfolios during a crisis and buy at the bottom. This paid off in 2009 when median account balances grew by 33% at Vanguard against a 26.5% rise for the S&P 500.

Vanguard is the leading name in indexing, a passive way of owning securities that mirror the investment performance of the world's financial markets. Many, including Vanguard founder John Bogle, argue that indexing remains the easiest, most cost-efficient way for the average investor to invest.

Of course there are arguments to be made against buying and holding indexes. The leading argument is that there are skilled investors that have consistently beaten the markets. This may well be true, but there are caveats to putting your money with a great money manager. The biggest caveat, again, is timing.

Fund managers Ken Heebner, manager of the CGM Fund; and Bill Miller, of Legg Mason's ( LM - news - people ) Value Trust both have earned well-deserved praise for their abilities to beat the Standard & Poor's 500 during their respective tenures as the heads of their respective funds. No one can, or would try, to take this away from them. Yet both of these guys lagged the markets for years, even decades. Rare is the investor with the fortitude to stick through almost 20 years of losses, compared with the market, to reap later gains.

Let's start with Heebner: He became manager of his fund on the first day of 1981. From that day until March 22, 2010 he beat the S&P 500, but it was closer than you might think, according to data supplied by Morningstar. In that time Heebner earned annualized returns of 10.93% against the market's 10.67%. Again, all credit to Heebner. It should also be noted that Heebner badly lagged the markets through the end of 1999, returning 15% against the market's 17.2%.

This means that $10,000 invested with Heebner, if you stayed for the whole ride, would now be worth $207,420, against $193,389 for the S&P 500. Yet what if you stuck with him through the end of 1999 and, entering a new decade, simply got fed up? You would have had returns of $143,228 from Heebner against $202,586 for the S&P.

It's possible you would have bailed at that point. CGM couldn't provide data as to how many, if any, investors fled the fund, but assets certainly dwindled after 1999. By the end of the year Heebner's fund had $909 million under management, which shrank to $654 million by the end of 2000, and bottomed at $376 million by the end of 2002. For those who hung tight, the story had a happy ending, though, as Heebner ended up beating the markets over the past decade, by a nice margin. As of the end of 2009 the fund had $549 million in assets under management. Yet the ride was not smooth.

Bill Miller has managed the Value Trust since April 17, 1982. If you had stayed with him for the whole ride you would have, again, beaten the markets. The value of $10,000 invested at the start of his tenure would be worth $245,579 as of March 22, against $219,441 for the markets. Impressive. The actual annualized percentage points were closer, with Miller's fund earning 12.1% against 11.7% for the markets. Miller's fund has seen a reversal of fortune over the past decade, though, earning annualized total returns of -2.7% against the market's -0.7%.

(One irony: Despite making more money during his time managing the Value Trust, Miller's fund currently has one star from Morningstar against five for Heebner's.)

Miller saw his assets shrivel during a tough period, in his case 2006 through 2008, only to have the fund roar back to life in 2009. Once again nervous investors missed the ride. As Miller himself noted in a 2008 letter to shareholders, "We (and everyone else) get the most inflows and the most interest AFTER we've done well, and the most redemptions and client terminations AFTER we've done poorly. It will always be so, because that is the way people behave."

Some people, that is.
So while it may be better to lucky than good, sometimes it's better to be lazy than smart.

David Serchuk, 03.29.10, 06:00 AM EDT

Rio Tinto sacks four executives jailed in China for bribery

Jane Macartney, Beijing

(Reuters / Aly Song)

Australian Consulate General, Tom Connor speaks outside the People's Intermediate Court in Shanghai after the trial of a Chinese-Australian executive of Rio Tinto

Rio Tinto, the Anglo-Australian mining giant, has sacked four iron ore executives after a Chinese court sentenced them to jail terms ranging from seven to 14 years for commercial espionage and taking bribes.

Within hours of Australian citizen Stern Hu and his three Chinese colleagues being convicted, Rio Tinto to limit damage to its business interests in China.

The company announced it had sacked the four executives and said it hoped the case would not affect its trade with the world’s largest steel producer.

Mr Hu, Wang Yong, Ge Minqiang and Liu Caikui all pleaded guilty to accepting bribes during negotiations over iron prices, but disputed the amounts and aspects of the accusations. One of the four had admitted to commercial espionage.

Sam Walsh, the company’s iron ore chief executive, described the behaviour of the four workers as “deplorable”.

He said: “We have been informed of the clear evidence presented in court that showed beyond doubt that the four convicted employees had accepted bribes.”

Mr Walsh declined to comment on the charges of stealing commercial secrets which were heard in a closed court last week, because the company “has not had the opportunity to consider the evidence”.

Mr Hu was sentenced to seven years for taking bribes and to five years for stealing business secrets, the Shanghai Number One Intermediate People’s Court ruled.

The court said Mr Hu would serve parts of the sentences concurrently, reducing his jail term to 10 years. Mr Wang, accused of taking 75 million yuan (£7.5 million) in bribes, received the longest sentence, of 14 years.
The two other Rio staff, Mr Ge and Mr Liu, were sentenced to eight years and seven years respectively.

All four stood passive while the sentences were read out. Mr Hu’s usually dyed black hair was now white. Tao Wuping, a lawyer for Mr Liu, said: “I think all of them were already mentally prepared to appeal both the bribery and secrets convictions.”

Jin Chunqing, a lawyer in the Mr Hu’s team, said the defence team were gathering to decide their next step. He said: “We haven’t decided yet if we would appeal.” Appeals in China have about a one per cent chance of success.

Australian Foreign Minister Stephen Smith described the sentences as “very tough”.
He said: "It is a tough sentence by Australian standards. As far as Chinese sentencing practice is concerned, it is within the ambit or within the range. According to Australian officials there was evidence indeed, if not substantial evidence, that bribery acts had occurred."
Announcing its verdict, the court said it had shown leniency because the defendants had made admissions of guilt.

However, it said the sentences were in line with the seriousness of a crime that had caused major losses to the Chinese steel industry.

The court found that the four had helped to obtain information from confidential strategy meetings of the China Iron and Steel Association, which was representing the Chinese steel industry in last year’s negotiations with the world's three top iron ore suppliers, Rio, BHP Billiton and Vale.

It is unclear how the actions of the four Rio executives differed from usual practices by businesses seeking to learn details of the position of an opposite number in any business negotiation.

The four Rio employees were arrested last July during contentious iron-ore contract talks between top mining companies and the steel industry in China, the world's largest consumer of the raw material. The talks collapsed. This year’s negotiations are still under way.

Tom Albanese, the chief executive of Rio Tinto, said: “I am determined that the unacceptable conduct of these four employees will not prevent Rio Tinto from continuing to build its important relationship with China.”
Mr Smith said the outcome of the trial would not impact relations between China and Australia. He said: “I don’t believe that the decision that has been made will have any substantial or indeed any adverse implications for Australia’s bilateral relationship with China.

“We did go through some tensions or some difficulties last year, but whilst this has been a sensitive, very important and very difficult consular case, I don’t believe that what has occurred today will have an adverse impact on our own relationship.

“We continue to have a very strong economic and broader relationship with China,” he said.
At the three-day trial, the court heard evidence that millions of yuan in bribes had been stuffed into bags and boxes for the accused.

Mr Hu took money from small private steel companies which, before the global financial crisis, were locked out of buying iron ore from Rio Tinto because the mining giant gave priority to large state-run steel companies.

Mr Walsh said today: "Shortly after the four employees were detained we appointed independent forensic accountants and lawyers to assist us in carrying out an internal investigation into the claims. This was done to the fullest extent possible. It did not uncover any evidence to substantiate the allegations of wrongdoing.
"Rio Tinto has concluded that the illegal activities were conducted wholly outside our systems.

He added: "We have already implemented a number of improvements to our procedures, and we have now ordered a further far-reaching independent review of our processes and controls. We will introduce any necessary additional measures and safeguards the review recommends and will spare no effort in doing everything we can to prevent any similar activity."

Dong Zhengwei of the Beijing Zhongyin law firm, said: “Based on the crime, Mr Hu’s sentence is not harsh for China. He faced up to 15 years. This sends a real signal to foreign companies that they must act in accordance with business ethnics. They face a risk if they engage in illegal activities.”

The men will likely serve their sentences at Shanghai’s Qingpu prison, where American Jude Shao served 10 years of a 16-year sentence for tax evasion and fraud. Mr Shao was released in 2008.

US Treasuries Fall as Foreign Demand Wanes

Yield on US Treasuries advanced this week as demand for the $118B  of 2, 5 and 7 year notes was weak.  Demand from indirect bidders, the group that contains foreign central banks, and direct bidders, which includes domestic money managers both slipped.  The yield on the bench mark 10 year bond increased to 3.90% before retreating to 3.86%.  This yield is far less than the 6.3% the Greek's had to pay for their 10 year notes, but a continuation of this trend in the US may hinder recovery in the US housing market.  Many home loans are priced in relation to the 10 year paper and the recovery  is endangered by the biggest rate jump since December.

Some attribute the Greek sovereign debt crises as a catalyst for the higher rates.  In a Market Watch bond review this morning they said:


"What's changed is that investor outlooks on the fiscal side have turned decidedly more downbeat since Greece's debt woes were first splashed onto the front pages of the main papers," RBS Securities' Bill O'Donnell and Aaron Kohli said.

"The spotlight on Greece only helped to reveal that that the U.S.'s kitchen (federal and state budget balances) was itself full of cockroaches," the bond strategists wrote in a note."


Fed Chairman Bernanke, during the past year, expanded the balance sheet of the Central Bank by the purchase of agency paper from Fannie and Freddie.  If these lns were priced, mark to market, as the IRS demands, what would the new Fed balance sheet look like?

With current massive US budget deficit heading for a record of $1.6T, big bi weekly Treasury auctions will be the norm.  We wonder if the current auction is a fluke or the beginning an upward spiral in rates, as global governments compete for money to fund their deficits.  Bill Gross, the world's largest bond fund manager has expressed his views, when he told CNBC he prefers stocks over bonds.  According to
MONEYNEWS.COM he said:

"Let's suggest the economy looks good, that risk assets — whether it's high-yield bonds or whether it's stocks — have a decent return relative to the potential of declining bond prices," he said. "I'll go with the stock market."

Gross also cited "the healthcare situation and the $40 trillion worth of present value in terms of entitlements we have in the United States," he said.

"We just added in my opinion another $500 billion in terms of healthcare and the markets are beginning to look at that suspiciously."
The dollar got a boost this past week, benefiting from the chaos caused by the Euro bankers response to the Greek crises.  If the current agreement, which assigns two thirds of the bail out to the Europeans, and one third to the Washington based IMF holds, what will be the next problem that concerns currency traders.  Higher yields in the US may attract some investor interest from yield seekers, but we all know which direction bonds go if the rates work higher.  We are very cautious about the short side of the euro versus the dollar.  Not all of the debt problems are in Greece.

British Times papers to charge for Web content

It appears the day when we we'll be paying to read general interest news stories on the Web is coming sooner, rather than later--perhaps as early as June for readers of the U.K.-based Times publications.
News International, the British division of Rupert Murdoch's News Corp., announced on Friday that two of its newspapers, The Times and The Sunday Times of London, are set to begin charging readers using its sites in June.

The two papers have been offering their content in a combined news Web site called Times Online. Under the new plan, however, News International would introduce new, separate sites for each publication in May, according to several news accounts citing a company statement.

The sites will reportedly be offered for 1 pound ($1.48) for a day's access, or 2 pounds ($2.96) for a week's subscription. Those fees will cover access to both sites, which will be available for free during a trial period.
As newspapers struggle to stay alive amid declining print circulations and weak advertising revenues--only made worse by recessionary times--there's been much talk about charging users for online stories.


"At a defining moment for journalism, this is a crucial step towards making the business of news an economically exciting proposition," News International CEO Rebekah Brooks said in a broadly reported statement. She added that "This is just the start," but did not offer up details on plans for the company's two other U.K. publications.  http://newscri.be/link/1055863

The Wall Street Journal, which News Corp. acquired in 2007, is already behind a pay wall and has fared much better than some of its print-media brethren in the aftermath of the recession. The Financial Times and Newsday also charge for access and The New York Times has plans in the works to do so as well.

But the move by the British Times publications, would mark the one of the first mass-market, consumer newspapers to start charging for content. (Newsday and Le Monde in France are two that we know of.)
Meanwhile, in another move to save his business, Murdoch continues to point fingers at Google for depriving the industry of revenue by making news articles searchable for free. He plans to press legal action against the search giant if talks fail over its indexing of news content.

by Michelle Meyers  http://newscri.be/link/1055863

Steve Jobs spotted not hating Eric Schmidt

Meets ex for coffee

By Rik Myslewski in San Francisco 

The on-again, off-again relationship of Steve Jobs and Eric Schmidt may be back on again.
According to a Friday afternoon post posted from Gizmodo, the Apple and Google CEOs were spotted at a Palo Alto, California coffee shop - out front on the sidewalk, mind you - chatting over coffee. The site's tipster even snapped photos, it would appear:

Gizmodo's tipster caught this convivial scene of talkative Steve and attentive Eric

According to the tipster, Jobs did most of the talking - with one snippet of overhead conversation being the Cupertinian saying: "They're going to see it all eventually, so who cares how they get it."

We'll leave it to your imagination what the unknown antecedent to "they" might be. Users? The Federal Communications Commission? Steve and Eric's wives?

And what is "it"? Some secret Apple/Google pact? Innappropriate content banned from the iTunes App Store? Sub-rosa political communications with Sarah Palin and/or the US Tea Party movement?

Whatever that cryptic comment might mean, the entire tête-à-tête seems bizarre in the extreme. Two love-'em-or-hate-'em billionaire tech gods, in broad daylight, sipping what one can only presume to be caffè lattes at a sidewalk table outside a coffee shop - which, by the way, Gizmodo identified as being owned by former Google chef Charlie Ayers."

Why was the notoriously private Jobs baring his all-too-familiar face for the world to see at all, let alone in the company of a man with whom he allegedly can't stand? The oh-so-recognizable Jobs would attract attention if he were wrapped in a burnoose in a nargileh parlor in northern Yemen. And according to CNBC's Silicon Valley bureau chief Jim Goldman, multiple sources have told him that "Steve Jobs simply hates Eric Schmidt."
We can only assume this sighting was no accident. Jobs and Schmidt wanted to be seen together and to have reports of their parley leak out to the public at large.

And now it has. The real question isn't who are "they" and what is "it", but instead: Why do Steve and Eric want us to know they're in conversation? ®

Source: http://newscri.be/link/1055717

Google and Censorship

China isn't the only place where Google faces tough choices.

By Erica Naone

All eyes have been on Google's battle with the Chinese government since the company announced on Monday that it would no longer maintain its censored Chinese-language search site. Instead, the company began redirecting users of Google.cn to its Hong Kong-based search service, Google.com.hk, where it maintains unaltered Chinese-language search results.

Credit: Technology Review

However, China isn't the only front in Google's battle to protect its vision of an open Internet. When Google announced that it might cease operating Google.cn in January, David Drummond, senior vice president of corporate development and the company's chief legal officer, wrote that "this information goes to the heart of a much bigger global debate about freedom of speech."

"These issues are coming up all over the world," says Cynthia Wong, Plesser Fellow and staff attorney at the Center for Democracy and Technology, a nonprofit organization based in Washington, D.C., that promotes an open Internet.

Wong says governments around the world are making policy decisions about material on the Internet--particularly when it comes to questions of child protection, copyright, and cyber attacks. She says it's tempting for them to enlist "technology intermediaries"--companies such as Google that host content or help users find information--to police what users can access. Because Google is so dominant in search and involved with many other Internet services, it often winds up at the center of these controversies, she notes.

Technology has shifted censorship from something that governments do to something that often requires participation from companies, says Ross Anderson, chair of the U.K.-based Foundation for Information Policy Research and a professor of security engineering at the University of Cambridge.

Google faces pressure to censor content in many different countries. Inside Thailand it censors YouTube videos that mock the country's monarch. In Turkey it deletes videos that portray the country's founder, Mustafa Kemal Atatürk, as a homosexual. In France and Germany, Google abides by strict hate speech laws and censors content produced by extremist groups. And in India, it censors pornography and anything the government deems politically dangerous.

Google is involved in a number of squabbles over censorship. The company recently criticized the Australian government for a plan to introduce mandatory filtering for Internet service providers. Google says that the proposal goes too far. In addition to blocking child sexual abuse material (which Google already filters out of its search results worldwide), the company believes that the proposed Australian plan would block "socially and politically controversial material," such as information on safer drug use or euthanasia.

"This type of content may be unpleasant and unpalatable, but we believe that government should not have the right to block information which can inform debate of controversial issues," wrote Iarla Flynn, head of policy for Google Australia.

Elsewhere, governments are putting pressure on Google to police the content that users upload to its sites. In late February, three Google executives--Drummond, Peter Fleischer, global privacy counsel, and George Reyes, former CFO--were convicted of criminal charges in Italy for failure to comply with the Italian privacy code. The charges were brought in response to a video uploaded to YouTube. Google notes that these executives "did not appear in [the video], film it, upload it, or review it," and that the video was removed from the site "hours" after the Italian police notified the company.

"In essence, this ruling means that employees of hosting platforms like Google Video are criminally responsible for content that users upload," wrote Matt Sucherman, Google's vice president and deputy general counsel for Europe, the Middle East, and Africa.

Wong says that Google's battles in China, Italy, and Australia all ultimately threaten the company's ability to publish user-generated content, since liability for what users upload and access would mean needing to police it, which would be financially and legally difficult.

But Wong points to a key difference in China. Under U.S. and European laws, there are strong protections for companies that host or index content, she says. Because of this, in Italy, for example, Google can challenge the ruling through the legal system. In China, the situation is very different--every intermediary down the line can be held responsible for content, regardless of where it came from. That legal situation promotes self-censorship, she says.

Google is well-known for explaining its actions by an altruistic-sounding refrain: "What's good for the Internet is good for Google." But Evgeny Morozov, a Yahoo! fellow at Georgetown University's E.A. Walsh School of Foreign Service, notes that the anticensorship position the company has promoted is also directly related to the bottom line.

If Google gets forced, by any country, into the position of having to police and restrict what content users can access, Morozov says, this draws the company into a morass of expense and liability. He believes Google has "a strong commercial interest" in maintaining a role as a simple intermediary, which lets it focus on developing its search and other money-making technologies.

Morozov says this also explains why Google is framing many of these free speech issues in terms of international trade. Especially since the company faces questions of censorship all over the world. "The governments are finally catching up with the Internet and they want to regulate it," Morozov adds. The question for Google is how well it can protect its stance on Internet freedom, wherever that battle is being fought.

Source: http://newscri.be/link/1054578

A more competitive South Korea emerges

I LEFT booming Shanghai on Sunday for South Korea, Asia’s fourth largest economy, to attend a gathering of social scientists in the future city of Incheon and its adjacent port.

This ancient city is Korea’s first Free Economic Zone (1,000 sq km), designated in 2003. It is already fast becoming an intelligent high-tech city with state-of-the-art infrastructure and facilities to house world-class businesses, schools, universities, hospitals and MICE and cultural complexes.

This sets Incheon as the next northeast Asian hub for global logistics and centre for investment. What I saw was most absorptive – a far cry, I thought, from the Port Klang Free Zone that failed to be.

You can’t but be impressed with the Koreans’ determination to do what it takes to seriously compete with its two towering neighbours – China and Japan, and India.

It’s the beginning of spring in Incheon, but it snowed! First time in 40 years, I am told. A rare treat.
This meeting of a mix of some smartest analysts in economic affairs and public policy from the US, Europe and Asean+3 provided the needed warmth to fascinate each other on the prospective state of goings-on in the world, especially Asia.

The collaborative research of young Koreans was an eye-opener. I intend to share some of their analytics and findings in the hope that we can learn from their lessons and policy action experience.

Korea before global crisis
Korea was hard hit in the 1997/98 financial crisis. But rebounded with V-shaped recovery in 1999. Since then, economic fundamentals had consolidated and strengthened to grow at over 4% a year in the 2000s. Reforms were undertaken to re-strategise underlying macroeconomic structures and the financing framework of banks and enterprises.

The objective was simple: Transform the economy and inject sufficient resilience to withstand the next crisis.
The focus was to allow private enterprise and initiative take the lead, with increasing reliance on the market for price discovery and to sharpen competitiveness. Indeed, Korea has since relied on market power to drive adjustment to basic macroeconomic soundness but with varying success. It significantly liberalised the financial market.

Restrictions against foreign investment were lifted; exchange rate was allowed to float; foreign capital was encouraged to move in (foreign investment was soon 40% of total listed shares); and banks were pushed to restructure, recapitalise and improve basic soundness.

Korea’s corporates and industry responded by strengthening governance and balance sheets, reduced debts, and restructured and re-invested to raise productivity.

With new-found confidence, Korea raised its share in some global markets as weaker competitors exited, e.g. in semi-conductors and LCDs. Korean autos penetrated deeper into the US, European and Asian markets.

Indeed, Korea had the audacity during the crisis not just to reform, restructure and rebuild, but also to invest in new private productive capacity for sustained future growth.

Its rising competitiveness was reflected in strong export growth for 10 years since 1997. By end-2007, Korea’s foreign exchange reserves rose to US$262bil, as against only US$20bil in 1997.

Shocks from the global crisis
Not unlike its neighbours, the 2007/08 global turmoil hit Korea hard, even though it had restructured its economy and built some resilience.

Impact of the severe shocks was visible in the virtual collapse in export demand; and the tightening financial markets and liquidity crunch. Effects were as sudden as they were severe.

This “double whammy” from both export loss and large capital outflows drastically weakened its external payments position. In 2008, Korea recorded its first current as well as capital account deficits since the 1997/98 crisis.

Collapse of global demand reduced exports by 12% in the fourth quarter of 2008, despite the sharp depreciation in the won in 2008. However, imports also declined reflecting weakened manufacturing output which fell by 12%. Poor business sentiment led to a 16% fall in private investment. Private consumption declined by 5%. As a result, GDP recorded a negative 5.6% in the fourth quarter of 2008.

The devastating impact was centred on financial markets, with capital flows dripping in red. In 2008, foreign exchange outflows totalled US$55bil, comprising both FDIs and portfolio outlays.

Sharp de-leveraging prompted domestic businesses to borrow massively short term; by end-2008 short-term foreign debt rose to the equivalent of 97% of national reserves. This mismatch of long-foreign assets and short-liabilities remains until today a source of concern.

These simply meant tightening domestic financial conditions, considering that in 2008 the stock index (KOSP1) fell 41%, loan-deposit ratio rose to 135%, and bank profits declined by 47%.

The severe credit crunch reflected the 50% depreciation of the won from early 2008 to the fourth quarter of 2009. Overall, Korea’s balance of payments looked awful: Current deficit of US$6bil and capital account US$51bil.

As a result, Korea’s national foreign reserves fell by US$57bil to just over US$200bil at end-2008. That’s a far cry from a position of persistent surpluses since 1998 (reserves at end-1997 being only 10% of 2008).

Policy response
Like its Asian neighbours, Korea had learnt well from prior experience in successfully handling crises. More important, it had previously credibly reformed and restructured the economy. It was better placed than most in terms of technological infrastructure, to effectively deal with what came along.

The policy mix adopted this time comprised four rather traditional thrusts:

·Expansive monetary policy to ease liquidity crunch, including very low interest rates and accommodative quantitative measures (including purchase of long-dated assets);

·Aggressive expansionary fiscal policy to raise domestic demand directly, with tax reductions and front-loading large spending;

·Ready access to substantial official financing, and guarantees to relieve pressure on exchange rate and other asset prices, especially in stabilising forex markets (using new swap arrangements with the US, Japan and China); and

·Strengthening restructure and reform mechanisms to reduce inefficiencies in debt work-outs, bank recapitalisation, and SME credit support.

These measures are still on-going. Since the crisis, this mix of policies has worked reasonably well, with intended objectives being increasingly met.

The banking system appears to have stabilised with most indicators looking sound enough. Improvements are visible in bank asset quality and SME support looks solid with low NPL ratios.

True, the forex market continues to be of concern, but measures to address uncertainties are working sufficiently. Others like direct forex liquidity provision (US$55bil), government guarantees to banks (US$100bil), currency swap lines with three majors (US$90bil, with usage already repaid) and the Chiang Mai Initiative (reserve pool of US$120bil) have proved adequate to help calm markets.

Short-term foreign debt has slowly declined (now below US$150bil) as has the foreign debt ratio (39% of GDP).
On the fiscal side, economic stimulus spending since 2008 reached 5% of GDP by end-2009, with the three-year total for 2008-2010 at 7%. This was made possible because of its solid fiscal position until 2008 – with a public debt of 36% of GDP (lowest in OECD, average being 72.5%).

Korea post-crisis, 2009/10
It now appears Korea’s policy responses have had most of the desired effects. Financial markets are certainly more stable.

However, forex markets are still not yet calm enough, with continuing currency maturity mismatches which need time to unravel.

Nevertheless, the overall situation remains vulnerable. Korea still does not have a completely convertible currency even though its exchange rate is market-determined.

Its recent experience showed off vast volatility in the won, which impact cuts both ways. Certainly, the sharp depreciation since mid-2008 helped boost exports in 2009. But the speculative massive capital movements inflicted high costs on the nation’s finances.

Overall, the economy is in recovery – a V-shaped one at that. GDP expanded 6% in the fourth quarter of 2009 (-5.6% in the fourth quarter of 2008). Latest forecasts point to a 4.5%-5.5% growth this year.

Between February 2009 and January 2010, the KOSPI was up 51%, the won appreciated by 24% against the US dollar, consumer prices were down 25%, BIS capital ratio of banks up 15% and currency reserves up 36% to US$273bil, even higher than the previous peak at end-2007.

Exports are doing particularly well, up 19% in 2009. It’s significant that Korea’s export markets have become more diversified (China now accounts for 24% of total trade; Asean 19%); so have the product-mix (semi-conductors 8% of total; autos and parts 11%; flat TV panels 5%; ship-building 10%).

Korea’s share of global LCD market is now 50%; and autos close on 15%. Koreans have done rather well for themselves.

Nothing is over-optimistic
As you get familiar with Koreans – academics, policy-makers, businessmen and consumers – you know they know they have come a long way. Indeed, they have successfully evolved from passive followers to becoming active agenda setters. This role befits a country on the move: From destruction in the 1950-53 Korean War to be one of Asia’s richest nations.

With per capita income now above US$20,000 a year (China, US$3,300 and Asia US$4,000), it’s within earshot of its former colonial master. But it has a much healthier economy than Japan and growing much faster to be merely catching up.

For Koreans, “nothing is over-optimistic,” notes an observer. Global brands acknowledge how quickly Korean names have risen.

They are already well-known for innovativeness and efficiency in electronics, cars, LCD display panels and ships, and are rising rapidly in building high-speed railways and atomic power plants.

But new successes will not come easily. Its economic model needs to be regularly updated to boost productivity and develop a more competitive service industry to move rapidly up the value chain.
Otherwise, they will be squeezed by low-cost producers from China, India and others in Asia, and out-innovated by the likes of the US, Japan and Germany.

Under pressure on costs, Korea knows it has to move into more advanced areas like clean energy technology, including wind-tunnels and hybrid electric cars.

It is making strides in low-carbon industries (already commands one-fifth of global lithium battery production). Its well-developed technological infrastructure is a plus.

Overseas, Korea’s top brands are making new breakthroughs. Samsung (the largest of Korea’s 60 biggest business groups) already outsells Hewlett-Packard in electronics.

According to a recent report, Samsung is on track to make more profits in 2010 than the top 15 Japanese electronic firms combined. Similarly, Korean autos already have 8% of the US market. Given Toyota’s predicament, Hyundai cars may well make further significant strides.

Korea still has a way to go. It has not yet arrived. But the Korean spirit is no longer just one of catch-up. Its enterprises have demonstrated with increasing frequency a determination to compete almost anywhere and with almost anyone. They deserve the credit of always trying harder.

WHAT ARE WE TO DO? 
By TAN SRI LIN SEE-YAN
 ·Former banker Dr Lin is a Harvard-educated economist and a British Chartered Scientist who now spends time teaching and promoting the public interest. Feedback is most welcome at
starbizweek@thestar.com.my.