Taiwan Today

After three years of wild ascent, Taiwan's stock market has finally crashed from its dizzying heights, sending a major tremor throughout society and its economic underpinnings. Individuals, families, and businesses have been jolted awake from a dream world in which stock prices necessarily and forever spiral upwards. The real world of financial risk and accountability has arrived, forcing agonizing adjustments in lifestyle after personal fortunes turned to rubble in a fortnight.

As of June 30, when the Taiwan Stock Exchange (Taiex) price index closed at 5,047, the cumulative decline from the peak of 12,495 on February 10 was a staggering 60 percent. In fact, over half of the listed stocks had shed 70 per cent of their market value during the period. The total market value of the listed stocks had dropped from US$260 billion to US$107 billion, with a paper fortune of US$154 billion (an amount which exceeds Taiwan's 1989 GNP by US$8 billion) disappearing from the market like smoke in a heavy wind.

Observers regard the crash as the end of Taiwan's spectacular bull market, a time that should become a valuable case study in the world of finance. The wild market climb started in 1986, when the Taiex price index hit 1,000 after twenty-four years of development from its index base year of 1962. In only two years and eight months, the index soared tenfold, breaking the 10,000 mark on June 19, 1989, when the index closed at 10,013. At that time, the index level was the second highest in the world, only behind Japan's bourse. In the course of the climb, the charge of the bull was held back only a few times, notably in 1987 during the global market crash and in late 1988 when the government announced its intention to reimpose the capital gains tax on stock profits.

Daily trading figures also expanded at incredible speed. Whereas daily transactions in the range of US$100 million used to be considered high, in May 1989, the market recorded an average daily transaction volume of US$3.9 billion, compared with US$6.9 billion for the Tokyo market and US$5.7 billion for the New York exchange. On March 16, 1990, the transaction volume hit the record high of nearly US$8 billion, equaling one-fourth of the ROC central government's budget for fiscal 1991 (beginning from July 1, 1990).

Taiwan's market performance is extraordinary considering that the ROC's G P in 1989 was only about one­ twentieth of Japan's and one-fortieth of the U.S.' in the same year. Moreover, Taiwan's market lists only 188 companies, compared to over two thousand listed on the Tokyo exchange and a similar number in New York.

The gigantic transaction volume provides a fertile ground for brokerage houses, which numbered close to four hundred (over two for every listed company) and had a total employment of 60,000 by mid 1990. Assuming that each brokerage occupies an office space of twenty-five thousand square feet, they created a total demand of nearly ten million square feet of space, putting a serious strain on the supply of office space in the Taipei metropolitan area. This demand for space was an important factor behind the doubling of office rents in 1989.

The hectic market, along with its twin, the overheated real estate market, also nourished the mushrooming development of underground investment houses. These firms, whose number topped two hundred by the market's heyday, solicited an estimated US$7.4 billion in funds from hundreds of thousands of investors.

The ballooning stock prices were attributed mainly to the idle capital flooding the Taiwan market, a result of the ROC's chronic foreign trade surplus, which generated a huge foreign exchange reserve (US$73 billion, as of the end of 1989). With abundant money in hand but limited channels for investment and low bank interest rates, more and more people were attracted to the promise of high returns on the stock market.

As stock prices soared to ever higher levels, the majority of the inves­tors adopted the habit of putting their money into the market, and then turning right around and taking it out again for fear of a market downturn. Ironically, as larger numbers of people joined this speculative merry-go-round, it produced a strong momentum which enabled the market to maintain its balance and advance further, however dangerously. As one active investor said only half-jokingly, "In the Taiex, a long-term investment is three hours."

The phenomenon explains the huge transaction value and high turnover rate on the market. For example, the entire inventory of stocks on the market changed hands six times in 1989. On the average, investors held their shares for just ten days!

The market reached its peak without the support of favorable underlying conditions, such as a positive prognosis for the economy, desirable industrial trends, and a list of companies that show good profitability and a solid assets picture. The so-called P/E ratio (price/earnings ratio), the yardstick for evaluating the reasonableness of stock price levels, reached high double-digit levels for most stocks and even triple-digit figures for some. At the end of 1989, when the Taiex price index closed at 9,624, the average P/E multiple of all the listed stocks was 55.9, second only to the Tokyo exchange's 70.6. By comparison, the P/E ratio for Seoul is around 14 and it ranges from 10 to 12 for London Hong Kong, and New York. The P/E multiples for banking and life insurance stocks in Taipei were in excess of 200.

The star performers in the bull market were the stocks of companies with small capitalization. Because of a tight float of new companies offered for investment and a limited supply of shares, the prices of small capitalization stocks were easily manipulated by major players. It was not uncommon to see a P/E multiple in excess of 500 for small capitalization stocks. But the strangest development in the market had to be the prices of full delivery stocks (mainly bankrupt companies). In theory, full delivery stocks have no real value because they have a huge negative net worth and virtually no earnings. Some of the companies ceased operations years ago. Because of their low unit value, these stocks were used as cheap objects for manipulation, and their prices rose manyfold, even more than the blue chip stocks in some cases.

In this heated atmosphere, the stock market developed quickly, becoming an increasingly important source for the supply of long-term capital to local businesses. Attracted by the hefty market prices, companies overcame a long-standing reluctance and rushed to list their stocks on the Taiex, boosting the total number of listed companies to 188 by mid-1990. This was 62 higher than the total in early 1987. In addition to the huge amount of funds flowing into the newcomers when they entered the market, all the listed companies solicited a total of US$5 billion from the market during the 1987-1989 period, or an annual average of about US$1.7 billion in the form of new equity capital. This enabled the companies to expand their operations, install automated facilities, intensify R&D, and make overseas in­vestments. (There are indications, however, that some companies decided to play the market instead, using their newly gained funds to gamble for quicker returns.)

The US$1.7 billion annual fund amounts to 5.4 percent of Taiwan's total fixed capital formation of over US$30 billion in 1989, making the stock market the third largest source of capital. The first rank is held by banks, which held outstanding loans of over US$132 billion provided to private enterprises as of the end of 1989. The second largest source is other financial institutions, including in­vestment and trust companies, life insurance companies, and the postal savings system, whose loans outstanding with private enterprises topped US$8.3 billion at the end of 1989. Corporate bonds occupy the fourth place; the outstanding amount of corporate bonds issued by private enterprises totaled over US$280 million as of end of 1989.

Taiwan's overheated stock market caused serious side effects on the economy as well as the sociocultural and political aspects of life. Stock fever spread to people in every walk of life, casting its spell over housewives, storekeepers, laborers, public functionaries, teachers, farmers, and businessmen. As of mid-1990, there were a total of four million investment accounts at Taiwan brokerages. Even after deducting the surrogate accounts, an estimated three million people were actively engaged in stock market investment—more than one-third of the labor force of 8.3 million persons. During boom times, an estimated one million people crowded into brokerages every morning.

Prevalent stories of overnight millionaires had a serious impact on individual attitudes. Obsessed with get­-rich-quick dreams, people experienced an erosion of self-discipline, making it difficult for them to work at routine jobs for relatively small pay. Immediate mate­rialistic pursuits became the order of the day, and the phenomenon remains an important factor behind the serious labor shortage.

For those people still on the job, productivity was slowed because of the market. It is generally thought that many employees were distracted from their work because of volatile stock activity, and the owners of many businesses, large and small, also became reluctant to invest further in their own operations. Instead, they put their money into the stock market to obtain quick returns. To a certain degree, society was transformed by the existence of a gigantic casino that touched everyone's lives.

The get-rich-quick mentality stimulated the criminal elements of society as well, and they used brute force to jump on the big money express train. The number of reported felonies, including murder, robbery, kidnapping, and blackmail, jumped from 2,987 in 1987, to 3,836 in 1988, and further to 5,839 in 1989. Police authorities say that over 60 percent of the criminal cases were related to financial matters.

Worried about the abnormal effects of the stock market fever, the government decided to take focused action. On September 24, 1988, Shirley Kuo, then minister of finance, announced that effective January 1, 1989, the government would restore the capital gains tax on stock transactions, which had been suspended for twelve years. According to the new measure, for all stocks pur­chased after January 1989, investors would have to include transactions gains in their personal income and pay a maximum 50 percent tax On the case of in­comes over US$128,700). To protect small investors, those who sold less than US$110,300 worth of stocks during the year would be exempt from the tax.

Kuo said that the restoration of the tax would uphold social justice and narrow the gap between the rich and the poor. The official view was that stock gains should be treated like any other kind of income, and that the tax exemption for stock gains was markedly unfair to salary earners, who contribute almost 80 percent of the government's revenue from income taxes.

The announcement of the new tax dealt a heavy blow to the stock market. It was caught at a sensitive moment, having just climbed to a record high at the time. The market responded by sliding into a steep decline which lasted for nineteen consecutive trading days, slicing 36 percent off the Taiex price index from the peak of 8,789 (September 24) to 5,615 (October 21). More alarmingly, the transaction volume shrank drastically, from the record US$1.75 billion on September 24 to the negligible level of below US$36.8 million. Investors strongly resented the reinstatement of the tax, and the decision touched off a series of street demonstrations. Protesters demanded that both Kuo and then Premier Yu Kuo-hwa should step down. The tax decision quickly developed into a serious political issue.

The political force of a large number of single-minded investors proved to be too much for the government: the tax-exempt quota for stock sales was therefore raised to US$367,600 per person, and the 0.3 percent stock transactions tax was halved to 0.15 percent. Moreover, as happened during the 1987 global stock crash, government-run banks, following the instructions of the Ministry of Finance, intervened in the market and once again began buying large amounts of blue chip stocks. This action ignited a fire that was fueled further by the concerted efforts of the market's big players, and Taiex finally revived. While the 1987 government intervention involved the heavily publicized purchase by government-owned banks of about US$260 million worth of stocks to prop up the market, this time the operation was strictly low-key. The general managers of the government-owned banks were told privately to make the purchases, and the scale of the activity is still unknown.

Unfortunately, the relaxation of tax exemption standards created major loopholes that virtually nullified the ef­fects of the new capital gains tax. Large investors circumvented the tax by trading through surrogate accounts, and the volume of transactions continued to expand at an unbridled pace. This finally prompted the government to abolish the new tax and to make up for it by an increase in the stock transactions tax to 0.6 percent, effective January 1, 1990.

Despite the levy of the enhanced stock transactions tax and a subsequent gradual decline in the market, the speculative fever did not abate significantly during the first half of 1990. The transactions value topped an annual rate of US$550 billion, or a daily average of US$2.6 billion during the period. The colossal transaction volume channeled US$3 billion in revenue into the National Treasury coffers in the first half of 1990. For all of FY 1990, which ran from July 1, 1989 to June 30, 1990, the government collected a total revenue of US$3.9 billion from the stock transactions tax, one-eighth of the government's total tax revenue of US$31 billion.

But mounting disillusionment with the stock market, together with the depreciation of the New Taiwan dollar and the existence of favorable overseas investment opportunities, stimulated a huge flow of capital offshore. Net capital outflow in the first quarter of 1990 reached about US$3.7 billion. This was partially offset by the US$2 billion surplus in the ROC's net exports of goods and services (referred to as the "current account surplus" in foreign trade jargon).

But that still left red ink amounting to US$1.9 billion in the ROC's balance of payments. The net capital outflow soared to US$7.5 billion in the first five months of 1990, and the Central Bank predicts that the amount will reach US$13 billion to US$15 billion for the whole of 1990. With the current account surplus predicted to hit US$8 billion, the nation for the first time in ten years may suffer a deficit of US$5 billion to US$7 billion in its balance of payments this year.

In addition, disappointed stock market investors are now withdrawing their money from demand and checking accounts, which had been used extensively for stock market transactions, and are re-depositing it in higher-interest time accounts. In May 1990, demand and checking account balances dropped by US$801 million compared to the amount twelve months earlier. The combination of this trend and increasing capital outflow is responsible in large part for the 3.4 percent decline in the growth of the money supply (MIB) in May, the third such decline in as many months.

The stock market is now decidedly lackluster, especially as more investors come to realize that Taiwan's economy is less beguiling than bedeviled. True, the economy continued to register a strong growth of 6.7 percent in the first half of 1990, but after deducting the dubious contribution of the stock market, the development of which actu­ally neither increased the available goods nor enhanced the overall quality of life, the economy grew by only 5 per cent. (The contribution of the stock market is based on the brokerage commissions and revenue from the stock transactions tax.) Industrial output declined 2.4 percent in the period, while exports in terms of NT dollars tumbled 4.5 percent.

The effects of the market's plunge appear to be widespread. When stock prices started declining, many investors bought even more shares, intending to sell them quickly once the market rebounded. But the recovery failed to arrive, and investors found themselves in deepening financial trouble as the market became even more uncertain. According to a survey of 1,214 investors in the Taipei area, which was conducted by the U.S. Gallup Organization for a Taiwan-based securities company, as of mid-1990, 54 percent of those interviewed reported suffering an overall loss from investing in the stock market.

Because there are more than four million stock accounts, the shrinkage of individual fortunes caused by the market decline is having a profound effect on the consum­er market, chilling such businesses as real estate, auto dealerships, and restaurants. In fact, many Taiwan automakers were forced to suspend operations in the middle of 1990 in order to cut down on their large inventories.

Many companies, whose owners had made handsome gains from stock investments in the past, have run into major financial difficulties because they were caught with their capital trapped in the market. A number of listed companies are also experiencing difficulties in soliciting capital from the market to use for financing investment projects. Moreover, the nearly 400 brokerages are undergoing a major shakeout.

More worrisome is the impact on the financial system. A number of credit cooperatives have involved themselves heavily in financing stock investments for individuals and corporations, and other financial institutions have extended loans to borrowers who have put up their stocks as collateral. In addition, as of the end of April 1990, the various monetary and financial institutions in Taiwan had poured a total of almost US$5.9 billion into the purchase of stocks. The situation has led to urgent calls for government intervention to pre­vent the collapse of the stock market in order to avoid severe financial disruption of the economy.

In the middle of 1990, the chairmen of the three major business associations—the Chinese National Association of Industry and Commerce, the Chinese National Federation of Industries, and the General Chamber of Commerce of the ROC—jointly urged Premier Hau Pei-tsun to adopt effective measures to salvage the stock market, including steps such as halving the maximum permissible daily decline for any given stock (which now stands at 7 percent for either price increases or price declines), lowering the reserve requirement for banks, cutting the stock transactions tax, and maintaining the stability of the NT dollar exchange rate.

But the premier refused to cut the stock transactions tax, saying that it was at a reasonable level and was conducive to the encouragement of long-term in­vestment. He said that the government's primary objective was to create a healthy stock market through measures such as the elimination of insider trading, the expansion of the scale of the market, liber­alizing margin trading and short selling, and strengthening the function of the Securities & Exchange Commission (SEC) and the Taiwan Stock Exchange. He also pointed out that it was useless to prop up the stock market if it did not have a healthy basic structure in the first place.

Wang Chien-shien, the new minister of finance, also reiterated the government's unwillingness to lower the stock transactions tax, saying that it was instru­mental in helping the government maintain a sound and orderly stock market. He noted that it was unhealthy when the earnings of a hardworking entrepreneur could not equal the overnight gains of stock and real estate speculators. Wang said that according to past experience, any salutary effects of a tax cut on the stock market would last only a few days at most. He added that for the purpose of creating a healthy stock market, the government would first allow the existing investment trusts to expand their scale of operations, and it would approve the establishment of new funds.

The purpose of creating more favorable conditions for the growth of institutional investors is to lessen the im­portance of individual investors, who now account for over 90 percent of all stock transactions. Wang noted that individual investors were vulnerable to rumors and easily fell prey to the manipulation of big speculators, and this contributed to market volatility. The minister favored the policy of allowing general securities companies to engage in margin trading and short selling, and he wanted to strengthen the supervisory role of the SEC.

In line with Wang's statement, the SEC on June 28 agreed to allow the four existing securities investment trust companies to issue new closed-end funds of US$184 million each. Previously, the four companies had issued various investment trust funds (with a total book value of US$1.6 billion) as a means of soliciting money for investment in the stock market. On July 5, the SEC announced that it would soon allow foreign institutional investors to invest in the Taiwan market. At present, foreign investors can get into the market only by buying beneficial certificates of the overseas investment trust funds managed by the four existing securities investment trust companies. These trust funds now have a total book value of US$206 million.

In addition, government officials are considering the possibility of allowing the labor retirement fund, which amounts to US$1 billion or more to invest in the stock market. They are also considering whether to provide the fund with guarantees against possible losses should it be authorized to invest in the Taiwan stock market. Apparently, the official view is that the market decline in the first half of 1990 was a natural correction of the unbridled stock price surges of the past. Thus, the conventional wisdom indicates that the decline may help relieve the serious side effects that the stock market fever has caused in society and the economy.

Past experience has taught government planners a hard lesson: If they interfere with stock prices in a bear market, they risk rekindling the fires of stock speculation; if they interfere with a bull market, they will spur violent protests from investors. Consequently, the proper government role in the stock market seems to be the maintenance of an orderly and healthy environment, while adopting a strictly neutral role when it comes to the level of stock prices, leaving it to the market forces of supply and demand to determine the level of stock prices.

For three years, the stock market has been the center of daily life for millions of people. It became the source of their happiness, dreams, anxieties, frustrations, sorrows, and fears. Now the casino atmosphere has been replaced with a more reasonable understanding of how a modern stock market operates. The financial shakeout is still continuing, but the market may soon achieve a firmer and healthier footing. When it does, the difficult work of economic development, which has been overlooked by too many for too long, can get back on track. —Philip Liu is the editor-in-chief of Business Taiwan, an English-language weekly newspaper published in Taipei.