The Volatility Machine: Emerging Economics and the Threat of Financial Collapse

266 Pages·2001·12.95 MB·English

by  Michael Pettis

The
Volatility
machine
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The
Volatility
Machine
Emerging Economies
and the Threat of
Financial Collapse
Michael Pettis
OXFORD
UNIVERSITY PRESS
2001
OXPORD
UNIVERSITY PRESS
Oxford New York
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Copyright © 2001 by Oxford University Press, Inc.
Published by Oxford University Press, Inc.
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Oxford is a registered trademark of Oxford University Press
All rights reserved. No part of this publication may be reproduced,
stored in a retrieval system, or transmitted, in any form or by any means,
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without the prior permission of Oxford University Press.
Library of Congress Cataloging-in-Publication Data
Pettis, Michael.
The volatility machine : emerging economies and the
threat of financial collapse / by Michael Pettis.
p. cm.
ISBN 0-19-514330-2
1. Financial crises. 2. Loans, Foreign. 3. Debts, External.
4. Capital. 5. International finance. I. Title.
HB3722.P47 2002
336.3'435—dc21 00-049180
9 8 7 6 5 4 3 21
Printed in the United States of America
on acid-free paper
Amid the seeming confusion of our mysterious world, individ-
uals are so nicely adjusted to a system, and systems to one
another, and to a whole, that by stepping aside for a moment
man exposes himself to a fearful risk of losing his place
forever.
—Nathaniel Hawthorne
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Acknowledgments
This book was written in 1999 and 2000 but incorporates work dating
back over four years. A lot of friends and colleagues have helped me
in this work, and it is difficult to name them all, but it would be
extremely ungenerous not to thank the many contributions made by
my good friend and Columbia University colleague Michael Adler. In
addition, Jared Gross and Fernando Saldanha read early drafts of the
book in great detail and provided an enormous amount of help and
advice. Several other people contributed either directly on the book
or in the many prior discussions in which I was forcibly educated (or
both). These include Craig Blessing, Arminio Fraga, Gary Evans, Frank
Fernandez, Carlos Hernandez Delfino, Bob Kowit, David Malpass,
Celso Pinto, Lee Sachs, and Robert Wade. Finally, my editor, Paul
Donnelly, has made this whole publishing business surprisingly easy
and straightforward.
I also owe a lot to my colleagues at Bear Stearns. Thanks to Don
Mullen and Peter Herzig, I was able to work part-time for six months
so that I could focus on writing the book. The boys on the EM desk—
Jorge Cantonnet, A. J. Mediratta, Carlos Vargas, Frederico Gil-Sander
and king-of-all-media Fernando Bravo always kept me in the loop.
Brian Kim and Bobby Lee, that amazing duo, struggled mightily to
maintain the fiction that the Capital Market Strategies group at Bear
Stearns couldn't function without me. Economists Carl Ross and Jose
Cerritelli were always able to take time from their schedules to give
me the advice and information I needed. Jeff Urwin has been an im-
portant friend and one of the main reasons I am at Bear Stearns, and
of course both things are equally true of el profesor Bruce Wolfson.
viii ACKNOWLEDGMENTS
There are many friends in the market who have contributed knowl-
edge, advice, or drinks. My former partner and supertrader Con Egan
is the best source for how bond markets actually work. Hans Humes
is both a great friend and a great fount of information on the hazards
of debt restructuring. Rudy Amoresano, Bo Bazylevsky, Jon Blum, En-
rique Boilini, Rodrigo Briones, Chiao Chiu, Fulvio Dobrich, Alison
Harwood, Ken Hoffman, Harry Krensky, Pedro-Pablo Kuczynski, Ri-
cardo Lacerda, George Liberatore, Ross McLaren, Vince and Leigh
Perez, Joe Rinaldi, Ian Ross, Susan Segal, Ken Telljohann, Craig Tor-
res, Peter Urbanczyk, Alberto Verme, Tommy Vecchhione, and Rich-
ard Watt have all directly or indirectly also had a hand in this.
Finally, a number of students at Columbia University have been
very helpful. I spent a lot of time discussing the capital structure
framework with graduate students Fabio Bicudo, Steve Kim, Gerrit
Koester, and Chi Le. Undergraduate students Sami Mesrour and Ejike
Uzoigwe helped out with research while Charles Saliba and Evan
Hutchinson participated actively in and out of class. I have only to
add the names of John Kim, Dong-Jun Johnny-5 Lee, Kevin Woodson,
and Reza Vahid to assure this book a place in history as the first time
the names of this amazing group of students have been mentioned
together in writing.
Contents
Introduction xi
Part I The Structure of Financial Crises
1. Capital Structure and Policy Collapse: The Financial Crisis
of the Late 1990s 3
2. Market Structure Issues 24
Part II Global Liquidity and Capital Flows
3. Why Does Rich-Country Capital Flow to Poor
Countries? 35
4. 180 Years of Liquidity Expansion and International
Lending 51
5. The Contraction of International Lending 72
Part III The Corporate Finance of Crises
6. The Theory of Capital Structure and Financial Risk 91
7. The Capital Structure Trap 124
8. Toward a Theory of Sovereign Capital Structure
Management 146