MAKING SENSE OF RECENT financial developments in Asia requires more than an advanced degree in economics. A good imagination, an appreciation for the big picture and a little patience are also useful. First, imagine that Asia is an icy highway. Then, picture a single car spinning out of control and crashing into a guard rail. That is Thailand's devaluation of the baht last year. Next, watch as one car after another skids on the same spot and crashes into the growing wreckage. Now you have the big picture. As for patience, go back to the icy highway. Envision approaching automobiles in ultra-slow motion as they slam on the brakes and swerve. You'll have to wait to see whether the evasive maneuvers are successful. The point is, all the debate about market interventions and capital controls and the death of capitalism is really about trying to avoid the pileup. Here are some details:
Economics seemed more straightforward when the Free Market was king. But in just the last couple of weeks, laissez-faire Hong Kong has intervened in its stock market. And after a decade of growth built with the help of foreign investment, Malaysia has announced capital controls. What's going on?
Remember the big picture: Both Hong Kong and Malaysia intervened with an eye toward lowering interest rates, which they figure will help beleaguered domestic businesses. Has Hong Kong renounced its free market credentials? Is Malaysia divorcing itself from the world economy? Absolutely not, though both moves suggest growing disillusion with unfettered capitalism.
What do Malaysia's capital controls accomplish?
Malaysia essentially ordered foreign speculators to take their money, leave the country and not let the door hit them on the way out. By ejecting them and removing the ringgit from free-market trading, Malaysia believes it can goose its economy without worrying that speculators will sit in judgment. Foreign corporations will still be able to exchange ringgit profits for foreign currency. Malaysians traveling abroad can take the equivalent of about $2,600 with them. Travelers to Malaysia are welcome to bring in as much foreign currency as they want. Many foreign investors with holdings in Malaysia will have to wait a year to take their money out of the country. Malaysia mutual funds and unit trusts outside the country have mostly suspended activity.
Was it a smart move?
In the short run, yes. The Kuala Lumpur Stock Exchange (KLSE) initially surged 70% before retreating somewhat. In part, that may reflect the fact that Mahathir ordered all ringgit overseas to be returned to Malaysia. Much of this returning cash ended up being invested in the KLSE, fueling a rally. On another front, the government is encouraging banks to lend by lifting restrictions on them. That could help businesses with cash-flow problems.
Sounds like a plan. What's the problem?
Economists say capital controls tend to look worse over time. For instance, low interest rates may benefit businesses that need to borrow, but they also encourage investors to look for something better. And there are ways to beat currency controls. Under-invoicing exports or overstating imports can allow traders to keep money outside Malaysia. Also, controls are not likely to help Malaysia's banks, which need fresh capital much more than they need freedom to lend.
What do controls mean for the rest of Asia?
The economy is too closely linked with others - especially Singapore - for the impact to be contained without any fallout. Soon after the controls were announced, Singapore had to halt trading on its CLOB (Central Limit Order Book) over-the-counter market, which is dominated by Malaysian stocks. Singapore had served as a parallel trading ground for some corporate shares outside the Kuala Lumpur Stock Exchange. But Malaysia said it would not recognize trading beyond its borders. Singapore says the impact of closing CLOB is minor. Elsewhere, the biggest threat of Malaysia's move may be that investors stop putting money in Asia altogether.
Last month, Mahathir chastised Hong Kong for not paying attention to his 1997 diatribe against speculators. Was Hong Kong's August intervention in the stock market a sign that Dr. M was right all along?
Not exactly. There is no doubt that speculators have wreaked havoc on Asian currency and stock markets over the past 14 months. The question is whether the speculators have been taking advantage of fundamental weaknesses or merely marauding from one market to the other in an effort to make money. Mahathir's vote is clear: "marauders." He denies that Malaysia has any fundamental problems to justify an attack. Others, including Malaysia's former deputy prime minister, Anwar Ibrahim, disagree. The critics say the worst thing about Malaysia's capital controls is that they could temporarily boost the economy without addressing underlying weaknesses.
When Mahathir leveled his "I told you so" criticism, Hong Kong was in the middle of spending $15 billion in the stock market - trying to accomplish what?
Authorities had detected big-time speculators taking advantage of links between Hong Kong's currency and interest rates. Investors call their move a "double play." Part I: Speculators bet that the entire market or specific stocks will fall. To place their bets, they use tactics like short-selling, which is where they sell borrowed shares in anticipation that prices will drop by the time they have to make good. Once the bets are placed, it is time for Part II: Traders use Hong Kong dollars to buy U.S. dollars. In big enough quantities, the selling automatically triggers the Hong Kong Monetary Authority to raise interest rates as a defense. Higher interest rates generally hurt the prospects and stock prices of businesses, which make the bet in Part I look good. The HKMA tried to cross up the speculators by buying so stock prices went up instead of down. The government hoped speculators would give up the game and go elsewhere, which would alleviate pressure on the currency and allow interest rates to fall.
Did it work?
Too soon to say (patience, remember). On the last Friday in August, after two weeks of HKMA buying, speculators had a choice: either repay the stock they had borrowed - at relatively high prices - or borrow the stock for another month. Both options were expensive. However, September is a new month. Will the government intervene again? What about October? John Seel, Hong-Kong based associate director for the investment bank of Bear Stearns Asia, says the HKMA probably succeeded if it intended to introduce risk in an investing play that had seemed like a sure winner. He is skeptical, however, that the move chased away speculators: "I hope [the HKMA] doesn't waste any more money." The HKMA followed up its intervention with several regulatory moves designed to make betting against the market less desirable.
Does the additional regulation mean Hong Kong is no longer a free market?
Hardly. The administrative controls imposed are unremarkable. Chris Tinker, regional head of economics for ING Baring in Hong Kong, points out that, by comparison, U.S. restrictions on short-selling are much tougher. Hong Kong hasn't gone that far. The real question, he says, is what the changes will mean in the future: "It seems to me the new restrictions represent an acceptable constraint. But we'll have to wait to see the long-term impact on liquidity."
As a small investor, can I take advantage of the titanic battle between the HKMA and speculators?
You have several options depending on how wealthy, lucky and patriotic you feel. If you are out to make a killing, you can decide whether the market is or is not overvalued, and you can bet for or against further intervention. Of course, if you sell short, you've become one of the evil speculators lambasted by the HKMA. Many investing experts advise a less bold strategy: Sit on the sidelines until the elephants finish stomping around.
Will other countries copy the route taken by Malaysia and Hong Kong?
If Malaysia's capital controls succeed, other crisis-affected economies in Asia may think about following suit. With sky-high interest rates crippling its economy, Indonesia might seem a likely suspect. But it can't afford to anger the IMF or scare off the tiny number of foreign investors who might be interested. Thailand has followed the IMF prescription for recovery more closely than its Asian neighbors and is unlikely to change course soon. The Philippines has tried capital controls and officials say they want no part of them. South Korea may be most susceptible to embracing a Malaysia-type solution. Although the IMF has promised $57 billion in loans if Korea follows its instructions, the nation now has a current-account surplus that could allow it to go its own way. South Korea practiced capital controls until 1992. Will it return to the past? Will it go forward despite the pain?
What are the options if currency controls don't work? What else can be done?
If the problem is "hot money" - speculators moving investments in and out of emerging markets in search of quick profits - there are ways to fight without erecting Malaysia-sized barriers. Some nations heavily tax profits from the sale of stocks held short-term. At one time, Brazil levied a 1% tax on all foreign investment in its stock market. Mexico has restricted the amount banks can lend to foreigners.
Mahathir says the Malaysian controls are permanent until the world's developed economies, such as those represented by the G-7, move to protect vulnerable markets. What can the rich countries do?
They could establish a global institution along the lines of the Bank for International Settlements, which oversees banks, to regulate currency traders. The regulation might require traders to disclose the source of their money or where else they have investments. Regulators could restrict the use of borrowed money for speculating or require high reserves. The danger is too-onerous restrictions could strangle currency markets.
What's wrong with that?
The inescapable fact is that some economies run more smoothly and efficiently than others. Until the day a single global currency takes root (unlikely anytime soon, mostly for nationalistic reasons) currency markets remain the best early-warning systems available to alert governments of economic weaknesses that need attention.
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