Hong Kong crash is evidence of speculator's influence

The crash of the Hong Kong stock market recently is further proof that financial markets are driven by speculation and not 'objective market forces'. For Hong Kong was the darling of economists and analysts who pointed out its economic strength and financial stability in contrast to the financial turmoil in South-East Asian countries that were said to have bad economic fundamentals. Malaysia and other developing countries have added reason now not to give in to the rich countries' pressures at the WTO to open up their financial sectors to foreign firms.

By Martin Khor

THE dramatic fall in the Hong Kong stock market for four days recently provided new and outstanding evidence to the argument that it is speculation that is mainly driving the financial turmoil in Asian countries.

Malaysia has been in the forefront of this point of view. Both its Prime Minister and the Deputy Prime Minister have been advocating reforms to the global financial markets, including the establishment of monitoring and regulatory mechanisms in the currency trade in general and for hedge funds in particular.

Although officials in the World Bank and the International Monetary Fund are now examining these proposals, there have also been many people in the market and in the media who have opposed them.

They portray the Malaysian proposals as an attempt to put the blame for the region's financial woes on speculators like George Soros, and on the hedge funds.

According to these 'free-marketers', the financial markets are guided by sound policies and practices. The fund managers are experts on the 'economic fundamentals' of countries and move the funds under their control into currencies and stock markets where these fundamentals are sound, and move them out of countries where the economies are weak.

So if a country were to experience a devaluation and a stock market crash (as the South-East Asian countries recently have undergone), that's because their fundamentals are weak. So the free-market theory goes.

It's an example of a circular argument, of course. There's the basic assumption (more like an article of faith) that the market is an objective and clever evaluator of countries' economic performances, a kind of Supreme Court making the most superior judgments on countries based on the best information. So if a country's currency or stock market falls, it must be because it has feet of clay. If a country's currency is strong, it must be because the economy is strong. How do we know this is true? Because the market is always wise, and always right.

Of course, given this basic assumption of the infallibility of the financial market's judgment, the rest follows.

The problem of this circular argument is that everything depends on the assumption. And now the recent Hong Kong episode shows up, once again, how untenable this assumption is.

When Malaysian Prime Minister Dr Mahathir Mohamad made his now famous address to the World Bank-IMF seminar in Hong Kong in September 1997, many critics pooh-poohed his proposal to ban currency speculation as an attempt to hide the fact that Malaysia's economic fundamentals were weak.

They pointed to the fact that the currency turmoil had not affected Hong Kong, whose economy they said was in great shape. Thus, if Malaysia and other countries were affected, that's because their economies were basically weak.

Financial analysts are fond of pointing out the deficits in the current account of Thailand, Malaysia and Indonesia. In contrast, Hong Kong has a good current account situation and moreover has solid foreign reserves worth US$88 billion.

Recently this theory of the strong-won't-be-affected suffered a setback when the Taiwan currency's peg to the US dollar had to be removed after the Taiwan authorities spent US$5 billion to defend their currency from speculative attacks, and then gave up.

And now the four-day meltdown in Hong Kong, when the stock market index lost 23%, before its partial recovery, has busted the free-marketers' theory that economies with strong fundamentals would be left alone.

It won't be surprising, though, if they change their tune after the fact, and now point out that Hong Kong's fundamentals were after all weak, and that's why the stock market plunge was well justified!

That's the beauty of a ciruclar argument. You need not be wrong, when events contradict your prediction.

After all, Malaysia had been held up as a model economy, by no less than the IMF's director-general, only a few months ago. Of course when Malaysia's currency fell, the same admirers retrospectively insisted that the economic fundamentals had been weak all along!

But the Hong Kong stock market crash did shock the analysts and the media. It may finally change the tide, and lead world public opinion to believe that speculators, not the Supreme Court of sound economic judgment, are the drivers of global financial markets.

A series of articles in Canada's biggest paper, the Globe and Mail, on 24 October 1997, demonstrates this turn in thinking.

Its front-page cover story described the Hong Kong crash in near-apocalyptic terms: 'A continued meltdown of Hong Kong stocks sent markets around the globe sharply lower yesterday, vaporising billions of investment dollars. Hong Kong stocks plunged 10.4% on the fourth day of a rout that has lopped more than 23% off the high-flying market, once considered the safest haven in Asia.'

Another article in the Business Section said: 'For weeks, investors turned a blind eye to the carnage in Asia's lesser markets as country after country, led by Thailand in July, succumbed to economic and currency problems.

'But Hong Kong was supposed to be different. With its Western-style markets, the second largest in Asia after Japan, it was thought to be immune to the financial flu that had swept through the rest of the continent. And no one imagined that the stability of its currency, which is pegged to the US dollar, would ever be called into question.

'All that changed this week...Despite assurances from finance secretary Donald Tsang that the currency would never be devalued, analysts warn that Hong Kong may be left with no choice.'

A third and very interesting article reported that the hedge funds had led the process of the speculation in Hong Kong. It revealed that: 'Fund managers said that hedge funds, which have been variously credited or blamed for falls in currencies or shares throughout South-East Asia, have once again made a killing from market turbulence.'

It quoted Peter Robson, who manages $1.5 billion in the region for AIG Govett, as saying that 'Hedges are playing a clever game.'

Robson added that with confidence that Hong Kong would defend its commitments to the US dollar peg, hedges built up short positions in the forward and spot currency markets, while at the same time taking larger shorts on shares and cash Hong Kong markets.

As pressure on the Hong Kong dollar rose, he said, monetary officials soaked up liquidity by raising interest rates. 'If they short the currency, they know it will push rates up and slaughter equity values. They are profiting at Hong Kong's determination to maintain the peg.'

From these reports, it appears clear that big speculators, and in particular the hedge funds, have been behind the attack on Hong Kong's stock markets as well as the Hong Kong dollar.

If a strong economy like Hong Kong's, with such solid reserves, can be so seriously attacked, it should also be clear after this that speculation and manipulation activities are way out of control, and have very negative destabilising and disruptive effects on whole economies, including economies which have been considered in good or even great shape until the attacks.

When Hong Kong's stock market came under attack, the World Bank senior adviser Peter Bottelier defended the authorities' defence of the currency, saying there was no reason for Hong Kong to abandon its currency peg to the US dollar.

'This is not a country where the banking system is suspected of severe weaknesses or where the balance of payments is very, very bad,' he declared. 'This is pure contagion, which of course can have a life of its own. Hong Kong fundamentals are basically very, very strong.'

Let's hope the nice things being said about Hong Kong won't be retracted in the circular argument syndrome, but will be cited instead as evidence of the power of the speculators and of their damaging effects.

The potential hazards for developing countries of allowing the global financial markets to have free play cannot be over-stressed, especially when Malaysia and other Asian countries come under pressure to open up their financial sectors to huge foreign banks, insurance companies, stock broking firms and other institutions, under the World Trade Organisation's financial services negotiations.

The WTO's director-general, Mr R Ruggiero, is in fact scheduled to be visiting Kuala Lumpur to persuade Malaysia to agree to the further rapid opening up of its financial sectors to these big financial institutions.

In September 1997 in Hong Kong, Malaysian Deputy Premier Anwar Ibrahim had told the WTO chief that Malaysia would agree to further liberalisation, but when adequate regulations were in place internationally to prevent the damaging activities of speculators from adversely affecting developing countries.

Ruggiero will most likely try to persuade Malaysian leaders that liberalisation under the WTO rules will not increase the dangers of financial destabilisation and that regulations of the financial markets are already adequate, or can be established or improved later. He will make the case that liberalisation should come first and quickly because there is a deadline of mid-December 1997 for the WTO talks to end.

But the recent violent gyrations of the Hong Kong market, which have also negatively affected Malaysia and the region, provide yet another lesson: that Malaysia and other developing countries should be very cautious not to agree to further open their financial sectors to foreign firms as this will make these countries even more vulnerable to financial speculation.

As Rubens Ricupero, the secretary-general of UNCTAD (the United Nations Conference on Trade and Development) declared recently: 'In the absence of broad international consensus on how to curb volatile capital movements, a reasonable degreee of flexibility for measures to deal with inward and outward capital movements remain essential for national authorities of developing countries.

'Not even the most spectacular rapid and continuous growth performance for decades was a guarantee of immunisation against risks of sudden and serious setbacks.'

This message, by Brazil's former Finance Minister, and now the United Nations' most senior official on development issues, should be clearly borne in mind during the WTO chief's visit to Kuala Lumpur.

Opening up our financial sectors to foreign firms may be very nice in theory, and pleasing to our partners in the industrial countries. But it can be hazardous to the economy and to national development. And the nation's interests have to come first. - Third World Network Features (October 1997)

Martin Khor is Director of Third World Network.