SEA currency turmoil renews concern on financial speculation

The turmoil in South-East Asia's financial and stock markets and the resulting economic slump in Thailand have brought to the fore the whole problem of financial speculation in the world economy.

by Martin Khor

THE current currency turmoil in South-East Asia has renewed serious concern among policy-makers and the public alike on the volatility of exchange rates and the disruptive role of speculation in the global financial markets.

The concerns emerged during the Mexico peso devaluation of December 1994 and its aftershock, and has re-emerged in the series of currency depreciations in Thailand, the Philippines, Malaysia, Indonesia and Singapore.

Protecting currencies from speculative attacks has become a major priority and preoccupation of South-East Asian governments.

Political and financial officials of these countries, with Malaysia vociferously in the lead, have taken up these concerns at various recent fora, including the IMF-World Bank annual meeting in Hong Kong, the Asia-Europe Finance Ministers' meeting in Bangkok and the Commonwealth Finance Ministers' meeting in Mauritius, all held in September. At the IMF-World Bank meeting, Malaysia's premier Dr Mahathir Mohamed slammed currency and stock market manipulation and proposed that the international trade in foreign exchange be banned, except if it is for purposes of trade. It was probably the first time a political leader has made such a strong proposal against financial speculation.. However, the region's financial authorities have yet to establish concrete measures that can control (if not prevent) the activities of financial speculators.

The initial attempts by some countries (Hong Kong and Singapore) to help Thailand shore up the baht succeeded for some days, but the speculative attacks proved too strong and the Thai authorities eventually allowed the baht to devalue.

In the Philippines and then Malaysia, attempts to maintain the currencies against the US dollar also proved too costly and were abandoned. It was reported that US$4 billion was by the Malaysian central bank to defend the ringgit.

The South-East Asian experience shows how difficult it is for a country to defend itself from a determined and concerted attack on its currency by a speculator or fund with enormous resources.

A hedge fund with US$15 billion of investors' money can command up to US$150 billion of resources and thus wield enormous influence.

For some years now, some economists have tried to ring warning bells over the way the world money market has been allowed so much 'freedom' by policy-makers that it has now veered out of the control of central banks, monetary authorities and governments.

The collapse of the global fixed exchange rate system in 1972, and the floating of currencies, was the first step in the journey to volatility in exchange rates.

Then came the increasing use of computer technology for electronic financial transactions, coupled with the liberalisation and deregulation of financial services and the removal of financial controls in most countries.

With the International Monetary Fund advocating (including through its structural adjustment programmes) the lifting of controls over the inflow and outflow of money in most countries, the stage was set for speculation in currencies, commodities, and share equities.

In the past, money moved around the world mainly to pay for imports and exports of goods and services, or in other words, to service the real economy of production and trade.

In recent years, however, with governments everywhere lifting the barriers to international financial transactions, the doors were opened to financial speculators wanting to make fast profits through betting on changes in currency rates, commodity prices and share prices.

Overwhelmingly speculative

As a result, an overwhelming part of financial flows is now speculative in nature. This is brought out by data in an article in the UNCTAD Review 1996 by University of Washington economics professor, David Felix.

In 1977, the annual value of world exports was US$1.3 trillion whilst annual global foreign exchange transactions were US$4.6 trillion. Exports were 29% of forex volume.

By 1995, world exports were US$4.8 trillion but annual forex volume had jumped to US$325 trillion. Export value formed only 1.5% of forex transactions.

In other words, only $1.50 of every $100 of foreign exchange movements was used to finance trade in real goods and services, whereas $98.50 was used for investment and speculative purposes.

Another interesting fact is that in 1977, global official forex reserves were US$266 billion whilst daily global forex turnover was US$18 billion. By 1995, however, the daily value of forex dealings (US$1,300 billion) had exceeded world official forex reserves (US$1,202 billion).

The implication of these figures is that it is now much more difficult for central banks individually, or even in unison, to fight a concerted attempt by powerful speculators to influence the level of particular currencies.

The investment funds, with such substantial financial resources under their control, are allowed relatively cheap or free access for billions of dollars to criss-cross the world in the wink of an eye (to be more exact, US$1,500 billion in a single day, in 1995).

In his recent book, When Corporations Rule the World, the American researcher David Korten calls the speculator an 'extractive investor', who unfairly extracts profits from other people's productive work.

'The extractive investor is taking advantage of price fluctuations to claim a portion of the value created by productive investors and by people doing real work.

'The speculator's take represents a kind of tax on the financial system to no useful end...The greater the volatility of financial markets, the greater the opportunity for these forms of extraction.'

Korten adds that the more destabilising forms of extractive investment were boosted by a new breed of mutual funds (hedge funds) that specialise in high-risk, short-term speculation and require a minimum of US$1 million.

The biggest of these, Quantum Fund headed by George Soros, controlled more than US$11 billion of investor money a few years ago (and the amount has probably risen). Since hedge funds may leverage investor money to borrow as much as $10 for every investor dollar, this gives Quantum Fund potential control over as much as US$110 billion, according to Korten.

'Currency sabotage'

Soros has been accused by Malaysian premier, Dr Mahathir Mohamad, as being responsible for the speculative attacks on South-East Asian currencies. The premier has called for such 'currency sabotage' to be made an international crime.

Many large hedge funds produced a rate of return of over 50% for their shareholders in 1993. But there are also risks: a small hedge fund lost $600 million in two months and had to close.

The claim made by some that speculators increase price stability was debunked by Soros himself when testifying at the US Congress' Banking Committee a few years ago. He told the Committee that when a speculator bets that a price will rise and it falls instead, he is forced to protect himself by selling, which accelerates the price drop and increases market volatility.

Soros, however, said price volatility is not a problem unless everyone rushes to sell at the same time and a 'discontinuity' is created, meaning there are no buyers. In this case, those unable to bail out of the market may suffer 'catastrophic losses'.

Comments Korten: 'Soros speaks from experience when he claims that speculators can shape the directions of market prices and create instability. He has developed such a legendary reputation as a shaper of financial markets that a New York Times article titled "When Soros Speaks, World Markets Listen", credited him with being able to increase the price of his investments simply by revealing that he has made them.'

In September 1992, Soros sold US$10 billion of British pounds in a bet against the success of British Premier John Major's effort to maintain the pound's value.

'In doing so he was credited with a major role in forcing a devaluation of the pound that contributed to breaking up the system of fixed exchange rates that governments were trying to put into place in the European Union,' says Korten.

Soros extracted US$1 billion from the financial system for his investment funds, and the pound fell 41% against the yen over a period of 11 months. 'These are the kinds of volatility that speculators considered a source of opportunity,' comments Korten.

He also quotes Felix Rohatyn, a senior partner with Lazard Freres Co., as concluding that:'In many cases hedge funds and speculative activity in general may now be more responsible for foreign exchange and interest rate movements than interventions by the central banks.'

Interestingly enough, Soros himself recently criticised the free market system for giving rise to instability and inequities, in a widely quoted article entitled 'The Capitalist Threat' in Atlantic Monthly (February 1997).

As is well known, Soros has invested substantial funds supporting groups in Eastern Europe and opening up foundations to overcome totalitarian communist rule, and to establish 'open societies.'

In this article, however, Soros makes a startling about-turn: 'Although I have made a fortune in the financial markets, I now fear that the untrammelled intensification of laissez-faire capitalism and the spread of market values into all areas of life is endangering our open and democratic society. The main enemy of the open society, I believe, is no longer the communist but the capitalist threat.'

Soros says that fascism and communism both relied on power of the state to repress the freedom of the individual and thus were enemies of the 'open society'. However, he adds, an open society may also be threatened from the opposite direction, from excessive individualism.

'Too much competition and too little cooperation can cause intolerable inequities and instability. Insofar as there is a dominant belief in our society today, it is a belief in the magic of the marketplace. The doctrine of laissez-faire capitalism holds that the common good is best served by the uninhibited pursuit of self- interest.

'Unless it is tempered by the recognition of a common interest that ought to take precedence over particular interests, our present liable to break down.'

According to Soros, because communism has been so discredited, 'I consider the threat from the laissez-faire side more potent today than the threat from totalitarian ideologies. We are enjoying a truly global market economy in which goods, services, capital, and even people move around quite freely, but we fail to recognise the need to sustain the values and institutions of an open society.'

Given this testament only a few months ago, it is ironic that Soros is now being pointed to as the man behind the economic and social instability caused by the fall in South-East Asian currencies.

In response to currency instability and financial speculation, several economists and international agencies are now supporting the proposal first put forward by James Tobin in the 1970s to levy a small globally-uniform tax on private forex transactions.

This proposed measure, now widely known as the Tobin tax, would act as a disincentive against financial speculation, slow down the speed of global financial markets and roll back the volume of forex transactions.

A recent paper supporting the Tobin tax was published by Washington University emeritus economics professor David Felix in the UNCTAD Review 1996.

Felix describes the Tobin tax as a 'sin tax' which 'penalises and thus restricts socially undesirable behaviour; in this case it is global financial behaviour that is undermining a major global good, i.e. a stable international financial system that is supportive of high-employment economic growth.'

According to him, the Tobin tax has these advantages:

* The tax would fall heaviest on earnings of traders engaged in forex transactions involving short round trips, as over 80% of forex transactions now relate to round trips of a week or less.

* Since much of this is related to cross-country interest rate arbitraging and exchange-rate speculation, the tax would squeeze the profitability of such speculative activity while impacting lightly on the earnings of longer-term round trips related to foreign trade and long-term investment.

* Since the tax would lower exchange-rate volatility, the tax burden on international trade and investment would be further offset by reduced hedging outlays against exchange rate risk.

* Revenue from a small tax can be sizeable. Felix estimates that a 0.25% tax on forex transactions can yield US$267 billion a year.

* The tax can reduce fiscal deficits through revenue enhancement and lower costs of debt servicing.

Felix makes three other important points. Firstly, the mainstream currency stabilisation proposals (by the International Monetary Fund, to lift all controls on capital movements, and by other institutions, for a group of countries to maintain their currency levels within a certain band) are not workable in the face of the growing power of the market.

'With the reserves-to-forex ratios dwindling to impotence, and the IMF and G7 monetary authorities persisting with a crisis management strategy that encourages riskier global financial forays, the likelihood of a future crisis exceeding the crisis management resources of the monetary authorities is becoming uncomfortably high,' says Felix.

'Rolling back the global forex volume and slowing the reaction speed of global financial markets is needed to reduce that likelihood. It is also an essential precondition for any of the mainstream stabilisation programmes to become viable.'

Secondly, Felix disagrees with critics of the Tobin tax that such a tax is uncollectible and he puts forward proposals for collection.

Thirdly, Felix says developing countries have suffered the most from speculation and thus have the most to gain from the Tobin tax.

'A Tobin tax jointly levied by developing countries would suffice to curtail the funds of open-end emerging market mutual quite substantially,' says the paper.

'Indeed since the modus operandi of such mutuals makes them excessively volatile sources of external funds, curtailing their volatility is an important reason why the developing countries should collaborate in globalising the Tobin tax.'

It remains to be seen if the current spate of currency crises, starting with Mexico and now hitting several countries in South-East Asia and Eastern Europe, will generate new momentum for a forex tax.

Of course, the proponents of such a tax will also find great resistance in the US Congress, the majority of whose members are dead against any global tax and are moreover staunch supporters of finance-based owners and businessmen.

Nevertheless, this need not prevent countries from putting forward proposals for regulating financial speculation at the IMF, the UN and other policy fora, either through a Tobin tax or other means. (TWR No. 86, October 1997)

Martin Khor is the Director of Third World Network.