Who Sank, or Swam, in Choppy Currents of a World Cash Ocean (Part 2)

By Sven Buttler, 17 February 1999

For all the dazzling size and complexity of the global financial markets, it is not clear that the markets are operating with an intelligence that matches their scale. There may be computer equipment analyzing blips in exchange rates, but investors are fundamentally prey to emotions and panics and tend to overshoot.

Paul Samuelson, the Nobel laureate in economics, argues that sophisticated analysis has done a marvelous job in achieving microefficiency in financial markets. The result is that share prices adjust almost perfectly to specific news like currency movements or changes in dividends.

But I also believe the evidence is overwhelming that there is no macroefficiency of speculative markets, Samuelson added. They experience self-fulfilling swings, and they can swing far above and below any kind of sensible fundamental value. There does not exist an efficiency which is self-correcting, except in the case that every bubble will someday burst.

Investment Analysts Predict

How do these speculative swings come about?

Part of the answer is changes in market sentiment because of pronouncements by people like Barton Biggs. One of the gray-haired elders of Wall Street, Biggs, 65, the chief global investment strategist for Morgan Stanley Dean Witter & Co., commands the attention of pension fund managers in Illinois and around the world.

In an industry that has drifted toward computer models and number crunchers, Biggs is a generalist who is famous for his brilliantly written investment reports, which are often funny and always influential.

In 1993, in typical seat-of-the-pants style, he made a weeklong trip to China and came out starry-eyed. He urged investors to increase their holdings of Hong Kong stocks sixfold, to 7 percent of a global stock portfolio.

We were all stunned by the enormous size of China, he declared. Sometimes you have to spend time in a country to get really focused on the investment case. After eight days in China, I’m tuned in, overfed and maximum bullish.

Hong Kong stocks soared at those words, and gained 28 percent over the next seven weeks. Then, in August 1994, Biggs declared that the smaller Asian markets—Thailand, Indonesia and Hong Kong—would be the best place in the world to be for the next five years.

Biggs’ comments were representative of Wall Street’s euphoria about Asia. When executives of an obscure Indonesian polyester company called Polysindo visited New York in 1996 to discuss issuing bonds, they were squired around and accorded meetings with top executives at Merrill Lynch and Morgan Stanley. No comparable Chicago company could ever have got such a welcome.

American investment banks were so eager to arrange stock offerings for the likes of Polysindo that they often charged Asian companies about 3 percent of the value of the deal, compared with 6 percent that they would charge companies in the United States.

This reflected the ease with which some foreign companies could raise money, and the head of a U.S. corporation plaintively queried a New York investment bank, Why do I have to pay 6 percent when you charge an Indonesian company only 3 percent?

At Templeton, Mobius was more careful in his pronouncements than many other analysts, emphasizing that emerging markets can go down as well as up. But his moderation was taken as simply a token of his modesty, and he was rapidly becoming a celebrity.

An investment of $10,000 in the fund at the beginning of 1988 would have turned into $100,000 by the end of 1993, and Templeton began to use his picture in its advertisements. His shaven head smiled out at investors, and he came to symbolize the truly global fund manager.

Mobius speaks at least a bit of six foreign languages—Chinese, Korean, Japanese, German, Spanish and Thai—and he comes across as a citizen of the world. In 1992 he dropped his American nationality for German citizenship, for tax reasons, and he spends most of his time in hotels.

Nominally a resident of Singapore, with a second home in the Philippines, he travels 250 days a year, roaming Asia, Latin America and Eastern Europe. In a typical week he might visit four cities and 20 companies.

My job is to go out and find bargains, he said at an investment conference in Chicago. You can’t find bargains sitting at a desk reading annual reports.

A Hedge Fund Starts Selling

n March 8, 1996, the first shot was fired at the emerging markets. A New York hedge fund sold $400 million worth of the Thai currency, the baht, betting that it would fall.

Hedge funds, famous for secrecy, are large pools of speculative funds that make investments for banks, pension funds or other large investors. The first hedge fund was founded in 1949, but they came into their own only in the 1990s, with their assets soaring twelvefold between 1990 and 1997. Now there are 3,500 hedge funds, managing $200 billion.—And they are able to leverage that, through borrowing, into a much greater sum.

The baht was pegged to the dollar so that they rose and fell together, and the peg was frequently praised as a source of stability for the Thai economy. But the hedge-fund managers were shrewd enough to see that Thailand’s economy was faltering, its exports slowing, its property sector sagging and its banks sinking under bad loans.

The baht should have weakened along with Thailand’s economy, but instead the peg kept it as strong as the dollar. The hedge-fund managers sensed that the baht was too strong considering Thailand’s weaknesses, and they knew that if Thailand’s slowing economy forced the government to float the currency, they could make a quick killing.

In this case, though, that first hedge fund’s bet against the baht fizzled, and a few days later the fund gave up.

Most analysts continued to rave about Asia. At Morgan Stanley, Biggs had been wrong when he predicted that stock markets in Thailand would soar in 1996 (instead, Thai stocks fell 36 percent), and so in January 1997 he went on what he called a fact-finding mission, to clarify my thinking on the Thai stock market.

The facts that Biggs found were, on the whole, positive ones. He said at a Morgan Stanley investment seminar in Tokyo on Jan. 14, 1997, as recorded by Bloomberg News Service: We tend to think there are a lot of opportunities in Asian emerging markets, and he specifically referred to Thailand, South Korea, India and Singapore.

When you have a market that is down 50 percent, Biggs told the investors, you have to be looking for values. We can find values for Thailand.

Others could not. From that date through the end of 1997, Thai stock prices fell 75.3 percent in dollar terms.

Tracking Capital Flight

n judging countries like Thailand, bankers and investors rely partly on expert assessments from credit-rating institutions like Standard & Poors and Moody’s Investors Services. So what was S&P saying?

Standard & Poors does not expect that the likely scale of financial-sector losses will seriously impair the kingdom’s credit standing, S&P said about Thailand on March 18, 1997. It added that any crisis in Thailand was most unlikely to approach the levels of the problems in Mexico in 1995 or Indonesia or Finland in the early 1990s.

If S&P’s prediction was off base, that might not have been so unusual. Scholarly analyses find that the rating agencies usually offer warnings only when it is too late. For example, a study by two American economists, Carmen Reinhart and Morris Goldstein, looked at 72 financial crises around the world since 1979 and concluded that rating agencies tended to react after crises instead of anticipating them.

S&P sees things differently. John Chambers, one of its managing directors, said that his company’s analysis had been thorough and had identified potential risks.

For all the scorn heaped on Asians for their cronyism and other foolishness, local people in Thailand, Malaysia, Russia and South Korea were showing the most savvy. They were selling—usually to the kind of enthusiastic, well-trained foreigners who were making many times their salaries.

Capital flight is hard to track precisely, but it is the main reason for the errors and omissions line in the International Monetary Fund data. These data show that there was no significant capital flight from emerging markets between 1990 and 1995.

Capital flight soared to $16 billion in 1996, a full year before the crisis began, and reached $45 billion in 1997. This money then ended up in major banks based in Switzerland, London and New York.

Drenched in a ’Blood Bath’

Japan, the dominant economy in Asia and the one that might have been the locomotive to pull countries like Thailand out of their difficulties, instead administered the coup de grace. On April 1, 1997, against the strenuous protests of Summers, who flew to Tokyo to deliver a testy complaint from Washington, Japan raised its sales tax to 5 percent from 3 percent.

Summers had insisted that this would harm Japan’s incipient economic recovery by dampening consumer spending, but Japanese officials scoffed at that argument. Eisuke Sakakibara, Japan’s deputy minister of finance for international affairs, was particularly emphatic that Japan was doing just fine. He told reporters that those who denied Japan’s being on a recovery course were irrational.

I am an optimist on the Japanese economy, he said in May 1997, adding a month later, Real growth in Japan’s gross domestic product will exceed the government’s projection.

But it was Summers who was proved right. In the second quarter of 1997, Japanese economic output was actually plunging at an annual rate of 11 percent. Japan became mired in its worst recession in six decades, and instead of dealing decisively with its troubles, it steadily sank deeper. Japan’s imports from Asian countries like Thailand slumped.

With Thai exporters now struggling, along with property developers and hotel companies, the entire country became edgy. The overvalued currency resulted in alarming trade deficits, and speculation grew that the peg would be broken and the baht devalued.

Thailand’s own investors and companies began buying dollars, and this attracted the attention of foreign speculators. In May, Tiger Management, based in New York and one of the biggest hedge funds of all, began to bet heavily against the baht, and other banks and hedge funds piled on as well.

It looked as if the speculators would win. Normally baht-dollar trades totaled $200 million a day, but the amounts now soared. On May 13, 1997, the Thai central bank sold $6.3 billion to buy baht that everyone else was selling. A central banker wrote that day in a sober memo to his bosses, The market was not afraid.

The next day, officials met in the central bank to try to figure out what to do. There was fury at hedge funds, but most of all there was utter desperation.

Everyone panicked, and some even cried, Rerngchai Marakanond, the head of the central bank, recalled later before a government commission.

If Thailand had decided on that day to give up and devalue the baht, while it still had reserves left, the world might have been able to avoid the worst of the financial crisis.

Thailand would have faced a severe domestic banking crisis and property glut, and other countries would also have faced slumps. But the country would have saved its reserves and perhaps avoided a severe panic, and the fury of the crisis and the impact on nations as far away as Brazil and Russia might have been minimized.

The meeting went the other way, with the central bank now determined to risk everything in a battle against speculators. That day the central bank intervened again, selling more than $10 billion. It was one of the biggest interventions any central bank had ever made, but it had little impact.

The Thai central bankers had one more trick up their sleeves. On May 15, 1997, they sold dollars and simultaneously ordered banks not to lend to foreign speculators. The speculators were unable to unwind their bets as their losses mounted, and they screamed into their phones, threw chairs across the room and watched their computer screens in horror.

In one day, the hedge funds lost around $450 million, according to Callum Henderson, a currency analyst who wrote a book about the crisis. That day became known among traders as the blood baht.

Thailand’s prime minister telephoned the central bank to congratulate officials and promise a celebration party, but it was a Pyrrhic victory. The central bank had supported the baht by selling dollars in forward contracts, committing itself to using its dollars to buy baht in the future.

In practical terms, this meant that its official reserves of $30 billion were mostly already pledged and no longer usable to defend the baht. And speculators continued the attack, carefully but constantly keeping up the pressure.

Who were these speculators? They were mostly American, and the hedge funds were prominent among them. But they also included major U.S. banks, trading for themselves to make a profit. Mrs. Paoni could not have known it, but a tiny fraction of her savings might have been thrown, by a circuitous route, into the attack on the baht.

Some of the funds in Mrs. Paoni’s money market account, for example, went to J.P. Morgan, and J.P. Morgan said in a court document that it had traded $1 billion worth of baht in the fall of 1996. The bank did not disclose its trades in the spring of 1997, and bank officials refused to comment.

Thai officials were furious that U.S. hedge funds and banks were investing billions of dollars in a bid to destabilize their country, and they worried about the consequences of such speculative battles on all of Asia. In May 1997 Rerngchai, the central bank chief, sent a secret letter of complaint to Alan Greenspan, the chairman of the Federal Reserve Board, urging him to rein in U.S. hedge funds and other financial institutions.

Rerngchai warned that the attack on Thailand could have far-reaching implications on the economy both of Thailand and the Asian region and threatens to jeopardize the stability of international financial markets.

A similar letter was sent to Hans Tietmeyer, the president of Germany’s central bank, noting that one German bank had joined in the attack on the baht. Tietmeyer quickly responded himself, a Thai official recalled, with a question of his own: Which of our banks? That warmed hearts at the Thai central bank, but the response from Washington annoyed them.

The correspondence, made available by a Thai central bank official and confirmed by another government official, shows that the Fed’s response came not from Greenspan but from an aide, Edwin Truman. He blandly acknowledged that large financial firms can disrupt markets of countries like Thailand but added that these matters were best left to the markets.

Greenspan declined to comment. All communications with other central banks are private, said Lynn Fox, spokeswoman for the Federal Reserve in Washington.

There was another opportunity for the leading countries to confront the problems before the crisis erupted. In late June, the seven leading industrialized nations held their summit meeting in Denver, and aides say that in the confidential discussion among leaders, the Japanese prime minister at the time, Ryutaro Hashimoto, called for the industrial countries to discuss the financial instability in Thailand.

Japanese officials were expectant, waiting for President Clinton and other leaders to take up the matter. But according to one U.S. official who was there, Hashimoto was typically understated, tentative and vague (as is considered polite in Japan), and did not call for any specific action.

So President Clinton and the other world leaders paid no attention.

The View From Ground Zero

Thanong Bidaya, one of Thailand’s most respected bankers, is an imposing man with a round face, a gentle manner and a passion for collecting antique watches. A fluent speaker of both English and Japanese, he flew to Hong Kong for a weekend in June 1997 with his wife, planning to scour the shops for old watches. He settled into a hotel in the Tsim Sha Tsui district, and the phone rang. It was Thailand’s prime minister, asking him to take over as finance minister.

If you’ve found no one, I’ll do it for you, Thanong agreed.

Later, he recalled thinking, The situation can’t be that serious. So the next day Thanong flew back to Bangkok. And then, on the evening of June 27, 1997, he climbed into a navy blue Mercedes-Benz limousine and zigzagged through throngs of traffic to the central bank headquarters. He wanted to meet Rerngchai, an old friend from the time they had both studied in Japan.

As Thanong’s car approached the stately gates to the majestic eight-story central bank building, a guard waved it through. It was about 7 p.m. when they entered a conference room, and Rerngchai gave his friend the shock of his life.

Thailand was out of cash, Rerngchai explained. After subtracting the dollars that had been committed in forward transactions, Thailand had just $2.8 billion in usable foreign-exchange reserves.

Even though he was finance minister and one of his country’s most experienced bankers, Thanong was stunned. Rerngchai had brought reams of studies examining the options, but he and Thanong both knew that it was all over.

The foreign banks and hedge funds had won, and Thailand had lost. The two men agreed that since Thailand had run out of money, it would have to drop the peg with the dollar and let the baht float at whatever rate the market set. It was a foreshadowing of what would happen in Brazil 18 months later.

I said I didn’t see any choice in dealing with the situation, Thanong recalled.

A few days later, on July 1, the Thai prime minister, Chavalit Yongchaiyudh, declared that the baht would never be devalued. But that night, if anybody had noticed, the lights burned brightly at the central bank. Officials stayed up all night, first calling major central banks abroad.

Then, at 4:30 a.m., central bankers called the homes of the heads of all Thai banks and major foreign banks in Bangkok, summoning them to an emergency meeting that would begin at 6 a.m.

When the bleary-eyed bank executives had taken their seats, an official grimly announced that Thailand could no longer stand behind the baht. Instead of being pegged to the dollar, it would float freely.

The global crisis had just detonated.