Martin Khor on free markets

[Robert Weissman <rob@essential.org>]

Dear Friends,    The continuation of the Asian crisis and its
spread to Russia and Latin America is causing a reaction against
the IMF orthodox approach, both in theory and in policy.  Below is
an article that gives some information about Malaysia's
introduction of capital controls and recent measures by Hongkong
and Taiwan.  With best regards,  Martin Khor (TWN).
 
 
 
TIDE TURNING AGAINST FREE-MARKET ORTHODOXY
 
By Martin Khor, Director, Third World Network (twn@igc.apc.org, fax
60-4-2264505).
 
 
SUMMARY:  The introduction of capital controls in Malaysia last
week was the biggest blow so far against the orthodoxy of laissez-
faire and total freedom for financial markets.  With Hongkong and
Taiwan also acting against speculation, and Russia's experiment
with the free market in tatters, the tide has begun to turn against
inflexible the free-market approach.  Will a new paradigm emerge? 
------------------------------------------
 
 
The tide may be turning against the financial free-market system
that has been dominating the financial operations of most
countries.
 
Last week, Malaysia had led the backlash movement through its
"shocking measures" that imposed wide-ranging controls over the
foreign exchange and new rules in the stock market.
 
Although the Malaysian policies were the most radical and
prominent, indicating a systemic change, some other countries
have also recently introduced measures aimed at limiting the
exposure of their markets to speculation and sudden shifts in
capital flows.
 
They include Hongkong and Taiwan (which both tightened regulations
against manipulation) and Russia (which was forced to default on
some of its debts and at one stage suspended all trade in its
beleaguered ruble).
 
Interestingly, although the majority of market analysts and
international commentators have condemned the market interventions,
some serious and influential components of the economics profession
and the Western media have looked more favourably upon the attempts
to regulate the financial markets.
 
This represents the beginning of a shift of opinion, indeed a shift
of paradigm, about the net benefits and costs of allowing financial
markets to operate in a laissez-faire manner.
 
The new Malaysian policy package included:
 
   ** The official fixing of the ringgit at 3.80 to the US dollar,
thus removing or greatly reducing the role of market forces in
determining the day-to-day level of the local currency (the
ringgit's value in relation to currencies other than the dollar
will still fluctuate according to their own rates against the
dollar).  This measure largely removes uncertainties regarding the
future level of the ringgit. 
 
   ** Measures relating to the local stock market, including the 
closure of secondary markets so that trade can be done only via the
Kuala Lumpur Stock Exchange (this is to prevent speculation or
manipulation from outside the country); and the radical measure
that non-residents purchasing local shares have to retain the
shares or the proceeds from sale for a year from the purchase date
(this is to reduce foreign speculative short-term trade in local
shares).
 
   ** Measures to reduce and eliminate the international trade in
ringgit, by bringing back to the country ringgit-denominated
financial assets such as cash and savings deposits via the non-
recognition or non-acceptance of such assets in the country after
a one-month dateline.  (Permission will however be given under
certain conditions).
 
   ** Measures curbing the taking out or taking in of funds, for
instance travellers are limited to carry RM1,000 when entering or
leaving, and to another RM10,000 worth of foreign currency when
leaving.
 
   ** Measures imposing conditions on the operations and transfers
of funds in external accounts.
 
Up to the end of last week, there was still considerable
uncertainty over the details of several of the measures, and the
confusion has to be sorted out in the days to come so that the
public and the business sector are clear what the rules mean in
practice.
 
In general, the ringgit is still to be freely (or at least easily)
convertible to foreign currencies for trade (export receipts and
import payments), inward foreign direct investment, and
repatriation of profit by non-residents. 
 
Convertibility up to a certain limit is also allowed for certain
other purposes, such as financing children's education abroad.
 
But convertibility for autonomous capital movements for several
purposes not directly related to trade will be limited. 
 
As stated above, not all the details are yet clear to the public,
and further clarification will be needed. 
 
As expected, many brickbats were thrown at the Malaysian
authorities for this clear break with financial orthodoxy.  
 
The International Monetary Fund expressed dismay, stating that in
general it believes that "any restrictions imposed on the movement
of capital are not conducive to building investor confidence."
 
The IMF, which generally reflects the views of the financial
establishment of the rich countries, is the main upholder of the
prevailing strong orthodoxy that countries must allow the
unrestricted inflow and outflow of capital.
 
It has been advising (and in cases where it provides loans, it has
been insisting as a condition for the loans) countries to
liberalise and open up their economies to the free flows of funds. 
 
Some analysts, especially those related to investment funds that
depend on free capital movements to make speculative or investment
gains, have been vitriolic in their criticism.  One London-based
analyst said Malaysia was now suffering from an "IQ crisis" as the
measures were the stupidest action possible.
 
However there were many bouquets as well. Business groups, consumer
groups and trade unions in the country supported the measures and
the local stock market went up. A few foreign investors in the
country, including the financial giant AIG, also expressed support.
 
The Financial Times, which represents an independent and
conservative opinion within the financial establishment, gave
guarded support, stating that there was an argument for temporary
capital controls in time of crisis.
 
An editorial noted that some economists argued that controls on
short-term capital should be a standard part of policy for emerging
markets to avoid destabilising capital inflows and outflows that
were at the heart of the Asian crisis.
 
Controls on short-term capital would give crisis-hit countries
great monetary flexibility, making banking reform easier, whilst
lower interest rates would give a boost to growth.  Without
controls, the Asian countries had great difficulty restructuring
their banks whilst maintaining tight monetary policies in order to
keep their currencies stable.
 
It cautioned however that capital controls should be temporary and
should be used to assist in economic reforms and not avoid them,
warning that they are a double-edged sword that create better
conditions for reforms but lessen the incentive for undertaking
them.
 
The American economist Paul Krugman published an open letter
to the Malaysian Prime Minister stating that he fervently hoped the
dramatic policy move pays off.  
 
Krugman, who had recently come out in favour of capital controls as
a way out of the Asian crisis, however warned that these controls
are risky with no guarantee for success.
 
He gave four guidelines, that the controls should aim at minimal
disruption of business, that they be temporary, that the currency
should not be pegged at too high a level, and that they serve to
aid reforms and not be an alternative.
 
Besides Malaysia, two other Asian countries known to be free-market
champions also recently took measures to curb speculation.
 
The Hongkong authorities reportedly spent over US$14 billion to buy
shares in the local stock market to prop up the Hang Seng index in
an attempt to defeat speculators that had placed heavy bets on a
fall in the index.
 
Last week it introduced measures to curb the short selling of
Hongkong shares.  The new rules are aimed against speculators who
have been short-selling shares whilst at the same time speculating
that the currency will drop.
 
Firstly the stock exchange reinstated a rule that shares in a
company can be sold short only when they are rising.
 
Secondly, the exchange also announced it had temporarily banned
short sales on the shares of three of Hongkong's biggest companies,
HSBC Holdings, HK Telecommunications and China Telecom (Hong Kong).
 
Thirdly, the Hong Kong Securities Clearing Co. increased
regulations on settlement of stock trades, giving brokers two days
after a deal is executed to deliver the shares.  Previously more
time was allowed.
 
According to the Asian Wall Street Journal, this change of rules
will hurt speculators who had entered contracts to sell shares
short without even having those shares on hand.
 
There have been howls of protest from dealers, investors, analysts,
and commentators about how the series of interventions by the
Hongkong authorities would cause tremendous damage to Hongkong's
free market reputation.  
 
The authorities have however countered that manipulation of the
financial markets itself has distorted the market and has to be
curbed.
 
Also last week, the Taiwan authorities took measures to prevent
illegal trading of funds managed by George Soros, which have been
blamed for causing the local stock market to fall.
 
A report in last Saturday's The Star said a task force was formed
to investigate sales and trading by Soros-managed hedge funds via
proxy accounts in Taiwanese markets.
 
Although local sales by Soros' funds are banned, at least six local
securities firms are selling those funds on proxy accounts,
according to officials.  The Securities and Futures Commission
announced that securities firms would have their licenses revoked
and dealers could face two years jail for selling the unauthorised
funds.
 
Meanwhile in Russia, the country's experiment with the free market,
lies in tatters, with the government having to announce a default
on government bonds, currency trade grinding to a halt for some
days, an on-going devaluation, a run on the banks and thousands of
firms facing bankruptcy. 
 
"Russia's economic upheaval has profoundly shaken the confidence of
Russians in the goals of a free-market economy and democracy that
the West championed," said an International Herald Tribune article
on 31 August.
 
"Perhaps more than an any time in Russia's quest over the last six
and a half years to remake itself after the collapse of Soviet
rule, the concepts of liberal market reform and democracy are in
retreat."
 
And in a front-page article entitled "Acceptance of capital curbs
is spreading", the Asian Wall Street Journal of 2 Sept. said that
"the failure of IMF orthodoxy to arrest the contagion sweeping
through Asia has made ideas like capital controls intellectually
respectable again.  Policy makers can't help but notice that China
and Taiwan both have capital controls and neither has succumbed to
the region's contagion."
 
The tide that has made an orthodoxy of deregulation and absolute
freedom to financial operators is now beginning to turn. 
Regulation of financial markets and capital and exchange controls
have made an entry.  With that, the battle between paradigms will
be watched closely by the public, the market and policy makers.