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Shoring up fiscal defences

 

Thanong Khanthong looks at the growing consensus to clip the wings of hedge funds.

 

EVEN a relatively strong economy like Australia had to endure a bitter war against the hedge funds, which attacked the Aussie dollar in the aftermath of the Asian regional currency crisis.

So it comes as no surprise that on Tuesday, Ted Evans, a special representative of Australian Prime Minister John Howard, met Prime Minister Chuan Leekpai at Government House to discuss measures to curb the flow of short-term capital and repel the brute power of the hedge funds.

The measures, which appear to have broad support from members of the Asia-Pacific Economic Cooperation forum, will be passed on for further discussion and possible agreement to build a new architecture for the world's financial system at the upcoming Apec meeting in Kuala Lumpur.

In the past, Australia has taken a strong economic and trade liberalisation stance similar to that of the United States. With the financial crisis in Asia, however, Australia appears to have shifted its position closer to that of the Association of Southeast Asian Nations. In bilateral ties, the Reserve Bank of Australia did play a significant role in advising the Bank of Thailand in the management of its foreign exchange reserves during the baht crisis last year.

When Thailand was forced by the US and the IMF to disclose its currency swap obligations in exchange for the bail-out fund of US$17.2 billion, Australia was the only member in the IMF who protested, arguing that by doing so it might lead to a further loss of confidence. In August 1997, when Thailand told the world that it had US$23.4 billion in currency swap obligations, or US dollar outflow over the next 6-12 months, the financial markets were shocked that Bangkok had allowed its foreign exchange reserves to become depleted. Hence the massive capital outflow to the point that the baht plummeted to Bt56 to the US dollar in January.

At that time the Bank of Thailand was still locking horns with the hedge funds. The BOT realised that it might not have enough reserves to unwind its sell dollar/buy baht positions, while the big-time hedge funds were also nervous that they might not have the baht to settle the buy dollar/sell baht positions because Thailand had played hardball by shutting down the foreign exchange swap market to deny them access to the baht.

If the hedge funds could not get hold of baht, they would default. Defaulting against the Hong Kong Monetary Authority and the Monetary Authority of Singapore, which also bought up baht to help prop up the Thai currency, meant that the investment banks or foreign banks which had entered into the currency swap contracts on the hedge funds' behalf would be punished by seeing their licences revoked. Imagine the calamity on a global scale if the major US banks lost their licences.

However, the disclosure of the Bank of Thailand's swap contracts also created a loss of confidence at home, leading to massive capital outflow. Throughout June capital was flowing out of the country at the rate of US$400-500 million a day, forcing the Bank of Thailand to float the baht on July 2, 1997. Some Thai officials involved in the baht's futile defence still carry painful memories of seeing Thailand being blackmailed into revealing its cards as if in an intense game of poker, while the hedge funds, which ambushed the baht from every corner of the world's financial centres, were able to keep their's face down.

A week after the mid-May baht attack, during which the Bank of Thailand fired a salvo of US$20.51 billion from its foreign exchange reserves to defend the currency, Dr Chaiyawat Wibulswasdi, the then deputy governor, held a meeting of central bankers of the region, which included representatives from the Reserve Bank of Australia, People's Bank of China, Hong Kong Monetary Authority, Bank Indonesia, Bank of Japan, Bank of Korea, Bank Negara Malaysia and the Monetary Authority of Singapore. Representing the Reserve Bank of Australia was Dr Stephen Grenville, the deputy governor.

Chaiyawat, who chaired the meeting, hoped to arrive at some form of regional cooperation to take on the hedge funds. He wanted the meeting to come up with more surveillance cooperation to monitor the activities and the tactics of the hedge funds. But it was reported that the Hong Kong Monetary Authority and the Monetary Authority of Singapore did not agree to any surveillance cooperation for fear of creating a ''big brother'' impression and undermining Hong Kong's and Singapore's reputations as regional financial centres.

Grenville was reported to have shared Thailand's concern about the activities of the hedge funds. He recommended that the regional central bankers convey to the OECD nations that their banks should act better when coming into the emerging markets in this region. He said the prevailing view that the market players could always beat the central banks should be reversed.

With the recent collapse of Long-Term Capital Management, the big-time US hedge fund, there is a growing consensus for the regulators to tame the hedge funds, particularly the macro funds who have only one dollar in capital but can bet up to US$20-US$25 because they get the credit lines from the banks.

In short, the banks, mostly US banks in this case, are the prime movers of the recent turmoil in the global financial markets. With the rouble crisis, banks are calling back margins extended to the hedge funds, hence creating a credit crunch. Hedge funds are also unwinding their emerging market positions to pay off to their banks when the emerging markets appear to win some temporary respite.

At this upcoming Apec meeting, there should be more progress on talks to curb the hedge funds. The world will be a better place without them.

 

 

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