Tackling global capitalism

January 29, 2001

In his latest book, George Soros admits having played a role in the 1997 baht crisis. Thanong Khanthong reviews.

George Soros is equally at ease in his dual roles of philosopher and hedge fund operator.

As a champion of open society, the Hungarian-born international financier advocates civil society and the pursuit of individual freedom.

His Open Society Fund, established in 1979, has given generously to promote the cause of open society in repressive regimes. As a money manager, Soros has fiercely taken on the central banks and the financial markets, making money by betting on the directions of currencies, stocks and interest rates.

Now he is becoming less active in the financial markets, spending more of his time promoting open society and recommending remedies for the problems of global capitalism.

With the growing volatility of the financial markets, Soros decided to transform Soros Fund Management, which lost money badly in 1999, into a less aggressive investment scheme. In the early 1990s, Soros walked away with US$1 billion (Bt42.83 billion) in profit after battling the Bank of England, which eventually caved in and took the sterling out of the Exchange Rate Mechanism.

As head of Soros Fund Management, which also manages Quantum Funds, Soros admitted to having played a role in the baht turmoil.

In his latest book, Open Society: Reforming Global Capitalism (NY: Public Affairs, 2000), Soros reveals that in early 1997 the Quantum Fund attacked the baht and the ringgit in the six-month or one-year forward markets.

By selling the two currencies short, the Quantum Fund promised to deliver the baht and the ringgit back for the dollar according to the maturities.

Soros' role was quite controversial. Thai banking authorities held Soros as the country's No 1 enemy. There was an attempt by the central bank to write a note to the US Treasury Department to protest against Soros' "immoral" action.

Later, Malaysian Prime Minister Mahathir Mohamad accused Soros of being part of a Western conspiracy to bring an end to the Asian economic miracle.

But it was not the Quantum Fund alone that was raiding Southeast Asian currencies. Other US and European hedge funds and investment banks also took part in the attack that sent the regional financial markets into turmoil.

The traditional war of guns and canons was transformed into the currency war, waged on computer screens. Later it was also discovered that local banks and corporations in Southeast Asia also speculated against their own currencies.

Soros defends his role in the financial crisis. He writes that Asian countries were doomed to crash due to a misalignment of their currencies.

Through a "dollar peg" policy, Asian banks and corporations heavily borrowed US dollars in the short-term and converted, without hedging, the dollar into local currencies for long-term investments.

This appeared to carry no risk due to the implicit foreign-exchange guarantee. The heavy foreign borrowing led to a credit boom, with the money going into unproductive use, mostly real estate speculation.

Then Japan's slowdown worsened, the US dollar appreciated and the balance of trade of the Asian economies deteriorated.

Soros said it was clear that the trade accounts and the capital accounts of the Asian countries were becoming untenable, hence the attack on their currencies. He argued that hedge funds did not trigger the crisis, although they played a role.

"If a trend is unsustainable, it is surely better if it is reversed sooner rather than later," he writes.

"For instance, by selling the Thai baht short in January 1997, the Quantum Funds managed by my investment company sent a market signal that the baht may be overvalued. Had the authorities responded to the depletion of their reserves, the adjustment would have occurred sooner and been less painful. But the authorities allowed their reserves to run down; the break, when it came, was catastrophic."

Soros acknowledges that there was pressure from the US and the IMF to encourage countries to prematurely open up or liberalise their financial markets, which was an important factor in triggering the crisis.

Open Society is divided into two parts. The first provides a conceptual framework for Soros' theory of reflexivity, which has guided his investment strategy throughout his career, and open society as an ideal.

Thai readers acquainted with his theory are advised to begin reading the book from the second part, which covers the financial crisis.

Soros also takes on a role as IMF basher. He charges that the IMF was not equipped for the task of combating the Asian crisis, which was a complex crisis that included a currency component and a credit component.

"The credit component, in turn, had an international aspect and a domestic aspect, and all the various components were interactive. What made the Asian crisis different from any previous one was that it originated in the private sector; the public sector was in a relatively good shape," Soros wrote.

But the IMF, which provided the support programmes for Thailand, South Korea and Indonesia, did not restore confidence because "they addressed only some aspects of the crisis, not all".

Soros says the IMF's failure was perhaps attributed to the absence of "a methodology to deal with the imbalances in the private sector; certainly some IMF officials had an inadequate understanding of how financial markets operate. This was demonstrated in Indonesia, where the IMF insisted on closing some banks without making provisions for the protection of depositors, provoking a classic run on practically all banks." Soros reveals that Soros Fund Management lost money in the rupiah speculation.

He suggests that the only effective way to deal with the Asian crisis was to impose a moratorium on debt repayments, followed by a debt-to-equity conversion scheme.

International lenders or investors would take a hit, while the debtor countries would be given time and some debt forgiveness to stand back on their own feet. But this method would be unthinkable to the IMF or the US, since the IMF programme was created to ensure protection of the creditors' claims, Soros said.

Thailand also resisted debt moratorium, fearing that it would plunge the country further into the crisis with no way of winning back the confidence of the international community.

Hence, interest rates were kept high to defend the currency and to ensure that creditors had a way to get their loans back.