Financial turmoil spreads across the world
The wild movements in stock markets around the world in late October 1997 bewildered policy-makers, analysts and investors alike. The events highlighted the globalised nature of and the domino effect in the markets, as well as the factors that have magnified volatility. Suddenly Malaysia's earlier attack on speculation and call for reforms, that were so severely criticised or laughed off only weeks ago, have found echoes even within the financial establishment.
By Martin Khor
THE wild fluctuations in stock markets around the world in late October 1997 have highlighted the risks and potential dangers of an increasingly globalised financial system that by and large is uncoordinated and unregulated.
The turmoil that started in South-East Asia and then spread to Hong Kong has finally landed in the United States and Europe, the great centres of financial power.
It has also badly rocked many South American countries, which now face the prospect of stock market and currency problems that could eventually be on the scale of South-East Asia's.
On 30 October 1997, Brazil's stock market index plunged 9.8%, with the level having fallen 23% over five days. The Brazil Central Bank has spent over US$5 billion to defend its currency.
Also affected are Argentina and Mexico, whose stock markets also dropped 9.1 and 3.4% respectively on 30 October.
It would be no surprise if some of the South American countries (particularly Brazil) are forced by speculation to sharply devalue their currencies in the next few weeks.
Thus the prediction by some ASEAN (Association of South-East Asian Nations) leaders, made recently during the ASEAN Ministerial Meeting in Kuala Lumpur, that currency speculation poses a threat to development in all developing countries, is coming true.
As the yo-yo movements of stocks continued throughout the week, more and more influential voices are now calling for reforms to the free-wheeling way financial markets have been allowed to function.
Now that Wall Street itself has been hit, the need for reforms may be taken more seriously.
When Malaysian Prime Minister Dr Mahathir Mohamad first called for curbs to be placed on currency trading to prevent the damaging effects of speculators and manipulators on the real economy, he was widely and strongly attacked in Western financial and media circles.
Dr Mahathir was portrayed as being 'seriously out of touch' with the modern world of finance, where the free markets operate efficiently to reflect the economic fundamentals of countries, and where manipulation by a few big players was not possible.
Several Western magazines suggested that his calls for financial reform were responsible for South-East Asia's continued weakness, and that he would be doing everyone a favour by resigning.
Today the Prime Minister should feel vindicated by the recent events. He would be justified for saying 'I told you so' to his detractors.
In New York on the night of 27 October 1997, after the Dow Jones index plunged by over 7%, TV news commentators were describing the incredible events in terms such as 'carnage' and 'blood everywhere'.
On every TV channel in North America, the US Treasury Secretary Robert Rubin flashed across the screen, insisting that 'the fundamentals of the US economy are strong and the prospects for growth are strong'.
His performance and words were really reminiscent of the way Malaysian Deputy Premier Anwar Ibrahim and other finance officials were defending the strength of the Malaysian economy when the currency had come under onslaught several weeks earlier.
In a telling episode on the popular 'Larry King Live' programme on CNN, two prominent finance figures were being interviewed: Michael Metz, chief investment strategist of Oppenheimer and Co., and Congressman Jim Leach, head of the House Banking Committee.
In trying to explain the daramtic fall in Wall Street on 27 October, Metz highlighted the role of speculation caused by funds dealing with derivatives.
'These derivatives have too much leverage,' he said. 'They are uncontrolled. With $4,000 under them, they can control $80,000 worth of stocks. This is crazy. This causes enormous risks and it is highly speculative. This situation is due to deregulation.'
Metz asked for a response from Leach, prodding him to comment on whether the laws regulating financial markets were too lax.
Leach replied: 'You're absolutely right. It's become a gamble. It doesn't add to corporate strength.'
This exchange, at the height (or rather the lowest point) of the Wall Street panic, is very significant as it reflected a swing in opinion among the financial policy elite in the United States about the way markets work and what should be done.
As the Malaysian saying goes, he who bites the chilli knows it's hot. When Malaysian leaders warned about the role and the dangers of the highly leveraged and highly speculative hedge funds in the South-East Asian currency turmoil, they were laughed off by the clever 'financial analysts' and the political leaders of the rich countries, who blamed the turmoil on the region's 'weak economic fundamentals'.
When the crash began to hit in their own home turf, the finance officials tried to assure their own people that their economic fundamentals were 'strong' and that the dips were bound to be temporary due to 'contagion effect'.
Thus the spread of the financial crisis from Asia to the West has, in a way, been a blessing, in that the problem of financial globalisation and unregulated markets can now be more objectively and seriously looked at.
The risks of a globalised market, and how volatility is magnified by short-term profit motives (rather than long-term investment motives) were highlighted in the 31 October 1997 edition of the Ottawa Citizen of Canada.
An article 'Market turmoil emphasises global links' by Bertrand Marotte made three significant points:
** Financial markets are now global and interdependent: 'The tremors reaffirmed as never before that financial markets across the globe's time zones are closely connected. Events in distant foreign lands like South-East Asia can inflict serious damage on the domestic equities scene in the blink of a computer screen."
** Market movements are driven by short-term speculation rather than long-term fundamentals. It quotes Roger Kubarych, chief investment officer at global money manager Kaufman & Kubarych in New York, as saying:"Sure, the markets are interdependent but the more significant shift has been the increasing focus of big institutional fund managers on the short term."
"There really isn't any long-term view at work in the market. This leads to a lot of suspension of reasonableness and quick shifts in position."
** The use of derivatives has multiplied the scale of volatility, a point also made earlier by Michael Metz. The article quotes Kubarych as saying that the market's volatility is magnified by the massive increase in the use of derivatives - options, swaps, futures and other sophisticated hedging instruments that are a kind of side bet on stocks, bonds and other real assets.
"The constant hedging behaviour that goes on requires access to liquidity 24 hours a day. And if trouble happens in Hong Kong, then traders who can't sell out fast enough will shift to the US market, the biggest in the world. That's why so much of what happens in global financial markets ricochets through the US market."
The disruptive nature of the current bout of financial volatility across is bound to generate stronger calls for reform.
The Secretary-General of UNCTAD (the UN Conference on Trade and Development) recently warned about the need to curb volatile capital movements. Until there was international consensus on how to do that, it is essential that governments in developing countries retain the instruments to take measures to deal with inward and outward capital movements, said Rubens Ricupero.
He was indirectly referring to the need for developing countries not to give up the policy option for regulating capital flows.
Developing countries are coming under pressure by the International Monetary Fund to have full 'capital convertibility', or to fully open up their economies to the free inflow and outflow of funds.
They are also under pressure by industrialised countries and the World Trade Organisation secretariat to agree to liberalise their financial services and allow increased foreign ownership and participation in banking, insurance, stock brokerage and other financial sectors.
If developing countries were to give in to these pressures, they would be reducing their ability to control or regulate the flows of funds into and out of their countries. And this could magnify the risks of financial volatility which in turn would increase the dangers of disruption to the real economy.
Also in October 1997, an eminent Canadian economist, Prof. G K Helleiner, called for a new global framework to oversee international financial markets.
Speaking at the United Nations General Assembly's Second Committee, Helleiner pointed out that there was a vastly increased flow of private capital to a few developing countries.
Unfortunately, says Helleiner, 'Private capital has proven highly fickle and volatile in its behaviour: portfolio managers have proven just as nervous in the 1990s as banks were in the 1970s and 1980s. It is simply in the nature of financial markets that they are susceptible to panics, crises and volatility.'
There is an overwhelming intellectual case for a strengthened multilateral framework both for the conduct of international/global finance and for sound global macroeconomic governance in the interest of both stability and development.
He proposed that the UN set up an expert panel or a Commission to address the major questions on resolving global financial issues.
Some developing countries or some industrial 'middle powers' might initiate their own independent or intergovernmental review with recommendations.
And there should be an international conference on financial reforms, under the UN umbrella.
These good proposals are essential if the currency and stock market turmoil that started in South-East Asia and that is now enveloping the world is to be addressed in a structural and more permanent way.
However, political will and cooperation of the rich countries is required. So far that has not been forthcoming. Perhaps it will take a real meltdown in the American and European stock markets and currency markets to create a change of mind. - Third World Network Features (October 1997)
Martin Khor is Director of Third World Network.