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The Doctor's Prescription...

Sep 1, 1997

So it is finally out in the open. Malaysian Prime Minister, Dr Mahatir, has said what few people had the guts to say in front of anaugust gathering of global bankers and policy makers: Gentlemen, currency trading is an unnecessary evil - lets stop it.

As the audience of policy makers, each out to prove their capitalist credentials to the army of World Bankers and IMF types,shrunk in their seats Dr Mahatir went on to use his international platform to speak about the jealousy and envy of the whiteskinned race against the success of the yellow and brown skinned population of the world. What happened in South East Asia(especially in Malaysia), he implied, was part of a global conspiracy.

I will leave this race conspiracy theory out for the moment and focus on this clarion call to ban this unproductive, unnecessarything called currency trading. First, a refresher on some numbers. The total daily trading volume in the currency markets isestimated to be over US$ 400 billion. The total daily global trade in goods and services is estimated to be about US$ 2 billion. Thissuggests that the trading of currency is supposed to be 200 times the need for the currency by actual users: the multinationals whosell dollars to buy Rupees when they have to pay for building factories in India; the exporters from Indonesia who convert theirdollars into Rupiah; the importers from USA who convert their dollars into Ringitt to pay for palm oil or tin; the Philippine maids inthe Middle East who sell their dollars to send Pesos back to their families. Each of these transactions needs a foreign exchangemarket. Dr Mahatir was not asking for banning this market - he was asking for banning the excessive trading and the speculationin the market. Not an unusual request, actually, considering that regulators have trading restrictions on some markets - even theshare market.

Take the case of ITC, an active stock on the Indian share bazaar. On a normal, high-strung speculative day, the ITC counter couldclock in a trading volume of US$ 150 million - less than 3% of its total market capitalisation. The actual daily delivery of ITCshares is probably in the region of US$ 10 million. In this case, our excessively speculative stock markets (a common view of mostregulators) is seeing activity in ITC at 15 times its physical demand. If ITC was a currency with a factor of 200 times tradingvolume versus physical demand, it would have a trading volume of US$ 2 billion every day - 13 times its present volumes! If youfactor in the amount of money stock brokers make on share commissions on ITC's present volume, you will understand why thereis an extremely rich and strong lobby of foreign exchange dealers around the world, who will not be too keen to dismantle thisfreewheeling currency market that throws economic planning to the wolves but gives fx traders a shot at a fortune for fairlyunproductive work.

Which takes me to the next argument of why currency trading in its present laissez-faire form is an unnecessary evil. Lets moveagain to the stock market. Remember the euphoria surrounding HDFC a few months ago? The stock zoomed from Rs 3,400 to Rs4,600 within a few days in July on news that foreign investors were in queue to buy the share after the raising of the 24% limit.Well, two months later that stock is down to Rs 3,000 and HDFC has seen a US$ 800 million erosion in its market value. Has thefundamentals of the company worsened? Not that anyone seems to know of - not yet, anyway. But, yes, you batter the stocksome more and every shareholder will start to get frightened and, at some point in the fear cycle, there will be a queue of sellersand no buyers. The stock price will plummet, HDFC's standing in the market will decline and it will be hard pressed for loans andit will be in bad financial shape. All this up and down movement caused by some people took a speculative position in HDFCwhich they got wrong. Replace HDFC for Malaysia which has a loss of US$ 150 billion in market cap and you will understandwhy Dr. Mahatir has thrown away his scalpel for an axe.

Here was an economy which most economists were pretty comfortable with. Yes, there are allegations of crony capitalism,excessive spending on symbolic projects (the tallest buildings in the world), and concern over this ambition. But there was nodoubting the strategy: educate the people, move up the value chain, be a base for multinationals, and give them the bestinfrastructure including a high technology super corridor. Sounds good to me. But now a lot of projects may have to be abandonedor will take longer than before to accomplish because the currency guys saw a Thailand blowout in every new construction and acurrent account deficit each time a multinational opened an office in Kuala Lampur. Malaysia will suffer slower growth suggestingthat its people will grow richer but in a lot more time.

The currency markets in their present form bear little resemblance to economic reality and, by the very might of their actions, theoutcome of events are influenced to occur just as currency traders predicted. Remove the trading and delivery restrictions on theNSE and BSE and see how ITC gets to a price of Rs 1,000 this week and possibly Rs 10,000 next week. Once in a while, centralbankers step in and make some noise (they don't have the firepower to match the markets, you see) about what their views ofcurrency levels are, but the market pauses only to catch it breath before it runs in its own direction again. Since Bretton Woods,when the gold standard and the fixed currency regime was given up as failures, the world has moved to a managed currencysystem where central banks influenced exchange rates. But the last seven years has seen the growth of market forces that arenow ready to take on - and pulverise - any central bank, be it the Bank of England or the Bank of Malaysia. And by their actionsthese fx traders influence economies and lives of people. Exchange rates are supposed to be a reflection of economicfundamentals, not determinants of it. May the Doctor's prescription not lie discarded on your table.

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