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Saving the system - Views on News from Equitymaster
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  • Oct 1, 1998

    Saving the system

    If anyone believes that capitalism is a system of taking risks in a free market environment that leads to profits or bankruptcy, take off those illusory glasses. And if you believe that the United States is the bastion of capitalism or that Hong Kong is an even better example of free markets, find something else to believe in. Recent events in the global financial system indicate the extent of the rot that has taken hold of this promised path of free markets and individual enterprise. A few weeks ago the Hong Kong authorities announced that they were using their reserves to purchase shares in the Hong Kong market. Victims of their own adherence to free capital flows, the Hong Kong monetary authorities were out to punish the shorts who were making huge bets on the Hong Kong Dollar's peg to the US Dollar. Yes, the Hang Seng Index gained about 15% during this rescue mission but Hong Kong got a lot of criticism from the western world, and the United States in particular, for not allowing the stock markets to take their own course. Government intervention, the United States said, is bad.

    Well, over these past few days, the United States has been busy rescuing a hedge fund started by some very prominent and brilliant people. The founders of Long Term Capital include two Nobel laureates and one ex- Vice Chairman of the Federal Reserve (the central bank of the US). Long Term Capital, apparently, has a total capital of US$ 3 billion with positions in various derivative instruments totaling over US$ 80 billion. And - as a trader explained to me - those positions in derivatives translate to bets on real assets of US$ 1 trillion (12% of GDP of USA!). News reports suggest that turmoil in the global financial markets since July, 1998 have resulted in a decimation in the value of Long Term's holdings and have, effectively, bankrupted the company. Guess what the United States government is doing? Bailing out Long Term.

    Capitalism, as practiced by the capitalists of Wall Street and Exchange Place, is a little different from the theory we were taught. Our books tell us that entrepreneurs take risks, and if those risks are correct, they get to keep the rewards but, risks that turn sour, are the problem (and the cost) of the government! For all its criticism of Hong Kong, Japan, and Malaysia, the United States' actions suggest that capitalism as practiced by many countries is little more than a bogey to prevent the rich from getting poor. The political quote of President Truman with reference to the US tolerance for dictators is relevant to its treatment of capitalists: "He may be a son of a ----, but atleast he is our son of a ----". And the folks at Long Term were as "establishment" as you can get. Blue-blooded Wall Street gurus were shareholders of Long Term and they seem to have got their respective big-pocketed employees to pitch in billions of dollars to save the company. For saving Long Term, is saving the system. The system that is only 25 years old: the system of free movement of capital across borders at exchange rates that are allowed to fluctuate freely - and wildly. A system that glorifies trading in derivatives to make the world a more efficient place for resource allocation. How a company with a capital of US$ 3 billion that influences assets whose value is US$ 1 trillion (333 x its capital) adds to the efficient allocation of scarce global resources is beyond my understanding! And when such a company falters, it is not allowed to fail because the "system" is at risk!

    If the 1970's was the decade when the first cracks of socialism were known, then the 1990's is the decade when the first crack of capitalism are being exposed - and quickly covered up. The share scam in India, the Barings fiasco in Singapore, Long term Capital in USA, the aggressive loan-giving to Asia and Russia which is now being rescued by IMF money: these are all incidents which show how people in power can manipulate the "system" to help their friends. If you and me lent money to a friend and he went bankrupt, don't wait for the IMF to help you. But if you are a global bank and had made those loans, call your friendly politician and convince him of the risk to the "system".

    Socialism had many flaws: at its extreme the five year plans and ration mentality allowed for irrational behaviour that, ultimately, caused anguish to those who it was supposed to save. Capitalism is no alternative: recent events suggest it is largely a fall-back system for the big guys to get bailed out by governments. One day, someone will suggest a better system and get an opportunity to implement it. Until then, bailing out the over-enthusiastic telecom operators, aggressive bankers, or insane hedge-fund managers will be the norm - not the exception. Capitalism, as Lenin predicted, is being given the rope to hang itself with.



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