Rogue Capital and Speculation
January 5, 2000
This article appeared in Mirat Al J'ama, Sultan Qaboos University, April 2000
According to a paraphrasing of views expressed by the Malaysian Prime Minister, the Asian financial crises was caused by "rogue capital." The purpose of this essay is to address this claim. The term "rogue capital" has been defined in the following way. Rogue capital
is the volatile movement of capital in financial markets seeking profits by speculating against currencies and the issuing governments regardless of the effects of changes in the exchange rate on the issuing country's economy. It can take the form of investments or bank deposits seeking higher returns than are readily available in more mature economies, but the funds are withdrawn the instant that any hint of possible future instability becomes a rumor. It can make an economy sick when the economy becomes integrated with the world economy and relies on that economy for supplies and markets for a large share of its GDP. Sudden shifts in the exchange rate throw the domestic economy into chaos.(Mike Mckeever, International Political Economy Discussion list, message of November 15, 1998)
The term "rogue" is synonymous with the terms "criminal" and "villainous." Now capital itself cannot be criminal. So in using this term, one must be referring to the individuals who speculate on currencies by buying shares of stock and making short-term loans in a particular currency (say the Malaysian Ringgit). The claim is that these people are rogues.
The Harm Caused by Speculators
To explore this claim, let's try to put ourselves in the shoes of such people. We must presume that they make their financial investments for one or both of two reasons: (a) they expect to receive some income from the investment and (b) they expect the currency to rise relative to other currencies. After one or both of these events occurs and if the individuals do not expect them to occur again, they will do two things: (1) sell their stocks and collect the principal on their loans and (2) shift their investment to some other currency, say German marks, which they expect to rise in value. For example, I myself (with my modest income) bought some Thailand time deposits during the depths of the Asian financial crisis. Since I was living in Taiwan at the time I exchanged my New Taiwan dollars for the Thailand currency: the baht. The Thai bank in Taiwan offered 14 percent interest and I expected the Thai baht to rise relative to the other currency. When it did rise, I was pleased. My total gain in terms of interest was about 25 per cent for the six month period. At the end of the period, I changed my baht into US dollars because (a) the rate offered by the bank had fallen and (b) I did not expect the baht to rise any further. Other small investors like myself often buy and then sell shares in mutual funds corporations that purchase a number of different stocks and bonds in a foreign country. Larger investors use stock and bond brokers.
To use the term "rogue capital" is to imply that people like myself are rogues. We are evil or at least cause some harmful effect. When we decide not to renew our loans or when we sell our stock, we do damage. I agree that we cause harm _to some people_. Let's return to the Malaysian example. I agree that when speculators shift their funds away from the ringgit, their actions will harm some Malaysian enterprisers. Our action surely causes stock prices to fall. In addition, downward pressure on the exchange value of the ringgit is likely to force Malaysian banks to reduce their loans. (Moreover, if Malaysian firms had relied on borrowing foreign currency, they will find that the interest rate they must pay will rise substantially, measured in terms of ringgits.)
The result of the reduced availability of funds in Malaysia is that some Malaysian producers and government officials will be disappointed. Specifically, those who expected to be able to finance their activities by selling stock at high prices or by borrowing short-term funds at low interest will either be unable to complete their plans or they will face higher costs than expected. Long term projects like housing, industrial parks, government buildings, and infrastructure would be especially vulnerable.
The Function of Speculators
In spite of these harmful effects, I believe that the speculators actually perform a function for an economic system. The point at issue is whether the abandonment of such projects is a sign of sickness, as Mr. McKeever claims, or a sign of health. Mr. McKeever writes that such speculators can make an economy sick because they cause the economy to be integrated with the world economy. My view, to use this metaphor, is that integration with the world economy through free capital markets is likely to make an economy well rather than sick.
By definition, whether the projects started by the Malaysian businesspeople and government officials turned out to be profitable depended on the continuing availability of short-term capital. If Malaysian businesspeople did not expect to have continuing access to the short term capital, they would never have started the projects in the first place. (The government officials may have somewhat different motivations than profit.) It follows that, in retrospect, these businesspeople miscalculated.
Because their miscalculations are a consequence of the currency speculators, one can say that the currency speculators did harm to the Malaysian businesspeople. However, one must recognize that the speculators would never have moved their money out of Malaysia unless (a) they expected greater returns on their investments elsewhere and/or (b) they expected the ringgit to fall relative to other currencies. So we must inquire further into what basis they had for expecting these things. It is here that we discover the function of the speculators.
The speculators perform a dual function. On the one hand, they compare the expected rates of return on their short-term money in different countries. On the other hand, they compare the expected value of currency. They shift their money from countries (a) where low rates of return and (b) currency depreciations are expected. They shift their money to countries where the opposite is true. In doing this, they integrate the Malaysian businesspeople and Malaysian government with businesspeople and governments throughout the world. They "force" the businessmen in Malaysia to make long-term plans that are no less realistic that the long-term plans made by businesspeople in other countries. And they force the Malaysian government to make long-term plans that are no less realistic than those of other governments into which speculators can invest their funds.
The speculators moved their money out of Malaysia because they judged that, in relation to other countries, the businesspeople and government officials were embarking on unprofitable projects. They believed that the economy was sick already and they sent a message to this effect. Unfortunately, in my view, the Prime Minister did not receive the message. Moreover, by imposing short-term capital controls, he blocked future messages of this type. I am certain that the Prime Minister is not a better doctor than "market forces." But it is not easy to open one's economy up completely to market forces. Other factors besides the economic ones need to be considered.
In short, I don't see such short-term speculators as rogues. I see speculation as performing an important integrating function in the world economy. Given that the speculators are likely to be right more than they are wrong, their actions provide important signals concerning the "health of an economy." Instead of making an economy sick, the speculators are like doctors. They give a diagnosis of relative wellness. To interfere with this process through capital controls is like rejecting the free services of a doctor. In effect, the Malaysian Prime Minister rejected free medical advice because the advice was not to his liking
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Gunning’s Address
J. Patrick Gunning
Visiting Professor
U.S. Coast Guard Academy
Management Department
15 Mohegan Avenue
New London, CT 06320
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