Rough Trade.

How currency traders profited from the Asian meltdown 

On July 2, 1997, Thailand's prime minister, Gen. Chavalit, stood screaming at his Minister of Finance, M.R. Chatu Monkul Sonakul, in his country's National Assembly. M.R. Chatu Monkul had advocated devaluing Thailand's currency for months and today, he argued, devaluation was absolutely necessary. The prime minister was in denial and furious. Thailand had conquered capitalism and, in the previous decade, the kingdom had literally grown as fast as any nation ever had. Paupers had become princes and cars were now clogging roads in towns where shoes had been rare two decades before. Thailand was too strong, too smart, and too successful to fall prey to currency speculation. M.R. Chatu Monkul was fired.

As the now ex-minister of finance left, he mumbled prophetically, "It will fall anyway ... but we won't be able to control it."

The most severe world economic crisis since the depression of the 1930s would begin that afternoon when even Prime Minister Chavalit had to throw in the towel. By the end of the day, Thailand's currency, the baht, was slipping into freefall. It would lose 40 percent of its value within weeks. Soon every other Asian currency would slip down with it and, by the end of the summer, the economies of Indonesia, Malaysia, and Thailand would be plummeting like Icarus. Within a year, the streets in two of the three nations would be on fire.

As this scene exploded in Bangkok, hundreds of young currency traders jabbered into their telephones around the world selling baht to anyone who would buy. Traders wore the same plain blue shirts as the day before and stared into the same blue computer screens. The scene in major companies was intense but not chaotic and the mood was one of satisfaction. Traders had predicted that Thailand would devalue and now they had hit a home run: They were both looking smart and making lots of money.

Traders that day weren't concerned that Thai businessmen were losing everything they had labored for a generation to achieve and that companies were going belly-up. They weren't concerned that losses would trickle down to construction workers in Bangkok, the women who sold pineapples to the workers, and to the peasant families of everyone up to the north. Thailand's currency was collapsing because it merited a collapse. Could it have been that the punishment didn't fit the crime, that Thailand had made mistakes but not enough to merit a collapse, and that the market was overreacting and overshooting?

"I don't believe in overshooting. The market couldn't overshoot in a billion years," said Robert Gray, a former trader with First Interstate. "The market is always right."

Political incompetence, corruption, and economic nonsense contributed greatly to the Asian crisis. Put the government of Thailand on trial for mismanagement and it would be judged guilty. But the more interesting trial would be of capitalism itself and of the trigger of the explosion: currency markets and traders. The traders could plead no contest and be given a slap on the wrist but the market would be judged guilty and sentenced to a stint in reform school.

Riders on the Storm

Currency markets arguably are the most important markets in the world and, with daily transactions exceeding one trillion dollars, they are certainly the largest. There are no regulations and there is no central trading center; it's free market capitalism at its purest--like Wall Street before Black Friday. Unlike the New York Stock Exchange today, collapses don't even trigger automatic shutdown mechanisms. In the past five years, these markets have kicked over the stones that started avalanches in Mexico, Southeast Asia, and Russia.

The money that flows through these currency markets comes from either speculative or non-speculative sources. Non-speculative sources include exchanges made by multinational businesses that need foreign currency. If McDonald's wants to build a restaurant in central Thailand, it will have to pay the workers in baht. To get the baht, it will have to trade some of the dollars earned selling Big Macs in the United States. If McDonald's is worried about the stability of Thailand it may also want to hedge against the currency's collapse by borrowing baht from a bank and then exchanging this money for dollars (selling baht short). Investors and their funds make up another significant part of the non-speculative market. If I want to buy stock or real estate in Bangkok, I have to change my money as well.

These trades lubricate the gears of international capitalism and, without them, there would not have been the economic boom and globalization of the last generation. If you couldn't freely exchange currencies, McDonald's couldn't open in Bangkok, Nike couldn't make shoes in Indonesia to sell in the United States and, if you wanted to buy miso soup from Japan, you wouldn't go to your local supermarket: You'd have to go to Tokyo and barter. Countries that have closed their economies to these transactions, like much of Africa after independence, have stumbled and slipped into the new world order where no-holds-barred capitalism reigns.

Beyond these business transactions, there is speculation: the purchase of currencies purely to make money. If a trader thinks Brazil's interest rates are going to go up, he (they're almost all men) buys the real. If he thinks that Indonesia's political system is going to crumble, he sells rupiah. No trader pretends that these transactions add value to an economy. These trades are simply about making money, and it is this type of currency trading that now makes Southeast Asian officials steam. A business wants to hold its currencies for years, and a stock investor is likely to at least hold his investment through the short term. A speculator just needs a trade that will last until the market makes its next move--and that can be instantaneous. As John Maynard Keynes famously wrote, "Speculators may do no harm as a bubble on a steady stream of enterprise. But the position is serious when enterprise becomes a bubble on a whirlpool of speculation."

The people who go into currency trading are quite unlike most young people. They are the brightest and the best. They all graduate from college with honors and ambitious dreams. But they also lust for intensity and unpredictability. They crave being called at 3 o'clock in the morning and forced to make a deal. Some have screens displaying currency prices arranged throughout their houses--from the bedroom to the kitchen to the bathroom--just in case they are put into this situation. One currency trader at a major firm glowingly told me of another young rising star.

"He likes to drive a motorcycle and carry a knife in his boot.... If he's bored on a plane, he's not going to sleep or read a book; he'll flip a coin 5,000 times to see if there is a slight advantage that can be gained by guessing one side or the other."

These are not young money-hungry investment bankers. They like to have their weekends off to dive from mountains or meditate or just live; they want to work 60 hours a week, not the 100 that other graduates who aim to get rich do. It's not a profession for the straight and narrow but it's also not a profession for idealists. Young men and women who want to save the world don't go into markets; they go into medicine or work for non-profits or travel a thousand other roads that don't mandate that The Financial Times be gobbled with the morning's orange juice. As another young trader responded when pressed to give a moral justification for his career:

"Look, it's not the Peace Corps."

In fact, almost every trader argues that his profession is a fundamentally amoral one. For every winner in a trade there must by definition be a loser. Even investment bankers can claim to be helping to make companies with good ideas grow. Currency traders know that they would immediately lose their jobs if they started to act on deliberate moral impulses. However, behind this veneer and pride in amorality, there is a sense among traders that they are the disinterested jurors casting out quasi-divine judgment on economies that stray from the road of proper free market economics. To one trader, "we just serve as the thermometer. If a country is sick, we tell him."

In this sense, Southeast Asia was currency traders' Tower of Babel. Ask a trader what happened there and you will be told that the governments of Southeast Asia brought the crisis on themselves through hubris. They let billions of dollars flow unregulated into their country. They didn't scrutinize loans (their friends were the ones getting rich) and they ran huge budget deficits. Malaysia spent billions on glamour projects like trying to build the world's tallest buildings. With this folly, the traders argue, the region's economic boom deserved to be crushed.

However, even if traders are a bit imperious, they have a case to make that they do benefit the world economy. Bill Jacobson, a trader at a major American bank, said, "even if currency traders had 100 percent control over the economies, which they don't, why would having millions of different people influencing markets through the way they choose to invest their own money be any worse than having a bunch of corrupt bureaucrats in control?"

It wouldn't--if you assume that politicians are corrupt or incompetent, that traders are just benevolent judges of economic guilt and innocence, and that the system works. Of course, not everyone accepts these assumptions. To some of their critics, traders aren't benevolent judges; they're monsters. In the worst case, traders deliberately manipulate currencies for personal gain. According to Prime Minister Mahathir of Malaysia, the most infamous critic of the profession, "Currency traders have become rich--very, very rich--through making other people poor ... Currency trading is unnecessary, unproductive, and totally immoral. It should be stopped."

Mahathir is both a hypocrite--his country's central bank reportedly lost $6 billion in currency speculation over the last few years--and wrong about the impacts of trading and the motivations of traders (Jacobsen, for one, just wants to earn some money so he can pay for his children's education and move back to a quiet life in western Massachusetts). A more effective argument acknowledges that blaming traders is akin to shooting the messengers. Traders themselves are not the problem; fundamental flaws in 1990s-style capitalism are. Specifically, without regulation or controls, the market is able to run wild, overshoot, and wreak havoc. Even worse, the market can be driven by impulses that evade objective measures of economics and politics.

When currency traders make decisions on whether to buy or to sell, they generally look at three factors: politics, economics, and perceptions. If traders think that economic policy is sound, they are likely to buy that currency. If they think that the political system is going to collapse, they'll sell. These political and economic evaluations are objective, but the third factor, perception, is subjective. If a currency trader thinks that other traders are going to start selling the currency in the near future, he would do well to sell now, regardless of other considerations.

Currencies collapse when a country tries to maintain a fixed currency. In Thailand, up until July of 1997, the government stabilized the currency near 26 baht to the dollar. If there were more sellers than buyers at that price, the government would either raise interest rates (slowing economic growth but making the baht more attractive), or use some of its dollars to buy baht in the open market until the price returned to 26. If there were more buyers than sellers, the policy would be just the reverse.

The trouble with such a policy comes when currency traders perceive that the government will no longer be able to defend the currency, either because of economic weakness or because the government is running out of reserves. From this moment on, there are far more sellers of the currency than there are buyers, and it takes either exorbitant interest rates or more and more dollar reserves from the central bank to maintain the price. Moreover, currency traders who have entered into the market early can push the collapse forward by making public statements about its imminence, giving interviews to The Wall Street Journal and intensifying the strong influence that perception has upon price. The scenario runs circles around itself with momentum building until, boom! the currency can drop into oblivion just because every trader thinks that every other trader will soon start unloading.

In the instance of Thailand, there is certainly a case to be made that a collapse was in order. Yet there is a more persuasive argument that the punishment exceeded the crime and that the political and economic problems that contributed to the meltdown were augmented by the ruthlessness of global capitalism.

There were two main problems in Thailand that led to the sudden collapse. First, Chavalit Yongchaiyud, the prime minister of Thailand at the time, had become intoxicated by his country's growth over the past generation. Wherever he ruled, the economy boomed, and gradually Chavalit developed unlimited faith in his own abilities. Because money means more in Thai politics than even in the United States, he became more and more indebted to Thai businessmen (all of whom were bound to take a bath with devaluation). As the currency weakened and sporadic attacks revealed his policy's weakness, Chavalit held on and believed that he could will the currency to stay strong, as Canute did the waves. Currency traders, however, kept pounding, and, like a high pressure hose firing on soft clay, they gradually wore everything away until the baht collapsed.

Second, Chavalit's obstinate position did not encounter adequate opposition because the underlying economic problems in Thailand were almost precisely the opposite of the ones that had caused the collapse in Mexico a few years before, and analysts had not immediately grasped the weaknesses. In Mexico, the problem was overconsumption. Billions of dollars had flowed in and been spent on expensive cars and luxury goods. In Thailand, billions of dollars had come in and been invested, and then more had been invested, and then even more had been invested and lent out. This was hardly a problem in standard macroeconomic terms and it wasn't until increased prices and indebtedness had reached crisis proportions that people took notice. Only in July of 1996, one year before the devaluation and well into the cycle, did the IMF first argue that Thailand needed to devalue.

Still, the collapse didn't have to be as brutal or as sudden as it was. The Thai economy was growing at six percent a year, inflation was running at a mere four percent, there was a constitutional reform movement brewing, and even declining indicators were simply coming down from the stratosphere. More importantly, the chinks that had been found in Thailand's economic armor did not justify the panic that quickly hammered the rest of Asia and, almost instantly after the Thai devaluation, sent the high-pressure hose spraying wildly around, overshooting and destabilizing the region. Thailand's currency dropped 40 percent of its value in three weeks and Indonesia's has dropped 80 percent in the past year and a half. This cycle has been repeated in other countries over and over in the past year, and not only could the changes not possibly be justified simply by economic and political changes, they also haven't led to rational political reforms as a currency trader might hope. They happened so fast that people started demanding blood. Indonesia and Russia are approaching anarchy, Malaysia is moving toward totalitarianism, and the Thai system has been thrown into such chaos that fundamental reforms are next to impossible.

Tax 'em

The most commonly offered solution to the problem of currency runs and instability is the creation of a system that revolves around one, or three, stable major currencies. Proponents of this idea range from President Jacques Chirac of France to assorted South American economists. This system would be modeled after the new European economic union. Countries would fax their currencies to the dollar (or to the dollar, euro, and yen) and in this way be able to avoid currency runs, speculation, and the investor uncertainty that comes with potential currency instability.

This solution, however, like all other solutions that keep the value of a currency fixed, is incompatible with two other goals of international policy: free capital mobility and domestic sovereignty over interest rate policies. Countries like to have control over their interest rates so that, when the economy is in recession, rates can be lowered to stimulate growth (lower interest rates make lending and investment easier). However, unless there are capital controls, a country cannot control interest rates while maintaining a fixed currency. If the values of the dollar and the yen were guaranteed at a fixed rate, and the U.S. Federal Reserve raised interest rates even by a fraction of a percent, every investor would immediately be able to make a fortune by borrowing yen at the low interest rate and then buying dollars and lending them out at the high interest rate.

A better solution is an international tax on currency transactions. This idea was originally pushed forward in the early 1970s by Nobel Prize-winning economist James Tobin. A "Tobin tax" would be a very small levy on all international currency transactions. Traders would have to pay the tax to the regular collecting authority of the country in which the transaction originated and the tax revenues would then be sent to the World Bank, IMF, or a yet to be determined international financial agency that would focus on development. A tax of as little as one-tenth of 1 percent on all foreign currency exchanges would easily raise hundreds of billions of dollars a year with current transaction levels and, with a slightly higher tax, revenues could quickly move into the trillions. Countries that try to circumvent the tax and become havens of tax-free currency trading could be denied World Bank loans and international support.

A tax of this level would hardly deter long-term (or even medium-term) investors. If I want to buy a factory in a developing country to hold onto for 20 years, or even two, a levy of one-tenth or one-half of one percent on my currency transaction is unlikely to stop me. It would, however, slow down short-term speculators who try to pounce on tiny movements caused by perception and minuscule spreads and make trades every day. It would surely have dampened some of the chaos in Thailand's currency markets and it would help eventual market outcomes to be determined more by the fundamentals that drive long-term investment than the perceptions that can dominate the short term.

International investors opposed to such a tax make the argument that there would be difficulties in implementation. A Tobin tax, however, would rely on existing infrastructure and governments would also have incentives to make the tax work so that their central banks could set interest rate policies based on economic growth, not on potential currency speculation.

Of course, the principal reason that international investors are opposed to a Tobin tax has nothing to do with implementation concerns. Keeping markets completely free has simply become a religion. No regulation is good and no controls are worthwhile. It's not even worth it to have a small tax that would work like the surge protectors that most of us use to protect our computers: draining a little bit of energy all of the time but preventing the whole system from crashing in the event of a storm.

Today, the traders in New York, London, Tokyo, and every other center around the world are still wearing the same blue shirts and staring into the same blue computer screens. They are looking for economic weaknesses and looking for the next currency that's going to collapse. If they find a likely suspect, they'll attack it, and if enough speculators start to sell, the perception of weakness might become self-fulfilling. This will continue on and on, with markets around the world sinking like Thailand's. When this happens, the beneficiaries will claim that they were just pointing out weaknesses (just as they did in 1929) and that currency markets are vital to global commerce and to lubricating the gears of global capitalism that have certainly brought prosperity to people all over the world. Their implicit argument, however, will be the notion that global capitalism, like a brothel, works best when there's no regulation. As has been clearly seen in Thailand, that isn't always true.

NICK THOMPSON is co-author of the forthcoming book The Baobab and the Mango Tree, on development in Ghana and Thailand.