The news that Thailand’s “takeover king” had himself been forced into a takeover was an unnerving sign of how bad things were for the finance companies as they struggled to recoup the loans they had made to the erstwhile highflyers of the property and stock booms. Many of the finance companies’ depositors and creditors—both foreign and domestic—had assumed that the finance companies were immune to failure, because a number of the companies enjoyed close links with businesses owned by powerful politicians and their families. But now the Jaws of financial hell appeared to be closing on Thailand, and scores of finance companies began experiencing heavy withdrawals by Jittery depositors.
This was a fine mess Thailand was getting into. But the Thais didn’t produce it by themselves. They had plenty of help from their admirers overseas, who provided much of the money that made it all possible.
Every year, IMF staff missions visit each member country—including the United States and other rich nations—to consult with government policymakers and conduct an assessment of the economy, known as an “Article IV report.” In March 1996, an Article IV mission arrived in Bangkok and prepared a report noting that private capital flows into the country in 1995 were equal to 13 percent of gross domestic product. That was a much larger percentage than most other developing countries received at any time during the emerging market craze of the 1990s; and since only a small portion of it consisted of long-term investment in plant and equipment, it signified that Thailand was positively gorging on hot foreign money.
Thailand, like a number of other developing countries, had opened its economy to foreign capital with the encouragement of the IMF and World Bank, but it had needed little if any prodding. The Thai government, in fact, had long harbored dreams of turning Bangkok into a financial hub for the booming Asian region. On April 18, 1990, the Bank of Thailand outlined such a plan, stating that it would soon begin relaxing rules and regulations “to facilitate foreign capital flows and boost foreign investor confidence.” The bank knew the plan entailed risks. In a letter to the Finance Ministry, the bank cautioned that lifting controls “must be accompanied by the strengthening of financial institutions to enable foreign investors to develop confidence in such institutions.”
Unfortunately, the government never got around to achieving that goal. Instead, in late 1992—with IMF support—it created a new mechanism, called the Bangkok International Banking Facilities (BIBFs), aimed at enhancing Thailand’s lure as a banking center. The theory was that banks based in Thailand (both Thai banks and the local branches of foreign banks), spurred by the incentive of special tax breaks, would attract money from around the globe that they could either relend abroad—say, in China or Indonesia—or lend at home in Thailand. The officials who concocted the BIBFs evidently assumed that much of the money would be relent outside of the country; instead, most of it ended up being lent to Thai businesses and converted into baht. The financial appeal, after all, was compelling all around, and the tax breaks only made it sweeter: Since interest rates in Thailand tended to be several percentage points higher than rates in the United States or Japan, foreign lenders got higher interest rates on the money they deposited in Thai banks than they could get at home. The Thai borrowers paid lower interest rates on the dollars they borrowed than they had to pay on regular baht loans. And since the baht was relatively fixed against the dollar, neither lenders nor borrowers had to make bothersome calculations about how much they might lose on a swing in the Thai currency’s exchange rate. By 1997, these transactions totaled $56 billion, triple the 1994 level.
It’s perfectly healthy for a country to borrow heavily if it uses the money in ways that improve its long-term capacity to generate goods the rest of the world wants, but many of the dollars flowing into Thailand ended up in the hands of companies like Finance One (which borrowed about $600 million from abroad) and the developers of Muang Thong Thani (whose parent company borrowed from foreign banks and sold stock to, among others, Mark Mobius’s emerging-markets fund). As the Bank of Thailand would later admit: “It was inevitable, .. .. [given the] insufficient profitable investment projects to support such a large influx of capital, that much investment moved into the stock and property sectors.”
So, were those IMF staffers who traveled to Bangkok in March 1996 worried when they finished examining the Thai economy? Not unduly. Their confidential report, which was submitted to top Thai officials and to the IMF board, said that the amount of short-term debt Thailand had incurred to foreigners was “high by both Thai and regional standards.” That debt, and the current account deficit, “pose risks, and action should be taken to reduce them.” They offered some advice that looks sensible in retrospect, given the circumstances at the time—namely, for Thailand to give up the fixed rate for the baht and adopt “a greater degree of exchange-rate flexibility.”
But the report said nary a word about the overheated property market and precious little about the state of the banking system (though in fairness to the Fund, the Thai authorities refused to share their confidential data on the banks showing the extent of nonperforming loans). Perhaps most important, the report implied that Thailand would do Just fine by sticking to its present course. It contained two scenarios—a “baseline” scenario in which the fixed rate for the baht was left in place, and an alternative in which Bangkok took the Fund’s advice to adopt a more flexible exchange-rate system. Even under the baseline scenario, economic growth was proJected to continue at 7 to 8 percent a year, with moderate inflation, over the five years covered by the forecast.
Of course, at that time, few if any analysts foresaw a systemic crisis in Thailand, and the government hadn’t yet taken the steps that would put the economy in truly grave peril. But as 1996 wore on, Thailand’s underlying weaknesses began to attract notice from some observers on Wall Street and in London and other financial centers. Even as mutual funds and foreign commercial banks continued to invest blithely in the country, the baht was coming under occasional selling attacks from a less beneficent quarter of the financial world—hedge funds.
“Predatory” is a word often used to describe hedge funds, and many of the industry’s titans seem to relish the image. Louis Bacon, head of Moore Capital Management, once hunted water buffalo with a crossbow in Zimbabwe. Paul Tudor Jones II, head of Tudor Investment Corp., also enjoyed stalking game and owned a private hunting preserve on Maryland’s eastern shore. Tiger Management’s Julian Robertson named his funds after fierce cats—Jaguar, Puma, and Ocelot.
The fame of hedge-fund managers derives from another sort of predation—shooting down currencies and markets. George Soros, the Hungarian refugee who founded the Quantum Fund, earned more than $1 billion in 1992 by betting that Britain, then in recession, couldn’t stop the pound from falling outside the limits set under a system designed to keep European currencies relatively stable against one another. Robertson similarly reaped handsome profits in a 1990 bet that Japanese share prices were due to tumble.
Hedge funds defy simple definition, because they number around 3,000 and engage in a wide variety of investment strategies. One generality applies: They are open exclusively to the rich, which means they can escape regulations designed to protect ordinary investors. As their name implies, they often (though not always) seek to hedge their bets, and one of the techniques by which they both speculate and hedge themselves is “short-selling,” which involves making a bet that the price of something will fall. For example, the first hedge fund, which was established in 1949 by a man named Alfred Winslow Jones, sought to create a balanced portfolio that would be neutralized against the ups and downs of the general stock market. Stocks that Jones believed to be cheap, he bought; stocks he considered overpriced, he sold short. (A short seller borrows stocks—or bonds, currencies, or other financial instruments—then sells them at the current price, in the expectation that the price will fall, making it possible to buy them later at a cheaper price and repay the loan, collecting a tidy profit in the process. In other words, inst
ead of buying cheap and then selling dear, the short seller first sells dear, then buys cheap.)
For all their fabled power to drive markets up or down, hedge funds command much fewer dollars than other market players such as commercial banks. But given their reputation for canniness, hedge funds can help ignite or accelerate a run on a currency by betting on its fall, and that is what several of them, including Soros’s firm, were trying to do in late 1996 and early 1997 by going short against the baht. Destructive though this sort of practice may seem, hedge-fund managers contend that they provide a healthy disincentive against bad government policies. As Soros wrote in The Crisis of Global Capitalism: “[B]y selling the Thai baht short in January 1997, the Quantum Funds managed by my investment company sent a signal that it may be overvalued. Had the authorities responded, the adjustment would have occurred sooner and it would have been less painful. As it is, the authorities resisted and when the break came it was catastrophic.”
Back in Washington, the IMF was watching the attacks on the baht with a mounting sense of alarm. Stung by accusations that it had failed to anticipate the Mexican peso crisis in 1994, the Fund had been beefing up its capacity to detect and head off crises. It equipped economists’ offices with monitors showing up-to-theminute market developments (the IMF building had been deplorably short on such equipment prior to Mexico), and staffers were expected to maintain much more regular contact with finance ministries and central banks during periods of market turbulence. The Fund created a website that displayed a vast array of figures on countries’ key financial indicators, and member governments were strongly exhorted to provide timely data, so that financial markets could base their Judgments on accurate information rather than rumor. Thailand was shaping up as a key test of the Fund’s earlywarning capabilities, and on January 31, 1997, a day after a particularly intense amount of baht short-selling, the Fund went to a stage of high alert, transmitting a letter signed by Camdessus to Finance Minister Amnuay Viravan.
A letter from the IMF’s managing director in such circumstances is intended to convey a degree of great concern and galvanize the country’s authorities to act before they lose control of the situation. The Fund believed the Thais should swallow their pride as soon as possible and substantially loosen the exchange-rate system for the baht. By trying to keep the baht at the fixed level of 25 per dollar, the Thais risked running out of the dollars held in the central bank’s reserves, should too many baht-sellers come demanding greenbacks. Moreover, lowering the baht’s value would cause imports to decline and exports to rise, thus reducing the trade deficit and making it less necessary for Thailand to run up a tab. In his letter, Camdessus referred to the recent spate of short-selling by hedge funds and gave this advice: “In the present circumstances, provided that policies succeed in calming markets in the next few days, I would not recommend an immediate change in exchange-rate policy. However, I urge you to move quickly and decisively to reform the present system, taking into account the need for greater flexibility.”
To underline the urgency of the message, Stan Fischer sent a letter to Amnuay shortly thereafter conveying a similar warning, and in March, the advice was reiterated by an IMF mission visiting Thailand to prepare the 1997 Article IV report. “We continue to believe that the introduction of a more flexible exchange-rate arrangement is a policy priority,” the mission said in its confidential report to the Thai authorities. “During our discussion you have indicated that you intend to introduce greater exchange-rate flexibility at the appropriate time; we encourage you to do so promptly.” The mission chief, David Robinson, “was of a strong opinion that without [a devaluation], the risk of the damage to Thailand was very high,” according to a report by the Nukul Commission, an official Thai panel that later investigated the government’s handling of the crisis, and Camdessus also “pleaded for a baht devaluation” in a phone call with Rerngchai Marakanond, the central bank governor.
The advice went unheeded, which highlights one of the fundamental paradoxes about the IMF. The Fund has immense power to compel governments to accept its remedies when they seek its aid. Not only can the IMF extend or withhold loans; its approval of a program for a country also confers a sort of “Good Housekeeping Seal” signaling its economic endorsement for the World Bank, other foreign aid donors, and private investors and lenders to again put in money. The Fund’s refusal to provide the seal can doom a country to a virtual cutoff of foreign aid and hard currency.
But in nations that aren’t seeking its help, the IMF feels obliged to tread lightly. Even when Fund economists grow concerned about a country’s economic shortcomings, they deliver their bluntest warnings secretly to government authorities, and they couch their public advice in extremely diplomatic language rather than “blow the whistle.” The approach is partly because they want to avoid unnerving markets and igniting the very crisis they’re trying to prevent; in some cases, they’re also concerned about arousing the wrath of powerful member nations.
This practice helps account for the IMF’s ineffectiveness at preventing crises, and in Asia, the crisis-prevention system suffered from yet another problem—the lack of conviction among the staff that the countries’ vulnerabilities were genuinely serious. When surveillance teams would express worries to officials of a country in the region, “They’d be politely told ‘Go away,’ and the country would grow seven percent,” a former IMF economist recalled. “The teams would go back the next year and tell the country again there was a problem, and they’d be told ‘Go away’ again, and then the country would grow by eight percent. True, there were all these warnings given to the countries in letters and so forth. But in terms of the dialogue with these countries, we ratcheted down the concerns. They seemed to be surviving.”
In a similar vein, another IMF staffer remembered the words Stan Fischer scrawled on a briefing paper for a Fund mission that was visiting South Korea in 1995 to prepare that country’s Article IV report: “It’s hard to argue with success.”
The man the IMF couldn’t convince to devalue the baht was an avid stamp collector, who had written books and articles about stamps under the pen name “Winnie the Pooh” because, as he once explained to a Bangkok newspaper, his nickname in Thai is Pooh, and his American friends called him Winnie.
His real name is Chaiyawat Wibulswasdi, and he was deputy governor of the Bank of Thailand, a position to which he had risen in 1995 after two decades at the central bank. Though he was the bank’s second in command, he was, like Stan Fischer, the intellectual leader of his institution, especially in the realm of currency issues, where the central bank effectively exercised control over policy. A graduate of Williams College with a Ph.D. from MIT, the intense, bespectacled Chaiyawat was known at the central bank as a perfectionist who insisted on well-reasoned, neatly presented reports from his subordinates. He tended to be aloof, although he often became quite animated when asked about stamps.
Chaiyawat understood the IMF’s case for a devaluation, but he disagreed with it strongly, as did many of his Bank of Thailand colleagues. For starters, they questioned whether a devaluation would hold for long, because hedge funds and other speculators would probably take the move as a sign of weakness—evidence that the government lacked the resolve to keep the baht from falling even further. “The issue was, would you find yourself in a situation where the baht keeps depreciating uncontrollably?” one central bank official recalled. “If you devalue the baht from 25 [baht per dollar] to 28, would you be able to hold it at that level? Would speculators be satisfied with the baht at 28? Would they be satisfied at 30? If they attack again, what would you do then?”
Furthermore, once the baht started to fall, its decline would call into question the solvency of the numerous Thai financial institutions and companies that had borrowed dollars from abroad. So Chaiyawat’s strategy was to hold the line on the exchange rate and buy time in the hopes that the government could fix the country’s underlying problems.
In the IMF’s view, the Ban
k of Thailand was committing classic errors in currency policy. Many a government has learned the folly of hanging on to an unviable exchange rate until the bitter end. But the IMF’s efforts to talk the Thais out of this approach were, in retrospect, misguided.
In a visit to Bangkok on May 22, 1997, Fischer and a couple of other IMF officials urged the Thais to devalue the baht by 10 to 15 percent and widen the “band” within which the baht was allowed to move. Chaiyawat objected that Mexico had tried a similar controlled devaluation a couple of years earlier—and failed to keep the peso from falling precipitously. The visitors from the Fund, however, were concerned that allowing the baht to float freely might produce even worse results, because no one could be sure where the currency would stabilize. A letter from Camdessus also urged the band-widening approach.
The IMF was advising Bangkok to adopt policies that the Fund itself would subsequently brand as foolish. A couple of years after this episode, the Fund would adopt the gospel that it is almost always futile for developing countries to ward off assaults on their currencies with band-widening and other halfway measures. Said Fischer when he was asked about the counsel he gave Thailand in May 1997: “It’s very hard to know how to advise a country on how to get out of [a fixed exchange rate]. More and more, we Just say, ‘Let it go.’ We’re much more aware of how devastating the capital flows can be. What did the Europeans do [when a crisis hit the continent’s currencies] in 1993? They broadened their band, and it worked. Well, that was sort of our thinking [in Thailand]. Now you see that we have these emerging-market countries, with devaluations of 50 to 70 percent. So in a country under attack, we’re less inclined to think a devaluation of 15 percent plus a band-widening will do any good.”
The IMF’s influence with the Thais in May 1997 was weak, in any event. Worse, the Thais were holding back vital information. In meetings at the Bank of Thailand, Fischer asked for one key piece of data that the Fund would need if it were to come to Bangkok’s aid—namely, the full details concerning how much hard currency the central bank held. The governor, Rerngchai Marakanond, declined to answer but said he would think about it. When the same question was put to Chaiyawat, he promised to call the IMF team at the airport after getting permission from Rerngchai to release the data. True to his word, Chaiyawat called, but he said the governor had refused to allow the disclosure.
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