Malaysia in the Era of Globalization #37

By M. Bakri Musa

Chapter 5: Understanding Globalization (Cont’d)

Trading in Money

Malaysia cannot modernize its financial sector and capital markets in part because its leaders are stuck in the pre-globalization mindset, especially in their attitude towards money and capital. While to consumers everywhere money is now simply a convenient medium of commercial transaction, to Mahathir and other Third World nationalists it assumes a more important symbolic function. Currency represents the nation’s sovereignty. It is instructive that one of the first orders of business for many newly independent nations is to declare a new currency or to rename its old one. Malaysia has the ringgit, and to symbolize its new beginning, prints a portrait of its king on the paper notes. Money is no longer simply money, rather a powerful symbol of the nation’s sovereignty.

It is this symbolic attachment to the currency that irrationally dictates many economic policies. Governments often go to extreme lengths to defend the value of their currency when market conditions dictate otherwise, as happened in Thailand and Malaysia during the 1997 crisis. They forget that the value of a currency is a reflection of consumers’ and investors’ confidence in the underlying economy. A weak economy will have a weak currency, regardless of the nationalistic frenzy used to whip support for it. Malaysia lost billions and nearly exhausted its foreign exchange reserves in the early part of the 1997 economic crisis trying to defend the value of the ringgit, only to admit finally that the market was correct.

Even as a medium of commercial transaction, money or more accurately cash, has been supplanted by other instruments. The most widespread is the credit card. Even when I travel abroad I carry very little cash, only a pair of credit cards with the second as insurance in case the first is stolen or lost. With that I could purchase anything and execute any transaction. It is also safer and more convenient; if stolen all I have to do is notify my bank and the card would be rendered useless and a new one reissued. In practical terms my credit card with my picture on it is as good as the paper money with the King’s portrait on it!

To an increasing number of people today money is just a commodity, like rubber and sugar. And like those commodities there is a market in money futures, that is, in predicting or anticipating its future values. Just as sugar “futures” traders take the risks from the producers and consumers of sugar, so do currency traders take the risk from lenders and borrowers.

In its simplified form a commodity futures trader works thus. Imagine I am a beverage manufacturer and use tons of sugar every day for my product. I cannot afford to have the price of sugar, my prime ingredient, fluctuate wildly. I need it to be relatively stable so I can budget appropriately. But the price of sugar, like other commodities, will vary depending on weather, political upheavals, world markets, and labor disputes, among others. As a wholesale consumer, I do not have the time or expertise to monitor the various market conditions affecting the price of sugar, otherwise I cannot devote my full energy towards producing my primary product. All I need is a steady supply of sugar at a reasonable and predictable price. Enter the futures trader. For a fee he will guarantee for me my supply of sugar for the next few months (or years) at an agreed upon price. If the price of sugar drops he will reap his profit, but if Castro throws his usual political antics and the price of sugar suddenly jumps, then I will be protected but the trader will lose in the deal.

And if that sugar commodity trader were prudent, he would spread his risks by diversifying. That is, he would also invest in other commodity futures so that if he were to lost money in sugar, he would be able to recoup in soya beans, for example.

Traders in currency futures too serve a similar function. Assume MAS were to borrow US $100 million to buy a 747 jet and have to repay the loan in US dollars. MAS’s revenue however, is in ringgit (at least the bulk of it). If the ringgit appreciates in value with respect to the US dollar, then MAS will need fewer ringgit to service the loan. That would be a bonanza to the company. However if the ringgit were to depreciate, then MAS would have to spend more to service the same loan. Small variations in the exchange rate would not be disruptive, but wild fluctuations could put the company under by making the amount of loan payments unpredictable.

Competent financial managers guard against such unanticipated changes by “hedging,” that is, for a small down payment (“options”) he would be guaranteed a certain amount of dollars at a preset conversion rate. As with the sugars options discussed earlier, if the dollar appreciates then the currency trader would absorb the loss and spare MAS the added costs. By securing such options, MAS would be acquiring an insurance policy against the potential weakening of the ringgit. The debacle that snared MAS and many other Malaysian companies during the 1997 economic crisis was in part because they borrowed huge sums of dollars that were “unhedged.” When the ringgit depreciated, the costs of those loans effectively went up.

Thirty years ago almost all cross-border transfers of currencies were for payments of goods and services, that is, for payments of actual trading. Today the overwhelming bulk of cross-border movements of funds are by currency traders using money as a commodity, trying to exploit changes and small differentials in exchange and interest rates in the different markets. Every day over trillion dollars are sloshing around the world’s money markets, and only a very tiny fraction of that is being used to pay for actual physical trade in goods and services.

Money is now a commodity, to be traded across borders just like sugar and rubber futures, and with as much sentiment as for those products. Just as traders at the Chicago Commodity Board earn more than the farmers who produce those commodities, so do currency traders make more money that those whose hard work generated those cash in the first place. Mahathir may rail against these speculators but they are not likely to disappear. I have always regarded futures trading as nothing more than 90 percent gambling and 10 percent useful economic activities (protecting producers and consumers from the risk of price volatility), but as long as it serves even that small an economic function, it will remain. No government can outlaw it; doing so would only drive them underground. Then they would become 99 percent gambling.

Left wing social science professors may condemn these commodity traders. Why should these young hustlers in their bowties and red suspenders working in the comfort of their air-conditioned trading pits, and who cannot tell apart the wheat from the shaft, be earning more than the hard working wheat farmers? It is sinful and unjust. If anyone should benefit from any increase in the price of grain, it should be the farmers, not those speculators. This was the theory behind the Soviet collective farms, with the farmers (with the help of the state) controlling not only the production but also the distribution and marketing of their products.

The collapse of the Soviet farms proved the fallacy of such a system. Farmers should stick to farming, marketers to marketing, and risk takers (commodity traders) to managing financial risks.

Currency traders like George Soros indeed make a killing – when they guess or gamble right. But when they are wrong, they eat more than humble pie. They could be wiped out. The near collapse of the billion-dollar hedge fund Long Term Capital Management in 1999 is a grim reminder of the stakes in this new form of “trading.”

Economists and others who have long tried to grapple with how to control or tame currency trading have been humbled by their attempts. Many a conference and seminar have been devoted to rebuilding the “architecture of international finance.” The fact that there is no solution as yet points to the difficulty of getting unanimity on the issue.

Chile once charged a premium for short-term capital (“hot” money) by requiring a portion to be deposited in a non-interest bearing account with the central bank. That was then. Now with the intense competition for foreign funds, Chile has done away with that novel scheme.

The Yale Nobel economist James Tobin suggested a similar concept, the so-called Tobin Tax, to damper speculative activities of currency traders. The fact that such schemes have not been adopted suggests that there are associated costs. Ultimately it is borrowers, not lenders, who would end up bearing the added cost. Thus instead of ranting and raving against currency traders, we would be wiser to accept them and to learn their ways in order to protect ourselves. Countries should concentrate on producing goods and services efficiently, and let the currency traders assume the foreign exchange risks.

While Mahathir may now righteously condemn currency traders, specifically George Soros, his own central bank was actively involved in the foreign exchange market. Indeed Bank Negara’s excessive speculative activities in the early 1990s prompted the United States Federal Reserve Bank to issue a stern warning. As it turned out, that was unnecessary as Bank Negara was later humbled by the loss of billions on a wrong gamble on the dollar. The difference between Soros’s and Bank Negara’s loss is that with the latter, it is the Malaysian taxpayers who ultimately foot the bill while Soro’s loss was borne entirely by his affluent clients and investors.

Thirty years ago there was no currency trade. For one, there were only a few major currencies in the world so there was not much room to speculate. Today, every tiny little independent country wants its own currency; thus opportunities for speculators are wide open. The other reason is that currencies then were tied to the value of gold. Money then held its value. The US dollar was the last major currency to “de-link” itself from gold. Without an underlying precious metal to support it, the value of paper money is based largely on the confidence people (the market) have on the underlying supporting economy. Of course if the world were to have a single currency then those speculators would be out of business.

In this Internet age, money is nothing more than blips of positive and negative charges (digitization) spinning around the globe at the speed of light seeking the highest returns commensurate with the risks. Once we consider money as a commodity in addition to its traditional functions, we will then better understand and come to terms with the currency market, which is now so much an integral feature of globalization.

Next: The Forces Driving Globalization