Thailands Woes Hang From A Peg

If you want a sophisticated but incorrect analysis of what went wrong in Thailand in the recent Southeast Asian crisis, you must read Ashok Desais admirable article in Business Standard (January 13). Or even the Financial Times of January 12. But if a naive and simple answer will satisfy, you should perhaps continue to read this piece.

The long and complicated explanation claims that the Thai economy was doing spiffingly well. The 1994 fiscal deficit of 3.7 per cent had been miraculously turned round to a 7.8 per cent surplus; the GDP was belting along at 9.8 per cent per annum. Domestic savings rates rose from 24 per cent to 35 per cent, the only fly in the ointment apparently being that the trade deficit was quite high at 7.8 per cent of GDP; but that was no real problem, because exports were growing at 16 per cent per annum and anyway foreigners were so impressed by the Thai economy that they were happy to lend or even invest in Thailands property boom. The exchange rate was stable it was maintained almost constant in terms of a basket dominated by the US dollar. Thus exchange risk was almost eliminated.

 

Now that is the first warning bell that the reader should be listening for. A major risk eliminated? How, one asks, did the Thais do it? The answer is both simple and very familiar. They did it by purchasing useless dollars doubtless through selling valuable bahts. Why were the dollars useless? Well, consider what the Thai authorities did with them, they probably went and bought US Treasury bills, that is, they loaned back the money to the United States government to reassure the world and their own central bankers that they had plenty in reserve against any run on the currency. In these circumstances, is it fair and proper to describe the dollars as useless? If we simply mean that no one had any immediate use for them, that no one actually consciously bought the dollars so that they could buy US T-bills. In that primitive sense at least, the exchange of bahts which could be used to buy real resources, for dollars which could only be invested in US Treasuries, was an exchange of an immediately valuable asset for an asset to be kept for a rainy day.

There is, of course, nothing economically improper for storing up assets to be used when bad times come. That, after all, is what the reserves are there for. It lends credibility enabling the authorities to make soothing noises to the effect that the fundamentals of the economy are sound, or tell a gullible media that the Reserve Bank has declared war on speculators, or that the countrys reserves are large enough to beat back any contingency. The authorities are always attempting to eliminate exchange risks. In practice, what this means is that a drop from, say, Rs 17 to the dollar to Rs 30 to the dollar is a fundamental correction, but a drop from Rs 30 to Rs 35 is unjustified speculation.

I have no doubt that the Thai authorities thought in a similar vein. They had pegged their currency to the dollar and that was the guiding light to all their policy making. The whole thing was so simple; when money was flowing in, the Thai Central Bank bought the dollars at a pegged exchange rate so that when the money wanted to flow out they would buy the bahts and sell dollars at the same exchange rate. There was to be no point in taking an exchange risk for, as Ashok Desai reminds us, exchange risk had been eliminated.

To me it is strange that he misses the point that by eliminating exchange risks, the authorities were exposing Thailand to every other risk, the biggest of all being the risk of mis-investment. Every Tom, Dick and Harry could see that if there was no exchange risk, both the properties market and the stock market offered amazing returns. All you had to do was to borrow cheap dollars and invest in these higher yielding assets. It was money for old rope, the old rope of course being the low interest dollar and the real money being bahts.

Every authority in the world has a passion for eliminating exchange risks. Sometimes it is done by fixing the exchange rate, at other times by deliberately under-valuing the domestic currency, to encourage exporters to make profits. Economists love playing these games but they never quite realise that keeping the exchange rate stable is as big an act of mis-pricing as deliberately over-pricing or under-pricing a currency. Perhaps, it is only obvious in retrospect but what the authorities in Thailand should have done is allowed the baht to appreciate when foreign investment was trying to pour in. It might have then given investors some food for thought whether the stock markets were over-priced or under-priced. The signals would have been more immediate and dramatic.

This business of market signals is not at all obvious to non-market players. I remember that in my own industry, shipping, there had been such a dramatic slump that for 19 long years no one thought of investing in ships. It so happened that I was sailing in Mumbai harbour when my colleague pointed out that a 19000 tonner anchored there was worth less than half a million dollars. From our boat we could see Colaba, where a single three-bedroom flat was worth more than the ship, and that to me was a signal that the time had come to invest again in ships.

I tell this story only to illustrate that those who are in the business of investment do not sit around applying profound logic and making a deep study of statistics. They leave that to economists. They depend on simpler and more obvious evidence. I have, therefore, no doubt at all that if the Thai baht had been allowed to appreciate when the world wanted to invest, it would have been obvious even to the meanest intelligence that property and stocks in Thailand were over-priced. The terrible mis-investment that took place would not been undertaken and Thailand would still have been in good shape.

The trouble with economists is that they are often slaves of defunct ideas. In this case, the defunct idea is fixed exchange rates and exchange rate stability. It is a hangover of the Bretton Woods days. Good economists, particularly Cambridge-trained ones, cannot escape the analysis that grows out of fixed exchange rates. All the complicated jargon of trade deficits, export competitiveness, and the rest, so mesmerises them that they forget that exchange rates in the 19th and early 20th century were flexible and that economies did work perfectly satisfactorily without regulations and the useless distinctions between current and capital accounts. It was the current account deficit that misled the Thai authorities. Had they left the exchange rate to find its own level, it certainly would have fluctuated but they might not have found themselves in such a mess as they are now in.