Global capital gets government scrutiny

By Christopher Lingle

HONG KONG (JP): A new attitude is gaining momentum among public officials that involves considerable distrust for private sector actions in financial markets.

Joseph Yam, chief executive of the Hong Kong Monetary Authority, is outspoken in his belief that the most obvious defect in capital markets is a lack of transparency by private actors.

This theme seems to find increasing resonance. Officials are searching for appropriate curbs on the actions of an unnamed enemy. However, it is clear that the goal is to rein in hedge funds and other highly leveraged investment strategies.

Undoubtedly, Yam is concerned with protecting Hong Kong's reputation as a regional financial market and as a bastion of free enterprise. In all events, officials from other countries and even international financial bureaucrats at the International Monetary Fund and the World Bank are now nodding in agreement. At least many of them think that limiting capital inflows to small, open economies might not be such a bad idea, even if nearly all oppose restrictions on capital outflows.

However, demands for limiting the freedom of action of hedge fund managers require some balance. Consider for a moment the role of public officials in post-crisis Asia.

On the one hand, there is widespread belief that unfettered and fickle capital flows were an important cause of Asia's financial turmoil. On the other hand, there is considerable good cheer over the region's rising stock market indexes and their apparently stabilizing currencies and interest rates. Yet most of the good news on the financial side of these economies arises from the most fickle of all inflows, foreign portfolio investments.

So gentlemen, which is it?

Sometimes punishment comes in the form of getting what you wish for. Had short-term capital flows been halted or impeded, East Asia would have little to cheer about when assessing their economies. The bad news is that if critics of short-term capital are correct, what is happening is transitory and may constitute a mini-bubble.

And all these funds, where did they come from? Well, central banks, especially America's Fed and the European Central Bank, have loosened credit policies. While there are differing degrees of independence of central banks, such steps are certainly not a private sector decision.

Oh, and what about the actions by certain East Asian governments to intervene on their domestic stock markets. Of course, Hong Kong's government joins those of Japan and Taiwan. Buying into local equity markets puts a floor on the indexes and distorts pricing. And it almost certainly provides an illusion of recovery that would evaporate if the funds were withdrawn.

At the same time, many East Asian governments have increased deficit spending in hopes of boosting growth. Unfortunately, unsustainable pump priming is driving a considerable portion of the higher numbers showing up in gross domestic product. When this stops, as it must, air will come out of the new bubble that these actions are helping to form.

Turning to the proposals for new regulation, governments are discussing greater cross-border scrutiny, perhaps with the aid of new or beefed-up international agencies. They would demand more information through closer examination of high-powered investment strategies. Then, if and when things go amiss, loss of confidence in certain markets would be offset through timely injection of a new pool of contingency funds. The presumption is that increased transparency and more taxpayers' funds will make global capital markets safe for the world.

There are several logical flaws in these reasonable sounding proposals. In the first instance, attempts to force certain economic actors to disclose more about their dealings is a quixotic task. Such requirements imply that exchanges are guided by objective information that can be supplied costlessly and understood equally by all.

In fact, voluntary exchange operates otherwise. It occurs only when one person places a higher value on an object that they give up when offered a trading opportunity. Trades involving capital in all its forms operate in this same manner. In this sense, decisions that make some people behave as "bulls" and other as "bears" arise from highly complex motives and understanding. In all events, providing knowledge and understanding of markets is not a costless activity. Attempts to impose the impossible may result in capital markets becoming less efficient.

Further, the choice for the amount of secrecy and disclosure involves a delicate balance of costs and benefits. As such, enterprises choose their own optimal level of secrecy that is probably different for others.

Voluntary disclosures can be beneficial while an unwarranted lack of transparency may arouse suspicions and make it harder for investors to raise capital.

In the second instance, even an unlimited number of regulators, auditors and supervisors can control the urges of risk takers who may simply act upon a whim or the advice of some geomancer or the effect of a full moon or an empty stomach. With all due respect, because market players are taking risks with their own money and reputation, they tend to be more sophisticated than regulators.

Even the best regulator will be powerless to anticipate the nature of a "bad" investment strategy until it blows up in the investor's face. Were such outcomes predictable, investors would obviously avoid them. Long-term financial capital management problems arose from a combination of Russia's unpredictable refusal to honor its debts and its bet on widely expected merger deals that eventually collapsed.

Increased transparency and new pools of public money are not silver bullets. As seen above, other government policies can provide incentives for investors to act with the sort of irrational exuberance that makes the target of another round of policies. Before leaping headlong into new sets of regulations, government officials ought to undertake a full accounting of their own actions. This would allow for a removal of policy- induced distortions that contribute to unwelcome market outcomes.

The writer is an independent corporate consultant and adjunct scholar of the Centre for Independent Studies in Sydney who authored The Rise and Decline of the Asian Century (Hong Kong: Asia 2000, 1998). His e-mail address is: CRL@po.cwru.edu.