Rational expectations

The crucial role of timely, credible and comprehensive information in the financial market has been reemphasized in the wake of the latest bout of speculative attacks on the currencies of several countries in Southeast Asia. The most notable attacks being on Thailand, the Philippines, Malaysia and Indonesia.

That the financial industry, notably the foreign exchange market, is highly sensitive to information is nevertheless not a new phenomenon. But this fact, established a long time ago through a series of empirical studies, resurfaced after an ASEAN reaction to the regional currency instability..

The foreign ministers of the nine-member Association of Southeast Asian Nations (ASEAN) agreed, at their latest annual meeting in Kuala Lumpur late last month, to blame an international conspiracy for the speculative assaults on their currencies.

The ministers, riled by the currency speculations despite what they persistently claim as their strong economic fundamentals, agreed in their joint statement that the speculative attacks could be traced to well coordinated efforts to destabilize ASEAN currencies for self-serving purposes. Prime Minister Mahathir Mohamad of Malaysia, the host of the meeting, even went as far as singling out American financier George Soros.

However understandable the foreign ministers' disillusion with the havoc caused by the currency crisis-- because the economic fundamentals of their countries (except Thailand) have been assessed even by international analysts as fairly sound-- finding a scapegoat is not useful, if not a wholly futile exercise.

American Undersecretary of State for Economic Affairs Stuart E. Eizenstat, who visited Jakarta last week after the Kuala Lumpur meeting, conveyed a more sensible message. He asserted at a news conference that it had been the strained economy of a country (in this case Thailand) which set off its currency instability with a consequent contagion to other Southeast Asian countries.

Eizenstat said the regional currency volatility had not been triggered by speculators. In fact, it was because the financial markets detected problems and reacted accordingly. Speculators only took advantage of this trend and made money. But as its name suggests, speculation usually spreads quickly and widely on the back of irrational expectations. However speculation lasts only for a short period of time until a sensible reality once again prevails.

What Eizenstat implicitly alluded to is that market perception of an economy's condition greatly influences the price of its currency. The market perception in turn influences the rational market expectations of appreciation or depreciation of a particular currency. Herein lies the pivotal role of timely, credible, comprehensive information on an economy. It is this information which affects market perception.

This, however, does not defy the fact that sound economic fundamentals and prudent macro-economic management as well as a consistent policy are prerequisites for maintaining a stable currency. However they are, by themselves, not enough.

Lack of credible, timely information could create a wide gap between how the condition of an economy is perceived by the market and the actual situation.

As the financial market -- of which the foreign exchange market is the largest segment with an estimated average daily turnover of more than US$1.3 trillion -- has increasingly been globalized, it has also become more sensitive to information.

It is no wonder, therefore, that the International Monetary Fund has issued guidelines for countries regarding the kind of basic or key economic indicators they should disseminate to the market. The more up-to-date, comprehensive and credible the disseminated information, the more effective it will be in preventing or reducing the gap between the market perception and the actual condition of an economy.

Well-informed markets have rational expectations and minimize the possibilities of irrational, wild speculations.