Don’t Restrict
Capital Markets

I am glad Asia is in a financial crisis and stock markets the world over have the shakes. Not because my money is in bonds, so I can wag my finger and say I told you so. I rejoice because speculators have done the ordinary citizens of Asia and retirees in the West a favour.

If you are wondering whether I have taken a blow to the skull, the answer is yes. The object that struck me was a recent book by Yale University economist Robert Shiller. In Macro Markets Shiller explains how international capital markets are a stabilizing force in the world economy.

Reading his work was refreshing after being exposed by the media to the miasma of intellectual piffle emitted in recent weeks by world financier George Soros. Soros has lectured Congress that capitalists are short-sighted herd animals who need the lash of an international government regulator to keep them from stampeding the world into financial ruin. Shiller has a different story.

According to Shiller, speculators try to spot countries where governments take good care of the economy. The moment news leaks out that governments are mismanaging the economy, misreporting economic statistics, or protecting fraudulent businesses, speculators yank their money out.

Speculators can make mistakes, but in practice, their guesses about government mismanagement have been good.

In a number crunching study that must have fused the circuits of several computers, economist Barry Eichengreen and his colleagues studied exchange rate movements of 20 industrialized countries between 1959 and 1993 and found that “governments bring currency crises on themselves through reckless pursuit of excessively expansionary monetary and fiscal policies. Governments that are serious about defending the exchange rate need to be prepared to take serious, and often seriously painful, policy steps with uncomfortable macroeconomic implications.”

The message is that speculators put pressure on governments to reform their bad economic ways. The country may wince, but a stitch now saves its economy from ripping apart later. That is how speculators stabilize the world economy.

This is also why the large swings you see in financial markets are a good sign. Unstable financial markets mean that capital is moving quickly out of bad areas. This protects wealth from being destroyed and gives stability to the economy.

Speculators also protect pensioners in the West from having their money stolen in the East. If the investors who handle our pension money had not panicked, we would still be feeding the great Asian Ponzi scheme. Ponzi was an American con artist early this century whose company paid out high dividends with money from the sale of stocks. These dividends attracted investors whose purchase of stocks fuelled further dividends and raised the price of stocks further. Eventually the bubble burst leaving founders of the company rich with money they stole from later waves of investors. If investors in Asia had not pulled out when they did, the Ponzi-style theft would have continued.

Speculators are able to swing large amounts of money in and out of foreign currencies by selling insurance. Yes, insurance—just as State Farm and Sears sell it to me. In stock markets the insurance is known as a derivative. If I am a US firm that imports raw material from Asia I can protect myself from a rise in the value of Hong Kong dollars by purchasing a call option—one example of a derivative product. The call allows me to buy a specified number of Hong Kong dollars for a specified number of US dollars over a fixed period. The rise of this derivative market has allowed world trade to boom by allowing importers and exporters to buy insurance against currency risks, or the risks in the prices of commodities.

What happens in the call market influences currency markets and interest rates because calls are hybrids of bonds and currency. Calls allow speculators to borrow on margin and lever their hunches into large currency movements. Their reward for a successful guess is that they get to keep their insurance fee. The people who bought the insurance have about as much regret as do car drivers who don’t crash by the end of the year, and so fail to cash in on their insurance premium.

The only parties bothered by these private insurance deals are naughty governments. Derivatives are modern financial instruments that allow investors to rapidly discipline misbehaving politicians.

Soros’ proposal to slow down capital markets appeals to world leaders. It must also appeal to Soros. He has lost hundreds of millions of dollars in the recent financial crash and would not come to harm if governments of the West galloped to the rescue.

To preserve world stability, governments must ignore the bugle call of prominent investors who are trying to make their particular problems look like everyone else’s problem. These investors are demanding, among other measures, a taxpayer-financed global insurance pool that would protect bad bets made by speculators. Investors will destabilize the world when they know that governments are there to pick them up should they fall after putting their money in ventures that would raise hairs.

Whether politicians can resist listening to Soros is not clear. What may count with our leaders more than reason is the fact that Soros controls tens of billions of investment dollars. The Roman philosopher Favorinus came up against the same problem at the court of the emperor Hadrian. After bowing to a feeble argument by the emperor, Favorinus’ friends asked him why he had shut up. His answer was that “I must regard as the most learned of men he who commands thirty legions.” Soros is one emperor we should not bow to.

info@fraserinstitute.ca You can contact us at the above email address for any comments or information requests. Please report any dead links or technical problems.

If you know someone who would be interested in this web page, please enter their email address below, and we will forward this URL to them: Email Address:

Last Modified: Wednesday, October 20, 1999.