Hong Kong’s Hard Lesson

By Paul Krugman

Don’t tell anyone, but I’ve come up with a nifty financial scheme. First, a few of my billionaire speculator friends quietly take a short position in Microsoft stock. Then we spread the rumor that Bill Gates has gone Hare Krishna or some such. Microsoft’s stock plunges, and doink! we make hundreds of millions.

Okay, on second thought, maybe this isn’t such a great plan. For one thing, I don’t actually have any billionaire speculator friends. And even if I did, there’s another little problem: My scheme would lead to an interesting conversation with the Securities and Exchange Commission, ending with a polite but firm invitation to spend the next few years of my life in a minimum-security prison.

So let’s revise the plan. Instead of conspiring against a corporation, let’s do it to a small country. We take a short position in the country’s stock market, then sell enough of its currency on the foreign-exchange market to start a general run on the currency. The country’s central bank will have to raise interest rates, causing the local stock market to plunge–and we can live wealthily ever after.

Oh, there are a few pesky details. I still need some billionaire friends. The main problem, though, is that I may have come up with this idea too late. You see, it appears that some speculators have already figured out the strategy for themselves and put it into practice. Or at least so claims the Hong Kong Monetary Authority, which, as you have probably heard, has been accusing short-selling investors of a deliberate conspiracy to undermine the city-state’s economy. So the Authority poured money into the Hong Kong stock market to give it a boost and squash the short-selling miscreants; then outright banned the short-selling of the largest-cap stocks, period.

Let’s back up for a moment here. Hong Kong’s government has long been famous for its laissez-faire attitudes. In this town, being a speculator has never meant having to say you were sorry. The Monetary Authority has been determinedly noninterventionist in its policies: By establishing a “currency board” that pegs the Hong Kong dollar rigidly to the U.S. dollar, with the local currency 100% backed by U.S.-dollar reserves, it has come as close as any modern central bank to recreating the gold standard. To conservatives in the U.S., Hong Kong has been a living demonstration that all a government needs to provide is sound money and secure property rights, and the private sector will do the rest.

So when Hong Kong authorities launched their war on speculators, laissez-faire-ists around the world were horrified, to say the least. What happened to the sacred principle of nonintervention?

Well, I can’t confirm or deny a conspiracy of speculators against Hong Kong. However, many economists agree that there are conditions under which a currency may be subject to what are known as “self-fulfilling speculative attacks”–that is, where a potentially sound currency is forced into a devaluation by a collapse of investor confidence, a collapse that is then validated by the devaluation. Under such circumstances there are indeed potential profits for Soroi–big players who take a short position in the currency, then deliberately provoke such a self-fulfilling attack. Hong Kong–which does not want to impair its credibility by devaluing but also does not want to raise interest rates when its economy is already suffering a deepening recession–fits the profile of a speculative victim perfectly. And while earlier Asian claims of conspiracy have come from shrill anti-Western voices like Malaysia’s Mahathir, this time they come from ultra-respectable technocrats like Joseph Yam, chief executive of the Hong Kong Monetary Authority.

If Yam is so convinced there’s a conspiracy afoot, why didn’t he simply turn his evidence over to the regulators and have them haul in the perpetrators for questioning? The answer is, what regulators? If I conspire against the stock of a U.S. corporation, that is a violation of U.S. law. But if hedge funds in New York attack some overseas financial market, it’s unclear who, if anyone, has jurisdiction. Never mind that we are a lot more likely to cry for Hong Kong or Argentina than for Microsoft: Speculative conspiracies against companies are effectively regulated; those against countries are not.

And that is the real moral of the story. If there’s a theme to the economic chaos of the past few years, it’s this: Capital markets are global, but the institutions that support and regulate them–that allow them to work–remain national. It’s hard to imagine how truly global institutions could come into existence–how we could, for example, prosecute American traders working in London for manipulating some market in China. But until we figure it out, it’s going to be a very rough ride.

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