Currency Manipulation and Economic Sabotage

This started circulating on blogs and social media sometime late last week:

How Tong Kooi Ong is attempting to break Bank Negara and crash the RM

An owner of a prominent news media empire is casting undue influence on the financial and political state of Malaysia for his own personal monetary gain.

Sources within Bank Negara Malaysia (BNM) revealed that Tong Kooi Ong, the owner of the Edge Group and The Malaysian Insider has taken a USD1.4 billion short position on the Ringgit through a proxy. The first transaction took place in August 2014 and subsequent short positions have been taken leading up to January 2015….

The government’s reaction can be read here and here. I find it telling that Deputy FM Datuk Ahmad Maslan mentions MCMC, which suggests the investigation would include not just the allegations, but the allegers as well.

It's a long, and fairly erudite posting – there are little details in there that suggest the writer knows what he/she is talking about, like for instance the role Germany played in the UK’s 1992 ERM crisis.

But to summarise, the blog post alleges that Mr Tong took multiple short positions on the Ringgit, and used his control over his media empire to foster a climate of doubt and uncertainty over the Ringgit to profit from its selldown. The blog post also alleges that this was also an attempt to “break” BNM (*snort*) and undermine the economy.

I won’t address the media angle (which honestly sounds fiddly to me), only the economic and financial ones.

First, here’s the volume of transactions on the FX markets over the past three years:

Tong’s alleged USD1.4b would have been big money – in 1997. Today, not so much. Between August and December last year, total FX turnover (inclusive of spot, swaps, forwards and options) in Malaysia exceeded RM1 trillion. USD1.4b would have been a blip. It’s also laughably small compared to BNM’s international reserves of nearly RM400 billion.

So much for that. I think most people would recognise the claim of trying to “break” BNM for what it is – hyperbole.

More pernicious however is the allegation of economic sabotage, that selling down the Ringgit is “unpatriotic” and would damage the economy. This speaks more to our prejudices, and to our denial of complicity. The overarching narrative of 1997-98, and of most currency crises around the world, is that it was the fault of greedy, unscrupulous currency speculators that cause currency devaluations and the resulting economic fallout.

The harsh and unpalatable truth is that it was mostly our fault. The Asian Financial Crisis was the culmination of a number of external factors combined with our own policy missteps. Blaming the whole shebang on speculators blinds us to our own culpability. I won’t get into all that (somebody really needs to write a definitive monetary history of the AFC), but the whole “currency devaluation = economic crisis” as alleged in the blog post is totally wrong. Rather, it’s the resistance to currency devaluation that precipitates crisis.

In the UK in 1992, in Mexico in 1994, and in Thailand, Indonesia, Malaysia and Korea in 1997-98, the key ingredients were an overheating economy and overvalued, fixed exchange rates. Combined with insufficient international reserves, and we have the conditions for a currency devaluation. In essence, currency traders were presented with that rarest of market opportunities – a sure-fire, can’t-lose, one-way bet. If you’re going to wave a red flag in front of a bull, don’t blame it if it charges.

And when that pressure came, the response typically has been to intervene in the FX markets by selling foreign currency for domestic currency, and to hike up interest rates to make short selling prohibitively expensive. I’ll get to the specifics of this in a follow-up post, but it’s the defense of the initial overvalued currency peg that damages the economy, not the inevitable devaluation afterwards.

In Malaysia in 1997, overnight rates reached as high as 50% with monthly averages around 10%, about 3%-4% above rates prevailing in 1996 and early 1997. That prompted a massive monetary contraction – M1 growth crashed to –20% by September 1998. Businesses that were used to paying 8%-9% on revolving credit and working capital were suddenly having to pay 15%, 20%, 25%. No business can sustain those kinds of interest rate shocks for a quarter or two, much less for a year.

On the other hand, the currency devaluation of 1997-98 carried with it the seeds of economic recovery. Lower relative prices created export demand, which boosted the economy and allowed businesses to recover.

Contrast that with what’s happening today. BNM no longer uses a fixed exchange rate to anchor monetary policy; now its anchored on the overnight rate, which generally moves within 0.05% of the OPR and hasn’t budged since the last hike in the OPR last July. No interest rate shocks here. The depreciation of the Ringgit in recent months (driven almost wholly by the decline in crude oil prices) has actually helped buffer the economy from job losses and a growth slowdown.

CPO for example has seen little change in international pricing, but the depreciation of the Ringgit has effectively boosted producer income by near 10% in Ringgit terms. Every drop in the Ringgit has helped to save jobs in the oil & gas sector, which would otherwise have been lost if the Ringgit had not dropped.

People still see the decline of the Ringgit in the last six months as a negative, for obvious reasons – the cost of foreign holidays has increased, as has the cost of imported goods (hmmm, neither is exactly relevant for the bottom 80%). But the flip side is – you’ve still got a job. That might not have been the case if BNM made a futile (and economically damaging) gesture towards defending an unsustainably high exchange rate.

If I can overgeneralise, currency depreciation is essentially an income transfer, from consumers to producers. The opposite would also be true – a currency appreciation is an income transfer from producers to consumers. Since its the USD that has been appreciating (against everybody, mind), what’s going on now is an income transfer from US producers to producers outside the US, and from ex-US consumers to consumers in the US.

Given the overall slowdown in global growth, that’s not a bad trade-off to make.

To summarise:

1. The charge of allegedly trying to manipulate the currency? False
2. The charge of economic sabotage? False

I’ll leave the charge of media manipulation to those better equipped for it.