Mahathir and his economic aides did not know about the mechanism of the financial market operation
The global fund managers were the major players in the KLSE ie they were the stock market heavyweights. With so much funds, the moment they withdrew their investments from the market, it caused the collapse within days. The Mahathir cronies who gambled with borrowed bank money could not defend the crash and lost billons. They lost twice, firstly lost money due to the fall in the shares’ prices, and secondly they owed the banks RM billions which they could not repay.
Awang Abdillah
We have seen during his tenure as the premier how Mahathir had abused his power by successfully turning the largest single political party in the country namely UMNO into the most powerful single entity in the country encompassing all aspects.
He was able to achieve such a great political feat through undemocratic practices backed by authoritarian rule.
Firstly he reduced the power-sharing rights of the other BN component parties thereby enabling UMNO to achieve the
status similar to that of a single party government. With BN component parties having very little executive power in the government, Mahathir was able to bloster his personal executive power by taking full control of the government apparatus. By having full control of the government machinery,he was able to muzzle the media, placed the special government agencies namely the police, EC and MACC under his direct control and turned them into his power buttons.
With such commanding executive power, Mahathir was able to move one step further by taking away the independence of the legislature and the judiciary, making his party not only as the de facto government of Malaysia, but giving him personal power to control the political, executive and legal entities in the country enabling himself to achieve the status
of an undemocratic-cum-dictatorial leader.
Under such harsh political environment, the opposition could not undertake the check-and-balance role as required under a true democratic system. Hence it is not surprising then in some countries an undemocratic leader can turn into a dictator, because their border lines sometimes crisscross one another.
Such an undemocratic-dictatorial political system has some similarities with the communist political system where the
communist party has full control over the executive government. The differences are in the means to achieve power.
With such a political system in place, Mahathir could devise economic policies based on mega economic models that were designed to benefit oneself and his cronies on an unprecedented maximum scale.
Unlike people tailored policies, personal tailored ones serve mainly the political elite while the needs of the masses are sidelined. Eventually the follies of such kind of policies and practices will surface once the power abuser leaves the political scene.
Mahathir’s economic management follies
1) Gambling away nation’s foreign reserves
With so much political and economic power under his control, by 1992 Dr M thought Malaysia’s economy was ready to take on the economies of the Western powers. Armed with the foreign reserves of Bank Negara (the real amount taken remains a mystery), he was confident he could influence the London forex market through speculative activities.
However as we know Malaysia had lost $billions of Bank Negara vital foreign exchange through Dr M mega gambling activities. The actual amount of the colossal loss was never revealed to the public.
Consequently this very massive loss had crippled Bank Negara’s ability to recover in time ie continued to suffer low foreign reserves up to the time when Malaysia was hit by the financial crisis in 1997.
2) Failed to block the ripples of Thailand’s economic crisis of 1997
When the economic crisis in 1997 hit Thailand’s financial and stock markets directly, the aftereffects that hit Malaysia initially was in the form of ripples only. However, the government of the Malaysia did not know how to handle such an economic phenomena, thereby failed to defend its’ financial variables ie the ringgit and the equity stocks from the indirect onslaught.
The moment the government could not find a quick solution, the market became panicky. The sensitive sentiment began to push the ringgit in a downward trend. Within a short period the sensitive sentiment turned into an uncontrollable volatile one.
The strong selling pressure hit the forex and stock markets badly. The crucial issue at that time was to defend the ringgit value or to stop the volatile selling pressure sentiments. Since the Central Bank was experiencing low foreign reserves, there was no way to defend the ringgit. Mahathir and Bank Negara thought that Malaysia’s fundamentals were stronger than Thailand and hence let the market forces adjust the ringgit exchange rate.
So they allowed the attacks on the ringgit and the stock market to continue until 1 september 1998 more than one year until the capital controls were imposed! It was an act that was too little, too late. The ringgit fell so low that it had to be pegged at RM3.8 to 1US dollar while the composite index of the KLSE fell from 1300 points in early 1997 to 262 points by 2nd September 1998!
Even Britain pegged its sterling to the German mark under the European Exchange Rate Mechanism (ERM) prior to the
devaluation of the currency in 1992 and Thailand pegged the baht to the US dollar before floatng it on 2 07 1997. What Malaysia should have done was to stop the sensitive sentiment before it became volatile. Consequently, the free fall of the ringgit over a long period (more than 1 year) that failed to recover had devastated the equity market!
As the currency commodity (ringgit in the case of Malaysia) is the base commodity in the global trade and the financial market, the stability of the stock exchange is very much dependent on the outcome of the trading activities in the forex market.
The foreign fund managers feared that the fall in the ringgit currency value would cause a substantial loss in the value of their stocks if they disposed them, and secondly they would suffer losses when they exchanged the ringgit (from sale of stocks) for the US dollar in the forex market before they can take out the foreign currencies out of Malaysia. Hence the sensitive panic sentiments in the forex market triggered the chain of volatile events in the whole financial market!
The global fund managers were the major players in the KLSE ie they were the stock market heavyweights. With so much funds, the moment they withdrew their investments from the market, it caused the collapse within days. The Mahathir cronies who gambled with borrowed bank money could not defend the crash and lost billons. They lost twice, firstly lost money due to the fall in the shares’ prices, and secondly they owed the banks RM billions which they could not repay.
Consequently many banks were left with billions of non-performing loans (NPL).
Being a mega speculator himself, Dr M should have understood as to why albeit Bank Negara had used $billions of foreign exchange to trade for the pound but failed to push up its’ currency value in the London forex market and instead suffered massive losses when the British government devalued the currency.
The London forex market is the biggest currency trading center in the world where billions of dollars of currency transactions are done daily. Hence, there were many global forex players preying on the pound at that time. Bank Negara
was just one of them.
The British sterling is among the 4 top global currencies besides the US dollar, euro and yen. These are considered currency heavyweights. Dr M wanted to knockout a seasoned heavyweight fighter while veteran speculator Soros chose to ‘fight’ an injured heavyweight fighter who could not put up a fight.
The British intended to devalue the currency to stimulate its’ economy to recover, while Mahathir only wanted to make money by doing the reverse. Soros only wanted to profit from the British economic downturn. So who was the smart guy?
Mahathir should firstly learn from the lessons of the pound speculation fiasco, that strong macro economic fundamentals and sound government economic policies and practices can withstand sensitive market sentiments and even curb volatile market sentiments from any form of market influences including the speculators’ activities.
Secondly, Mahathir should know that Thailand on the other hand had weak macro economic fundamentals as well as the financial variables especially a shaky currency that would tumble any time with or without the speculators. Hence the sensitive and volatile market sentiments to ‘trade-in’ the baht for the dollar brought the collapse of the baht.
Consequently, the equity market was badly hit because the stocks were valued in baht. Investors’ strong sentiments to sell the shares caused the stock market to crash.
The economics of pegging
It is normal that a financial market is sensitive to the market factors but when it turns volatile (on attacking mode), there are two options – defend the currency if you have strong macro economic fundamentals and financial variables such as sufficient foreign reserves to buy the ringgit to stop its slide, or stop the attack itself if you don’t have the reserves.
In the case of Malaysia it lacked the sound economic fundamentals and financial variables at that time to defend the ringgit. Under such circumstances, Malaysia should stop the volatile attack by imposing currency control ie peg the
ringgit to the dollar immediately. Secondly, how much you decide to fix the ringgit to the dollar is another tricky question before you can peg it.
Pegging can be done in 3 ways – fix the exchange rate back to the original exchange rate, or fix the ringgit lower than the original rate ie depreciate it or fix the ringgit at a higher level ie appreciate it. If the authority wants to stop the volatile selling sentiment attack, fix the exchange rate back to the original ie 1US to RM2.5. If they want to slow down the volatile sentiment, depreciate the ringgit at say 1 US to RM 2.8. But if you want to stop the volatile atack as well as reverse the market sentiments then you fix the ringgit at an appreciative value ie higher than the original exchange rate say 1US to RM 2.3, thereby reversing the selling sentiment of the ringgit and the stocks, ie you restore both sectors of the financial market.
But what Malaysia did was to let the ringgit defend itself ie allow the ringgit to float against other currencies under unfavourable circumstances for about 13 months while the stock market was left devastated! Where were Dr Ma Ti’s so called economic experts or gambling experts at the crucial time?
Pegging one currency to another has a number of advantages depending on when and at how much you fix your currency to another –
i) To implement damage control due to the selling pressure on the ringgit
ii )To give time for Malaysia to adjust to economic changes ie to stimulate exports and reduce imports, thereby earns more foreign exchange.
iii) By gaining more foreign exchange Bank Negara can have sufficient funds to regulate the ringgit when it will be floated later. The cooling period may range from 6 months to 1 year.
iv) If the pegging still could not produce more foreign exchange, then Malaysia has to borrow foreign loans to get enough foreign exchange. There is no risk here since the ringgit has been pegged to the dollar. The cost of the loan would not increase too as long as the ringgit has been fixed.
v) Reverse currency trading
This is an option that I believe no country has done before in the face of a currency crisis. However I will discuss this option if the Pakatan Rakyat forms the next federal government.
Bailout
Bailing out banks and corporations that were hard hit by the economic crisis is unnecessary if currency control ie pegging was imposed in the early stages. Capital controls was unnecessary too as long as you have imposed the currency control. The government did not have to resort to public borrowing from EPF and Petronas to the tune of billions of ringgit to restore these entities.
