Monetary Shock Therapy

By: Mike Shedlock | Thu, Dec 21, 2006
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Today's post is on Thailand and Scotland. The former is on virtually everyone's radar while the latter is on almost no one's. Let's take a look at Scotland first.

The Financial Times is reporting Scotland weighs chance to go it alone.

Just under three centuries ago - in 1707 - the parliaments of England and Scotland united after centuries of conflict, signing a treaty called the Act of Union. Today, both nations - along with Wales and Northern Ireland - comprise the UK.

Next May the Scottish National party (SNP), a movement committed to taking Scotland out of the UK, could become the largest party in the Edinburgh parliament. If that happens - and latest opinion polls suggest it is a real possibility - then the struggle for Scottish independence could start to dominate the UK political landscape in a manner few could have imagined.

In recent weeks, Mr Blair has expressed mounting concern about the sudden surge in support for the SNP, saying victory for that party could "plunge us into constitutional nightmare". He told a Labour audience on November 26 that it should not take the SNP's ambition for independence lightly. "I hear you scoff: 'They say it, but they're not serious. They wouldn't do it.' But they are deadly serious and they would do it."

Alex Salmond, the SNP's combative leader, says that if his party forms a government, it would within 100 days publish proposals for a referendum on independence. The prospect of such a referendum has resonance with Scots. An ICM poll for the Sunday Telegraph last month found that 52 per cent of Scots favoured the idea of independence against 32 per cent against.

What is pushing the SNP forward? Two forces are key. First, there is the natural pendulum of politics. Labour is deflated after nearly a decade in power both in London and Edinburgh.

Another factor is the rise in world oil prices. The SNP has always argued that 90 per cent of North Sea oil in the UK sector belongs to Scotland. High energy prices have therefore given a mark of respectability to the party's economic plans, although these are contested by Labour. If the SNP proved victorious next year, oil would be a main point of friction between London and Edinburgh. Mr Salmond argues that, within 10 years and using only half Scotland's oil income, the country could have a £90bn ($177bn, €134bn) trust fund. "The choice for Scotland is clear," he says. "Those revenues either flow south to London or they can be invested for the people of Scotland."

Another area of potential discord concerns Trident, the nuclear weapons system based on submarines that operate from the Firth of Clyde west of Glasgow, Scotland's second city. The SNP says an independent Scotland would be non-nuclear. It therefore pledges that Trident - which the Blair government has just decided to renew - would have to move south of the border.

Mr Blair understands this demand by the Scots for economic betterment. One of his central arguments against the SNP is that the Union is economically good for the Scottish economy. Though the SNP disputes the calculation, official figures for, the latest available, show Scots receive £11bn more in total government expenditure than they give back in revenue.

This argument creates a problem on another front, however. While the £11bn of net receipts may persuade some Scots to remain part of the Union, this cash benefit is increasingly resented in England. Indeed, one of the new difficulties facing the UK is growing English irritation about the freedom devolution offers Scotland. This means the Scots, unlike the English, promise free care for the elderly and have rejected university tuition fees.

Hmmm. A fued over oil and WMDs, now where have we seen that before? It is ironic that Blair telling Scotland how good the Scottish have it led to resentment from some of the British who respond "just let them go". Is anyone happy?

Thailand

In Thailand we have a different situation known as EDAA (Every Day Another Adventure).

Let's have a recap.

Mon Dec 18

Annoyed over a currency up 16% this year vs. the U.S. dollar, the Thailand central bank said that investors based abroad would be able to invest just 70 percent of funds transferred to Thailand, and recoup all of their funds only if they kept the money in the country for more than a year. The rule said any withdrawals within a year would be penalized 10 percent of the original investment. The stock market plunged 15% in response.

Tue Dec 19
Thailand will not reconsider measure to halt baht rise

The Thai government will not reconsider draconian measures introduced to halt the baht's rise, the finance minister said, despite stocks plummetting to record losses on the news.

"The government will not reconsider the policy; let the market take (its) course and it will adjust itself," Pridiyathorn Devakula told Agence France-Presse, adding that the move would only affect brokers and short-term currency speculators.

"The Bank of Thailand had no choice since we found that there was speculation in short-term debt instruments," he said.

In the face of the unprecedented losses, dealers and the Stock Exchange of Thailand (SET) had asked the central bank to reconsider the new currency control measures announced yesterday.

The Stock Exchange of Thailand composite index plummeted 108.41 points, the biggest one day drop in the 31-year history of the bourse, shedding 14.84 pct to close at 622.14 after being down nearly 20 pct at one stage.

Tue Dec 19
Thailand Abandons Limits on Foreign Stock Investments

Thailand scrapped currency controls on international stock investors one day after their imposition by the central bank prompted the biggest stock market plunge in 16 years.

Thailand's government exempted stocks from the central bank rule that international investors must pay a 10 percent penalty unless they keep funds in the country for a year. The policy reversal illustrates Thailand's dependence on foreign investment and the degree to which investors resent restrictions on their investment decisions.

"The stock market has fallen too much today," Pridiyathorn told reporters at a press conference. "This is the side effect of the central bank's measure, but we have fixed it already."

The currency controls triggered declines in other emerging stock markets by highlighting the risks of investing in developing economies.

Thailand in 1997 untied the baht from a U.S. dollar peg, triggering currency collapses in South Korea and Indonesia and leaving much of Asia in a financial crisis that required an international bailout.

Wed Dec 20
Thailand Discovers Fury of Investors Scorned

In a span of 24 hours, the Bank of Thailand first outraged investors by slapping a Chilean-type tax on capital inflows and then tried to placate them by taking equity investments outside the purview of the levy.

The capital lockup rules revived memories of what Malaysia had done in 1998, although curbing the profit potential of new money entering Thailand is nowhere near as draconian as Mahathir Mohamad's trapping of existing foreign investment by fiat.

Nevertheless, the Bank of Thailand's actions have raised the specter of more widespread use of monetary shock therapy in Asia. The Thai authorities' flip-flop shows the level of desperation with a world awash with money.

Monetary-Policy Challenge

Consider the overwhelming challenge for the Bank of Thailand in controlling the growth of domestic money supply in the face of ever-increasing sums of incoming capital.

From May to October this year, the expansion in the monetary base -- currency in circulation and bank reserves -- remained restricted at about half a percent even as net foreign assets in the banking system grew 6.5 percent.

Central bank Governor Tarisa Watanagase couldn't possibly have kept her foot on the money brakes forever. One option was to let the currency keep rising. That would have eventually shut down exports, the only economic engine that's still firing. Or, the authorities could let the monetary base expand to a point where they lost control over inflation.

The Bank of Thailand's move, thus, is a desperate attempt to prevent its monetary policy from being compromised by capital inflows that had, until last week, caused an intolerable 16 percent surge in the baht, making it this year's best-performing Asian currency.

Wed Dec 20
Thai market rebounds 11%

Shares on the battered Bangkok market staged a recovery this morning after Tuesday's 15% plunge, but dealers said confidence remains fragile amid fears of a re-run of the Asian financial crisis a decade ago.

By the close local time, the Thai SET Index had jumped 11% to 691, its biggest gain in almost eight years. The market crashed by 15% on Tuesday as the Bank of Thailand and the finance ministry imposed currency controls in an attempt to curb the strength of the Thai baht.

Wed Dec 20
Tarisa Watanagase, governor of the Thai central bank, Defends actions.

Speaking as the Thai stock market rebounded from its record-setting plunge of 15 percent on Tuesday, Ms. Tarisa defended event that seemed to touch off the plunge, an attempt by the government to cut off short-term foreign investment in the country, sometimes called hot money.

Ms. Tarisa dismissed criticism that the move had tarnished Thailand's reputation among international investors. Rather, she said Thailand was a victim of the huge imbalances in trade and savings that send trillions of dollars sloshing in and out of developing economies.

"This is not a problem unique to Thailand," Ms. Tarisa said during an interview. "I'm sure that if this sort of problem is not cured in a cooperative manner, we could see similar measures elsewhere. Each country will have to find a way to take matters into its own hands."

The goal of the bank's policy was to slow the upward trend in the baht to give Thai exporters, particularly in the agricultural sector, time to adjust. Money had been pouring into the Thai bond market at a rate of $1 billion a week, Ms. Tarisa said, compared with $300 million a week last year. It remains to be seen whether the country can succeed in stemming that tide.

Thu Dec 21
Thai Stocks Drop as Baht Slumps

The baht today posted its biggest decline in more than seven years after the Bank of Thailand this week introduced curbs on the purchase of local assets. International investors yesterday sold more Thai shares than they bought for a ninth straight day.

"The baht has dropped sharply today and that reflects the declining confidence among investors in the Bank of Thailand's measure," said Visit Ongpipattanakul, a strategist at Trinity Securities Co. in Bangkok. "We could see overseas investors continue to sell Thai stocks for a while."

The SET Index fell 19.66, or 2.8 percent, to 671.89 as of 11:14 a.m. in Bangkok. The gauge yesterday surged 11 percent, the biggest advance since February 1998, after the government rescinded its restrictions on the purchases of stocks by foreign investors. It had slumped by the most in 16 years a day earlier.

The baht lost 1.9 percent to 36.49 per dollar today, its biggest drop in more than seven years and the weakest since Nov. 24. The decline reduced its gains this year to 12 percent. A weaker currency makes baht-denominated assets less attractive to international funds.

Overseas investors yesterday sold 2.87 billion baht ($78.7 million) more of Thai stocks than they purchased, the ninth straight day of net sales. A day earlier, they sold 25.13 billion baht more of Thai stocks than they bought, according to data from the Stock Exchange of Thailand.

Lost in the shuffle of these gyrations is the fact that curbs on foreign investments in bonds and other debt instruments remain. Can a policy that allows one set of capital inflow rules for the stock market but another set of rules for the bond market possibly work?

Thailand proved over the past few days what can happen to a country where there are enormous capital inflows followed by sudden capital outflows. That is exactly one of the things China has been fearing with all the hot money flowing into that country. It is also one of the reasons that China simply must keep a lot of U.S. dollar reserves until it first floats the RMB and thing stabilize.

Yet every Tom, Dick, and Harry keeps telling China to move it's reserves to the Euro and float the RMB. This little exercise just might show why that might not be such great advice. Imagine what might happen if China dumped the dollar for Euros and then later floated the RMB. Would that hot money exit without China having enough dollar reserves?

Yes China does need to do something. China can not stay pegged to the dollar forever. But as long as the RMB is pegged to the dollar China needs to keep sufficient dollar reserves.

Let's flashback to the 1997 East Asian financial crisis.

From 1985 to 1995, Thailand's economy grew at an average of 9%. On 14 May and 15 May 1997, the baht, the local currency, was hit by massive speculative attacks. On 30 June, Prime Minister Chavalit Yongchaiyudh said that he would not devalue the baht, but Thailand's administration eventually floated the local currency, on 2 July. The baht dropped very swiftly and lost half of its value. The baht reached its lowest point of 56 to the dollar in January 1998. The Thai stock market dropped 75% in 1997. Finance One, the largest Thai finance company collapsed. On 11 August, the IMF unveiled a rescue package for Thailand with more than 16 billion dollars. The IMF approved on 20 August, another bailout package of 3.9 billion dollars. The baht has only recently in November 2006 reached pre-crisis highs of 36.5 to the dollar.

This appears to be the reverse of 1997. Note that the Baht now floats but in 1997 was pegged to the dollar. In 1997 hedge funds were shorting the Baht. Recently hedge funds were plowing into the Baht and it is the U.S. dollar is that is perilously perched just above its multi-decade support levels. Still, the high probability bet is that support for the US dollar will hold (for now), but if it does break hard, the consequences could be momentous. EDAA (Every Day Another Adventure) and one of them will eventually matter.

 


 

Mike Shedlock

Author: Mike Shedlock

Mike Shedlock / Mish
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Mike Shedlock

Michael "Mish" Shedlock is a registered investment advisor representative for SitkaPacific Capital Management. Visit http://www.sitkapacific.com/ to learn more about wealth management for investors seeking strong performance with low volatility.

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