December 20, 2006
FOLLOW THE MONEY
With bull markets blooming around the world in recent years, the news of yesterday's self-inflicted financial wounds in Thailand has delivered an unscheduled reminder that prices also go down.
The calamity started when the Thai Finance Ministry yesterday announced a "lock-up" program to restrict capital flows into the economy. Investors reacted by selling…and selling and selling some more. The Thai stock market crumbled by 15% by Tuesday's close, although as we write this morning (New York time) prices have retraced the lion's share of the decline.
Students of market history will recall that Thailand was the source of the emerging markets crisis of 1997 that crushed equity prices around the world and unleashed an international banking debacle. But while crises are still around, and always will be, the underlying forces that cause them are different this time--and those differences matter.
In 1997, the ills that dispensed financial calamity were born of financial weakness. Thailand in 1997 suffered a large current account deficit and a currency that was vulnerable to bearish speculators. Ditto for many other emerging markets. The opposite is true today. Sitting on a tidy account surplus and an estimate $65 billion in currency reserves, Thailand in 2006 fears that its currency, the baht, will rise too far too fast. Many other emerging markets can also boast of sound finances this time around.
Nonetheless, too much of a good thing convinced the Thai government to slow the surge of capital coming into the country. Officials in Bangkok have since rescinded their ill-advised restriction, albeit on the unmitigated advice of one infinitely savvy force in the financial universe.
Mr. Market has once again had the last word. He always does. The only difference these days is that his verdict and the associated penalties come faster than in the past. The forces of supply and demand can't be suppressed, at least not indefinitely and sometimes not even for 24 hours.
The tragic experiment of communism is testament to that reality. Yes, it took decades for Mr. Market to reassert his authority in Moscow and elsewhere, but things move quicker in the 21st century.
Speaking of which, one of the many lessons that arise from the latest upheaval in Thailand is that capital is in a desperate search for currencies tied to growth, which in turn opens the doors to superior investing opportunities. Logic and economics 101 demand no less. The flip side of this law is that currencies associated with ailing economies are vulnerable.
Of course, reality's a bit more complicated when we speak of the world's reserve currency, otherwise known as the American dollar. Rebalancing takes longer when you're the top dog in the currency realm, in part because old habits die hard and there's debate over the contenders to the throne. But eventually, Mr. Market will have his way with this and all paper assets, including fiat currencies masquerading as intrinsic stores of value.
It's worth noting that while Thailand was taking its lumps yesterday, forex traders found cause to sell the greenback. The U.S. Dollar Index tumbled yesterday even as the world was focused on another Asian crisis. Why? Well, here's a news flash: Asia and the dollar are more than passing ships in the night. The story can be summed up by noting the growing current account surpluses in China and other Asian nations, and the deepening red ink on the same ledger for the United States. The fact that Thailand is trying to restrict capital from coming into its economy reminds that the same capital necessarily is trying to escape from somewhere else.
Mr. Market is certainly paying attention to the broader events unfolding over time as well as the news du jour, or so one could reason. The U.S. Dollar Index has fallen by nearly one-third since the end of 2001. The bear market in the buck enjoyed a respite for much of the last two years. But the clock is ticking, Mr. Market is reasserting his influence and investors are again receiving reminders that economics still matter in the long run for valuing assets and even nations.
Posted by jp at December 20, 2006 9:34 AM
Interesting take, especially with regards to the currency flows/actions of forex traders. Funny that they seem to have the problem of too strong a currency, as opposed to the situation in 1997.
Posted by: David at December 20, 2006 2:16 PM