In spite of Gillian Anderson, I'm not much of a fan of the X-files,
or of conspiracy theories in general. I've seen some of the world's movers
and shakers up close, and they seem a lot like the rest of us - that is,
most of the time they haven't got a clue, and fly by the seat of their
(well-tailored) pants. Anyway, as an economics professor I am by nature
inclined to the view that the truth isn't out there, it's in here - that
usually you learn a lot more by thinking really hard about the data than
you do by sniffing around for supposedly inside information.
Yet conspiracies do sometimes happen. George Soros really did stage
a run on the pound back in 1992; Sumitomo's Yasuo Hamanaka really did rig
the world copper market for a couple of years; and a cabal of hedge funds
apparently did try a squeeze play on Hong Kong's currency and stock market
last August. I've even heard a rumor that some guy in Seattle has been
trying to take over the ... (That's funny: my computer keyboard froze when
I tried to finish that sentence). But no conspiracy could be big or smart
enough to play games with the whole world financial market.
Or could it? On a recent visit to Australia I had a fairly spooky conversation
with some government officials.
Australia, in case you didn't know, is the miracle economy of the world
financial crisis. Even though most of its exports go either to Japan or
to the stricken tigers, Australia has managed to ride out the storm so
far without even a serious slowdown. The key to this resilience has been
a policy of benign neglect toward the exchange rate: instead of raising
interest rates to defend the Aussie dollar, the central bank allowed the
currency to slide, from almost 80 U.S. cents in early 1997 to the low 60s
by the summer of 1998. The result was that while export prices plunged
in U.S. dollars, they held up in local currency, and strong domestic demand
kept the economy humming.
Luckily, financial markets apparently decided that the decline in the
Aussie dollar - unlike, say, the decline of the Indonesian rupiah - represented
a buying opportunity rather than a foretaste of things to come. As a result,
the currency stabilized itself instead of going into free fall. But there
have been some anxious moments. In late August, in particular, it began
to look as if the Aussie dollar was going into free fall after all: day
after day it fell, reaching a low of barely 56 cents. If it had kept on
falling, the Reserve Bank might have had to raise interest rates after
all.
What was all that about? Well, the officials I talked to confirmed what
I had guessed: a lot of the plunge had to do with hedge funds shorting
the currency. But what I didn't know was that some people from the hedge
funds actually told the Australians, in effect, that resistance was futile
- that they were only a small piece of a coordinated play against Australia,
New Zealand, South Africa, and Canada - not to mention Hong Kong, Japan,
and China.
Was this just boasting? There is no question that last summer a number
of hedge funds did, in fact, bet on the proposition that a lot of dominoes
were about to start falling: that the yen was going to plunge, dragging
down the HK dollar and the renminbi with it, or vice versa, and that the
currencies of commodity-exporting countries like Canada and Australia would
get dragged down by the backwash. It is less certain whether the hedge
funds were actually the dominant source of speculation against the potential
dominoes. And whether they acted collusively is hard, perhaps even impossible
to know: if there was collusion, it could have been tacit, a matter of
carefully phrased generalities uttered over a bottle or two of expensive
wine.
Of course, if there was a conspiracy, it failed. In fact, if you wanted
to make up a supposed secret history of world financial markets over the
past 6 months, it would go like this: during the summer a few big hedge
players - let's call them the Relativity Fund and the Pussycat Fund - agreed
to stage a run on Asia plus. They acquired huge sums of cash by borrowing
in yen, shorting Hong Kong stocks, getting Australian credit lines, etc.;
then they began ostentatiously selling all of the target currencies, spreading
rumors about imminent Chinese devaluation, and so on. Meanwhile they put
the borrowed money into various high-yielding assets, including things
like U.S. corporate bonds and mortage-backed securities, and also some
risker things like Russian GKOs. But somehow it all went wrong: Hong Kong
refused to play by the rules, then Russia fell apart, and investors around
the world got more risk averse. Suddenly the funds found some of their
credit lines pulled. And since they had become such gigantic players, this
started a sort of cascade of margin calls: for example, as Pussycat began
to unwind its yen shorts it drove up the value of the yen, causing losses
that forced it to unwind even more. And correspondingly, of course, the
assets the funds had been buying - like non-investment grade dollar bonds
- plunged in value.
In short, all the strange things that have happened these last few months
- including the bizarre runup in the yen and the mysterious near-collapse
of U.S. financial markets - are, according to this story, the byproduct
of the ravelling and unravelling of a vast get-rich-quick scheme by a handful
of shadowy financial operators.
How seriously do I take this? The story does seem kind of out there; but it just might turn out to be the truth.