Hot money chills investors, nations

The Economy

April 18, 1999|By Jay Hancock

Day traders, who have tilted the bourses this year by darting in and out of Internet stocks like bumblebees on a lily, are a new form of an old financial problem: hot money.

Day traders try to make a living by buying and selling stocks in a very short period. Minutes, sometimes seconds. A couple hours is a long-term investment. They're as patient as piranhas, faithful as Delilah.

Internet bookseller Amazon.com has been prime day-trade prey. Its stock price tells the tale. It was $41 in November, $199 in January, $89 in February and $180 last week. A year ago it was $12, adjusted for splits since then.

Somebody has made a ton of money on Amazon, but, as is the case with every trade, somebody else lost it. Amazon's hairpin turns have distracted its employees and concerned regulators and brokers. Oscillating capital markets fueled by borrowed money are not a foundation for stable, confidence-breeding economies.

Go ask Daim Zainuddin, Malaysia's finance minister.

If Amazon at $199 is a hot-money investment at full bloat, Malaysia is what happens after the air escapes. Different country. Different securities. Bigger scale. Same problem.

In 1997, Malaysia was a fecund forest of construction cranes, cell phones, Daimler Benz automobiles and vertiginous securities markets. When economic turbulence threatened late that year, antsy cash poured from the country like Niagara Falls in April.

It was the international version of a bank run. Anything that couldn't be packed in a suitcase and shipped out of the country lost half its value. Stocks. Office buildings. Currency worth. Government and corporate debt. Malaysia today is on its knees. And the cyclone has spread across East Asia and hit Russia and Brazil.

Fifteen years ago, hot money was causing another kind of heartburn.

Investors were borrowing millions or billions of dollars at extremely high interest rates to buy undervalued corporations. Then they restructured the firms, laid off employees and quickly tried to resell the businesses for a tidy profit.

Again, timing was essential.

The debentures and notes that financed leveraged buyouts brooked no delays. They often expired in as little as two or three years, and they demanded 15 percent interest in the meantime. The idea was not to wait patiently for latent value in these companies to surface sometime down the road. The idea was to take it out. Now.

Again, the damage was substantial.

Many companies never recovered from leveraged buyouts, landing in bankruptcy. And the human trauma was just as bad, as Susan Faludi famously showed in her Wall Street Journal story a decade ago on Safeway's brutal LBO.

The answer, to all these situations, may be capital controls: restriction on hot money and encouragement of patient money.

The term raises hackles of economists and business people, smacking as it does of protectionism and the clumsy hand of government in the market.

But as Hofstra University economist Irwin Kellner pointed out last year, capital controls are already all around us.

The stock fund that imposes an exit fee on short-term money. The money market fund that requires a day's notice for withdrawals. Margin rules for stock traders. Net worth requirements for banks. The tax advantage for long-term capital gains vs. short-term ones.

All these are capital controls that we don't think of as such.

Gov. Parris N. Glendening's legislation to give Maryland corporations extra ammo against hostile takeovers: capital controls.

The point is that some forms of capital controls don't have to look like China's absolute prohibition on currency conversion. They can be speed bumps, not walls.

The world will always need speculators. They provide the liquidity that oils efficient markets.

But sometimes hot, speculative money wreaks damage additional to whatever is going on fundamentally. Panicked, quicksilver capital is not just an effect of economic turmoil; often it's a primary cause.

In many economists' minds, the case for free financial trade is not as strong as the case for free merchandise trade. The World Financial Organization, formed by the United Nations this month for "overseeing, and eventually regulating, international capital flows" is a step toward turning down the heat.

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