Thailand's Rash 'Lock-Up' Move
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Introduction

Today's Special Edition "Outside the Box" is presented by Stratfor and covers the effects spawning from the recent coup in Thailand. Upon the removal of the Prime Minister back in September, the country saw a retreat in the investment sector of its economy. But it did not take long for the speculation to arise as net investment inflows surged upwards to unsustainable highs. In response, the government took ill-advised actions only to later have them reversed. I believe that we should pay particular attention to this because of the fact that Thailand was the original source of the 1998 currency crisis.

Stratfor specializes in providing situational awareness, focused insight and actionable intelligence in the areas of geopolitics, security and public policy. The President, George Friedman, has been a long time friend of mine and, because of so, has decided to continue offering a special discount of 50% off the normal subscription price to his service. In order to receive the discount, you must click here. I trust that you will enjoy this breaking analysis on the current geopolitical event.

On a side note, there will not be another "Outside the Box" until January 8, 2007, as the following two Monday's are Christmas and New Year's.

John Mauldin, Editor

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Thailand's Rash 'Lock-Up' Move

Wednesday, December 20, 2006
By George Friedman

In an action aimed at ending more than a year of political instability, the Thai military staged a coup Sept. 19, stripping then-Prime Minister Thaksin Shinawatra of his office. Unlike in most countries, coups in Thailand -- though relatively common -- are not particularly disruptive. In fact, they tend to function as safety valves whenever the civilian government begins to break down. As such, while most observers -- including Washington and Wall Street -- watched with a wary eye, they withheld judgment and indulged in calming platitudes that Bangkok should soon get back to whatever Thais consider "normal." No firms were nationalized, no opposition (or former government) officials were shot, and life more or less went on.

In fact, outsiders' votes of confidence in the Thai system were so firm that investors -- after a few-week retreat -- came back in droves as technocrat after technocrat was appointed to positions of economic importance. The Bank of Thailand (BoT), the country's central bank, estimates the net investment inflows in November were steady at $300 million -- a respectable level for a country of Thailand's size. By December, however, the inflows had reached $950 million, a level far above Thailand's ability to handle safely.

The Thai government feared that such inflows were "hot money," cash placed by investors looking to make a quick buck by betting on short-term changes in stocks, bonds or other investments. Of late such hot money has been particularly active because of the falling dollar. If a foreigner uses U.S. dollars to invest in a Thai asset that increases by 10 percent, and then the Thai baht increases versus the U.S. dollar by 10 percent (as the baht has done since mid-October), then the net gain is more than 20 percent in a very short period of time.

Of course that gain is only realized if the money is pulled out of Thailand as fast as it was put in. Neoliberal economists claim that allowing such strategies room to function encourages the most efficient use of capital, and in the long run vastly benefits countries by giving them both more access to capital and experience in dealing with foreign financing. Those on the receiving end of such capital inflows and outflows complain of the volatility caused by such flows, as well as the artificially inflated currencies that they cause, reducing the competitiveness of a country's exports. Both are right. Thailand's until-now commitment to weathering such flows has made it among Asia's healthiest, most dynamic and flexible economies -- and its currency is at a nine-year high.

In order to reduce Thailand's vulnerability to what Bangkok feared would be an eventual outsurge of capital, it sought to crimp the insurge.

So on Dec. 19 the Thai Finance Ministry announced the implementation of a "lock-up" program to limit capital flows into the Thai economy. Under the program, 30 percent of all investment dollars would be forcibly deposited into a non-interest-bearing account with the BoT, with the investor free to invest the 70 percent at his or her whim. Should the investor withdraw the funds before one year has passed, the BoT would refund only two-thirds of the money in the lock-in account. In essence, investors would be denied access to three-tenths of their monies and be subject to a new 10 percent tax should their investments prove short in duration. Officials further added that should this policy not achieve their goal of slowing inward hot money flows, they would not hesitate to take more "aggressive" action.

Investors immediately panicked.

The Thai stock market plunged at opening by 10 percent, which triggered a trading suspension. The decline renewed once trading reopened half an hour later with the exchange ending 15 percent down for the day, its largest single-day drop ever. The government quickly amended the policy after market closing so that it now applies only to bonds.

On the upside, the Thais have most certainly gotten their point across and only the bravest (or most stupid) of daredevil traders are now going to be seeking to play the market in the way they were before Dec. 19. One goal of the policy -- weakening the baht -- has also been achieved (albeit perhaps a touch too well).

Daily Exchange Rates Chart: U.S. Dollars per Thai Baht

The downside is clearly a bit more comprehensive. Thailand has severely damaged its reputation for being a well-run economy that shies away from investor-unfriendly actions, and in two ways. First and most obvious, even during the depths of the 1997-1998 financial crisis, Thailand never adopted a policy as restrictive as this.

Second, the policy was not just restrictive, it was ham-handed.

It is not so much that investors do not like to be told what to do with their money, but that this policy was not particularly well thought out. During the financial crisis, a number of states adopted a number of policies in attempts to cope. The most successful by far was in Malaysia, which pegged its currency to the dollar and enacted strict capital controls that prevent speculators from removing their gains until a great deal of time had passed. That offended market purists, but completely squeezed all but long-term investors out of the market.

On Dec. 19 Thailand went about it backward. Instead of restricting capital outflows, it hijacked capital inflows. Put another way, not only did it adopt a policy designed to spook a certain class of investor (speculators), it did not do it in a way that would prevent others from running. So sure, the Thais achieved their goal, but exposed themselves to a great deal of unnecessary collateral damage in the process.

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That has created a double hit to market confidence in the Thai authorities, injecting immense doubt into the heretofore dominant belief that recently elevated technocrats such as Finance Minister and former BoT Governor Pridiyathorn Devakula and current BoT Governor Tarisa Watanagase have some clue as to what they were doing.

What these two policymakers do next is of critical importance. If much-needed unified statements of explanatory calm flow forth from Bangkok before and during the opening of trading Dec. 20, then the lock-in policy probably will be filed away in Thailand's "never-do-this-again" file, the lesson will be learned, investors will mellow and life will go on.

If tomorrow's news is silence -- or, worse, confusion -- then Thailand has two issues to deal with.

First, the world will find out just how much Thailand has grown since its problems in 1997, because eight years of progress would be up for grabs. It is true that Thailand has come a long way since then. Its economy has doubled, the problem is now currency strength and not currency weakness, and the financial system that contributed to the crisis' severity is largely gone. But Thailand remains dependent on foreign capital -- and the owners of that capital are spooked. Contagion à la 1997 is not likely because, like Thailand, most of the region's states (with Indonesia the notable exception) are far stronger now than then. Investors, however, have a herd mentality and a mass exodus from Southeast Asia can hardly be ruled out. After all, the Hong Kong, Indian, Indonesian, Malaysian, Philippine and South Korean markets all took their cues from Thailand on Dec. 19 and went nowhere but down.

Second, Thailand's reputation as a solid economy with questionable politics would change to a reputation of questionability on both scores. Investors did not bolt after the Sept. 19 coup because there was trust that the Thais -- not to be confused with the Thai government pre- or post-coup -- were levelheaded enough to keep their money separate from their politics. Should the events of Dec. 19 not prove a mere hiccup, then coups will mean the same thing in Thailand that they mean everywhere else.

Conclusion

Your hoping it's not 1998 all over again analyst,


John F. Mauldin
johnmauldin@investorsinsight.com

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Posted 12-21-2006 4:19 PM by John Mauldin
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