How to Kill a Tiger: Speculators Tell The Story Of Their Attack Against The Baht, The Opening Act Of An Ongoing Drama

By Eugene Linden

TIME magazine Asia November 3, 1997 Vol. 150 No. 18 pp.26-7

The description was brutally honest: "We are like wolves on the ridgeline looking down on a herd of elk," said one of the currency speculators who helped trigger the cascading devaluations that eventually led to the stock-market tumbles that swept the globe last week. Late last year, eight months before Thailand finally succumbed and devalued the baht, the wolves had been on the prowl. They saw the Thai economy not as one of Asia's tigers, but more like wounded prey. Unable to resist, each predator began to plan his attack. "By culling the weak and infirm, we help maintain the health of the herd," said the trader. And cull they did. Through interviews with members of this wolf pack, Time has reconstructed the story of how the traders devoured the Thai currency and set in motion the ongoing crisis that caused last week's worldwide financial trauma.

The wolves, an amorphous group that includes secretive hedge funds as well as groups within banks with names as familiar as Citibank, began tracking the region in earnest in 1994. Economist Paul Krugman piqued speculator interest when he published a prescient article in Foreign Affairs titled "The Myth of Asia's Miracle," in which he argued that the Asian boom owed more to hard work and a shift from farms to industry than it did to investments in productivity. As a speculator put it, "We read this and thought, 'Well, well--Asian growth may have a limit.'"

Attention quickly focused on Thailand, which was being buffeted by a series of external and internal events. China devalued its currency 33% in 1994, allowing it to underprice neighboring economies on low-cost goods. Thai exports further eroded as the Japanese yen weakened, undercutting any Thai advantage in high-value products. With the baht tied to the strengthening U.S. dollar, the kingdom had little room to maneuver. Moreover, despite its large population, Thailand had a relatively small pool of educated, healthy workers, and wage inflation further undermined Thailand's competitiveness with surrounding countries.

Even as exports diminished, the flood of foreign investment continued. On the surface Thailand still looked good, with its open markets and a fiscal surplus, but underneath, the balance sheet was rotting. Foreign reserves remained steady at about $38 billion, but the amount of money Thailand owed to foreigners skyrocketed to $106 billion. By 1996 cash outflow exceeded inflow by 8% of the nation's gross domestic product, and the net foreign assets owned by the Thai government and commercial banks shriveled as the nation covered the outflow with borrowing. While in earlier years most of these loans had gone to build industrial capacity, now the money poured into real estate speculation, the stock market and finance companies, supporting an unproductive boom as consumers bought Mercedes sedans and cellular telephones. The Thai economy had become one big bulging bubble, and late last year the wolves took notice.

Currency speculators love a bubble economy because bubbles always pop. The billion-dollar question is When? Currencies, like the cartoon character Wile E. Coyote, can defy gravity long after they should be plunging to earth. By December 1996, speculators realized that Thailand's policymakers were trapped and bewildered. They had to keep interest rates high to dampen wage inflation and attract the foreign money to which the kingdom had become addicted. On the other hand, the high rates were badly hurting the debt-burdened economy.

One way out was to devalue the baht. This would hurt those who owed money in dollars. A confidential analysis done by a group of speculators estimated that a pre-emptive devaluation would cost the treasury about $10 billion of its $38 billion in reserves, which it would quickly recoup because of the credibility it would earn in the international marketplace. (It should be noted, however, that Indonesia did not oppose an attack on its currency, and its markets still got hammered mercilessly.)

The speculators guessed that the Thais would rather fight than devalue. Devaluation would hurt the elite, who would watch principal and interest payments soar for their dollar-denominated loans. The alternative to devaluation was a further hike in interest rates, but that would produce a flood of bankruptcies and further weaken a banking system that was already in trouble because lax government supervisors had allowed their banker cronies to ignore capital requirements.

Sensing that their prey had been cornered by their own venality, the wolves began to circle in early 1997. The amoral pursuit of profit was about to punish the sins of cronyism and corruption. Drawing from multibillion-dollar war chests, hedge-fund operators such as George Soros and Julian Robertson intensified their attack on the baht. One way the speculators bet against the currency was by entering into contracts with dealers who would give dollars in return for an agreement to repay a specific amount of bahts some months in the future. If the baht rose in value, the seller of the contract made money; but if it fell, the buyer profited because he could repay the contract with cheaper bahts. Demand for such contracts started to drive up interest rates, and the Bank of Thailand began issuing many of these so-called forward contracts itself.

This action turned out to be a fatal misstep that placed in the hands of speculators the perfect weapon with which to attack the currency. "It's as though an unarmed gunslinger walked into town and the sheriff handed him a pistol," remarked a beneficiary of the central bank's unintended largesse. Now speculators had access to an estimated $15 billion in forward contracts issued in February and March that they would not have to cover for as much as a year. An estimated 80% to 90% of these forward contracts ended up in the hands of speculators. By May the central bank realized it was contributing to the baht's undoing and abruptly stopped issuing any more forward contracts.

Sensing blood, traders began moving in for the kill and in mid-May flooded the market with orders to sell bahts. But the government began playing hardball. The central bank invoked a mutual-assistance agreement with monetary authorities in Singapore, Hong Kong and Malaysia and spent more than $10 billion in just a few days buying bahts and selling dollars.

The Bank of Thailand also squeezed the speculators by sharply raising interest rates, which restricted access to bahts that traders needed to cover short-term contracts. Holders of long-term forward contracts, however, knew the government could not pursue this painful course for long, and they emerged unscathed. "When governments resort to these tactics, you know the game is over," said a veteran of many currency battles. Indeed, the government tried ever more desperate measures. Finance officials allegedly used threats and bribes to try to get banks to divulge who owned which contracts, so they could exert strategic pressure. The Interior Minister, Sanoh Thienthong, threatened prosecution of newspapers that spread information damaging to the economy, and the special-branch police were authorized to track down callers to talk-radio shows who voiced the wrong opinions.

These antidemocratic actions turned out to be very expensive. They only served to convince foreign investors that the end was near. But what end would it be? Thai officials were so enraged by the attack that many speculators feared the government would default on its obligations, bringing down the speculators along with the Thai economy. California banks began taking out ads in Bangkok newspapers offering help for those who wanted to get money out of Thailand. Importers settled accounts early in anticipation of the fall of the baht, while exporters hoarded dollars offshore. Both reactions greatly exacerbated the drain of dollars. The government also tried to hide the extent of the damage, estimating that the loss of reserves in May was a moderate $2 billion. The speculators, relying on their own analysis and what they could glean from sources within the central bank, were estimating that the real number was $5 billion.

The question by then was not whether but when there would be a devaluation or default. Many speculators bet that the government would hold out until July so that companies could push losses into the second half of the year. "It's the old Asian idea that if you don't say it, it isn't true," remarked a player, "as if the market couldn't figure it out." And on July 2, the baht was devalued, setting off a chain reaction throughout the region's currency markets and then, last week, around the world's stock exchanges. While no hard number is available, the wolves who started all this turmoil were very well fed, probably with profits in excess of $3 billion.