This letter was published in the South China Morning Post on 20-Aug-1998.

Our letter on the Government's market intervention
20 August 1998

The HKMA's intervention in the equity markets is, in my view, extremely damaging to the markets' credibility.

Hedge funds would not be so successful were they not correct in their assessment of equity valuations and investor sentiment. Although they increase volatility, they do not distort values in the long run, as investors will eventually buy when they see good value. Prices do reach extremes, and speculators made profits during the bubble, as they did in the crash, but the government did not intervene in the bubble. Why should they do so now?

The peg is worthy of protection, and the government has been helping by buying HK dollars in the forward market at what are attractive prices so long as the peg holds. Due to the peg, devaluation must come directly through the prices of assets, goods and services (including salaries). Shares are no different in this respect, and if hedge funds have expedited this process it is no bad thing. The devaluation of real and financial assets has increased our competitiveness and lessened the rationale for devaluing the currency, and people should find confidence in this.

I was disappointed when the Financial Secretary advised us last October 28th that "we can see the market has bottomed out. In fact it is very cheap to buy". Now by directly intervening, the government is like a referee running with the ball -; things will never be the same again. When anyone connected with the government comments on the market, we will wonder whether they may also intervene.

When does "trading" become a "speculative attack"? When does "intervention" become "interference"? In the extreme, you get Tokyo, where public funds are routinely used to support the market, and investors have to second-guess the government.

There is also a legal question. Section 135 of the Securities Ordinance states "a person shall not intentionally create...a false market in respect of any securities on the Unified Exchange". It clarifies: "a false market is created... when the market price of those securities is raised or depressed or pegged or stabilised by means of... any act which has the effect of preventing or inhibiting the free negotiation of market prices".

The government's action may well fit these criteria. Their action is not designed to invest at good prices, but has the stated aim to raise and sustain prices to "hit them [hedge funds] where it hurts". If the government does not regard its action as market manipulation, then they surely cannot accuse hedge funds of creating a false market by acting in the opposite direction.

Ordinary investors who now buy blue chips risk acquiring shares at artificially high prices as a result. Ironically, the action may even impede the future recovery of stock prices, as investors will know that the government has large positions to sell.

A final legal point - investors of any type, including hedge funds, may deal based on knowledge of their own trading intentions. This is not insider dealing, nor is it front running (which is an offence in which a broker deals ahead of its clients' orders) - so the statements attributed to certain property tycoons in your newspaper (17-Aug-98) are wide of the mark.

If the government has evidence that hedge funds are colluding to create a false market, then they should pursue them under the Securities Ordinance rather than through the market. The chosen course of intervention (and the Chief Executive's threat to do it "time and time again") has set back the credibility of the market to the dark days of the market closure in 1987.

David M Webb, MHKSI

The author is a private investor and is not employed by any investment bank or hedge fund.

©, 1998

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