Time to close down the stock market?

10 August 1996

Should we close down Stock Exchange of Thailand? Probably not. But is it worth all the trouble it creates? Consider the record of the last few months.

The BBC disaster began from a massive share manipulation. The courts threw out the case against the biggest alleged stock manipulator. The head of the Stock Exchange Commission was clumsily dismissed, with political repercussions. The head of the exchange refused to extend his term, forcing government to find a replacement with no relevant experience. The head of the central bank was found to have accepted shares under conditions which were not illegal but certainly unethical. An investor shot himself in the stock exchange building.

Even after this record, the stock exchange gets treated as a sacred cow. Government throws in 30 billion baht to shore up prices. When this didn’t work, it tries a new scheme based on the dangerous idea of allowing investor more margin to play the market on credit. Suggestions that stock market gains should be taxed are greeted with howls of opposition. People in the finance industry, who are interested only in the stock price not the broader economy, feel qualified to lecture the government on how they should run the economy. Cadet stockbrokers just arrived from London or New York are especially good at doing this.

The stock market is not the economy, and the economy is not the stock market. The stock market index is not even a good measure of an economy’s health. The US and UK economies are not doing well, but earlier this year both their stock markets were higher than ever in history. When the US government released some good trade figures, the New York index promptly dropped. Stocks often thrive on wider economic misfortune.

Stock markets are not part of the natural order like rain or trees. They have to be created and maintained. Over the last decade, they have become a much bigger feature of the economic landscape across the world. The World Bank and other international bodies pushed governments to expand and liberalise their stock markets. They argued that stock markets help countries in two main ways. First, they raise the level of savings. Second, because they work on market principles, they channel savings to industries with the best potential for growth.

The Bank also argued that allowing investments to flow across international boundaries would benefit both givers and receivers. Over this last decade, these international flows have increased many times.

Other economists have been baffled by these arguments. They cannot find any evidence that stock markets increase the level of savings. They doubt very much if stock markets are good at channelling funds to the best industries. Even in very advanced countries, stock markets are subject to swings and fads with little relation to economic logic. The great economist, Keynes, remarked that stock markets operate on the same principle as casinos. Even most stockbrokers admit that "finance" and "the real economy" are separate things.

Certainly in Thailand, the impact of the big stock market expansion since 1987 has been mixed. Before this, big entrepreneurs had to rely on their private sources or borrow from the big banks. The technocrats argued that boosting the stock market would help to liberate enterprise and promote growth. Since then, market capitalisation has multipled 25 times. Between 1987 and 1991, a handful of ambitious entrepreneurs were able to achieve spectacular growth with the help of the stock market. Shinawatra and other telecoms firms are the best examples.

But does the stock market channel funds to the best uses? Doubtful. The basis of Thailand’s growth is exports. The stock market has done little to help firms in the main export sectors. The textile and agribusiness industries, which led export growth in the 1980s, each account for just 1 percent of the market. Among the medium-tech industries which are spearheading export growth in the 1990s, chemicals account for 2 percent, electronics 1 percent, and auto parts less than one. Combined together, these export sectors amount to only 7 percent of the market.

The stock market has done more to help property speculation than export growth. One property firm is as large a factor on SET as the whole electrical and electronics industry. Property as a whole accounts for 9 percent of market value, more than all the key export sectors combined. Boosted by the stock market bubble, property firms have built one third more houses, shopping centres and condominiums than we all need—ballast which is now helping to drag the Thai economy down.

But beyond all this, there is a bigger issue. In some advanced countries, stock exchanges dominate the capital market. In others, banks dominate. In recent decades, those with strong banks (like Germany, Japan) have been more successful than those with strong stock markets (like US, UK).

Why is this? When banks invest in a major firm, they become a partner with a vested interest in the firm’s success. The result is like a marriage in which both partners hope for long-term happiness.

By contrast, stock investors tend to "play around". Along comes a prettier face, and they are off. They force firms to show short-term profits to keep the investors loyal. This may make it difficult for the firms to set their sights on long-term success. The bank-based systems of Japan and Germany have been at nurturing the productivity improvements which result in long-term growth in today’s world. The stock-based systems of USA and UK are mired in stagnation or decline.

This short-termism becomes even worse when the investors are international funds. Their roving eyes look for talent all over the world. Those who come to Thailand have no interest in the long-term success of the Thai economy. They will depart for Sao Paulo or Ulan Bator in the nanosecond it takes to make a money transfer.

The SET index has fallen 20 percent over the last year. That sounds a lot but needs to be put in perspective. The index is still 40 percent higher than this time 3 years ago, and 400 percent higher than 1987. If you had put a million dollars on SET a decade ago, you would have made 7 million at the index’s 1994 peak and still be left with 4.5 million today. Not bad.

The index is dropping not because the economy is bad, not even because the Banharn government is a shambles. It is dropping because it was too high. In the late 1980s, stock investment became a new fad. Thai speculators pushed the index upwards. Companies could make so much money out of share flotations, that a new occupation was founded: people who "churned" shares upwards.

By 1990, the Thai stock exchange had become so exciting, that foreign investors plunged in. With the long-term recession in the west, big institutional investors like pension funds were trawling the world for good returns. Western firms competed with one another to invest in Asian markets. Often they had little idea what they were doing, and little in the way of controls. The follies of Nick Leeson were just the tip of a huge iceberg. From 1993 to 1995, over 200 billion baht worth of foreign portfolio investment flowed in. Share values on SET lost all connection to the profit and prospects of the listed companies.

This last year has been a reality check. Local investors are calming down. After the Leeson affair, foreign firms have become more cautious. Share values are dropping back to the "level of fundamentals". This is not a disaster. For the economy, it could be quite a good thing. It will stop more capital being wasted building empty condominiums.

Thailand is not the first country to have been on this yo-yo trip. In the 1980s, the Brazil market index went up 5 times in 3 years, and then came back to its starting point over the next two. The Taiwanese market went up 3 times in 3 years and then fell by 4 times in the next two. These wild swings are very damaging for companies, for investors, and for politicians.

We cannot close down the stock market. It is part of the modern economy. But we can try to limit the damage it may do. To begin with, we have to stop treating it as a sacred object, reading its index as an economic barometer, and wasting too much money and management time keeping it in order. Let the price fall back to a reasonable level. Scrap all the schemes to boost the index with extra credit. Impose a tax on turnover to dampen the index’s volatility. When the index movements become less exciting, the stock market will cease to seem as important.

Chang Noi says: don’t worship the stock market.