The financial community reacted in general horror, fearing yet another rusty wrench thrown into Asia's unsettled markets. "Mahathir is turning Malaysia into a Burma," says a Bangkok-based official of a Malaysian bank. "It will create a black market for the currency, and there will be panic in the country to buy U.S. dollars." Says a Clinton Administration official: "We tell everyone in the region that you'll do best by getting your system in shape to participate in a globalized economy. Mahathir clearly has chosen a different path."
But as the days went on, some saw wisdom of a limited sort. Currency controls clearly cut Malaysia out of the investment loop for international mutual funds, part of the so-called "hot money" that once gave the country some of the highest growth rates in the world. Direct investment by foreigners, though technically not affected, will probably stay away for more general reasons. "I know some banks that were seriously considering Malaysia to locate their back-room operations," says Bruce Gale, director of the Political and Economic Risk Consultancy in Singapore. "They will do some rethinking. There's a feeling you can't be sure about the government's policy." But nothing else was helping to stabilize the ringgit, including very high interest rates, and without that no economy can get on its feet. According to economic guru Paul Krugman, who argues the virtues of limited capital controls: "When you have a natural disaster in a city, you impose a curfew to prevent looting and disorder." Late last week, Krugman judiciously proposed some limitations to such tinkering in an open letter to Mahathir posted on the Internet. Currency controls must be temporary, he said, and accompanied by a real cleaning up of the financial system. A fixed exchange rate can't be used as a tool of national pride. If genuine market forces aren't allowed to ultimately work, he argued, the whole economy will suffer.
Mahathir's moves last week conformed to the first part of Krugman's prescription. The question now is whether Malaysia will take the rest of the medicine. "What is the breathing room going to be used for?" asks the head of a Wall Street trading firm's Singapore branch. "If it's used to further Mahathir's political agenda, then the whole thing will come apart and we will see collapse." A top Malaysian government official told TIME last week that the currency controls were necessary to prevent a ringgit meltdown following the collapse of Russia and the drop in the Dow. "Krugman can write about ideas," he said. "We have to implement them. We know it is risky." But he revealed that Malaysia's moves were also directed against Singapore, where an estimated 35 billion ringgit is held in banks, trading accounts and in Singapore's Government Investment Corp. Relations with Singapore have gotten testy lately, and Mahathir wanted to remove Singapore's control over its currency. "As long as Singapore is trying to benefit from our problems," the official warned darkly, "we have to isolate ourselves."
Currency controls ... tales of seduction by a Deputy Prime Minister ... sinister plots by Singapore ... isolation. The pieces are confusing, but they build to a familiar, if disturbing mosaic: of Old Man Mahathir, gathering the reins of power in his grip and lashing out in all directions.
Reported by John Colmey and David Liebhold/Kuala Lumpur, Kim Gooi and Tim Larimer/Bangkok, Nelly Sindayen/Manila, Ravi Velloor/Singapore and Douglas Waller/ Washington
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R E L A T E D S T O R I E S :
COVER STORY Prime Minister Mahathir Mohamad banishes Anwar
CRANKY OLD MAN The PM has a history of lashing out
VIEWPOINT Mahathir rails against financial orthodoxy
INTERVIEW Anwar explains what went wrong
OUT OF LINE Where does the ex-heir go from here?
POLL Does former Deputy Prime Minister Anwar Ibrahim have a future in Malaysian politics?
POLL Will the new currency controls help or hurt the Malaysian economy?
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