We would not have it any other way, because the advantages of openness far outweigh the disadvantages. But the risks involved in this exposure were brought home to us by the Asian financial crisis. 20. For Hong Kong, the consequences of that crisis have been first a sharp recession, and secondly the series of attacks on our currency which I have already described. At the height of these attacks, during the summer of 1998, there was clear evidence that the free market in Hong Kong was in danger of failing to fulfil its functions. Specifically, the currency, securities and futures markets were being distorted to the point where efficient resource allocation had given way to manipulative speculation; where prices in the markets were no longer being determined by changes in underlying supply and demand; and where interest rates, instead of reflecting the supply and demand of liquidity, were being hijacked for the purpose of engineering dramatic changes in the markets. Strong evidence suggests that at the time a very small group of players were responsible for a preponderant proportion of the short futures contracts open at that time. We also estimate that currency borrowings to the tune of $ billion, arranged in advance to avoid the expected interest rate volatility they were hoping to generate in Hong Kong, had been made by a similarly small group of players to be quickly dumped at a time when the markets were most vulnerable.
But if we were to find a single factor that has brought the crisis to a head and magnified its damaging effects, we should be looking, not to ‘crony capitalism’ or ‘Asian values’, but to a more specific and more universal phenomenon: the swift flow of large amounts of heavily leveraged capital into and out of the region through an international financial system that is globalised, liberalised, technologically advanced, but, from an international point of view, largely unmanaged and unregulated. 3. The freedom of capital flows is, of course, essential to effective financial intermediation in the international dimension, which has played a vital role in promoting economic development in this region. But, as the current crisis has shown, it also has the potential to distort, disrupt or even destabilise domestic financial markets: this applies not just to ailing economies, but also to sound ones. Being small and open, with predictable policy responses, their markets are susceptible to manipulation. As you know, last summer Hong Kong was exposed to this problem in an extreme form, and we took radical and controversial measures to address it. We remain convinced not only that what we did preserved our financial system 1  BIS Review 35/1999  from a serious threat to its stability at a time of stress and uncertainty, but also that our actions were entirely consistent with our responsibilities as a government mandated by law to safeguard the free operation of financial business and the free flow of capital within, into and out of Hong Kong.