Malaysian Twilight Zone.

• Author: OGUS, SIMON

Nobody saw the financial crisis coming, but it did. No one thought capital controls would work, but they have. Here's what happens next.

"Malaysia, don't you just hate it?!" "But isn't it delicious?!" Few countries or leaders in Asia can excite such extremes of opinion, as well as such perfidious shifts in the recommendations of the Glenda Slaggs of the analytical community, as Prime Minister Mahathir Mohamed's manor.

For the record, I have always had a soft spot for the place. Despite the dubious use of judicial power, the regular anti-foreigner rants, and the periodic manipulation of official data when it suits the authorities, Malaysia has always been better run than most of its neighbors. Besides, selling sensible policy moves to the recalcitrant Malaysian audience sometimes requires rhetoric heavy with assaults on foreigners -- and the behind-the-scene policy moves are often sensible. Sun Tzu's strategy of creating external diversions when facing internal problems is one that Kuala Lumpur understands well.

Let's be clear, though. Malaysia, along with the rest of the region for that matter, has rarely been an investment that could be made on ethical grounds. Hence, it's difficult to have empathy with holier-than-thou money managers crying into their decaffeinated double lattes, and easy to have sympathy for Mahathir's reply to his accusors: Crony capitalism was never an impediment to investment in the past. After all, capital controls had been employed by Kuala Lumpur in 1994, albeit in a different guise.

Nevertheless, the argument that Malaysia was hunky dory before falling victim to the dark speculative forces unleashed by the Darth Vaders of global capitalism does not add up. In reality, the country had nurtured a huge, easy credit-financed asset bubble in the preceding years, and the bubble was ripe for bursting. The chart below, which I first produced in 1996, shows the extent of the speculation which built up the stock market over the 1990s. Tall tower syndrome was yet another manifestation.

Malaysia's monetary authorities had been trying to calm things down for a long time, to be fair. But political imperatives always seemed to get the upper hand. From 1992 onwards, Bank Negara Malaysia (BNM) attempted on several occasions to use currency revaluations, direct credit controls, interest rates, moral suasion, and limited capital controls to tighten monetary policy. But all to little avail. Most of these measures were subsequently reversed or watered down as a result of well-connected lobbies throwing their rattles out of the pram. And by the time the central bank was allowed to significantly raise rates in 1995 and 1996, the stock market did not care. Although primes rose from 7.4 percent in April 1995 to 9.25 percent by the end of 1996, the Kuala Lumpur Stock Exchange put on 30 percent and the second board surged 150 percent. The logic was: Why worry about a rise in funding costs if your stocks will go up 10 percent next week? Does this sound familiar to our readers...