Your intervention in the Hong Kong stock market was condemned almost universally six months ago. Now, according to our poll [see box], it has widespread support. Does that surprise you?
Let's put that in context. You said universally condemned. It was a very popular move in Hong Kong. It stabilized the market almost immediately. It also reassured long-term investors that this wasn't a Wild West market.
When I travelled in Europe and the US two months after our incursion in the market, I frankly found all my central bank and finance minister colleagues concurred with my moves. But you are also right to say there were lots of foreign critics of what we did at that time. Times have changed.
You have long been a market fundamentalist. Do you now accept that markets have limits and require intervention?
I am still a market fundamentalist, but I also believe there are times that markets can fail - in extreme circumstances. The financial crisis was quite unusual - perhaps the worst Asia has seen in 50 years. So there were extreme conditions. I maintain my strong belief in the market, but I have to accept that in certain circumstances the market can fail.
The reform of the global financial architecture seems to have been shelved by the G7. Does this disappoint you?
Somewhat, but not completely, because it is still a live issue. But not as lively as it was in, say, October last year when we had a gathering that included President Clinton, US treasury secretary Robert Rubin, myself and 20 other finance ministers in Washington DC, beating our chests saying we are going to do something about it.
Since then, diverging views have appeared. In Asia there is still acute awareness that the problem is not over. We met in Malaysia last weekend for the Apec (Asia-Pacific Economic Cooperation) meeting and there was a general consensus that we should not lose track of the implications of erratic capital flows. They could contribute to future crises.
I don't know when that will be, but they are happening with rather formidable regularity - 1991-92 the European crisis, 1994-95 the Mexican crisis, 1997-98 the Asian crisis. These were all related to erratic capital flows. So I am not disheartened, but there has been an emergence of different views as to how we should solve the problem.
How do you prevent crises provoked by erratic capital flows. Do you need a single world currency? A global central bank?
If you want to have no speculation against currencies you should have a single currency. Whether that amounts to having a single world central bank I'm not sure. But it's clear the only way you can prevent a market being swamped is if the market is the only one. That is one of the driving forces of the euro's creation - because the early 1990s taught Europe that a single currency was the only way to prevent a crisis because that way you have enough depth and liquidity to deal with a capital flow.
The problem we have in Asia is that we all have sovereign currencies and different markets, the size of which compares unfavourably with some of the capital flows. It is like an elephant in the pond. I said this at Apec and it was accepted by all my ministerial colleagues including US treasury under-secretary Larry Summers. So no matter how manicured your pond is in normal times, once the elephant arrives everyone begins to flee and you have a real problem.
If a market is very large like the one in Europe, or Wall Street, or Tokyo, then you have a reasonable chance of survival because it is so large and hopefully all the investors and fund managers will not work in concert against you. But in Asia it's a different ball game. So we need to discipline these markets, their governments and economies.
Then you must have sufficient safeguards on capital flows. You must identify the elephants and have restraints. I am asking for greater transparency and disclosure of the activities of these hedge funds, and also the banks that finance them - the people that feed the elephants. You have to make sure there are trainers around so they are not running wild. On the one hand you ask the markets which are open to be disciplined and comply with the IMF requirement and Basle banking accords. At the same time you must have discipline on the part of capital flows.
The structural problem in Asia is the lack of a very deep domestic bond market whereby the savings in Asia can be recycled properly to meet short-term balance of payments difficulties. Now the Japanese are talking about this and hopefully it will gather momentum.
Are you in favour of regulating hedge funds?
No. I have never used the word "regulating" in relation to hedge funds. I am asking for the monitoring of the movements of the hedge funds and asking for greater disclosure, and greater discipline among the financial institutions that allow them enormous leverage.
Hedge funds got a lot of blame for the Asian crisis. But wasn't it just as much to do with the world's commercial banks withdrawing credit lines?
It was a combination of things. Go back to the elephant in the pond. When there are signs of an attack on a currency all players in the pond flee. You can't blame the banks for cutting their lines, because they want to cover their backs. So who started it? Perhaps you can blame the economies themselves. You can blame everyone. It's not a question of blaming one particular party.
Joseph Yam [Hong Kong's central bank governor] believes there was a conspiracy between banks' research departments and their hedge funds to destabilize the market. Is this what you mean?
Quite right. There is strong evidence of that in Hong Kong. Particularly in markets like ours where it is not only funds that have complete freedom, but rumours. We have a totally free press, free phone calls. You can start a stampede, just by rumour-mongering. In Hong Kong there was the rumour on Thursday, reappearing on the Friday, "Donald Tsang is going to devalue on Monday" or "the renminbi is going to be devalued in two weeks".