Outlook: Hedge funds

DONALD TSANG, Hong Kong's Financial Secretary, talks a good story as he jets around the world attempting to enlist the support of Western leaders in his battle against the forces of evil, for which in the Far East read Anglo Saxon speculators and hedge fund operators. He's here in London at the moment, and with Gordon Brown, the British Chancellor, he seems to be pushing at an open door.

According to Mr Tsang, the two are entirely agreed on what needs to be done; the activities of the hedge fund operators must be fully exposed to public scrutiny and accountability. Mr Tsang is talking from a position of some strength, since he has taken on the speculators and won. In doing so, he seemed to abandon some of the central principles of the free market system by using the Hong Kong government's extensive reserves to buy up great chunks of the Hong Kong stock market.

Mr Tsang gets very irritated by suggestions like this; actually he was defending the free market system from those who would rip it apart, he insists. Under the former colony's currency board system, any raid on the currency forces a corresponding rise in interest rates which can damage an otherwise healthy economy; the speculators' actions can thus become self fulfilling. According to Mr Tsang, the effect of hedge funds, with their ability to leverage up small amounts of capital into a fire power capable of swamping a sovereign currency's reserves, is to distort the free market, not to reinforce it. Plainly he has a point of some sort.

But actually the need to do something about the hedge funds is a good sight less now than it was last summer, when the Hong Kong dollar was under such vicious attack. Many bankers have stopped lending to hedge funds period, after the losses suffered on Long-Term Capital Management, D E Shaw and others. The rising cost of credit has also made much of what hedge funds do uneconomic. So to that extent, the markets are indeed self correcting. If Mr Tsang really believes in free markets, he should perhaps have more faith in them.