Dr. Mahathir's rhetoric is his alone, but his views are not. In the wake of the financial crises of the past few years, it has become routine to blame hedge funds, which abruptly move large sums of money in and out of nations, for destabilizing economies and impoverishing the innocent. Yet those who are considering the imposition of capital controls on portfolio investments and the regulation of hedge funds should pause before acting.

Such reforms would not eliminate the volatility of global capital flows, because the idea that the actions of hedge funds and other portfolio investors are its prime cause is false. In the recent crises in Asia and Russia, the "hot money" came chiefly from banks, not portfolio investors. Indeed, throughout the 1990s, lending by foreign banks was often a more unstable form of overseas financing than portfolio investments in equities and bonds, for most overseas bank lending takes the form of short-term interbank loans rather than long-term project finance. Furthermore, hedge funds are considerably smaller than other players in the system. Over the long run, as capital markets continue to grow in importance and ultimately replace traditional bank lending as the main source of external financing,...