Everyone thinks of changing the world, Leo Tolstoy once wrote, but no one thinks of changing himself.
Hong Kong finds itself in that very situation. As an increasingly cozy part of the Chinese juggernaut, the city of seven million people has a front-row seat for the changing of the guard in the global economy.
It’s debatable whether China will overtake the US economy in any of our lifetimes—or ever. What’s not is that with more than 1.3 billion Chinese—and more than one billion Indians—entering the financial system, nothing will ever be the same.
Why, then, is Hong Kong so reluctant to take an obvious step to restore sobriety to its bubble-plagued economy? The change in question is scrapping its peg to the US dollar.
Tolstoy died in 1910, yet were the Russian famed for realist fiction to walk the streets of Hong Kong these days, what a tale he could tell.
He might write of growing hardships as inflation increases at the fastest pace in about nine years.
He might depict how housing costs are skyrocketing beyond the means of average residents. He might dramatize how rising food and energy costs are taking their toll.
And Tolstoy would find plenty of fodder to buttress his belief that those changing the world rarely think to alter their own actions. He would find it in a government that stubbornly leaves its currency linked to a sliding US dollar—and to a central bank in Washington that continues to cut interest rates.
“Super easy monetary conditions are likely to spawn a property price and stock market bubble, which eventually should make the Hong Kong dollar peg impossible to stomach any further,” says Diana Choyleva, a London-based economist at Lombard Street Research Ltd.
Even though pressure for change is building, traders in Hong Kong aren’t exactly bracing for it. For one thing, the decision to de-peg the currency, or raise its value, will probably be made in Beijing, not Hong Kong. For another, it won’t be based on economic forces, but in spite of them.
When Hong Kong chief executive officer Donald Tsang or financial secretary John Tsang is are asked about the peg, the response is normally something like: The policy has served us well since 1983—why mess with success?
“Just as Hong Kong tolerated and absorbed years of deflation following the Asian crisis, it will tolerate and look through a period of inflation,” says Stephen Jen, Morgan Stanley’s London-based chief currency strategist.
Hong Kong’s stance has its defenders. The International Monetary Fund (IMF) on 5 February reiterated its support for the linked exchange rate. On its website, IMF said “the current real value of the Hong Kong dollar is in line with fundamentals.”
Hardly. Rate cuts by the Federal Reserve are forcing the Hong Kong Monetary Authority to follow suit, adding liquidity to an economy that doesn’t need it. Were Hong Kong to free its currency, there’s little doubt it would shoot higher from its current HK$7.8 (Rs40) per US dollar.
Inflation pressures are building and asset bubbles are growing. In 2007 alone, residential rents climbed 13% from a year earlier, while luxury apartment rents jumped 27%. That was when the Fed’s overnight lending rate was above 4%. It’s now 3% and likely to go even lower. That may lead to increased buying of real estate and stocks given the negligible interest on bank accounts.
Inflation is but one concern here. Recruitment will become even harder as a falling exchange rate reduces salaries on a relative basis. For a city that views itself as the gateway to mainland China, not being able to attract the best and brightest from London, New York, Sydney, Tokyo and elsewhere is a bigger problem than government officials may realize.
The city’s worsening air quality is enough of a disincentive for many expatriates. The last thing Hong Kong wants is to lose its competitiveness.
The peg has its supporters in the business community because it’s a transparent, simple and predictable policy. For all the talk about stability, though, the peg also has been at the centre of many of Hong Kong’s biggest challenges.
A decade ago, during the Asian crisis, speculators attacked the peg. While it was in vain, the episode was a distraction for policymakers. Earlier in this decade, an overvalued dollar helped worsen deflation. Now, with inflation rising, Hong Kong is facing new risks.
You have to wonder if the George Soroses of the world are eyeing a return to speculation in the region. One possible step is to sever the link to the US dollar and peg the Hong Kong dollar to the yuan. Others say pegging to a Singapore-like basket of currencies makes more sense.
The dollar peg has served Hong Kong well at times. That doesn’t mean it can’t outlive its usefulness. Hong Kong has reached that point, and its economy is paying the price. It’s time for Hong Kong to change itself before China changes the world. (Bloomberg)
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