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HONG KONG IN FLUX
Compradore no
more
By Henry C K Liu
Hong Kong was built on a compradore economy
under British imperialism. A few months ago, Hong Kong's
acting director general of investment promotion told
delegates to the World Services Congress 2001 that Hong
Kong would further enhance its role as a "Compradore
City" with China's accession to the World Trade
Organization. "Upon China's entry to the WTO, this role
is going to get bigger, making it more profitable for
those who seize Hong Kong's compradore spirit and who
base their businesses in Asia's world city," the
official stressed.
A compradore was a native
servant employed as head of the native staff and, as
agent, by foreign trading houses in China during its
shameful semi-colonial history. Imperialist interests in
colonial markets mediated through compradores. As a
class, the compradore bourgeoisie is despised by
socialist revolutionaries as well as by members of the
national bourgeoisie. The compradore has no positive
economic function in a regime of free and fair trade.
Ideology and national pride aside, in the era of
globalization and e-commerce through instant
communication, where efficiency is achieved through the
elimination of intermediaries, a compradore economy is a
dying breed. Economic nationalism will put the final
nail in the compardore's coffin.
The future of
Hong Kong as a compradore economy can be summed up quite
simply: non-existent. This is not nit-picking, for it
illustrates a basic flaw in Hong Kong's image of its
future.
Monday, July 1, marked the fifth
anniversary of Hong Kong's return to Chinese sovereignty
from British rule. On that day, Tung Chee-hwa, the chief
executive of the Hong Kong Special Autonomous Region
(SAR), began his second and final five-year term with a
newly appointed cabinet in a reformed government
structure of political accountability riding herd over
an apolitical civil service. Five years earlier, many in
Hong Kong, infested with the compradore spirit,
exemplified by the madame chief secretary (Anson Chan)
of the holdover colonial civil service at that time,
echoing US neo-liberal propaganda, openly worried about
undue Chinese interference on Hong Kong's "free market"
success, harping on the importance of human rights,
democracy and rule of law, none of which had been
particularly inherent under British colonialism as
indispensable ingredients of Hong Kong's freak
prosperity, all in which China was pictured as being
deficient.
On July 2, 1997, the day after the
historic return of Hong Kong to China, the Asian
financial crises began in Thailand. Those in the new SAR
government in charge of economic policy complacently
proclaimed that the "fundamentals" of the Hong Kong
economy were sound and that all that was needed was to
maintain Hong Kong's free-enterprise tradition to ride
through the passing storm. Oblivious to the structural
and systemic nature of the developing financial crises,
Hong Kong even contributed US$1 billion from its
foreign-exchange reserves to the International Monetary
Fund (IMF) to help contain the unfolding crisis within
Thailand. The uninformed hubris was answered by
devastating contagion hitting the Hong Kong economy by
October 1997.
The irony is that Hong Kong, which
tirelessly flaunts its "freedom", religiously chanting
neo-liberal slogans by rote, is now looking to China as
the hope of its economic future, never questioning why
China, which has been labeled derisively as less "free"
and with an underdeveloped regime of commercial law by
many in self-satisfied Hong Kong, is the only growth
economy in East Asia in the midst of global recession,
while "free" Hong Kong has been stuck in economic
decline for half a decade. All the condescending
accolades of "freedom" Hong Kong received from foreign
conservative organizations such as the Heritage
Foundation, Freedom House and the American Enterprise
Institute have not been of much help in convincing
global capital heading for China to bypass Shanghai in
favor of Hong Kong or transnational corporations in
search of the China market to locate their regional
headquarters in Hong Kong instead of Shanghai.
GE, the world largest conglomerate, has just
announced that it will move the regional headquarters of
its plastics division from Tokyo to Shanghai, at the
same time downsizing its operation in Hong Kong. All
transnational corporations now have localization
programs in China, staffed with mainlanders with masters
of business administration (MBAs) from US universities
who speak better Mandarin than most graduates from Hong
Kong, where Cantonese is the preferred Chinese language.
These corporations have no need for Hong Kong
compradores.
Hong Kong recognizes that it must
restructure its economy, but it is not clear that the
SAR government is prepared to accept that economic
restructure can only be achieved through strong
government policy. Hong Kong continues to cling to the
myth of an anti-statist past, for fear that any hint of
industrial policy or government interference with the
market would displease US neo-liberals and bring down
their political wrath of reduced access to US markets.
Yet it is undeniable that Hong Kong's current
dysfunctionalities had been caused by British colonial
policy disguised as free-market forces. For one and a
half centuries, the British ruled Hong Kong for the
benefit of the British Empire, not to promote human
rights, nor democracy, nor free markets, all of which
were slogans recently co-opted as Cold War rhetoric to
justify continuing colonial rule in an era of national
liberation. To correct these dysfunctionalities, bold
government leadership with political courage is needed.
The performance of the SAR government has not
enjoyed overwhelming popular approval because the public
expects strong political leadership and bold policies
and programs to deal with Hong Kong's economic woes,
while the government is fixated in its passive role as
faithful defender of free-market fundamentalism.
Hong Kong set up a Commission on Strategic
Development in 1998 to look decades beyond 1997 to see
what sort of community and economy Hong Kong should be
working toward. The commission report, with a title
sounding like a second-rate Madison Avenue ad campaign
("Bringing the Vision to Life - Hong Kong's Long-Term
Development Needs and Goals") identified four strategic
themes. One theme is to strengthen links with mainland
China, in particular the prosperous economies of
Guangzhou, Shenzhen, Zhuhai and Macau, Hong Kong's
neighbors in the Pearl River Delta. The other three are
to enhance competitiveness, improve the quality of life
and to reinforce Hong Kong's identity and image to
create a world-class business and living environment in
Hong Kong. The vision is to make Hong Kong a leading
world city, on par with New York and London, as well as
to strengthen its unique position as a major
international city in China.
Yet the former
madame chief secretary of the civil service, well
trained by the last British governor of Hong Kong (Chris
Patten - now of European Commission fame), repeatedly
and forcefully warned against turning Hong Kong into a
Chinese city. It is a peculiar posture, because New York
or London do not feel the need to renounce their
national identity in order to be international centers.
Typical of her compradore spirit, Anson Chan was bent on
being more Western than her British masters. To attract
tourists, a Hong Kong Disneyland is to open in 2005.
Surely very few Westerners would come to Hong Kong to
visit Disneyland. Thus the target tourist population
would be mainly Asians, mostly Chinese, an irony that
apparently escaped the lady.
Hong Kong has
merged its exchanges and clearing houses to make them
more efficient and competitive. The new exchange is
forging strategic alliances with other stock exchanges
to capitalize on its location in the East Asian time
zone. Hong Kong opened a growth enterprise market that
is modeled on the Nasdaq to help new companies with a
promising future to raise capital. Hong Kong's
telecommunications sector has been liberalized,
following global trends, with similar controversial
outcomes. The unfolding global telecom debt crisis will
not spare Hong Kong, as the Internet and dotcom bubble
burst did not spare Hong Kong. The ill-conceived
CyberPort will be a white elephant memorial to Hong
Kong's high-tech fantasy. No economy can develop a
high-tech sector without a research and development
program supported by national defense. Hong Kong's
market culture has been focused on property development
and labor-intensive manufacturing as a result of
government policy.
Much talk is heard about
offering high-value-added services, and building a
forward-looking community that utilizes innovation and
technology. Yet Hong Kong has the highest concentration
of family-owned and family-run enterprises anywhere, and
they are not particularly known for innovation. In
corporate governance, Hong Kong remains a developing
region. With all the fanfare about being a mecca for
free markets, Hong Kong does not have a rule-based
competition policy.
To its credit, the SAR
government has committed an enormous amount of resources
to the education sector, aiming to create the
best-educated and most well-rounded generation of youth
in the history of Hong Kong. Yet Hong Kong tolerates a
protracted and serious brain drain to the West, mostly
to the US, where many of Hong Kong's brightest have gone
for university education and stayed on because they were
not interested in a career in real estate or in joining
a family business. Every week, some recruitment
delegation from various regions of China visits the
United States to entice Chinese students, scientists and
professionals with promising opportunities in China.
Few, if any, delegations ever came from Hong Kong.
Moreover, a massive brain drain from Hong Kong to China
is currently in process.
Hong Kong commits
enormous resources to infrastructure building. Yet much
of the infrastructure serves merely to manage the
overcrowding caused by exorbitant land costs. Chek Lap
Kok, Hong Kong's $20-billion airport, Britain's parting
gift to Anglo-American contractors, has great
aspirations to be a regional logistics hub, and the
government has said that it will invest even more toward
that goal. But foreign air-cargo companies are put off
by the inability to do onward shipping from the airport.
The problem stems from the government's attempts to
protect Cathay Pacific, the airline owned by one of Hong
Kong's oldest conglomerates. Hong Kong needs to
liberalize its air-cargo aviation regime if it wants to
be a logistics center for the modern high-tech and
high-value-added world. Also, the over-investment has
produced world-class facilities that must also charge
world-class rates, leaving Hong Kong with a
disadvantaged price competitiveness.
Hong Kong
cannot independently improve its environmental standards
without close regional cooperation. There are signs that
the whole region has not faced up to the real cost of
environmental cleanup and protection.
The chief
executive has proposed to the central government to
devise specific policies in support of Hong Kong's
position as an international financial center, a trade
and logistic center, and tourism center. Specifically,
Hong Kong has asked Beijing to recognize and utilize
Hong Kong's established competitive advantages fully
when it makes overall planning for economic development,
infrastructure and other large-scale investments. Hong
Kong has it backward. It is Hong Kong that must adjust
to China's developmental needs, not the other way
around.
The chief executive also has proposed
the establishment of a free-trade-area arrangement
between Hong Kong and the mainland that will provide
greater opportunity to Hong Kong businesses and
professionals. With this arrangement, Hong Kong hopes to
explore fully the potential for greater economic
cooperation within the Pearl River Delta area. This is
of course a logical move. Yet Article 114 of the Basic
Law sets Hong Kong as a free port without tariffs unless
otherwise prescribed by law, and Article 115 sets a
policy of free trade, while Article 116 defines Hong
Kong as a separate customs territory. These articles, so
vigorously fought for before 1997, are now impeding Hong
Kong's development.
Still, the most serious
challenge facing Hong Kong as an international finance
center is to find its proper place in the global
financial system. The global financial crises caused by
US dollar hegemony that hit Asia on July 2, 1997, is far
from over. The fundamentals behind the crises, developed
over a decade of unregulated finance globalization, have
not been addressed at their roots. Most of the measures
adopted so far by the Group of Seven (G7) industrialized
nations, of which the US is the leader, pulling the G22
nations by their reluctant noses, have to do with
bailing out G7 transnational banks on their foreign
loans, and pushing down interest rates to keep global
stock markets artificially high, indicators of fleeting
financial robustness but usually mis-indicators of
fundamental economic health. Wall Street called it the
Goldilocks economy, where bad news was interpreted as
good and visa versa by naive investors led by
unprincipled analysts in collusion with fraudulent chief
executive officers. Well, Goldilocks has been abruptly
awakened by the bears demanding to know who has been
eating their porridge and sleeping in their beds.
Asia has experienced sudden financial collapse
not because the goods produced in Asia are suddenly
unmarketable worldwide, or Asian management has suddenly
become so inept as to incur unforeseen losses in Asian
companies. It is certainly not the inevitable outcome of
alleged inherent defects in Asian values, as Western
analysts claim. Rather, the collapse is the result of
abrupt and recurring ruptures in the unregulated global
system of financial markets.
Beginning in the
early 1960s, with the growth of Euromarkets where banks
in one European country could take deposits and make
loans in currencies of other countries, the tight
controls of the international flow of capital set up by
the Bretton Woods system of fixed exchange rates after
World War II were in effect bypassed. Drawing lessons
from the 1930s Depression, economic thinking prevalent
immediately after the war had deemed international
capital flow undesirable or unnecessary. When the
fixed-exchange-rate system finally broke down in the
early 1970s, the developed countries abandoned capital
controls officially. In the late 1980s, many developing
countries followed suit.
By the end of the last
decade, daily turnover of foreign exchange grew more
than 100-fold to over $2 trillion from $190 billion at
the beginning of the decade. By 1996, some $350 billion
of private capital flowed into emerging markets, a
sevenfold increase in six years. For the past two
decades, technical imbalances between interest rates set
by different central banks for funds in different
currencies distorted capital flow around the world. The
resultant inflow of capital into Asia through
inter-linked financial markets around the globe
outstripped the region's viable absorption rate.
Financial institutions took advantage of low cost funds
denominated in currencies of select countries, namely
Japan, Germany and the United States, to make loans at
higher interest rates denominated in local Asian
currencies. These institutions sought to strategically
profit from recurring technical imbalances in global
finance by assuming currency risks. Economists name this
development as international arbitrage on the principle
of open interest parity. In banking parlance, this type
of activity is known as "carry trade".
This
manipulative speculation was by no means limited to
emerging economies. Corporations based in developed
economies routinely engaged in global financial and
stock-market speculation at the expense of sound
production strategies. The public announcement of plans
to open new factories in Asia predictably lifted share
values in home markets, regardless that such factories
risked being loss-makers, for the loss would be more
than covered by the increase in market capitalization.
Corporate borrowers in Asia, attracted by low rates in
some foreign currency loans, have also assumed currency
risks, at times even bypassing local banks to borrow
directly in debt markets overseas. Borrowers,
anticipating asset inflation brought by run-away growth,
also succumbed to the irresistible temptation of
borrowing short-term to finance long-term projects, thus
adding to the risk they assumed. Simultaneously, many
Asian banks have taken local-currency deposits at low
saving rates (in Hong Kong at times at negative interest
rates) to invest overseas in risky foreign-currency
instruments yielding higher returns, engaging in carry
trade. Local banks in turn replenished the depleted
local capital pool with low-cost foreign-currency loans
from international banks, taking on both economic and
currency risks.
Borrowing low and lending high
is the basic business of banks, and there is nothing
wrong with it if the activities occur within a
well-regulated market of a bank's domicile community.
With the advent of global banking, however, the
unregulated internationalization of finance has created
perilous systemic stress. Banks began to act as
international loan brokers, profiting from interest-rate
spreads between local and foreign funds, often booking
the risk premium added to weak currency interest rates
as legitimate loan profits. These banks also began to
maximize their profits by maximizing loan volume,
abrogating their traditional economic function as
responsible financial pillars of local economies to
ensure the productive allocation of capital. In time,
local banks de-coupled their business self-interest from
the economic impacts of their loans on the local
economies, because they hedged the risk in such loans by
passing it to overseas hedge funds which became the real
loan originators. Western and Japanese international
banks in turn provided funds to the local broker banks
in Asia whose credit ratings were considered acceptable
because the borrowers' exposures were hedged by
instruments designed to transfer risk to other
international institutions. The global overcapacity in
manufacturing is the direct result of this unregulated
financial market.
In effect, the widespread
transfer of business risks into currency risks forced
the governments of the affected currencies to become
involuntary lenders of last resort. This is the real
effect of Hong Kong's and other Asian currency pegs to
the US dollar. China is relatively insulated from the
financial crisis mainly because the yuan is not fully
and freely convertible.
Hedging does not
eliminate risk, it merely passes risk along to other
parties. In fact, complex hedging schemes, with the
effect of reducing the risk exposure of individual
lenders and inflating the credit worthiness of the
hedged individual borrowers, when widely practiced,
actually increase systemic risk exposure, initially of
regional financial systems and ultimately of the global
system. Yet the soundness of financial institutions
continues to be assessed singularly within national
borders, while financial markets have become intricately
linked globally. A poor credit rating seldom means the
denial of credit. It only means a higher interest rate,
which actually attracts more eager lenders who
rationalize that the high risk has been compensated for
by the increased rate.
Through extensive
hedging, private financial risks have been largely
socialized globally. The ingenious layering of
protection against risk, while providing comfort to
individual players, buys such comfort at the expense of
the security of the total global system. At some point,
the strained circular chain breaks at the weakest link
and panic sets in. For Asia, that break occurred in
Thailand on July 1, 1997.
Because of this
circular system of global hedging, the economic crises
in Asia inevitably spread worldwide. The regional
crises, each with unique local characteristics, are
merely early symptoms of a ticking global time bomb
constructed out of the complex calculus of interlinked
financial markets in which countless individual credit
risks are legally masked as sound transactions through
sophisticated hedging. Derivatives, financial
instruments which derive their value from other
underlying financial instruments or benchmarks such as
stock indexes or exchange rates, are the cards in the
fragile house of cards built by a financial specialty
known as structured finance.
International
finance in recent years has been saturated with
disastrous and scandalous abuses that clearly and
repeatedly epitomize the deficiencies of the unregulated
global interlinking of financial markets. Speculators
have been blamed for precipitating the run on currencies
that started the financial crises. Yet speculation and
risk management are two sides of the same coin. At the
opposite end of a prudent hedge, a speculator is
required. Structured finance enables the unbundling of
risk for marketing to different levels of risk takers,
creating the illusion that risk is neutralized when it
is merely distributed imperceptibly throughout the
financial system. In a structurally flawed system,
perfectly honorable businessmen or institutions,
individually normally true to high ethical and financial
standards, can unwittingly participate in systemic games
of dubious value.
Data on the initial six months
of the Asian financial crises show that currency hedging
individually by sophisticated businesses and alert
government bodies, domestic and foreign, as protective
measures against foreign-exchange exposures in both debt
and revenue, had been mostly responsible for the sudden
currency turmoil in the region. In international
finance, a game of musical chairs in financial risk is
in full force in which the players are handcuffed
together through interlinking hedges between parties
unknown to each other. This game can cause serious
systemic rupture when the music stops. Yet world leaders
continue to deny its danger.
A good part of the
responsibility of the Asian financial crises is
attributable to international banks not facing up to
their lender liability, a legal concept holding lenders
liable for damages if they knowingly lend beyond any
borrower's capacity to handle the loan. It is convenient
for Western creditors to point fingers at Asian crony
capitalism and lack of transparency, but such practices,
albeit undesirable, are not unique to Asia and were
certainly not unknown to lenders when the bad loans were
made. Having been permanent cultural features in many
parts of the world, including Asia, such practices
cannot be the direct cause of the region's sudden
financial collapse, any more than its economic success
in the recent past.
Instead of focusing on
correcting the structural defects of the unregulated
globalization of financial markets, IMF rescue packages
have been devious vehicles for wholesale foreign control
of wounded Asian economies. IMF "off the shelf" rescue
approaches have exacerbated the financial crises in
Asia. Moreover, the austerity measures demanded by IMF
economists who are insensitive to local political
realities have turned the economic turmoil into
detonators of political instability throughout the
region.
A fundamental problem in world trade
finance is the excessive weight foreign-exchange markets
assign to the size of a country's foreign-exchange
reserves as an indicator of economic health and credit
worthiness, despite general recognition by economists
that the validity of this yardstick ended with the age
of mercantilism a century ago. Yet, despite claims of
scientific determinism, financial markets are not free
of political bias. And this residual focus on
foreign-exchange reserves is not applied evenly to all
economies. Curiously, the United States, the world's
largest debtor nation (carrying $20,000 of sovereign
debt per capita), with two-thirds of all US currency
being held overseas, with severe budget deficits and a
history of volatile fluctuations in the floating
exchange rates of its fiat currency, is considered the
safest haven from economic turmoil because of its
perceived political stability and the size of its
domestic economy. On the opposite end, Hong Kong, with
its huge foreign-exchange reserves, perennial budgetary
surpluses prior to the Asian financial crises, and zero
sovereign debt, has repeatedly seen its solidly backed
currency under relentless attack in a market
artificially fixed by a peg to the US dollar.
The reason for this is simple. Hong Kong's
linked-exchange-rate mechanism is itself an open
admission of no confidence in its own currency. With a
linked-exchange-rate mechanism, Hong Kong pledges to
exchange Hong Kong dollars at a fixed rate to the US
dollar and holds 110 percent equivalent US dollars in
reserve for each Hong Kong dollar in circulation. This
currency peg requires local interest rates to track US
rates, plus a country risk premium that is determined in
part by the market's view of the economic viability of
the peg rate. That viability has no economic basis. It
is based entirely on arbitrary political will. Thus, the
wider the gap between the official exchange rate and the
market's judgment of the economic value of the HK
dollar, the higher would be the cost of maintaining the
peg. The Hong Kong government also holds most of its
foreign exchange reserves in US dollar denominated
instruments, in excess of its trade-weighted needs.
These arrangements represent a loud and clear
declaration that the US dollar is a sounder currency
than the Hong Kong dollar. One can expect such a
discriminatory attitude from the former British colonial
government, but one is at a loss to understand why a new
Hong Kong SAR under Chinese sovereignty would feel the
need to hang on to such a self-defacing political
posture. Hong Kong should be reminded that the US
dollar, despite unjustified perceptions of its
soundness, is only as solid as the true state of the US
economy at any given time, and at this moment it is not
very sound.
In 1995, after the US Federal
Reserve started to increase interest rates in 1994 and
sharply curtailed its own purchase of treasury bills,
triggering the Mexico peso crisis and a subsequent US
slowdown, the Bank of Japan initiated a program to buy
$100 billion of US treasuries. China bought $80 billion.
Hong Kong and Singapore bought $22 billion each. South
Korea, Malaysia, Thailand, Indonesia and the Philippines
together bought $30 billion. The Asian purchase totaled
$260 billion from 1994 to 1997, the entire increase in
foreign-held US dollar reserves. These recycled dollars
pushed up stock prices in the US, forming part of what
Fed chairman Alan Greenspan referred to as "irrational
exuberance".
A sharp correction of the stock
markets accompanied by an abrupt slowdown of the US
economy was a matter of when and not if, and it began in
late 2000 with the bottom nowhere in sight. Also, the
euro will pose a direct challenge to the US dollar as
the preferred currency for international trade. The
financial world is in the process of shifting from a
dollar-centered system to a bipolar dollar-euro system.
Just like the postwar corrections in US markets in
1971-73, 1978-79, 1985-87, which critically stalled the
US economy because the contributing currency
overvaluations were permitted to go too far and for too
long, the coming correction which has apparently finally
begun after much delay, will have equally if not more
severe adverse economic consequences.
This means
that when the Asian economies finally are working
themselves out from the damages of the crises that began
in 1997, the US economy stalls and the US dollar falls
in value, ending the US as a market of last resort and
the dollar as a safe haven investment. Five years after
the 1929 crash, US president Franklin D Roosevelt was
forced in 1934 to ease monetary policy through a 59
percent devaluation of the US dollar against gold.
The global financial crises that began in Mexico
in 1995 and hit Asia in 1997 were not mere passing
storms or cyclical phases. They are the opening acts of
a historic restructuring of the global economic system
in which the stakes are very high. Economic
globalization requires enlightened nationalism to keep
it fair and just. China has shown signs that it is
becoming aware of this fact. Hong Kong as part of China,
despite the peculiar "one country, two systems"
arrangement, cannot be independent of Chinese national
interests.
Henry C K Liu is chairman
of the New York-based Liu Investment Group
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