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HONG
KONG IN FLUX
Pegged
down
By Henry C K Liu
Part 1: Compradore
no more
After the demise of political
imperialism in the world, capitalism manages to gain
another new lease on life through the transformation of
the newly set-up socialist planned economies into
capitalist market economies via the expansion of world
trade. Some political economists view unbalanced and
unregulated world trade as a new form of economic
imperialism, benign in appearance, rationalized under
the laws of neo-classical economics that hold sacred the
principle of marginal utility to maximize return on
capital and the operational dynamics of free markets
that favor the strong and perpetually condemn the weak.
These precepts, far from universal truth, were
merely US national opinion, giving the US an inherently
unfair advantage against the capital-starved and
ill-equipped Third World. The international division of
labor as currently constituted in globalization has been
driven by wage competition between countries with a
race-to-the-bottom effect. Countries also compete to
reduce taxes, welfare benefits, environmental protection
and trade regulations in the name of efficiency in a
global market economy.
Technology, lowering the
cost of communication and managing complexity, now
allows central control of highly decentralized
operations worldwide. Trade and foreign investment have
pre-empted economic development and aid as the main
paths for undeveloped nations to modernize and to
prosper. Yet globalization of trade and finance has its
critics in both developed and developing countries, but
for different reasons.
In theory, free
international movement of capital through integrated
financial markets in a global economy allows efficient
allocation of funds toward investments of highest
productivity. But truly free markets do not exist in the
real world and, even if they do, they operate under
narrowly single-dimensional rules and historical biases,
all of which aim toward maximizing return on capital
without due regard for local social, political or
environmental consequences or individual national
aspirations. Moreover, global financial market pressures
tend to supplant the traditional roles local political
leaders and government institutions play in formulating
macroeconomic policies that safeguard individual
national interests.
Despite all the noise the
United States makes about the benefits of world trade,
US exports of US$564.7 billion (FOB, or free on board)
constitutes only 7.6 percent of its gross domestic
product of $7.6 trillion (1996) and US imports of $771
billion (CIF, or cargo, insurance and freight)
constitutes 10.1 percent of GDP. Export to all of Asia
amounts to only 2.4 percent of its GDP, of which Japan
constitutes 1 percent. The US claims 12 percent of total
world trade, Germany 9 percent. Japan 6.25 percent,
China 4.1 percent and Hong Kong 2.5 percent. Thus, the
US can sustain a strong bargaining position in setting
the terms of trade on a take-it-or-leave-it basis. In
contrast, Hong Kong's exports of $197.2 billion
constitute 121 percent of its GDP of $163.6 billion
(1996), and Hong Kong's imports of $217 billion
constitute 130 percent of its GDP. It is obvious that a
rupture in world trade would impact Hong Kong
differently than the US. While Hong Kong has no viable
alternative to total dependence on trade, it should bear
in mind that it is now part of China, and that Hong
Kong's national interest is part and parcel of that of
China, where the issue of trade policy in relation to
national independence has not been definitively
resolved.
Excessive reliance on world trade may
not be in a country's best national interest, simply
because national governments are forced to surrender
their power to manage their economy to world market
forces, or international trade institutions and
agreements. It is an argument put forward not only by
the developing nations, but also by isolationists in the
United States, with sufficient public support to deprive
several US presidents of "fast track" authority to
settle international trade disputes.
When
capital is mobile, governments are able to enjoy the
benefits of fixed-exchange-rate stability only if they
are willing to forgo the empowerment of managing their
economies through the setting of domestic interest rates
and the supply and liquidity of money, the potent tools
of monetary policy. This means that when global capital
flows into a country, local interest rates will fall,
sometimes to negative rates, distorting the orderly
development of the affected economy. For example,
beginning in the mid-1980s, Hong Kong's
linked-exchange-rate mechanism created persistent
negative local interest rates, causing abnormal
investment flows into the property sector, resulting in
unrealistic and unsustainable asset and price inflation
that became a major problem in the subsequent downturn
in 1998.
Conversely, when investors begin to
pull out of a country or sell its currency, local
interest rates will have to rise to counter the flow in
order to maintain the exchange-rate peg. This invariably
distorts and weakens the banking system and the
financial markets, eventually causing bank failures and
corporate bankruptcies. This happened to Hong Kong in
October 1997, with disastrous long-term consequences
that are yet to unfold fully. Hong Kong will be plagued
by excessively high real interest rates until the
linked-exchange-rate mechanism is abandoned or until the
US dollar falls. There will be no sustainable long-term
economic recovery for Hong Kong until the Hong Kong
Monetary Authority (HKMA) regains its power to set
monetary policies, and not allow the US Federal Reserve
to dictate monetary policy for Hong Kong.
Pegging a currency's exchange rate to another
currency does not automatically make an economy more
stable. If domestic economic policies are inconsistent
with the chosen exchange rate, a fixed rate can itself
lead to instability. Small economies with less
sophisticated financial markets face greater risk from
opening to international capital. Sudden capital flight
can create economic havoc, as in the European currencies
crises of 1992-93, in Mexico in 1994 and in Thailand in
July 1997. In the last quarter of 1997, institutional
panic caused an abrupt drop of private capital flow, in
excess of $100 billion, to the five most affected
countries: South Korea, Indonesia, Thailand, Malaysia
and the Philippines. South Korea alone saw its capital
flow drop by $50 billion as compared with 1996.
And contagion effects can hit countries in an
economic region and eventually the entire global system.
As the economies of the lending nations contract, banks
will withdraw urgently needed funds from other healthy
economies where liquid markets still operate, thus
forcing the healthy economies to collapse. This happened
to the Hong Kong market in October 1997. It will happen
again and again before recovery is in sight. The impact
of Japanese banks retrieving capital from other
countries, including the United States, is very direct.
Japan has been in a prolonged phase of serious
deflation. The dollar will continue to fall unless US
interest rates rise, which in turn will cause the US
economy to contract more, which will push down the
dollar further.
To ensure a smooth transition,
the Hong Kong Special Administrative Region (SAR)
government has continued the policy of ensuring currency
stability through linking the Hong Kong dollar to the US
dollar at an exchange rate of 7.8:1 within a narrow
range. The policy was adopted in 1983 by the previous
British colonial government to encourage stability and
investor confidence in the politically contentious
run-up to Hong Kong's reversion to Chinese sovereignty.
As part of the high degree of autonomy granted to the
Hong Kong SAR government on all issues except foreign
policy and national defense, Chinese officials have
since declared their support for this monetary policy.
Under the leadership of the chief executive and the
policy responsibility of the financial secretary,
authority for maintaining the exchange value of the Hong
Kong dollar, as well as the stability and integrity of
the financial and monetary systems, rests solely with
the HKMA, not augmented by any multiple-exchange-rates
structure or any foreign-exchange control.
Under
the linked exchange rate, the global exchange value of
the Hong Kong dollar is influenced predominantly by the
movement of the US dollar against other currencies. Thus
the price competitiveness of Hong Kong exports and
services is affected in large part by the value of the
US dollar in relation to third-country currencies. For
the 14 years prior to 1997, the policy of linking the
exchange rate to the US dollar served a British Hong
Kong by insulating it from politically induced monetary
instability in the latter part of the Cold War, albeit
not without economic costs to the local economy. The
linked exchange rate requires that Hong Kong interest
rates generally track US interest rates. Hong Kong's
high inflation meant that savers in Hong Kong faced
negative real interest rates, forcing them to invest in
real estate. Yet the benefits of stability, coupled with
a high-growth Chinese economy and the boom economies of
the Asia-Pacific region, had justified the economic
costs for Hong Kong in the decade before 1997.
The economic fundamentals facing Hong Kong now
are structurally different. It is now clear that the SAR
can no longer afford the economic costs associated with
an artificially high (or low) currency linkage, in view
of the unfolding restructuring of all other economies in
the region, and the benign political climate in Hong
Kong resulting from China's non-intervention policies.
The argument that de-linking the currencies will cause
institutional investments to flee Hong Kong is
increasingly inoperative. The fleeing, in the form of
massive selloffs in the stock market, is now caused by
inoperative interest rates necessitated by the
artificial currency linkage. Hong Kong as a whole can
surely weather the unavoidable pains of this complex
regional economic restructuring which, while
precipitated by speculators, have been caused by
economic disparities created through years of government
policies in the region. The adverse impacts, while not
permanent, will not be short-lived, although Hong Kong,
because of its special relationship to China, may be
among the first economies in the region to recover if
its leadership has the foresight to adopt the right
policies. Even then, the resultant contraction may take
years to work through. Hong Kong's considerable
foreign-exchange reserves may be more beneficially
utilized on programs that build long-term
competitiveness than on defending an obsolete monetary
policy that lowers competitiveness. Macro-management of
the economy requires a macro-perspective, beyond being
fixated on an artificial exchange rate.
Moreover, the SAR government has a
socio-political responsibility to ensure that its
crisis-management measures distribute the economic pains
fairly among all segments of the population. A case can
be made that an obstinate currency linkage benefits
mostly those with low-interest US dollar debts, namely,
Hong Kong's large corporations and developers, at the
expense of the local population, which borrows in
high-interest Hong Kong dollars.
Press reports
until most recently have persistently reported that
China is opposed to de-linking the Hong Kong dollar from
the US dollar. The underlying logic attributed to the
alleged Chinese position is that decision makers in
Beijing are apprehensive of possible resultant
instabilities from de-linking and the adverse economic
impact on Hong Kong's and China's economies, which are
closely linked. Regardless of the reliability of these
reports, the validity of such apprehension can be
challenged by sound analysis.
Hong Kong prides
itself on being a free-market economy. Yet with regard
to its currency, Hong Kong strangely clings to an
obsolete exchange rate that has become markedly
unresponsive to market forces. A free-floating Hong Kong
dollar will have a number of positive effects on the
Hong Kong economy with minimum disturbance in the local
price structure. It will improve the price
competitiveness of Hong Kong goods and services in world
markets, lower the cost of doing business in Hong Kong
and attract new international capital to Hong Kong
because of its enhanced local purchasing power. A
free-floating currency will reduce interest rates on
local currency loans, thereby stimulating the stagnant
local economy. It will moderate the real inflation rate
in Hong Kong in global terms without requiring drastic
reductions in local prices.
It will revive the
depressed Hong Kong tourist industry without subjecting
it to destabilizing price cuts. It will encourage
localized savings by eliminating the surrealistic
phenomenon of negative real interest rates. It will
encourage localized corporate and personal expenditures
through the increased cost of foreign goods and
services. The hefty Hong Kong foreign-exchange reserves
will also increase in local-currency terms while
suffering no decline in real value.
To be sure,
despite all the benefits, there are transient detriments
in de-linking the Hong Kong dollar. Existing
US-dollar-denominated debt would experience an increase
in the cost of debt service and amortization. But Hong
Kong has no public debt, except infrastructure debt held
by quasi-public authorities. Indebtedness from
infrastructure improvements is serviced by user fees
that can be increased in local-currency terms without
fatal pain to the public and without altering Hong
Kong's price competitiveness in world markets, since
this debt has been structured on a fixed exchange rate
tied to the US dollar. Hong Kong's foreign-exchange
surplus will moderate temporarily, but if the Hong Kong
dollar reflects its true market value, there will not be
any compelling need for a large foreign-exchange reserve
to support a monetary policy that ignores market forces.
Property values will drop in real terms but an
asset-value deflation through exchange-rate fluctuations
is less damaging than a direct decline in local prices.
In any event, most analysts agree, including those in
government, that Hong Kong property values are
over-inflated.
The confidence factor is a
red-herring. International confidence will increase in a
Hong Kong flexible enough to deal intelligently with new
realities rather than being incapacitated by blind
adherence to obsolete policies.
Private debts
are worrisome. There does not appear to be a painless
way out. Some 40 percent (more than US$50 billion) of
the outstanding bank debt is issued to companies
purchasing or developing property. Much of this debt ($7
billion, the highest in Asia except for Japan) is in the
form of convertible bonds that do not appear on the
borrower companies' balance sheets. Convertible bonds
require the debtor to repay the investor if the shares
of the issuing company fall below a pre-fixed level
while they give the investor the right to convert the
debt into company shares if the price increases to a
level the investor finds attractive.
Persistently high local interest rates will
force these companies into financial difficulties if not
eventual bankruptcy. Banks and the property sector
account for half of Hong Kong's stock-market
capitalization. Still, the prospect for a soft landing
may be better with a currency de-linking than a drastic
collapse in local prices, because with currency
de-linking, the economy receives compensatory
stimulation through lower interest rates and lower
costs, which in turn may provide borrowers with
sufficient cash flow to service foreign currency debt at
higher exchange rates.
Hong Kong's prosperity
came from the opportunistic response to Cold War
peculiarities. It profited from the US embargo on China
during the Korean War and the Vietnam War. With the
opening of China since 1978, Hong Kong has benefited
from the China market.
Hong Kong promotes itself
as a world city. Yet nobody goes to Hong Kong to see the
world. People go there as a stopover to see China. The
warning of former chief secretary Anson Chan
notwithstanding, Hong Kong is a Chinese city, although
not all Chinese cities are alike.
As the economy
of Hong Kong changes, new elites will emerge. The old
compradores represented by Robert Ho Tung were replaced
by a wave of Chinese national bourgeoisie after World
War II, who brought to Hong Kong their know-how on
labor-intensive manufacturing, such as textile and toys.
Then the British, who owned all the land, engineered the
property boom, creating a docile and collaborative group
of property tycoons as the new compradores. During the
Cold War, the US controlled the Hong Kong economy
through its trade quotas.
The future of Hong
Kong will belong to the new wave of Chinese enterprises
from the mainland. Each wave on arrival was despised and
discriminated against by the establishment. Hong Kong
wasted five years with its fixation on being a world
city on the doorstep of China, rather than being a
Chinese city with a special window to the world. China
has now surpassed Japan as the largest investor in Hong
Kong. The number of mainland Chinese enterprises
registered in Hong Kong has topped 2,500, with total
assets valued at about US$40 billion. The Bank of China
is now the second-largest banking group in Hong Kong
after HSBC. Hong Kong's future depends on how it can
serve the Chinese economy constructively, and not as a
compradore serving foreign interest.
Hong Kong
helping the Pearl River Delta? What a joke. Hong Kong
needs to shed its air of superficial superiority and its
schizophrenic attitude toward Guangdong province, its
bigger brother. Exorbitant projects such as airports and
tunnels that enriched monopolistic British firms have
left Hong Kong with a bloated transportation system with
critical bottlenecks that poorly connect to the Pearl
River Delta.
Hong Kong cannot be the Switzerland
of Asia. Switzerland is an independent nation and
politically neutral historically. Hong Kong cannot be a
New York. New York is part and parcel of the US economy.
"One country, two systems" defines Hong Kong as external
to the Chinese economy. Hong Kong cannot be a Shanghai
because Shanghai is part and parcel of the Chinese
economy. The Hong Kong government untiringly defends
itself against criticism by pointing to external
problems. Yet all problems facing Hong Kong, or any
other country, are external problems. The government
cannot afford to take the position that it is powerless
to deal with external problems as they impact the
territory.
Hong Kong faces a severe identity
crisis. The economic downturn has exposed structural
problems in the economic system. Often lauded as the
bastion of freewheeling capitalism, the city has a
surprisingly closed economy. A handful of powerful
banks, holding companies and property developers control
key markets, driving up prices for everyone else. Hong
Kong will have to reinvent itself, weaning itself away
from its disproportionate reliance on property.
Hong Kong has always been run by and for its
commercial interests - first the British trading houses,
or hongs, and lately the Hong Kong tycoons. The bottom
line is that Hong Kong's economy is intimately tied up
with the government. The most obvious example of that is
the real-estate sector. The billionaires are rich
because of property development, the proceeds of which
have also filled the government's coffers. Although this
keeps taxes down - less than half of the populace pays
any salary tax at all and few pay the top rate of 15
percent - high rents form an oppressively high levy,
which squeezes consumers and small and medium-sized
businesses.
Even as property values dropped 60
percent since 1997, the high cost of real estate means
Hong Kong firms have a tough time competing with
regional neighbors, and increasingly that includes
southern China. Hong Kong companies, large and small,
have thus far found only one sure answer: move north.
Smaller firms relocate lock, stock and barrel to
Guangdong. Larger ones, such as Cathay Pacific and HSBC,
have moved back-office activities to Shenzhen. The
migration south from China into Hong Kong of the past 50
years is going into rapid reverse.
Finally, the
unemployment problem cannot be solved by market forces.
Hong Kong does not have unemployment insurance. Thus a 9
percent unemployment rate is much more serious in Hong
Kong than in the United States. Hong Kong has the means
and the need to institute a full-employment government
policy; what it needs is political courage.
In
US politics, the second and final term of a presidency
is a time for bold programs, unless the administration
is crippled by scandals. Hong Kong's chief executive,
Tung Chee-hwa, will have a window of opportunity of
three years before the lame-duck syndrome sets in. It is
a sure bet that the global economy will not recover
within the next three years, and quite possibly will
fall into a financial abyss. Hong Kong cannot afford to
wait for the US economy to recover or for a sudden
growth in world trade. It must find a useful role in the
building of China's domestic economy. There is no other
option.
Henry C K Liu is chairman of
the New York-based Liu Investment Group.
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