The discovery of the platypus in Australia created something of a dilemma for
zoologists. Some said that as a furry warm-blooded animal the platypus should
be classified as a mammal: others held that because the platypus reproduces by
laying eggs then it should be classified as a bird or a reptile. The solution
was to create a new classification especially for the platypus.
Hong Kong is also in a class of its own as a monetary platypus which uniquely
has no Central Bank as a lender of last resort. Supervised by the Hong Kong
Monetary Authority, Hong Kong's banks clear payments among themselves
"real-time".
Hong Kong is also a fiscal platypus, uniquely gathering a large
proportion of government income from the use value of land. Very few countries
have used land rental value as a fiscal basis to the same extent as Hong Kong,
and those few which have - such as Denmark - have typically levied a local tax
on land rental values.
Hong Kong gathered income through the creation and sale of long leases of
public land. The resulting "Crown Rentals" collected from property developers
had the effect of reducing the amount of taxation to be collected from Hong
Kong's entrepreneurial businesses and citizens. However, over the years the
amount raised from the sale of long leaseholds has been reduced considerably -
to the advantage of developers - through decreasing the discount rate applied
in calculating the lease premium.
Evolution
Hong Kong is, like the platypus, an evolutionary oddity, with a track record of
rapidly evolving its monetary and fiscal architecture in response to external
circumstances. This is due in no small part to an extremely flexible and
talented cadre of officials in the relevant policy making institutions.
From 1935 to 1972 the Hong Kong dollar was pegged to sterling through a
currency board arrangement, but the US dollar gradually supplanted sterling as
a global reserve currency, and in late 1974, after a brief flirtation with a US
dollar peg, Hong Kong let the local dollar float against other currencies
without any formal intervention.
Since 1983, after a crisis in confidence, the Hong Kong dollar has once again
been pegged to the US dollar within the Linked Exchange Rate System (LERS),
which has two mirror image - strong side and weak side - defenses against
capital inflows and outflows.
Strong side defense at 7.75 HK$: upward pressure on HK$ > Currency Board
sells HK$ > monetary base expands > interest rates fall > downward
pressure on HK$.
Weak side defense at 7.85 HK$: downward pressure on HK$ > Currency Board
buys HK$ > monetary base contracts > interest rates rise > upward
pressure on HK$.
Decline of the dollar
The US Federal Reserve Bank responded to the credit crisis in 2008 by reducing
dollar interest rates to zero, and by printing trillions of dollars and using
them to buy financial assets. These monetary policies have had two adverse
effects on Hong Kong.
Firstly, risk averse investors - not speculators in search of a
transaction profit - have been making financial purchases of commodities using
vehicles such as Exchange Traded Funds. These inflation hedgers have perversely
caused the very inflation they sought to avoid, and Hong Kong citizens have
been particularly hard hit in respect of essentials such as food and energy
prices.
Secondly, the low interest rates necessitated by the peg have exacerbated
property price inflation. Several international investors take the view that
the Hong Kong dollar is undervalued against the US currency by around 30% and
are placing major financial bets to that effect. In their view, the question is
not whether or not the peg arrangements will be changed, but when; and - the
$64 billion question - to what?
Triffin's dilemma
The economist Robert Triffin identified that where a global reserve currency is
backed by interest-bearing debt - such as the US dollar, and sterling before
that - then the result is that the issuer of that reserve currency will
eventually become unsustainably indebted to the rest of the world.
In order for China to become the global reserve currency, and suitable for a
Hong Kong currency peg, it would mean that China would not only have to cease
its mercantilist export policy but also reverse this into a massive trade
deficit.
Such a cosmic shift in Beijing's business model is sufficiently unlikely that
the well publicized bet of Bill Ackman's Pershing Square Capital - that the
Hong Kong dollar will appreciate and adopt a yuan peg - appears to be an
extremely long shot.
But if Ackman's thesis is accepted that the dollar peg is no longer
sustainable, what other basis for the currency might there be?
The global tidal wave of money in search of a safe haven has forced the Swiss
Franc (CHF) to levels which gravely threaten Swiss exports. The Swiss National
Bank recently surprised the financial world by capping the appreciation of the
CHF against the euro at a level of 1.20 euros. But the innovation which blew
away the speculators was the announcement by the SNB that it would defend the
cap simply by creating CHF and exchanging this money for foreign assets (and
hence currency) without conventionally backing ("funding") this money with
government debt.
The Swiss thereby demonstrated that on the "strong side" they could defend the
CHF against appreciation by printing - or even threatening to print - infinite
amounts of CHF and exchanging these for foreign assets or currency.
The monetary orthodoxy is that this will cause inflation in Switzerland. This
is true only to the extent that the overseas holders of the currency are
permitted to buy Swiss assets such as real property and stocks. Overseas
holders of CHF do not typically spend them on Swiss domestic consumption to
potentially cause retail price inflation.
This unorthodox monetary action by the Swiss blew away the myth that money must
necessarily be backed by debt. The truth is that both central and private banks
are simply middlemen - credit intermediaries - between people and government.
Modern fiat money is backed by the ability to use it to pay taxes, which in
most countries are largely levied upon productive people rather than productive
assets.
A simple but radical monetary and fiscal evolution for Hong Kong now enters the
realm of the adjacent possible: land-based money.
Back to the land
Land backing for bank created money is not a new idea. The remarkable Scottish
gambler and adventurer John Law proposed a land-backed currency for Scotland in
1705, based upon central bank credit creation and backed by loans secured
against leases.
Unfortunately, when he applied his monetary expertise in France in 1719 he
created not only the first recognizably modern central bank - the Banque Royale
- but also the first asset price bubble driven by bank credit. The land rights
owned by his Mississippi Company over a third of the US land mass were not then
worth what they are now, and Law ruined himself and France in the Mississippi
Bubble.
The absence of a central bank in Hong Kong opens up the possibility of a more
direct - "peer to asset" - approach. As freeholder, the government could
declare a new ground rental on the unimproved value of Hong Kong land and then
base the Hong Kong dollar on this value simply through the creation and issue
of credits redeemable in payment for HK$1.00's worth of rental.
The first fiscal effect of this ground rental would be to reduce speculative
development pressure. Secondly, the resulting HK Rental Pool may then be
distributed equally to all Hong Kong citizens as a land dividend. The effect of
this would be of a net fiscal transfer from those with above average exclusive
use of Hong Kong's scarce land to those with below average use.
Finally, under suitable management by service providers and supervision by the
Hong Kong Monetary Authority, this new source of HK public credit would be
available to finance new infrastructure. Such public investment would increase
the ground rental value of the relevant land and enable the public credit to be
retired and recycled out of the increase.
This land dividend would reduce the financial pressure on Hong Kong's poorest
citizens and would do so through a pre-distribution of future wealth rather
than a re-distribution of existing wealth. Properly executed - and Hong Kong's
executive are more likely than most to succeed - this fiscal policy should be
win/win: the rich would in future receive a smaller share of a larger pie.
The monetary effect of a land-based HK dollar would be of a currency with
exchange control hard-wired into it. Overseas holders could exchange the HK
dollar for other value with HK residents and businesses, but they would never
be able to redeem it against HK rentals unless they resided in Hong Kong.
This simple and radical concept of a land-based Hong Kong dollar would see the
evolution of Hong Kong's two monetary and fiscal platypi into a new and
resilient 21st century financial animal, still in a class of its own.
Chris Cook is a former director of the International Petroleum Exchange.
He is now a strategic market consultant, entrepreneur and commentator.
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