Sunday November 21 2010

Basket weaving can benefit Hong Kong

Philip Bowring

Can the highly paid people at the Hong Kong Monetary Authority, headed by Donald Tsang Yam-kuen's next-of-bureaucratic-kin Norman Chan Tak-lam, start thinking of some real policy options, rather than parroting media headlines and Beijing complaints about a 'wall of money' threatening Hong Kong, allegedly because of the new round of quantitative easing by the US Federal Reserve?

I hold no brief for Ben Bernanke but the fact is that, over the past year, US money supply expanded by a measly 3 per cent. The quantitative easing has been in the face of very weak credit demand by the private sector - a natural consequence of the pre-2008 credit binge. Meanwhile, China's equivalent has been expanding at over 19 per cent following a 30 per cent gain last year as interest rates have been held at exceptionally low levels despite strong growth in the economy, which is generating inflation of 4 per cent compared with 1 per cent in the US.

The hot money which has flowed into Hong Kong has mainly been into the higher end of the property market, almost all from the mainland - a natural consequence of the ease of credit. Hong Kong's own money supply has risen by a solid but unalarming 8 per cent. Elsewhere in Asia mini-bubbles have appeared but, again, more the result of the surge in their commodity export prices and the arrival of mainland property investors than Bernanke's doing.

The bleating from Beijing, echoed by its faithful servants in Hong Kong, is a smokescreen for the fact that credit excesses and now inflation surge are the direct and predictable results of a policy designed to keep its currency undervalued and interest rates abnormally low both to gain global market share and as a nationalist reaction to US pressure for currency realignment.

China also claims that the 1985 Plaza Accord which realigned currencies, notably those of Japan and Germany, did no good but caused the subsequent Japanese bubble. In fact, the realignment caused the US current account deficit to fall from more than 3 per cent to less than 1 per cent. Japan's problem was caused by the failure of easy money policy to stimulate domestic demand in an economy riddled with anti-competitive rules.

But at least the current exchange rate rows and uncertainties should again raise the issue of whether Hong Kong should have a peg and, if so, be pegged to what. I am not against pegs. A few months before the panic pegging in 1983, I wrote an article favouring one. But I believed that a peg to a basket of currencies, not a single one, was appropriate - and proposed the IMF's unit of account, the special drawing right.

Today, most assume that the peg will eventually be shifted, and perhaps sooner than you expect, from the dollar to the renminbi. But why? Even assuming that the renminbi does become fully convertible, it will be a very long time before it can begin to rival even the yen and the euro, let alone the dollar, as a trading medium and store of value. So, in the interests also of maintaining a separate currency appropriate to its trading status, Hong Kong needs to opt for a basket. A big help towards this could be the recent establishment by the Chiang Mai group comprising China, Japan, Korea and the 10 Asean countries of a weighted voting system which can also be used as a currency basket. Use that for half the Hong Kong dollar weighting and the SDR for the other half, and Hong Kong would have a currency as readily defined as the dollar, and inherently stable. It would also provide reason for Hong Kong to diversify its reserves.

Surely if little Singapore can successfully operate a managed float for its currency, requiring ongoing decisions, the world's highest paid central bankers should be capable of operating a mechanistic, transparent and predictable currency basket and an interest rate regime which reflects the basket's components. Simple arithmetic.





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