The Inflation Beast

The recently announced CPI headline figures appear mild enough, registering a year-on-year increase of 3.5 percent in the latest quarter and 2.0 percent in the last year. But if the latter percentage increase is broken down, one would notice that the preponderant portion of price increase comes from basic foodstuffs (7.1 percent) and private housing rental (4.0 percent), the two bare minimum subsistence elements for an average citizen.

For fat-salaried Hong Kong bureaucrats, price increases of this sort may be as insignificant as tipping a restaurant waiter a few more bucks on a daily basis. But for a family that has to scrape together enough dollars and cents to put food on the table and pay rent for shelter, these may be the last straw that breaks the camel’s back. In case bureaucrats forget, 20 percent of Hong Kong’s population live below the poverty line.

Apparently in the eyes of the Secretary for Financial Services, inflation in Hong Kong is nothing to be worried about, as he said in a Legco Q & A session “From a broader perspective, rising inflation pressure is a global phenomenon and the inflation rate in Hong Kong is still mild.” In his answer to a question from Legco on January 16, 2008, he seemed complacent about the possibility of “stagflation” (i.e. a stagnant economy coupled with high inflation) in Hong Kong caused by the U.S. subprime loan mess and consequent economic slowdown or recession.

First let us take a look at Hong Kong’s economic prospects. As David Eldon, former HSBC chairman, points out in his blog, the worrying thing about the U.S. economy goes beyond the subprime loan situation. What might soon come on the scene are a securitized commercial property loan debacle and a credit card securitized debt crisis, with the latter scenario being potentially the ugliest, as credit card debt securities are not backed by any collateral.

With these lurking nightmares still to unfold, the most optimistic of observers would be worried about the unsettling impact emanating from the largest economic locomotive in the world. Needless to say, the places that should worry most are those with an open economy and the U.S. as their major trading partner, and Hong Kong is one of them.

The export situation in Hong Kong apparently does not bode well. For the first 11 months of 2007, domestic exports slumped 21.4 percent year-on-year, while total exports (helped by re-exports) recorded a growth of 8.5 percent. In fact, over the last few years, total exports growth rate has been losing steam: +15.9 percent in 2004, +11.4 percent in 2005 and +9.4 percent in 2006. Going forward, with U.S. consumers tightening their purse strings while struggling with their mortgage and credit card debts, Hong Kong’s export trade, one of her economic pillars, in all likelihood cannot but suffer further deterioration.

One may argue that Hong Kong still has a strong retail and tourism sector to rely on for economic growth. But now with the U.S. and global stock markets (including mainland ones) teetering on the edge of a cliff and the Central government intent on reining in the property market, mainland customers, the main prop of those two sectors, who had previously been enriched by their stock and property speculation, may now be less spendthrift.

Thus expectation that a slower-paced to stagnant economy will eventually emerge thanks to the economic and financial fall-out from the U.S. is not that far-fetched.

As for inflation, it is certainly not a “global phenomenon” as described by our Secretary for Financial Services. The U.S. economy, for one, is clearly headed for recession (if it is not already in one) or at least a period of relatively benign inflation. The same can be said of some European countries. However, the case in Hong Kong tells an entirely different story. Unrelenting price increases in basic foodstuff imports from the mainland, wanton price and rent increases (prevailing and potential) for commercial and residential properties as a result of negative real interest rates and of a rigged land system, expensive energy cost and hiked utility rates and public transport fares, all presage a higher-than-normal inflation rate going forward.

The already heated property market in Hong Kong is likely to be further stoked by near-zero interest on savings and abnormally low mortgage rate, as local banks mimic every interest rate cut made by U.S. banks albeit the two economies are on divergent course, thanks to the pegged exchange rate which the SAR administration never had the guts nor vision to unhinge. That surging property prices and rents will push consumer prices further up is a foregone conclusion. A déjà vu indeed.

One does not need to be an economist to know that general price inflation is particularly hurtful to those with low and fixed income. But for self-serving pro-rich SAR government officials, inflation may be more of a blessing than a curse, as it hurts the poor but not the rich and so there is no need for government to lift a finger. Governments in economically advanced countries on the contrary always put fighting inflation on the top of their agenda, as they know very well that it is the poor and vulnerable who deserve help most. The latest evidence can be found in the European Central Bank president’s decision not to follow the U.S. Federal Reserve Bank to cut interest rates, as he is committed to fighting inflation. But the SAR government will hide behind the pegged exchange rate system and say there is nothing they can do to tame inflation.

Perhaps “stagflation” is a real threat to Hong Kong’s economy after all. While Eldon cautions Asia to be prepared for whatever storm that might be coming, Hong Kong bureaucrats are obviously unperturbed by what worries Eldon.