Saturday, March 01, 2008

Hong Kong's Inflationary Boom

The preliminary numbers for Hong Kong GDP during the fourth quarter of 2007 and for 2007 as a whole was recently released. It contained both good news and bad news for Hong Kong. The good news is that real growth remains high. During the fourth quarter, volume GDP growth was 6.7% and the terms of trade adjusted real growth number was even higher, 7.1%. Both private consumption and fixed investments increased by over 10%, while the trade surplus fell somewhat. Meanwhile, government consumption fell back to a new low of just 8% of GDP.

Thanks to a lower burden of government spending combined with soaring tax revenues, the Hong Kong budget has a record surplus of 116 billion Hong Kong dollars (roughly 15 billion U.S. dollars or slightly less than €10 billion) or more than 7% of GDP, which will now be used for tax cuts as well as some temporary spending projects.

While much of this success is attributable to Hong Kong's laiseez faire policies with low taxes, low government spending and light regulation, it should be cautioned that there is also a darker side of this boom, which are likely to cause future problems.

Hong Kong has pegged its dollar to the U.S. dollar, and this means that Hong Kong is forced to follow Bernanke's extremely inflationary policies. This has caused rapid increases in house prices and it is also evident in soaring consumer- and producer price inflation. As late as 2006, the price index known as the GDP deflator was falling and during the first quarter of 2007, the year over year rate of increase was just 1.2%. In the fourth quarter of 2007 it was 4.7%. Real growth has been in the neighborhood of 6-7% per year since 2005, but the difference is that price inflation and nominal growth is much higher now.

These inflationary excesses could have been avoided or minimized if Hong Kong would have ended its irrational U.S. dollar peg. And they should and could still do it in order to limit the build up of further inflationary problems.


Blogger Flavian said...

I do not know too much about the opportunities to hold bank accounts denominated in foreign currencies or precious metals in Hong Kong, but if it is allowed it is an important fact there is no capital gains tax in Hong Kong.

So if you bought 1000 euros for the price of 7.800 Hong Kong dollars and you sell those euros today for about 11.700 Hong Kong dollars all the "profit" is yours. To buy and sell foreign cash is of course legal.

The absense of a capital gains tax makes it much easier for people to hedge against inflation. In addition to that interest earnings are exempt from taxation altogether.

Just by allowing people to open up bank accounts denominated in any currency or precious metal, if that is not already the case, the government of Hong Kong would open up great opportunities for it's citizens to hedge against inflation.

In that case, we might see a situation where there is a spontaneous and unofficial shift away from the US dollar and it's satellite, the Hong Kong dollar.

1:10 PM  
Blogger Flavian said...

Look here:

1:15 PM  
Blogger Flavian said...

A spontaneous shift away from the icelandic krona can be observed on Iceland.

People prefer euros.

So in Hong Kong we might see a shift to yen, euro and gold.

11:59 PM  
Anonymous Anonymous said...

In one of your previous posts you stated the weak dollar is good, as it gets rid of imbalances? However, isn't the dollar still being severely overvalued? Plus, isn't a dollar crash inevitable if the US continues its horrible fiscal and monetary policies?

7:45 AM  
Blogger stefankarlsson said...

Anonymous: yes and yes....

10:29 AM  

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