Hong Kong's Inflationary Boom
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.