Hong Kong's U.S. Dollar Peg Fuels Inflation

Interesting article about how Hong Kong's peg of its currency to the U.S. dollar creates increasing problems now that Helicopter Ben decided to inflate even more than before.

Already before the decision, Hong Kong's economy was booming with 7% GDP growth, a booming stock market and booming house prices. While Hong Kong's fundamentals are mostly very strong with its low tax and government spending and laissez faire principles, some of the boom was related to extremely fast money supply growth. As late as 2005, money supply growth was just 5%, but the latest figures show it accelerating to more than 25%.

With this in mind, Helicopter Ben's rate cut couldn't have come at a worse time. In order to maintain the peg, Hong Kong was forced to implement its own rate cut, which is going to make inflation a lot worse in Hong Kong. At first, the effect has mainly been to raise stock prices, which was already boosted by the Chinese governments decision to allow mainland citizens to invest in the Hong Kong stock market. Ultimately though, this will spread to consumer prices. The Financial Times notes the redistributive effects of this:

"Even so, the financial secretary now says “the spectre of inflation” is one of his greatest concerns, and in particular its impact on the poor.....

...the poor bear the brunt of any cost-of-living increases while those better-off enjoy returns from soaring values of property and financial assets."

The only sensible thing would of course be to end the peg. There is no logic for Hong Kong to peg its currency to the U.S. dollar. If its main priority is to hold back inflation, they would peg it to gold. If their main priority was to increase trade, they would peg it to the yuan (and ultimately once the yuan become fully convertible, abolish the Hong Kong dollar and have a monetary union with China), as Hong Kong's trade with China is 5 times larger than its trade with the United States-a multiple that is rapidly increasing.

As long as it stays, significant asset price inflation is likely especially if Helicopter Ben continues to cut interest rates. That from an investment point of view means that the Hong Kong stock market will continue to provide good returns, especially with the likely continued large inflow of Chinese investment capital.

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