Price shocks are painful but good for us

PUBLISHED : Thursday, 24 July, 2003, 12:00am
UPDATED : Thursday, 24 July, 2003, 12:00am

HERE ARE TWO questions for you to put some perspective on the news that the rate of consumer price deflation grew steeper last month, with overall prices down 3.1 per cent from June last year.

(1) When you looked at your electricity bill recently and noticed you had been given a rebate on earlier payments (that is if you are fortunate enough to be a customer of CLP Power rather than Hongkong Electric), did you say: 'How nice. I wish we had this every month'?

(2) When you heard that consumer prices fell by 3.1 per cent last month, did you say: 'How terrible. I hope this ends soon'?

Take your choice. It is one or the other. Personally, I prefer to pay less rather than more for my everyday living necessities but if you like to pay more in order that you can say how wonderful, it is that we have inflation again, well, that is your view and you are entitled to it.

Of course, a simple perspective like this does not encapsulate all of the questions involved. Deflation tends to be associated with moribund economic growth. Everything goes down when the party has reached its end and the hangover of recession sets in. You can then have a hard time sorting out what led to what.

But it does not have to happen that way. In the first quarter of 2000, our consumer prices fell at an annual rate of more than 5 per cent, a steeper decline than at present, but economic growth in that quarter was a 12-year record of 13.6 per cent. Even this year, the first-quarter figures show our economy growing at 4.5 per cent, hardly recession despite a five-year history of deflation.

Hong Kong is a special case and the key to what makes it special is our currency link to the US dollar.

For various reasons, mostly having to do with the fact that our domestic markets are far from as free as we like to tell the world they are, consumer prices rose much faster than they did in the US since the peg to the US dollar was adopted in October 1983.

The reckoning had to be made eventually. If a shirt costs US$20 in New York and the same shirt costs the equivalent of US$60 in Hong Kong, then something has gone awry. Things finally started to go the other way with the Asian financial crisis in 1997-98. Instead of going up, our consumer prices started to go down.

We could conceivably have made that adjustment the other way through a devaluation of the Hong Kong dollar. It is the route most other Asian economies took. It was closed off to us, however. Our currency is pegged. We have had to take the hit entirely through falling consumer prices. But now look at some indicators of how far that price adjustment has gone in certain everyday necessities.

The first chart shows you the consumer durables component of consumer prices in Hong Kong and the US with the indices rebased to a value of 100 for October 1983, when the peg was adopted. It says that if you assume a coffee grinder is priced at $100 in both the US and Hong Kong in October 1983, then by May 1998 the price in Hong Kong had risen to $160 while in the US it was only $125. As of last month, however, the price in Hong Kong had fallen to $115 while in the US it was $116. The adjustment has been made here.

Take another example, housing costs. We have to go outside of the consumer price indices here as they account only for rents and not home prices. But let us assume again a value of 100 in October 1983 for home costs in both Hong Kong and New York State.

As the second chart shows, our official residential price index says the cost of a home then rose all the way from that 100 to more than 1,000 in October 1997 when New York state prices had risen only to 208.

Now, however, these indices show the Hong Kong residential price fell to a level of 346 as of April, while the New York price continued to rise and stood at 328. That was the state of affairs as of three months ago and I would be surprised if the difference had not been eliminated by now.

These price adjustments may be a painful process but we will be the better for them in the end - and the end approaches. Meanwhile, I continue to prefer paying less rather than more.