Peg puts question of consumer price index rise out of the equation

PUBLISHED : Wednesday, 25 August, 2004, 12:00am
UPDATED : Wednesday, 25 August, 2004, 12:00am

'While I deliver a piece of good news that we will have turned the corner on deflation and the general consensus of economists is that a healthy dose of inflation is good for the economy, I certainly do not want to see (the increase in CPI to become) too fast or too big. It will put pressure on the other end. So it still remains a challenge for us.'

Henry Tang Ying-yen Financial Secretary

Let us get something straight here. The last time inflation was a challenge for any financial secretary in Hong Kong was 20 years ago and Mr Tang's predecessor at that time thought it too much of a challenge. He gave up. He linked the Hong Kong dollar to the US dollar through a formal currency board arrangement.

I know that it cannot go down well for the standing and authority of a financial secretary to admit that there is nothing he can do about the local rate of inflation but this is a fact and has been since 1984. The peg determines whether our consumer prices go up or down. The only way Mr Tang could ever have a say in it is if he were to scrap the peg.

Think about it. If either he or Joseph Yam Chi-kwong at the Hong Kong Monetary Authority would like to exert some influence on our rate of inflation then they would need tools of monetary control at their disposal. They would have to be able to control the amount of liquidity in our financial system and be able to set interest rates.

But they can do neither. When people bring US dollars to Mr Yam and say they want Hong Kong dollars in exchange he has to give them those Hong Kong dollars at a rate of HK$7.80 to the US dollar. He has no authority in this at all. The rules of the peg require him to do it. We may call him our central bank chief but in these matters he is little more than a central bank technician.

We had an example of it only last year. There was a big inflow of foreign money starting in September after the Sars crisis was over and it forced Mr Yam to flood the market with HK$55 billion. The result was a short-term monetary bubble that pushed up the property and stock markets and briefly gave great joy to mainland interests looking to tap Hong Kong for easy money.

That bubble came to an end in April this year and, as if on command, the sudden joy in the markets evaporated almost overnight. There was nothing Mr Yam or Mr Tang could do about it. They certainly could not manipulate interest rates to stop it from happening. Our borders are open to capital flows. That is another requirement of the peg and if you decide that you like US dollar interest rates more, you are free to exchange Hong Kong dollars for US dollars, the reverse if you like Hong Kong rates more.

With the peg in place you run no currency risk in making your decision about this. Thus it is you who decides what interest rates will be in Hong Kong. If you choose to take your money out then rates will rise relative to US dollar rates and if you bring your money in then rates will fall. That is the way the peg works and the result is that our interest rates closely track US dollar rates.

So let us not have this talk about inflation being a challenge for us or, at least, let us not have it from Mr Tang as if inflation were more of a challenge for him than it is for you or me. He is no more important in this equation than you or me. No financial secretary has been since 1984.

Let us also not have this talk about how deflation came to an end only last month. That is the way it has been touted everywhere but the fact is our prolonged bout of deflation ended in August last year. As the chart shows, since that time the trend of consumer prices has been up.

All that happened this week is that the consumer price report for last month came out and it showed that prices were up on a percentage year-on-year basis too, which may be the way we commonly look at inflation but is far from being the definitive measure of it.

And, finally, let us be a little wary about this talk of how prospects for our economy are bound to improve now that we have inflation again. We may be singing a different tune in a year or two if the trend continues up. It would, in fact, be the lament we always sang about inflation before 1998. I do not like paying more for everyday goods. Do you?