Invest your savings to beat inflation

PUBLISHED : Monday, 11 February, 2008, 12:00am
UPDATED : Monday, 11 February, 2008, 12:00am

Inflation risks are on the upside IMF staff report on Hong Kong,

February 2008

Indeed they are. Almost every forecasting indicator of inflation says that our rate of inflation will go higher, and possibly much higher, over the course of this year.

We have imported inflation from right across the border and from most of our Asian neighbours, we have a peg to the US dollar, which is forcing down our interest rates at just the time that we might otherwise want to see those rates higher and we can do nothing about it. Inflation in Hong Kong is headed up.

But need this be all risk? Might there also be some possible benefit to derive from it?

I think there is. Inflation will not only drive up consumer prices. It will also force up the prices of Hong Kong dollar-denominated investment assets. To protect yourself from rising consumer prices, put your investment savings into an asset that stands an excellent chance of rising even faster in price than consumer goods will.

What I have in mind is property. Fixed-income investments are certain to undermine the value of your money in this inflationary environment and our stock market is now overly weighted to mainland stocks that have too much thin air under their wings. Property seems to me the best bet.

Taking only residential property, the supply of new flats is very tight at the moment. The first chart sets this in perspective. Not only are annual completions of new flats at a record low but, relative to the size of the economy, we are at present completing only 10 flats per HK$1 billion of gross domestic product where 25 years ago this figure was about 150 flats per HK$1 billion of GDP.

The trend has been steadily down and there is nothing to indicate that it is about to change. Public housing construction has slowed down and private sector developers do not like the present rules for auctions of public land.

You may argue that we no longer have as great a need for new flats as we did 25 years ago when population growth was much higher and we faced the burden of moving large numbers of squatters into decent accommodation. This is true but, even so, the present rate of construction appears unusually low.

And then there is the matter of price. We had our big property blow-out more than 10 years ago and fully paid for it with a nasty property market slump that, at its worst, took prices 70 per cent down from their 1997 peaks. Those prices have since recovered but are still on average well below the 1997 peaks.

Of course, this is not true for all sectors of the property market. As the second chart shows, prices on Hong Kong Island for large flats (160 square metres or more) have now soared to well above their 1997 peaks. The price recovery for smaller flats has come nowhere near to matching this.

It is a distinct anomaly that prices per square foot for big flats should be three times greater than for small flats when only 18 years ago prices per square foot were roughly the same across all classes of flats but we can probably attribute it to the fact that the luxury market is actually a very tiny one.

The big market is in medium-sized and small flats and it is in these classes that I think the Year of the Rat will see the biggest upward price movements. The property rally will become a general one. The benefits will be more widely spread.

I think it will happen because the looming recession and the subprime crisis in the United States suggests there can be no avoiding the downward pressure on US interest rates over the next year.

Our interest rates will have to follow suit and this, combined with currency weakness because we are linked to a weak US dollar, is a prescription for a boom in financial asset prices in an economy that is otherwise doing very well and would not ordinarily be a candidate for lower interest rates and a weak currency. Property seems to me to be the best way of playing it at present.

Thus I wish you well in the Year of the Rat and, if you have showed hard cash commitment to Hong Kong with your savings, I don't think you will need my wishes. You are likely to do well whatever I wish.