Soaring asset values spell serious trouble ahead

PUBLISHED : Saturday, 09 October, 2010, 12:00am
UPDATED : Saturday, 09 October, 2010, 12:00am

Chief Executive Donald Tsang Yam-kuen will tell us what he plans to do with Hong Kong on Wednesday. Whatever he says is futile unless he has some ideas for what to do about the looming asset bubble.

Liquidity has already pushed home prices skywards. The stock market has not been spared. With the Hang Seng Index reaching a two-year high, another illuminating case is the stellar performance of Agricultural Bank of China.

It was dubbed the worst state-owned bank in China and had a hard time getting its mega initial public offering completed only three months ago.

Yet the bank has seen its shares in Hong Kong gain more than 30 per cent since then. Ironically, as its H shares reached new highs almost every day, its shares in Shanghai have been striving hard to stay above their offer price.

The result is a 30 per cent premium for its H shares over the domestic ones. Why will a bank dumped by the locals be so much loved by the foreigners?

Is it because the foreigners have a better understanding of the bank's management and loan quality; the bad debt problem looming in the country; or the new capital requirement that are to come? Hardly.

Rather, it is the power of liquidity. It's the difference between a market barred from global liquidity and one that is not. It is an illuminating case of how liquidity has outraced fundamentals.

There is every sign that the liquidity flood is to increase. To stimulate its economy, Japan has just cut its interest rate to close to zero, while America is about to launch its second round of quantitative easing.

Central banks in emerging markets are stepping in to stem the rise of their currencies as the US dollar goes south. Given the harrowing experience in 1997, there is a good chance that they will overreact.

What kind of asset trouble will that lead us to? Compare the current situation with our 1997 experience, it's not hard to see it how nasty it will get.

First, in 1997 there was no global monetary easing. But now interest rates are at the bottom everywhere. Second, in 1997 the developed economies were sound. Now both the US and Europe remain weak, offering little investment alternatives.

Third, in 1997 China was only an up-and-coming also-ran. Now the country is the second-largest economy in the world. While the people's wealth has multiplied, the diversity of its capital market has not.

The investment hunger of its new rich is best illustrated by the spread of speculation from the stock market, to the property market, to the garlic market, to the cotton market and then, recently, to the jade market.

The latest round of tightening announced in the past weeks may not change the long-term outlook of the mainland housing market but it clearly gestured towards a determination by Beijing to rein in property over the months to come. Instead of pausing a bit, the new rich are now pouring more money into Hong Kong.

Fourth, there was no expectation in 1997 that the yuan would appreciate. Now everyone is expecting the yuan to rise and that's unlikely to be reversed in the near future. Putting the money into mainland corporations listed in Hong Kong is a good bet.

The only thing that remains unchanged is the limited monetary weapon Hong Kong has to defend itself against the looming asset bubble, with our currency pegged to the dollar and our economy open.

All signs point towards the development of a major asset bubble in Hong Kong. It will not be too aggressive to suggest the Hang Seng Index reaching the 1997 record-high in the coming 12 months.

While many of us will still remember the pain of the run on the Hong Kong dollar and the ultimate burst of the 1997 bubble, there are new dimensions to the current problem.

Over the past 13 years, the wealth gap in Hong Kong has significantly widened. The city has the highest Gini co-efficient in the developed world. An asset bubble and the inflation that follows will cost our social stability dearly.

If one listens to the latest interview of Premier Wen Jiabao with CNN in which he listed inflation as the top challenge for the mainland economy, one can see how real the inflation threat is.

The challenge is unprecedented. The only hope is that we are better prepared this time.

In 1997, the asset bubble was cooked up while we were focusing on the sovereignty handover and we welcomed the red-hot stock and property markets as a show of confidence. The latest bubble is cooking with our eyes wide open.

In 1997, our officials were caught totally by surprise. They intervened only when the speculators were harvesting the gain. Now, let's hope that our officials, including Tsang who spearheaded the 1997 fight against the speculators, are fully alert. Countries that fell victim to the bursting of the 1997 bubble have begun to put up shields against hot money. It's time for our government to look into its arsenal, oil the rusted weapons and get ready for a big battle to come.