Dose of reality looks like being a bitter pill to swallow

HONG KONG ENDS 2001 at its lowest ebb since the aftermath of the Tiananmen Square massacre. The 1998 financial crisis was more destructive and economic contraction was greater, but shock breeds a fighting spirit and expectation of a rapid rebound was widespread.

An import-hungry United States economy and the Internet stock boom delivered a rapid rebound that suggested the post-1997 bust was no different from past cyclical crises. China remained a land of economic opportunity and sustainable recovery seemed around the corner.

Recession and continuing deflationary forces have now knocked the stuffing out of those assumptions. Fears of Hong Kong being marginalised as a trading and financial entrepot are growing. Where only foreign journalists once sang the 'death of Hong Kong' tune, the same mantra is today heard from worn-out local businessmen.

The complaint is of an unresponsive government, rising political populism bent only on wealth redistribution, and poor future growth prospects. A currency board is a harsh master and the deflationary consequences are more than much of the population cares to bear.

The change in sentiment reflects a recession that is hitting the job security of the professional middle class. In 1998, white-collar workers sailed through largely with only the declining value of their property to worry about. Job losses were concentrated in low-skilled sectors but this time the heartlands of aspirational Hong Kong are taking the hit.

The discipline of a pegged currency means internal prices across the economy must adjust so that the external accounts balance. In 1998 Hong Hong saw a huge outflow of capital, causing asset prices to collapse. What did not adjust was internal real economy prices, ranging from wages to business fees.