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The way this world works - like it or not

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Why you can trust SCMP

IT IS OFFICIAL. Chief Executive Tung Chee-hwa and Financial Secretary Antony Leung Kam-chung have both said the government will do 'something' to support the property market to reduce deflation in Hong Kong. Mr Tung even promised to push the market 'up a bit'.

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If higher property prices mean a better Hong Kong, all the government has to do is announce that for the next 10 years it will sell no land by auction or by private treaty, build no subsidised flats, and reinstitute a height limit on buildings on the Kowloon peninsula. There can be no doubt prices will go up and property stocks will rebound sharply. The only uncertainty is by how much.

But then what? How long will these prices remain high? Will the economy recover? Hong Kong is in deflation for two principal reasons. First, the world is finding the mainland an increasingly profitable alternative.

In technical terms preferred by Morgan Stanley economist Andy Xie Guozhong, investors are arbitraging between Hong Kong and China, especially Guangdong.

If two areas are producing the same goods or services, the prices, over time, should be the same in both societies save for transaction costs (transport, exchange risks) or country risks (legal, political, social and the like). There are fewer and fewer such barriers separating Hong Kong and Guangdong, except in the financial business. Hong Kong has a convertible currency and a financial infrastructure that is part of global finance. China does not - at least not officially.

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Much of anything else Hong Kong can do - logistics, tourism, even education - Guangdong, Shanghai or Beijing can do as well. In arbitrage, the end result is straightforward: prices (including wages) in these two separate economic domains will converge. This means Hong Kong prices have some way to fall.

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