Hong Kong’s monetary authority should raise interest rates now to buffer the market – while it can
Andy Xie says the Hong Kong property market is set to stumble, and the US may return its interest rates to the ‘90s-era 5 per cent average. The HKMA should therefore raise its own interest rates; not doing so only serves Hong Kong’s property cartel
The Hong Kong Monetary Authority has been buying up Hong Kong dollars to stop it from falling below the lower boundary of its pegged range to the US dollar. But why has it been allowed to fall to the lower boundary and stay there so long? That’s not how a peg is supposed to work. It should try to hug the US dollar interest rate as close as possible.
By deviating from the US interest rate by so much and for so long, Hong Kong is setting itself up for an interest rate shock.
A dollar peg gives up monetary policy for confidence in the currency. The US Federal Reserve in effect fixes Hong Kong’s interest rates. The range around the peg offers some flexibility, but is not a tool for keeping the interest rate different from the US dollar’s. This regime has instilled confidence in Hong Kong’s dollar but exaggerated macro cycles in Hong Kong’s economy and asset market, with disastrous consequences.
After 1997, Hong Kong’s property price dove by 75 per cent over the following six years. The political pressure forced the government to contract supply, which massively exaggerated the subsequent upcycle, causing political pressure on the other end.
One strange thing happened on the way up in the current cycle. While the US interest rate has been rising for over one year, Hong Kong has chosen to keep a near-zero interest rate while allowing the exchange rate to slide.
Most mortgages in Hong Kong are linked to short-term interest rates. Following the Fed would have been the best tool for cooling the property market – which, as has been explained many times, is the government’s desire. Is this dumb, or done purposefully to give the big developers extra time to cash out?
The Fed is expected to raise interest rates at least twice more to 2 per cent. As the US economy may be overheating, the Fed could raise it more, possibly to 2.5 per cent. And, the Fed rate will keep rising, possibly to 4 per cent in 2019. In the long term, the dollar interest rate is on the way up. As globalisation unwinds, expect inflationary pressure.
In the years leading up to 2001 – when China joined the World Trade Organisation, triggering the subsequent global disinflation – the normal Fed rate was 5 per cent. It could go back to that. Considering this future, it would be in Hong Kong’s interests to increase rates at every opportunity. Instead, it is fighting every step of the way to keep the short-term rate close to zero.
The odds are that an interest rate shock is coming. By keeping the exchange rate at the lower end, the HKMA could punish speculators by pushing the rate back to the high end, causing them a 1.3 per cent capital loss. When the interest rate difference is insufficient for compensating for this potential loss, then Hong Kong’s interest rate can remain at zero. But as the dollar interest rate continues to rise, the tipping point for speculators to go all out will be soon reached, pushing the Hong Kong dollar interest rate all the way up to the US dollar level.
When the property market begins to tumble, which is quite likely this year, the market chat will turn to de-pegging and devaluation, which would cause Hong Kong’s interbank rates to move from below to above Libor – the London interbank offered rate, intended to represent how much banks pay to borrow from one another – again, amplifying the shock.
It would feel like 1997-98 all over again, though, this time, it would all be self-inflicted.
If Hong Kong wants to soften the blow, the HKMA should keep buying the Hong Kong dollar until Libor and Hibor – Hong Kong’s interbank offered rate, the short-term borrowing cost of funds between commercial banks – reach parity. It should stop buying only when the exchange rate reaches the upper end. Anything else should be considered a continuation of the effort to keep interest rates artificially low to abet the property developers.
Hong Kong works for property, or more precisely, for property developers. To feed the property beast, Hong Kong depends on financial markets that are often casinos or money laundering channels. Only such businesses have the profit margins to support Hong Kong’s property prices. This economic model may not last.
After the cold war, especially after China joined the WTO, the world embraced monetary stimulus and financial speculation. Globalisation kept inflation low, removing the main check on excessive monetary growth. Excessive financial expansion fuelled the prosperity of financial centres like Hong Kong, London and Singapore.
The trade war talk between the United States and China is just a symptom of a larger ideological dispute. It is clear by now that China won’t become more like the West. The ideological difference will inevitably become a conflict. And globalisation is likely to unwind. The deflationary trend will become inflationary, leading to monetary tightening and contraction of the financial balance sheet. Financial centres like Hong Kong will face strong headwinds.
As finance becomes a sunset and low-margin industry, how could Hong Kong support its high property prices? Its household debt is 70 per cent of gross domestic product, compared to 50 per cent in 1997. Will all the mortgages be paid off?
Andy Xie is an independent economist