(This essay was published in Hong Kong Economic Journal on 11 February 2015.)


Both Greece and Hong Kong have unified exchange rate regimes. Greece, as a member of the Eurozone, uses the Euro as its local monetary unit. Hong Kong, under the linked exchange rate regime, uses a local monetary unit with its currency fully backed by the US dollar at a fixed rate.


As a consequence, both economies have surrendered monetary independence to an external monetary authority. Both have committed to not using currency devaluation or revaluation as a policy tool for stabilizing their economies when struck by financial and economic shocks.


The only way they could regain monetary independence would be, in Greece’s case, exiting the Eurozone and reissuing the drachma, and in Hong Kong’s case breaking the linked exchange rate and putting in place an alternative monetary arrangement for issuing the Hong Kong dollar.


An economy that has joined a unified exchange rate regime will face situations from time to time when the requirements of global economic integration will be in conflict with the requirements of a political democracy.


In a democratic society, the domestic demands of workers, employers, and various special or popular interests may not align with the requirements of global economic integration. These demands are one of the reasons why governments have adopted protectionist measures at their borders to thwart deeper economic integration.


For example, they may prevent the immigration of foreign nationals to protect the jobs of local workers, particularly unskilled workers but also professionals. They may establish a variety of protectionist barriers to limit goods, services and investment flows from crossing their border under the pretext of safe-guarding industries, jobs, health, safety, the environment, national security, public morality, and so on. They often go so far as to accuse other nations of engaging in unfair, anti-competitive, and dumping practices.


Greece faced this conflicting situation after it went into economic recession following the global Financial Tsunami. Hong Kong has experienced conflicting situations twice in recent memory, first in 1997 with the onset of the Asian Financial Crisis and then again in the aftermath of the global financial turmoil of 2008.

Despite Greece’s legendary fiscal profligacy and Hong Kong’s equally legendary fiscal prudency, both governments have faced deep political economy crises as a result of conflicting situations.


After joining the Eurozone, the Greek economy became deeply integrated with that of Europe. There were considerable initial benefits. Greece was allowed to borrow huge sums of Euro dollar loans at low interest rates from French and German banks eager to earn money from the loans. But after running up a huge foreign debt, Greece, unsurprisingly given its fiscal profligacy, had great difficulty servicing it.


In the run-up to its debt crisis in 2010, the Greek government’s primary budget deficit (excluding interest payments on its debt) was 10% of national income. When the debt crisis erupted, the financial markets went into turmoil over how this would be resolved.


The agreement that was struck in 2012 required Greece to undertake deep fiscal austerity measures in order to repay international creditors; any debt forgiveness was off the table. Today, the Greek debt-to-GDP ratio is 175% and is clearly not sustainable. Greece has to pay about 4.5% of its GDP in interest and the economy has continued to contract year after year since 2008.


Greece’s economic downturn has been severe. From 2008 to 2013, on a cumulative basis, nominal and real GDP fell by 28.3% and 26.4%, respectively, and unemployment reached a peak level of 27.5% (with youth unemployment now at 50% after peaking at 58.4% in 2013). Facing these tough economic conditions, the Greek electorate wants fiscal relief.


With the large Syriza victory at the polls, a new round of negotiations on debt forgiveness and debt rescheduling will commence with the ‘troika’ of the Eurozone countries, the European Central Bank and the International Monetary Fund. Debt forgiveness is unlikely because the German electorate does not want to support that. So negotiations will soon focus on allowing more time for fiscal adjustment to take place. The agreed fiscal austerity measures will become less harsh to provide some breathing space for the suffering Greeks.


For Greece to exit the Eurozone at this stage would be extremely unwise. If exit were to make sense then it should have been tried in 2010, when unemployment was only 12.7% and before the economy sank further. To exit now would mean being cut off from international credit at a time when the economic crisis has deepened significantly. All the hard work that has gone into making fiscal adjustments would be wasted.


The conflict behind the debt crisis pitches the interest of the German electorate against the Greek electorate. The unfolding events demonstrate that politics everywhere is domestic in nature, especially democratic politics. And the requirements of democratic politics conflict with those of deep economic integration and the policy discipline imposed by unified exchange rate regimes.


Hong Kong similarly suffered through six years of deflationary pressure following the 1997 Asian Financial Crisis because its currency was fixed to the US dollar. During those years, the strong U.S. dollar took an additional toll on Asian economies that were already mired in economic recession. Recovery finally arrived after the US dollar weakened after 2002.


Almost every Asian economy devalued its currency to soften the effects of economic recession and deflationary pressure. During 1997-98, Japan devalued by 7.4%, South Korea by 32.0%, Taiwan by 14.2%, Singapore by 11.3%, Thailand by 24.8%, Malaysia by 28.2%, Indonesia by 71%, the Philippines by 27.9%, and Vietnam by 11.9%. But Hong Kong did not devalue and stood firmly committed to the linked exchange rate arrangement.


As a result, the Hong Kong economy was severely hit by deflation and unemployment. The people of Hong Kong had to endure a period of intense deflationary pressure. During the six years of 1997-2003, on a cumulative basis consumer prices fell by 11.6%, the GDP deflator fell by 17.5%, nominal GDP fell by 9.5%, and real GDP rose only by 8% because of the steep fall of prices.


The unemployment rate reached a peak level of 8.8%. Real interest rates reached their highest levels since World War II with the HIBOR rate peaking at 9.8% in real terms. Real property prices fell 61% from peak to trough.


The deflationary pressures of the Asian Financial Crisis were amplified by the linked exchange rate, and property owners were severely hurt. Young householders who bought property a few short years before the property market crashed saw their future vanishing with each passing month, and then with each passing year.


Property prices eventually recovered and would rebound remarkably in the years ahead. But in the meantime, Hong Kong’s middle class was half devastated by the property crisis. Those who survived had their appetite for risk-taking tamed.


Since 2008, quantitative easing adopted by the Federal Reserve, and later both Japan and Europe, has produced the opposite effect. During 2009-2013, Hong Kong recorded unemployment rates averaging around 4.0%. On a cumulative basis consumer prices rose by 19.5%, GDP deflator rose by 9.1%, nominal GDP rose by 24.5%, and real GDP rose by 14.1%. Property prices have soared from both internal and external demand. They have risen by 134% since the global Financial Tsunami.


The prospect of a prolonged period of low global interest rates after quantitative easing measures were introduced has fueled asset price increases in Hong Kong. Real interest rates have turned negative with the HIBOR averaging around -3.1% in real terms. The government is strenuously trying to dampen property price increases through punitive tax measures, and through measures to increase housing supply, but to little avail.


Hong Kong began to experience inflationary pressures in the aftermath of the global Financial Tsunami and these effects, too, are amplified by the linked exchange rate.


Many families whose incomes suffered during the Asian Financial Crisis years, and who are without property, now see themselves as missing out on the opportunity to own property. They feel miserable and frustrated because they have been unable to share in the rising tide of property prices. Meanwhile, property owners are able to benefit from refinancing their mortgage loans to take advantage of low interest rates and finance the purchase of more property.


The growing wealth gap between those with property and those without has become a permanent legacy of our economic crises and the primary source of political divisions in our society. They are not about to go away anytime soon. Hong Kong may not be a political democracy, but the people are not shy to express their anger and vent their frustration on the streets in massive numbers, fortunately with peaceful means, at least for now.


In 2003 people marched on the streets in sufficient numbers and with enough intense anger and frustration to force Tung Chee-Hwa to resign from office. His successor Tsang Yum-Kuen learned the lesson too well, and avoided flooding the market with new housing supply, but has today in a twist of fate also fallen from grace for so doing. The present administration has been struggling daily to solve this problem since it came to office in 2012.


The Greek electorate can vote in the extremist Syriza government to vent their anger and frustration, but sadly they cannot vote away their economic problems. Similarly, neither marching on the streets nor introducing more democracy (something the pan-democrats have been clamoring for) will narrow the property wealth gap between Hong Kong’s “haves” and “have-nots”. Hong Kong needs a smart housing policy and Greece needs a sound economic growth strategy.

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