Peter T Treadway, PhD
Historical Analytics LLC
September 13, 2010


“Money is a spiritual thing. It has no rank yet is revered; it has not status yet it is welcomed. Where there is money, danger will turn to peace and death will give life. Where money slips away, honor will turn to baseness and life will give death.”
-Lu Bao, The Money God (c. A D 300)

Armed Thug: “This is a stickup! Your money or your life.”
Long pause, no answer.
Frustrated armed thug: “I said — your money or your life.”
Jack Benny’s belated reply: “I’m thinking it over.”


De-Coupling with Bubbles

While the US, Japan and southern Europe limp along in a real estate collapse/ debt deflation and the talk is of a double dip in the Great Recession, Asia (ex Japan) has been booming. As the table below shows, GDP growth has been spectacular in 1H2010 for most of Asia.

So far at least in 2010 in Asia there has not been anywhere near a perfect correlation between GDP growth and stock market performance. The “niche” markets of Thailand, Malaysia and Indonesia have done quite well. But China which has shown substantial GDP growth has registered a -17.5% decline thus far in its equity market. Hong Kong and Taiwan – the two “Greater China” markets – are also down.

Still there’s enough here for the decoupling thesis. The thesis is that Asian and other emerging market economies will outperform the US, Japan and Europe. The US, Japan and Europe will be bogged down in deleveraging for the coming years. Moreover, all three areas have aging workforces, burgeoning government debt and soaring entitlement programs as far as the eye can see. So why will emerging Asia not be the place to put your money in the coming years. (Along with emerging Russia and the pro-capitalist countries in Latin America.) The strong GDP numbers posted by Asia in 1H2010 of course have some rebound in them from last year’s recession. But Asia is likely to outgrow the US and Europe in the coming decade.

I basically agree with the decoupling thesis but with one major caveat: the international monetary system remains inherently inflationary and the ultimate source of most investment bubbles. So long as the so called emerging market countries of the world can get away with holding down the value of their currencies against the dollar by buying the US dollar thus inflating their own money supplies and funding US profligacy, bubbles will be with us. Buyer be prepared for some bumps.

Hong Kong – China’s Best Indicator

Hong Kong is unique and if understood properly can serve as a leading bubble indicator for what is a far more opaque China. Increasingly integrated with the economy of China, it nevertheless pegs its currency to the US dollar and imposes no capital controls of any kind. Most of the countries in Asia peg their currencies to the US dollar to some extent. But Hong Kong is on a pure dollar standard that is totally transparent. Unlike with China, there is no sterilization of capital inflows even if these inflows added unwanted dollars to the monetary base. The US dollar for Hong Kong has the same function as gold under the classic gold standard. Were the HK dollar allowed to float, it would probably appreciate significantly against the US dollar and by a lesser amount against the renminbi.

Hong Kong’s monetary base and total loans and advances are up 29.4% and 21.2% yoy respectively thus far in 2010. Hong Kong cannot control the growth in its monetary base. The last thing Hong Kong needs is some kind of echo quantitative easing coming from the US or an overflow of investment money coming from China. But that’s what it’s getting.

Unfortunately for Hong Kong, it must live in a world where the two major economies that are most important to it are pursuing monetary policies inappropriate for Hong Kong. Let’s start with the US. Quantitative easing and near zero interest rates have been Bernanke’s answers to US debt deflation. But Hong Kong is not experiencing debt deflation. Far from it. Thanks to the dollar peg Hong Kong has imported US monetary policy. Hong Kong interest rates are inappropriately negative in real terms but so long as the dollar peg is in place there is nothing the Hong Kong Monetary Authority can do about it. In real terms Hong Kong investors lose money depositing in the bank.

In China the situation is equally bad. In China real interest rates at banks are negative. Although there is talk of an increase, bank deposit rates currently max out at 2.25% vs. the just announced August CPI increase of 3.5% which is itself probably understated. Yoy M2 in July was up 17.6% and bank loans were up 19.1%. This follows torrid growth in 2009. There is a lot of money looking for a place to go in China. A good deal of this money flows over the border and gets added to money from Hong Kong itself that is also looking for an investment home. How this mainland money moves into Hong Kong no one can be sure of since there are restrictions on taking money out of China. But, as Galileo once said in different circumstances, epure si muove – but it moves.

Unfortunately China is in a box of its own making. It cannot raise interest rates without inviting more capital inflows and putting more upward pressure on the renminbi. So the money has been going into real estate in China and pouring over the border into real estate in Hong Kong. Sooner or later China will raise interest rates and increase the value of the renminbi against the dollar.

The authorities in Hong Kong (and in Singapore and China) have become alarmed at the recent significant rise in the prices of upscale housing. Significant administrative measures including increasing down payment requirements have been announced in all three locales. Not that there is any problem with delinquencies. The Hong Kong mortgage delinquency rate for example is currently a miniscule .02%. Mainlanders have been blamed in Hong Kong for the rise in property values, but clearly the recent rise in the volume of mortgage loans at Hong Kong banks suggests that Hong Kong residents themselves have been buying property as well. (I am told Hong Kong banks do not lend mortgage money to mainlanders because they are unwilling to furnish the necessary documentation. The comrades pay cash.)

One might question the wisdom of a city that aspires to be one of the world’s major financial centers becoming upset because too many rich people want to buy property there. One might also wonder why the government doesn’t auction off more land and increase the supply of housing. Popular resentment is rising as many in Hong Kong feel their chances of buying a home are disappearing. And authorities are terrified of the day when interest rates do rise and banks get stuck with rising delinquencies. Nobody wants a repeat of the US experience. House and stock market prices are especially important in Hong Kong. There are no major football, baseball, basketball or soccer teams to distract the hoi polloi as in the US or the UK. People talk of nothing else but stocks and property. They know how much house prices changed last week.

I believe if the authorities introduce enough draconian measures they can slow down the housing market in Hong Kong. (And in Singapore and in China). But the money still has to go somewhere. The root cause of inflation lies in the monetary system, both international and domestic. Increased administrative controls on the housing markets in China and Hong Kong with no change in US and Chinese monetary/exchange rate policies will simply divert the overflow of money into the Hong Kong, Chinese and other Asian stock markets. And into gold and commodities. And as I wrote in the last issue this will show up as external supply side inflation in an otherwise deflationary US.

Unfortunately, longer term this is setting up another bubble. But near term investors may not be able to resist riding the bubble. Especially when it is added to solid fundamentals. If buying patterns in Hong Kong are any guide, it’s clear that stock market investors should be putting their money on Chinese consumers. Hong Kong is becoming a giant emporium for mainland consumers – everything from upscale European brand names, to the latest electronics (Steve Jobs is a god in Hong Kong) to women’s cosmetics, to milk that doesn’t poison children (unlike in the mainland). And jewelry with lots of gold is popular too. Bulgari and Piaget of course. But local jewelers with good Cantonese names like Chow Sang Sang and Luk Fook are doing a land office business as well as expanding in China itself. And forget about rice – that’s for poor people. The new Chinese consumer eats meat.


Peter T Treadway also serves as Chief Economist, CT RISKS, Hong Kong
Historical Analytics LLC
pttreadway -at- hotmail -dot- com

1 305 761 4718
852 94091186
September 12, 2010

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