A good part of the responsibility of the Asian financial crises is attributable to international banks not facing up to their lender liability, a legal concept holding lenders liable for damages if they knowingly lend beyond any borrower's capacity to handle the loan. It is convenient for Western creditors to point fingers at Asian crony capitalism and lack of transparency, but such practices, albeit undesirable, are not unique to Asia and were certainly not unknown to lenders when the bad loans were made. Having been permanent cultural features in many part of the world, including Asia, such practices cannot be the direct cause of the region's sudden financial collapse, any more than its economic success of recent past. To avoid political backlash in the region, IMF rescue packages should focus on correcting the structural defects of the unregulated globalization of financial markets and not be devious vehicles for wholesale foreign control of wounded Asian economies. Some economists, including Jeffery Sachs of Harvard's Institute of International Development, have been critical of IMF's "off the shelf" rescue approaches for having exacerbated the financial crises in Asia. Moreover, the austerity measures demanded by IMF economists who are insensitive to local political realities, will turn the economic turmoil into detonators of political instability throughout the region.
A fundamental problem in world trade finance is the excessive weight foreign exchange markets assign to the size of a country's foreign exchange reserves as indicator of economic health and credit worthiness, despite general recognition by economists that the validity of this yardstick ended with the age of mercantilism a century ago. Yet, despite claims of scientific determinism, financial markets are not free of political bias. And this residual focus on foreign exchange reserves is not applied evenly to all economies. Curiously, the United States, the world?s largest debtor nation (carrying US$20,000 of national debt per capita), with two-thirds of all US currency being held overseas, with chronic budget deficits until this year and a history of volatile fluctuations in the floating exchange rates of its currency, is considered the safest haven from economic turmoil because of its perceived political stability and the size of its domestic economy. On the opposite end, Hong Kong, with its huge foreign exchange reserves, perennial budgetary surpluses and zero sovereign debt, has repeatedly seen its solidly-backed currency under relentless attack in a market artificially fixed by a peg to the US dollar. Hong Kong's currency board mechanism is itself an open admission of no confidence in its own currency. With a currency board mechanism, Hong Kong pledges to exchange HK dollars at a fixed rate to the U.S. dollar and holds 110% equivalent US dollars in reserve for each HK dollar in circulation. This currency peg requires local interest rates to track U.S. rates, plus a country risk premium which is determined in part by the market?s view of the economic viability of the peg rate. The Hong Kong government also holds most of its surpluses in US dollar-denominated instruments. These arrangements represent a loud and clear declaration that the US dollar is a sounder currency than the Hong Kong dollar. One can expect such a discriminatory attitude from the former British colonial government, but one is at a loss to understand why a new Hong Kong SAR under Chinese sovereignty would feel the need to hang on to such a self-defacing political posture. Hong Kong should be reminded that the U.S. dollar, despite unjustified perceptions of its soundness, is only as solid as the true state of the U.S. economy at any given time. The U.S. economy at present looks good. This is due to a decade of ruthless restructuring that improved corporate competitiveness, particularly in the service sector. The globalization of the U.S. finance sector also contributed to the growth of the U.S. economy through the export of capital and inflation to the developing countries. Cross border sales and purchases of equity and bonds by American investors have risen from 9% of GDP in 1980 to 164% in 1996. But uncertainties loom large as the injurious impacts from the Asian crises, which are mere symptoms of a structurally flawed global financial architecture, begin to hit the U.S. economy. While the US dollar is currently strong, a downward correction is a high possibility within the next three years. While short-term fundamentals favor the US dollar, long term fundamentals are increasingly negative. U.S. trade and current account deficits are likely to each US$250-300 billion in 1998. Net debtor position of the U.S. will exceed US$1.5 trillion. Whenever foreign-held dollar reserves are sold, an equivalent of U.S. owned assets are liquidated immediately at market price. If the amount sold is large enough, it will cause a recession or even depression in the U.S., as in 1929-32, which the post-war Bretton Woods system of fixed exchange rates was designed to prevent from occurring again. In 1995, after the Federal Reserve started to hike interest rates in 1994 and sharply curtailed its own purchase of Treasury bills, triggering the Mexico peso crisis and a subsequent U.S. slowdown, the Bank of Japan initiated a program to buy $100 billion of US treasuries. China bought $80 billion. Hong Kong and Singapore bought $22 billion each. Korea, Malaysia, Thailand, Indonesia and the Philippines bought $30 billion. The Asian purchase totaled $260 billion from 1994 to 1997, the entire increase in foreign-held U.S. dollar reserves. These recycled dollars pushed up stock prices in America. A sharp correction of the stock market accompanied by an abrupt slowdown of the US economy is a matter of when and not if. Also, the new euro will pose a direct challenge to the US dollar as the preferred currency for international trade. The financial world is in the process of shifting from a dollar-centered system to a bipolar dollar-euro system. Just like the post-war corrections in U.S. markets in 1971-73, 1978-79, 1985-87, which critically stalled the U.S. economy because the contributing currency overvaluations were permitted to go too far and for too long, the next correction will have equally severe economic consequences. This means that just when the Asian economies are working themselves out from the damages of the current crises, the U.S. economy may stall and the US dollar may fall in value. Hong Kong will then be forced to suffer an untimely devaluation of its currency by virtue of its peg to the US dollar, causing HK dollar denominated assets to deflate in trade terms and an erosion of purchasing power. Thus Hong Kong, by surrendering to the U.S. Federal Reserve Board its ability to independently move interest rates to macro-manage its economy, or to allow market forces to adjust its exchange rate as the global environment changes, will be incessantly trapped with an out of phase monetary regime with regard to its economic needs by virtue of its currency peg to the U.S. dollar. An overvalued currency is suicidal even for a rich country in times of economic contraction. Five years after the 1929 crash, Franklin D. Roosevelt was forced in 1934 to eased monetary policy through a 59% devaluation of the US dollar against gold. Conversely, an undervalued currency is injurious to the economy in times of recovery or expansion. During 14 years of currency peg, Hong Kong experienced significant asset inflation caused by negative local interest rates, as the U.S. dollar fell against other currencies through market forces, notably the Japanese Yen and the German Mark. But Hong Kong gained compensatory price competitiveness from such currency devaluations. As the U.S. dollar rose abruptly in the course of the Asian crises, Hong Kong?s bubble economy burst. Events have shown the argument that the peg to the US dollar produces currency stability for Hong Kong to be not valid in practice on a global basis. It is not valid even in theory, because the target of its peg, the US dollar, is a free-floating currency. Defending the peg has the effect of transferring wealth from the people of Hong Kong to the local borrowers of foreign currency loans. Abandoning the currency board mechanism is a separate issue from devaluation of the HK dollar. De-linking only means that the HKMA will become a true central bank, free to manage HK?s monetary policy to suit the needs of Hong Kong, by setting interest rates and liquidity independent of other government policies. Market conditions will then set the proper value of the HK dollar in response to the monetary policy and economic fundamentals of Hong Kong.
Taiwan and Singapore both devalued their currencies early in the currency turmoil in 1997, by approximately 18%. Timely devaluation gave both these governments more flexibility in dealing with the impact from the crises in the region. As a result, the economies of Taiwan and Singapore are less adversely impacted by contagion. China is impacted less directly and immediately because its economy is not open, but Chinese export will be adversely affected. Hong Kong, being open and liquid with a fixed currency peg, is experiencing the beginning of an inevitable meltdown that will continue until the peg is abandoned. China has orchestrated public pronouncements from high places in praise of Hong Kong?s recent technical success in defending the peg during the early waves of assaults on the overvalued Hong Kong dollar. Such praise, though well intentioned, is premature. Such praise is based on misplaced national pride and questionable economic judgement. The peg, unjustifiable by its exorbitant economic cost, is an open admission of national financial insecurity. Chinese leaders should bear in mind that misplaced political postures that defy economic reality will only result in more otherwise avoidable economic damage to Hong Kong and eventually to China. Complacency and wishful thinking have no place at this critical time of serious danger. The Asian financial crises are not mere passing storms or cyclical phases. They are the opening acts of a historic restructuring of the global economic system in which the stakes are very high. Economic globalization requires enlightened nationalism to keep it fair and just. As Lenin insightfully hypothesized, Western imperialism provided the escape valve that postponed the deterministic evolution of capitalism into socialism as predicted by Marx. The collapse of Western imperialism, brought about by the rise of nationalism, heralded the advent of a wave of socialist economies after World War II in newly independent former colonies and semi-colonial territories, without the historical prerequisite of having first gone through capitalism. The historical relationship between capitalism and socialism is that capitalism is efficient in creating wealth and socialism is necessary for sharing the wealth that capitalism creates in order for society to be more just and stable. As such, the ripe candidates for socialist systems are the industrialized nations that have already benefited from the productive efficiency of capitalism, not the poor countries that have been ravaged by a century of Western imperialism. There is no economic benefit in socializing poverty. Most reasonable thinkers now accept that capitalism and socialism are not concepts adverse to each other, but are complimentary approaches to keep society prosperous and just. Each nation, according to its historical conditions, must seek the proper mix of these approaches to fit its own developmental needs. Indiscriminate global imposition of Western market criteria is not workable or desirable. After the demise of political imperialism, capitalism manages to gain another new lease on life through the transformation of the newly setup socialist planned economies into capitalist market economies via the expansion of world trade. Some political economists view unbalanced and unregulated world trade as a new form of economic imperialism, benign in appearance, rationalized under the laws of modern economics that hold sacred the principle of maximizing return on capital and the operational dynamics of free markets that favors the strong and perpetually condemns the weak. These concepts give the West an inherently unfair advantage against the capital-starved and ill-equipped third world. The international division of labor as currently constituted in globalization has been driven by wage competition between countries with a race to the bottom effect. Countries also compete to reduce taxes, welfare benefits, environmental protection and trade regulations in the name of efficiency in a global market economy. Technology, lowering the cost of communication and managing complexity, now allows central control of highly decentralized operations worldwide. Trade and foreign investment have preempted economic development and aid as the main paths for undeveloped nations to modernize and to prosper.
Yet globalization of trade and finance has its critics in both developed and developing countries, but for different reasons. In theory, free international movement of capital through integrated financial markets in a global economy allows efficient allocation of funds towards investments of highest productivity. But truly free markets do not exist in the real world, and even if they do, they operate under narrowly single-dimensional rules and historical biases, all of which aim toward maximizing return on capital without due regard for local social, political or environmental consequences or individual national aspirations. Moreover, global financial market pressures tend to supplant the traditional roles local political leaders and government institutions play in formulating macroeconomic policies that safeguard individual national interests. Despite all the noise the United State makes about the benefits of world trade, US export of $564.7 billion (FOB) constitutes only 7.6% of its GDP of $7.6 trillion (1996) and US import of $771 billion (CIF) constitutes 10.1% of GDP. Export to all of Asia amounts to only 2.4% of its GDP of which Japan constitutes 1%. Thus the U.S. can sustain a strong bargaining position in setting the terms of trade on a take it or leave it basis. Excessive reliance on world trade may not be in a country?s best national interest, simply because national governments are forced to surrender their power to manage their economy to world market forces, or international trade institutions and agreements. It is an argument put forward not only by the developing nations, but also by isolationists in America, with sufficient public support to deprive President Clinton of his ?fast track? authority to settle trade disputes. In contrast, Hong Kong export of $197.2 billion constitutes 121% of its GDP of $163.6 billion (1996), and HK import of $217 billion constitutes 130% of its GDP. It is obvious that a rupture in world trade will impact Hong Kong differently than the U.S. While Hong Kong has no viable alternative to total dependence on trade, it should bear in mind that it is now part of China, and that Hong Kong?s national interest is part and partial of that of China where the issue of trade policy in relation to national independence has not been definitive resolved. When capital is mobile, governments are able to enjoy the benefits of fixed exchange rate stability only if they are willing to forego the empowerment of managing the economy through the setting of domestic interest rates and the supply and liquidity of money. This means when global capital flow into a country, local interest rate will fall, sometimes to negative rates, distorting the orderly development of the affected economy. For example, beginning in the mid-1980's, Hong Kong's currency board mechanism created persistent negative local interest rates, causing abnormal investment flows into the property sector, resulting in unrealistic price inflation that became a major problem in the current downturn. Conversely, when investors begin to pull out of a country or sell its currency, local interest will have to rise to counter the flow in order to maintain the exchange rate peg. This invariably weakens the banking and financial system, eventually causing bank failures and institutional bankruptcies. This happened to Hong Kong in October 1997, with disastrous long-term consequences that are yet to unfold fully. Hong Kong will be plagued by excessively high interest rates until the currency board mechanism is abandoned or until the US dollar falls. There will be no sustainable long-term economic recovery for Hong Kong until the HK Monetary Authority regains its power to set monetary policies. Pegging a currency's exchange rate to another currency does not automatically make an economy more stable. If domestic economic policies are inconsistent with the chosen exchange rate, a fixed rate can itself lead to instability. Small economies with less sophisticated financial markets face greater risk from opening to international capital. Sudden capital flight can create economic havoc, as in the European currencies crises of 1992-93, in Mexico in 1994 and in Thailand in July 1997. In the last quarter of 1997, institutional panic caused an abrupt drop of private capital flow, in excess of US$100 billion, to the five most affected countries: South Korea, Indonesia, Thailand, Malaysia and the Philippines. South Korea alone saw its capital flow drop by US$50 billion as compared to 1996. It is projected that the region will experience a net outflow of US$9.4 billion in 1998, after a net outflow of capital of US$12.1 billion in 1997. And contagion effects can hit countries in an economic region and eventually the entire global system. As the economies of the lending nations contract, banks will withdraw urgently needed funds from other healthy economies where liquid markets still operate, thus forcing the healthy economies to collapse. This happened to the Hong Kong market in October 1997. It will happen again and again before recovery is in sight. The threat of Japanese banks retrieving capital from other countries, including the U.S., is very real. There are clear signs that Japan is entering a prolonged phase of serious deflation. When that happens, U.S. interest rates will skyrocket, sending Hong Kong rates beyond reach, foreclosing all hopes of a steady recovery. One way for a country to deal with currency risks is through sensible macroeconomic management by adopting sound monetary and fiscal policies. By maintaining the fixed peg of its currency to the US dollar through a currency board mechanism, Hong Kong closes itself on this option of monetary autonomy. The second way is make sure banks are well regulated and capitalized. In this area, Hong Kong claims to have a well regulated banking system although the financial sector in Hong Kong consists of large numbers of non-deposit taking institutions that are only minimally regulated by the HKMA. The third way is to restrict the opening to international capital flow. As an international financial center, this is not a viable option for Hong Kong. Yet as part of China, Hong Kong has a responsibility to coordinate with China, its largest trading partner (36.3%), to effectuate a capital flow regime that best serve the national interest. While the US dollar is currently strong, a downward correction is a high possibility within the next three years. This means that just as the Asian economies are working themselves out from the damages of the current crises, Hong Kong will face a forced devaluation of its currency by virtue of its peg to the US dollar, after years of forced overvaluation. Such boom and bust cycles will be extremely damaging to Hong Kong, and the fact that Hong Kong has weathered them in the past in no reason to tolerate them in the future. The world is in the process of shifting from a dollar-centered trade system to a bipolar dollar-euro system. But Hong Kong surrenders its ability to independently move interest rates to macro-manage its economy or to alter its exchange rate when global environment changes. For Hong Kong, as an autonomous part of China, serious open debates are needed to focus on the role Hong Kong should play, in close coordination with its sovereign motherland, in the coming historic restructuring of the global political economy that has been triggered by the regional financial crises in Asia. As a start, the undeniable fact that the currency peg is conceptually obsolete and functionally injurious must be faced squarely and immediately. No independent government should permanently set its policy for monetary stability by relying blindly on the currency of a distant land that has a fundamentally different socioeconomic and political system. American interest rates are set by the U.S. Federal Reserve Board to reflect the fluctuating needs of the American economy, and not for Hong Kong?s benefit. The peg worked for Hong Kong in the last 14 years because Hong Kong was an outpost of the American sphere of influence during the Cold War, and as such, was part of the American economic system. That geopolitical context has changed since July 1, 1997. Hong Kong?s leaders need to acknowledge this fundamental change in order to lead Hong Kong into a self-determining future in which we, the people of Hong Kong, can prosper by controlling our own destiny and by casting our lot and keeping our faith with our brothers in Asia. Within the community, the HKSAR government must immediately devise plans to insure the fair sharing of the sacrifices necessary to weather this painful restructuring. Such plans should include measures to provide emergency financial assistance to otherwise healthy small businesses and productive workers and professionals in Hong Kong whose survival is suddenly threatened by a financial crisis not of their making and by an economic contraction beyond the ability of their normal resources and savings to withstand. Hong Kong should use its public funds during this crisis to preserve its human resources: its workers, professionals and small entrepreneurs on whose shoulders a quick economic recovery depends. Recent studies showing local public perception of Hong Kong as a less than fair society that favors the rich are dire warnings. A house divided cannot stand, especially in hard times. The size of our foreign exchange reserves has little meaning if the majority of our citizens do not believe that Hong Kong is being administered for their benefit. Foreign trade is desirable only if it brings positive improvement to the lives of the people. It must not be allowed to be a vehicle for enslaving indigenous people merely to provide high returns to international capital. Even George Soros has warned that the uneven distribution of profit in favor of capital at the expense of labor is a fatal fault of the global capitalistic system. Externally, Hong Kong as a regional financial center of world class stature should promote the development of an Asia of independent nations, and not serve as an Asian outpost of a new wave of economic colonialism from outside the region.
Henry C.K. Liu