Oil prices have set a succession of new high records
in recent weeks and adversely affected the world economy.
Propelled by the tax debacle of Yukos in Russia, concerns
over political turmoil in oil production countries and
surging demand from China, it is even expected that
crude oil in New York will top US$60 a barrel in the
near future!
Higher oil prices will trigger inflation. Oil prices
will subsequently be translated into consumer price
by pushing up production costs. To cope with inflation,
monetary authorities must tighten their policy by curbing
money supply and raising interest rates. However, with
the Hong Kong dollar peg to the US dollar, we give up
our monetary policy autonomy. Worst still, Hong Kong
will have to lower its interest rates to turn away currency
speculation from buying in Hong Kong dollar.
In general, crude oil and petrochemicals constitute
a board range of items in the core inflation index.
However, the impact of oil price on inflation will be
varied for different economies, depending on the weightings
in their energy consumption patterns. Since the energy
crisis in 70s, most European countries have managed
to lower their dependency on crude oil by promoting
fuel efficiency vehicles and alternative energy sources
such as nuclear power, while the US has indeed increased
their oil import substantially. If high oil price persists,
chances are the underlying inflation in the US economy
will be higher than their European counterparts; the
US dollar will be more likely to decline.
Traditionally, inflation is the result of excess demand.
When unemployment rate stays low, there is upward pressure
on wages and prices. Nevertheless, cost-push inflation
may actually worsen unemployment; the economy runs the
risk of "stagflation", when both prices and unemployment
rise simultaneously. If the U.S. economy remains subdued
while high oil price prevails, we would see a drop in
profit margin followed by massive layoffs, and most
likely, stagflation. Although one can stimulate the
economy by lowering interest rates, it would add fuel
to the fire and further push up inflation. In short,
there is no silver bullet for the Fed. Then something
will have to give.
So where does that leave us? To be sure, it may reflect
on US export price increase, or a sharp rise in US domestic
demand for import substitutes; either way, it is very
hard for Hong Kong insulated from importing some inflation
from the US.
Hong Kong is an open economy, inflation can be easily
imported. As a service oriented economy, energy accounts
for only a small fraction of our operating cost. However,
owing to Hong Kong dollar peg to the US dollar, it may
bring unforeseeable disturbance in the flow of fund
and domestic money supply.
If the dollar declines, the pressure on the Hong Kong
dollar appreciation will resurge. To sustain the dollar
peg, fighting inflation by raising interest rates will
not be an option. On the contrary, Hong Kong may even
lower interest rates to ward off speculation on the
local currency. Also, the prospect of RMB appreciation
will enhance the attractiveness of Hong Kong dollar.
With the money supply surges, negative real interest
rates will come into play again.
Therefore, even if oil prices pose no imminent inflation
threat for Hong Kong, the impact can still be far reaching.
It may also make fixed asset a good hedge against inflation
yet again.
How to prevent inflation from eroding your asset value?
That is the question. Inflation leads to continual erosion
of the purchasing power of money. People will go after
fixed assets and buy on credit, resulting in an overheating
economy. Once again, Hong Kong economy will be driven
by domestic demand. By the same token, leverage ratio
will gear up for investment. IT vendors such as HP offer
attractive financing package, in which SMB will be able
to take advantage of in response to the changing economic
outlook.
(Last updated: 15th October, 2004)
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