By Lau Nai-keung (China Daily)
Updated: 2007-09-17 07:18

Our government can learn a few things watching the financial meltdown in the United States. They have a lot more experience in handling economic cycles and bursting bubbles which are part and parcel of a free market economy.

The central government has taken measures to cool down the property market, and the economy as early as last year. But unfortunately, our macro-economic management tools have not been sophisticated enough, and the results have not been too successful.

Although our property boom has to a certain extent been arrested, the stock market is still crazy, and the economy is growing even faster with signs of inflationary pressure setting in. In case the stock market crashes, we will have to face a similar situation as the US is confronting now.

It all boils down to one and only one question: Do we want to bail out the investors? Most economists will advise against it, as this will entail moral hazard. Investors are thus encouraged not to be responsible for their investment decisions and take a "head I win, tail government loses" attitude. Taxpayers are innocent losers.

However, since the stock market is so important to the economy, and a big crash will inevitably have serious repercussions throughout the world, more than $1 trillion has been pumped into the US and European financial markets to salvage the situation, and it has been openly rumored that the secretive Plunger Protection Team has been out to push up the US stock market.

Early this month, President George W. Bush made it plain that he wanted to do something about the situation. This is understandable as a general election is just around the corner, and the Iraq War is going neither here nor there.

We had similar situation in Hong Kong around 2000 when the property bubble burst after the Asian financial crisis. Initially the government of the Hong Kong Special Administrative Region let the property market take a free fall, at its height, more than 200,000 families were carrying negative assets. This means that the market value of the property was below the mortgage price, and even after selling the property, the mortgagee still owed the bank money.

Many of them were out of jobs, or had taken a deep salary cut. They were stuck - either unable to pay their monthly mortgage payments, or unable to repay the bank after liquidating the mortgage. The government was finally forced to step in. Subsequently, Hong Kong suffered 68 consecutive months of deflation, one of the longest in modern history, and many of the flats are still 60 percent of their value 10 years ago.

If the American government steps in, which I think it will sooner or later, like the Hong Kong experience, the country will have to pay a hefty price for people's excessive greed. There will be a slow recovery, and the position of the US dollar in international finance will be weakened.

The lesson is, since we know a big financial storm is on the way, it is advisable for our government to take early action to reduce the loss. Conventional monetary measures like raising interest rates and reserve requirements of the banking system are not as effective in this country, as most speculators do not borrow money from banks. Most of them do not even have a personal checking account. It will instead hurt our enterprises which rely more on bank loans and credits for their normal operations, and ultimately will hurt economic growth.

That is why I am all for increasing the supply of stocks in the market, both in the mainland and in Hong Kong to prevent it from rising too fast and to engineer for a softer landing when the crunch comes. Together with some administrative measures, a not too hard landing is achievable.

Most commentators think that China will be immune to the upcoming financial crisis. From disclosures so far, the exposure of the Chinese banking system to the subprime market, though more considerable than previously expected, is well within safety limits. In the short run, funds will flow this way, as witnessed by the recent performance of the Hong Kong stock market, and there will be substantial pressure on China to appreciate the yuan. In a global economy, we can never be immune, and should therefore be prepared. Fortunately this time the combined foreign exchange of mainland and Hong Kong is formidable enough to fend off any attempted attack.

On the other hand, there are growing concerns that the US financial meltdown will lead to a global recession, and this in turn will hit China badly. China is one of the most open economies in the world, with exports amounting to over 40 percent of its GDP. The US is China's largest trading partner. When the US sneezes, China is likely to catch a cold. Moreover, the repercussions of US economic performance are worldwide, and that means our exports to other countries will suffer also.

Like in the Asian financial crisis a decade ago, China's economic stability and prosperity is vital to the whole East Asian Region, if not for the world economy. Simply by maintaining our momentum in the economic storm will be a great service to the international community.

Our economy is exported-oriented with persistent overcapacity, and a general export recession will lead to excess inventory and increased unemployment. It is therefore not too early to kick-start internal consumption.

The author, from Hong Kong, is a member of the National Committee of the Chinese People's Political Consultative Conference

(China Daily 09/17/2007 page4)