Recently, the Hong Kong government has faced a deficit problem, which is not surprising given its late response to the COVID-19 pandemic and other changes in the legal landscape. Factors such as the middle class fleeing, foreign funds hesitating to enter, the central bank raising interest rates, and the withdrawal of existing funds have contributed to Hong Kong's financial difficulties. There are plenty of reasons why Hong Kong is running out of money, and the results have been as expected. Some people may rejoice at the prospect of Hong Kong's government facing financial challenges, as it is not well-liked by many. The hope is that the government will downsize, lay off employees, reduce salaries, or cut back on unnecessary projects. These are all things that would make many people happy to hear. On the other hand, those who are less optimistic also know that the government will likely first cut budgets for healthcare, education, housing, and other essential sectors before inflicting pain on officials. Layoffs would start from the lower levels, while more positions would be created for higher-level officials, resulting in an imbalance.
Indeed, these measures of cost reduction are expected. However, governments generally dislike cutting back on expenditures. If given the choice, they would prefer to expand the police force to a hundred thousand personnel. They are reluctant to reduce budgets for any department or implement salary cuts for themselves.
Consequently, the government must explore ways to increase revenue. There are several methods for the government to achieve this.
The first and most common method is "issuing government bonds." Although Hong Kong is not a sovereign nation, its government can still issue its own bonds. The key difference between government borrowing and individual borrowing lies in the fact that the borrowers and the ones responsible for repayment are typically different parties. It is the current officials who borrow money, while the future generations bear the burden of repayment. This allows the government to solve its problems and pass the debt on to others, causing minimal economic disruption and public resentment. Therefore, governments are fond of borrowing money.
However, this approach has a major drawback. It competes with US Treasury bonds, which are considered safer compared to bonds issued by other governments. When US Treasury bonds offer higher interest rates, they attract most of the global investment funds. If other government bonds cannot offer higher interest rates than US Treasury bonds, they are less appealing. Another reason for bond purchases is patriotism. Japanese people buy Japanese government bonds not because of higher interest rates but out of love for their country. Thus, they are willing to invest in bonds with lower interest rates. As for Hong Kong, the situation is quite straightforward. Do you love the Hong Kong government? Some individuals may have an unwavering loyalty, but their purchasing power for bonds is limited.
The second method is to "sell or lease government assets and rights." All government-owned land, equipment, and services can be privatized and rented or sold to wealthy conglomerates. Some countries even sell passports, nationality, legal rights, government endorsements, and even official positions in exchange for money. This has been a historical method of exchanging political and legal power for money.
However, this method has a crucial issue. The value of assets will be compromised. In the case of the Hong Kong government, the financial difficulties are a result of problems arising from the use of this method. For example, selling land becomes less lucrative when land prices fall or there is no demand. Moreover, the available rights and assets are limited. The more the government sells, the more it compromises its own power, and the lower the price it can obtain. If a country recklessly sells its nationality, their passports and nationality will gain a negative reputation internationally because those who possess such passports are likely to have issues. In the most extreme cases, the government's creditworthiness collapses, and banks no longer want to associate with such a government, as seen in many third-world countries.
The third method is "imposing fines." This does not refer to taxation but rather increasing the fines associated with various laws. Each law would impose higher fines, and law enforcement would be strengthened, with the hope that hefty fines would fill the fiscal shortfall. The units that were previously burning money, such as the police and the judiciary, would become revenue-generating entities. However, this method has a simple problem: it may be futile and result in more losses than gains. No matter how much money is fined, it is often a small amount compared to the government's budget, especially for a costly government like Hong Kong's, where even the lowest-ranking police officers earn salaries exceeding HKD 100,000.
The fourth method is "increasing taxes," whether through raising tax rates or imposing various burdensome taxes and license fees. The government would find creative ways to collect more money. However, the side effects of this method are evident. It kills the golden goose, making it even more challenging for businesses to survive and increasing the chances of closure. It also weakens the overall purchasing power of the society, accelerates capital outflow, and creates a vicious cycle. Additionally, imposing taxes has another problem: for truly wealthy individuals, there are many methods to evade taxation, and the results may not be as favorable as expected.
However, this is a relatively feasible method. Taking the Hong Kong government as an example, their strategy is to start with taxing wealthy minorities, such as increasing taxes on tobacco and alcohol or imposing taxes on horse racing betting. These measures are likely to face less resistance, as the general public generally does not oppose taxing these groups. However, in the end, the financial problem stems from the weakness of the real economy, which brings us back to the same question: the Hong Kong government is particularly expensive. It is likely that in the end, it will be a futile effort.
So, what is the ultimate solution to solve the debt problem? The answer is clear: "quantitative easing." Of course, this immediately brings to mind the negative consequences we have seen in history, such as currency devaluation, inflation, fiat currency, or even banknotes becoming worthless. We are all aware of these consequences. However, in terms of solving fiscal problems, quantitative easing not only allows the creation of money out of thin air to be used, but it also benefits exports and reduces the burden on individuals in debt throughout society. When a society has a large debt problem, it becomes more likely to issue more currency.
However, besides the pros and cons, or the negative effects, there is one fundamental problem: the Hong Kong government cannot directly implement this method due to the well-known "linked exchange rate." The Hong Kong dollar is pegged to the U.S. dollar at a fixed exchange rate. As long as the linked exchange rate system exists, the Hong Kong government cannot solve problems through currency issuance. When the U.S. government raises interest rates, leading to a high currency value, Hong Kong will inevitably be affected in the same way.
This method simply cannot be used unless, as often suggested in Hong Kong, there is a "decoupling from the linked exchange rate" where the Hong Kong dollar is no longer pegged to the U.S. dollar. Then, the Hong Kong government can regain control over currency issuance. Everyone knows the outcome when someone proposes this idea. There will inevitably be strong opposition, and the more people hold Hong Kong dollars in cash or assets, the more they will oppose it. The reason is also apparent because their wealth will shrink, or even collapse, in proportionate percentages, or ultimately lead to currency instability or credit collapse.
In reality, this is no different from a scenario where all civil servants have their salaries reduced because civil servants are paid in Hong Kong dollars. Decoupling is to allow the currency value to float freely, which essentially means letting it collapse. Those who receive their salaries in Hong Kong dollars, whether they are civil servants or teachers who follow the civil service pay scale, will not experience a change in their nominal income, but their actual income (to buying power) will be reduced. Of course, whether they hope for this or not is not essential. The fact is that they have no power to resist.
I wonder which method the Hong Kong government plans to use. Although I have indeed overlooked one. That is to seriously develop the industrial economy and increase tax revenue from profits... I have said it, Hong Kong should seriously engage in industry. How about that? It deserves an award for the most humorous solution.
in Insights
James Huang
October 6, 2023