Compradore no more


Henry C K Liu

First appeared in Asia Times on Line on July 2, 2002

Hong Kong was built on a compradore economy under British imperialism. A few months ago, Hong Kong's acting director general of investment promotion told delegates to the World Services Congress 2001 that Hong Kong would further enhance its role as a "Compradore City" with China's accession to the World Trade Organization. "Upon China's entry to the WTO, this role is going to get bigger, making it more profitable for those who seize Hong Kong's compradore spirit and who base their businesses in Asia's world city," the official stressed.

A compradore was a native servant employed as head of the native staff and, as agent, by foreign trading houses in China during its shameful semi-colonial history. Imperialist interests in colonial markets mediated through compradores. As a class, the compradore bourgeoisie is despised by socialist revolutionaries as well as by members of the national bourgeoisie. The compradore has no positive economic function in a regime of free and fair trade. Ideology and national pride aside, in the era of globalization and e-commerce through instant communication, where efficiency is achieved through the elimination of intermediaries, a compradore economy is a dying breed. Economic nationalism will put the final nail in the compardore's coffin.

The future of Hong Kong as a compradore economy can be summed up quite simply: non-existent. This is not nit-picking, for it illustrates a basic flaw in Hong Kong's image of its future.

Monday, July 1, marked the fifth anniversary of Hong Kong's return to Chinese sovereignty from British rule. On that day, Tung Chee-hwa, the chief executive of the Hong Kong Special Autonomous Region (SAR), began his second and final five-year term with a newly appointed cabinet in a reformed government structure of political accountability riding herd over an apolitical civil service. Five years earlier, many in Hong Kong, infested with the compradore spirit, exemplified by the madame chief secretary (Anson Chan) of the holdover colonial civil service at that time, echoing US neo-liberal propaganda, openly worried about undue Chinese interference on Hong Kong's "free market" success, harping on the importance of human rights, democracy and rule of law, none of which had been particularly inherent under British colonialism as indispensable ingredients of Hong Kong's freak prosperity, all in which China was pictured as being deficient.

On July 2, 1997, the day after the historic return of Hong Kong to China, the Asian financial crises began in Thailand. Those in the new SAR government in charge of economic policy complacently proclaimed that the "fundamentals" of the Hong Kong economy were sound and that all that was needed was to maintain Hong Kong's free-enterprise tradition to ride through the passing storm. Oblivious to the structural and systemic nature of the developing financial crises, Hong Kong even contributed US$1 billion from its foreign-exchange reserves to the International Monetary Fund (IMF) to help contain the unfolding crisis within Thailand. The uninformed hubris was answered by devastating contagion hitting the Hong Kong economy by October 1997.

The irony is that Hong Kong, which tirelessly flaunts its "freedom", religiously chanting neo-liberal slogans by rote, is now looking to China as the hope of its economic future, never questioning why China, which has been labeled derisively as less "free" and with an underdeveloped regime of commercial law by many in self-satisfied Hong Kong, is the only growth economy in East Asia in the midst of global recession, while "free" Hong Kong has been stuck in economic decline for half a decade. All the condescending accolades of "freedom" Hong Kong received from foreign conservative organizations such as the Heritage Foundation, Freedom House and the American Enterprise Institute have not been of much help in convincing global capital heading for China to bypass Shanghai in favor of Hong Kong or transnational corporations in search of the China market to locate their regional headquarters in Hong Kong instead of Shanghai.

GE, the world largest conglomerate, has just announced that it will move the regional headquarters of its plastics division from Tokyo to Shanghai, at the same time downsizing its operation in Hong Kong. All transnational corporations now have localization programs in China, staffed with mainlanders with masters of business administration (MBAs) from US universities who speak better Mandarin than most graduates from Hong Kong, where Cantonese is the preferred Chinese language. These corporations have no need for Hong Kong compradores.

Hong Kong recognizes that it must restructure its economy, but it is not clear that the SAR government is prepared to accept that economic restructure can only be achieved through strong government policy. Hong Kong continues to cling to the myth of an anti-statist past, for fear that any hint of industrial policy or government interference with the market would displease US neo-liberals and bring down their political wrath of reduced access to US markets.

Yet it is undeniable that Hong Kong's current dysfunctionalities had been caused by British colonial policy disguised as free-market forces. For one and a half centuries, the British ruled Hong Kong for the benefit of the British Empire, not to promote human rights, nor democracy, nor free markets, all of which were slogans recently co-opted as Cold War rhetoric to justify continuing colonial rule in an era of national liberation. To correct these dysfunctionalities, bold government leadership with political courage is needed.

The performance of the SAR government has not enjoyed overwhelming popular approval because the public expects strong political leadership and bold policies and programs to deal with Hong Kong's economic woes, while the government is fixated in its passive role as faithful defender of free-market fundamentalism.

Hong Kong set up a Commission on Strategic Development in 1998 to look decades beyond 1997 to see what sort of community and economy Hong Kong should be working toward. The commission report, with a title sounding like a second-rate Madison Avenue ad campaign ("Bringing the Vision to Life - Hong Kong's Long-Term Development Needs and Goals") identified four strategic themes. One theme is to strengthen links with mainland China, in particular the prosperous economies of Guangzhou, Shenzhen, Zhuhai and Macau, Hong Kong's neighbors in the Pearl River Delta. The other three are to enhance competitiveness, improve the quality of life and to reinforce Hong Kong's identity and image to create a world-class business and living environment in Hong Kong. The vision is to make Hong Kong a leading world city, on par with New York and London, as well as to strengthen its unique position as a major international city in China.

Yet the former madame chief secretary of the civil service, well trained by the last British governor of Hong Kong (Chris Patten - now of European Commission fame), repeatedly and forcefully warned against turning Hong Kong into a Chinese city. It is a peculiar posture, because New York or London do not feel the need to renounce their national identity in order to be international centers. Typical of her compradore spirit, Anson Chan was bent on being more Western than her British masters. To attract tourists, a Hong Kong Disneyland is to open in 2005. Surely very few Westerners would come to Hong Kong to visit Disneyland. Thus the target tourist population would be mainly Asians, mostly Chinese, an irony that apparently escaped the lady.

Hong Kong has merged its exchanges and clearing houses to make them more efficient and competitive. The new exchange is forging strategic alliances with other stock exchanges to capitalize on its location in the East Asian time zone. Hong Kong opened a growth enterprise market that is modeled on the Nasdaq to help new companies with a promising future to raise capital. Hong Kong's telecommunications sector has been liberalized, following global trends, with similar controversial outcomes. The unfolding global telecom debt crisis will not spare Hong Kong, as the Internet and dotcom bubble burst did not spare Hong Kong. The ill-conceived CyberPort will be a white elephant memorial to Hong Kong's high-tech fantasy. No economy can develop a high-tech sector without a research and development program supported by national defense. Hong Kong's market culture has been focused on property development and labor-intensive manufacturing as a result of government policy.

Much talk is heard about offering high-value-added services, and building a forward-looking community that utilizes innovation and technology. Yet Hong Kong has the highest concentration of family-owned and family-run enterprises anywhere, and they are not particularly known for innovation. In corporate governance, Hong Kong remains a developing region. With all the fanfare about being a mecca for free markets, Hong Kong does not have a rule-based competition policy.

To its credit, the SAR government has committed an enormous amount of resources to the education sector, aiming to create the best-educated and most well-rounded generation of youth in the history of Hong Kong. Yet Hong Kong tolerates a protracted and serious brain drain to the West, mostly to the US, where many of Hong Kong's brightest have gone for university education and stayed on because they were not interested in a career in real estate or in joining a family business. Every week, some recruitment delegation from various regions of China visits the United States to entice Chinese students, scientists and professionals with promising opportunities in China. Few, if any, delegations ever came from Hong Kong. Moreover, a massive brain drain from Hong Kong to China is currently in process.

Hong Kong commits enormous resources to infrastructure building. Yet much of the infrastructure serves merely to manage the overcrowding caused by exorbitant land costs. Chek Lap Kok, Hong Kong's $20-billion airport, Britain's parting gift to Anglo-American contractors, has great aspirations to be a regional logistics hub, and the government has said that it will invest even more toward that goal. But foreign air-cargo companies are put off by the inability to do onward shipping from the airport. The problem stems from the government's attempts to protect Cathay Pacific, the airline owned by one of Hong Kong's oldest conglomerates. Hong Kong needs to liberalize its air-cargo aviation regime if it wants to be a logistics center for the modern high-tech and high-value-added world. Also, the over-investment has produced world-class facilities that must also charge world-class rates, leaving Hong Kong with a disadvantaged price competitiveness.

Hong Kong cannot independently improve its environmental standards without close regional cooperation. There are signs that the whole region has not faced up to the real cost of environmental cleanup and protection.

The chief executive has proposed to the central government to devise specific policies in support of Hong Kong's position as an international financial center, a trade and logistic center, and tourism center. Specifically, Hong Kong has asked Beijing to recognize and utilize Hong Kong's established competitive advantages fully when it makes overall planning for economic development, infrastructure and other large-scale investments. Hong Kong has it backward. It is Hong Kong that must adjust to China's developmental needs, not the other way around.

The chief executive also has proposed the establishment of a free-trade-area arrangement between Hong Kong and the mainland that will provide greater opportunity to Hong Kong businesses and professionals. With this arrangement, Hong Kong hopes to explore fully the potential for greater economic cooperation within the Pearl River Delta area. This is of course a logical move. Yet Article 114 of the Basic Law sets Hong Kong as a free port without tariffs unless otherwise prescribed by law, and Article 115 sets a policy of free trade, while Article 116 defines Hong Kong as a separate customs territory. These articles, so vigorously fought for before 1997, are now impeding Hong Kong's development.

Still, the most serious challenge facing Hong Kong as an international finance center is to find its proper place in the global financial system. The global financial crises caused by US dollar hegemony that hit Asia on July 2, 1997, is far from over. The fundamentals behind the crises, developed over a decade of unregulated finance globalization, have not been addressed at their roots. Most of the measures adopted so far by the Group of Seven (G7) industrialized nations, of which the US is the leader, pulling the G22 nations by their reluctant noses, have to do with bailing out G7 transnational banks on their foreign loans, and pushing down interest rates to keep global stock markets artificially high, indicators of fleeting financial robustness but usually mis-indicators of fundamental economic health. Wall Street called it the Goldilocks economy, where bad news was interpreted as good and visa versa by naive investors led by unprincipled analysts in collusion with fraudulent chief executive officers. Well, Goldilocks has been abruptly awakened by the bears demanding to know who has been eating their porridge and sleeping in their beds.

Asia has experienced sudden financial collapse not because the goods produced in Asia are suddenly unmarketable worldwide, or Asian management has suddenly become so inept as to incur unforeseen losses in Asian companies. It is certainly not the inevitable outcome of alleged inherent defects in Asian values, as Western analysts claim. Rather, the collapse is the result of abrupt and recurring ruptures in the unregulated global system of financial markets.

Beginning in the early 1960s, with the growth of Euromarkets where banks in one European country could take deposits and make loans in currencies of other countries, the tight controls of the international flow of capital set up by the Bretton Woods system of fixed exchange rates after World War II were in effect bypassed. Drawing lessons from the 1930s Depression, economic thinking prevalent immediately after the war had deemed international capital flow undesirable or unnecessary. When the fixed-exchange-rate system finally broke down in the early 1970s, the developed countries abandoned capital controls officially. In the late 1980s, many developing countries followed suit.

By the end of the last decade, daily turnover of foreign exchange grew more than 100-fold to over $2 trillion from $190 billion at the beginning of the decade. By 1996, some $350 billion of private capital flowed into emerging markets, a sevenfold increase in six years. For the past two decades, technical imbalances between interest rates set by different central banks for funds in different currencies distorted capital flow around the world. The resultant inflow of capital into Asia through inter-linked financial markets around the globe outstripped the region's viable absorption rate. Financial institutions took advantage of low cost funds denominated in currencies of select countries, namely Japan, Germany and the United States, to make loans at higher interest rates denominated in local Asian currencies. These institutions sought to strategically profit from recurring technical imbalances in global finance by assuming currency risks. Economists name this development as international arbitrage on the principle of open interest parity. In banking parlance, this type of activity is known as "carry trade".

This manipulative speculation was by no means limited to emerging economies. Corporations based in developed economies routinely engaged in global financial and stock-market speculation at the expense of sound production strategies. The public announcement of plans to open new factories in Asia predictably lifted share values in home markets, regardless that such factories risked being loss-makers, for the loss would be more than covered by the increase in market capitalization. Corporate borrowers in Asia, attracted by low rates in some foreign currency loans, have also assumed currency risks, at times even bypassing local banks to borrow directly in debt markets overseas. Borrowers, anticipating asset inflation brought by run-away growth, also succumbed to the irresistible temptation of borrowing short-term to finance long-term projects, thus adding to the risk they assumed. Simultaneously, many Asian banks have taken local-currency deposits at low saving rates (in Hong Kong at times at negative interest rates) to invest overseas in risky foreign-currency instruments yielding higher returns, engaging in carry trade. Local banks in turn replenished the depleted local capital pool with low-cost foreign-currency loans from international banks, taking on both economic and currency risks.

Borrowing low and lending high is the basic business of banks, and there is nothing wrong with it if the activities occur within a well-regulated market of a bank's domicile community. With the advent of global banking, however, the unregulated internationalization of finance has created perilous systemic stress. Banks began to act as international loan brokers, profiting from interest-rate spreads between local and foreign funds, often booking the risk premium added to weak currency interest rates as legitimate loan profits. These banks also began to maximize their profits by maximizing loan volume, abrogating their traditional economic function as responsible financial pillars of local economies to ensure the productive allocation of capital. In time, local banks de-coupled their business self-interest from the economic impacts of their loans on the local economies, because they hedged the risk in such loans by passing it to overseas hedge funds which became the real loan originators. Western and Japanese international banks in turn provided funds to the local broker banks in Asia whose credit ratings were considered acceptable because the borrowers' exposures were hedged by instruments designed to transfer risk to other international institutions. The global overcapacity in manufacturing is the direct result of this unregulated financial market.

In effect, the widespread transfer of business risks into currency risks forced the governments of the affected currencies to become involuntary lenders of last resort. This is the real effect of Hong Kong's and other Asian currency pegs to the US dollar. China is relatively insulated from the financial crisis mainly because the yuan is not fully and freely convertible.

Hedging does not eliminate risk, it merely passes risk along to other parties. In fact, complex hedging schemes, with the effect of reducing the risk exposure of individual lenders and inflating the credit worthiness of the hedged individual borrowers, when widely practiced, actually increase systemic risk exposure, initially of regional financial systems and ultimately of the global system. Yet the soundness of financial institutions continues to be assessed singularly within national borders, while financial markets have become intricately linked globally. A poor credit rating seldom means the denial of credit. It only means a higher interest rate, which actually attracts more eager lenders who rationalize that the high risk has been compensated for by the increased rate.

Through extensive hedging, private financial risks have been largely socialized globally. The ingenious layering of protection against risk, while providing comfort to individual players, buys such comfort at the expense of the security of the total global system. At some point, the strained circular chain breaks at the weakest link and panic sets in. For Asia, that break occurred in Thailand on July 1, 1997.

Because of this circular system of global hedging, the economic crises in Asia inevitably spread worldwide. The regional crises, each with unique local characteristics, are merely early symptoms of a ticking global time bomb constructed out of the complex calculus of interlinked financial markets in which countless individual credit risks are legally masked as sound transactions through sophisticated hedging. Derivatives, financial instruments which derive their value from other underlying financial instruments or benchmarks such as stock indexes or exchange rates, are the cards in the fragile house of cards built by a financial specialty known as structured finance.

International finance in recent years has been saturated with disastrous and scandalous abuses that clearly and repeatedly epitomize the deficiencies of the unregulated global interlinking of financial markets. Speculators have been blamed for precipitating the run on currencies that started the financial crises. Yet speculation and risk management are two sides of the same coin. At the opposite end of a prudent hedge, a speculator is required. Structured finance enables the unbundling of risk for marketing to different levels of risk takers, creating the illusion that risk is neutralized when it is merely distributed imperceptibly throughout the financial system. In a structurally flawed system, perfectly honorable businessmen or institutions, individually normally true to high ethical and financial standards, can unwittingly participate in systemic games of dubious value.

Data on the initial six months of the Asian financial crises show that currency hedging individually by sophisticated businesses and alert government bodies, domestic and foreign, as protective measures against foreign-exchange exposures in both debt and revenue, had been mostly responsible for the sudden currency turmoil in the region. In international finance, a game of musical chairs in financial risk is in full force in which the players are handcuffed together through interlinking hedges between parties unknown to each other. This game can cause serious systemic rupture when the music stops. Yet world leaders continue to deny its danger.

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 parts 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 in the recent past.

Instead of focusing on correcting the structural defects of the unregulated globalization of financial markets, IMF rescue packages have been devious vehicles for wholesale foreign control of wounded Asian economies. IMF "off the shelf" rescue approaches have exacerbated the financial crises in Asia. Moreover, the austerity measures demanded by IMF economists who are insensitive to local political realities have turned 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 an 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 $20,000 of sovereign debt per capita), with two-thirds of all US currency being held overseas, with severe budget deficits and a history of volatile fluctuations in the floating exchange rates of its fiat 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 prior to the Asian financial crises, 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.

The reason for this is simple. Hong Kong's linked-exchange-rate mechanism is itself an open admission of no confidence in its own currency. With a linked-exchange-rate mechanism, Hong Kong pledges to exchange Hong Kong dollars at a fixed rate to the US dollar and holds 110 percent equivalent US dollars in reserve for each Hong Kong dollar in circulation. This currency peg requires local interest rates to track US rates, plus a country risk premium that is determined in part by the market's view of the economic viability of the peg rate. That viability has no economic basis. It is based entirely on arbitrary political will. Thus, the wider the gap between the official exchange rate and the market's judgment of the economic value of the HK dollar, the higher would be the cost of maintaining the peg. The Hong Kong government also holds most of its foreign exchange reserves in US dollar denominated instruments, in excess of its trade-weighted needs.

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 US dollar, despite unjustified perceptions of its soundness, is only as solid as the true state of the US economy at any given time, and at this moment it is not very sound.

In 1995, after the US Federal Reserve started to increase interest rates in 1994 and sharply curtailed its own purchase of treasury bills, triggering the Mexico peso crisis and a subsequent US 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. South Korea, Malaysia, Thailand, Indonesia and the Philippines together bought $30 billion. The Asian purchase totaled $260 billion from 1994 to 1997, the entire increase in foreign-held US dollar reserves. These recycled dollars pushed up stock prices in the US, forming part of what Fed chairman Alan Greenspan referred to as "irrational exuberance".

A sharp correction of the stock markets accompanied by an abrupt slowdown of the US economy was a matter of when and not if, and it began in late 2000 with the bottom nowhere in sight. Also, the 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 postwar corrections in US markets in 1971-73, 1978-79, 1985-87, which critically stalled the US economy because the contributing currency overvaluations were permitted to go too far and for too long, the coming correction which has apparently finally begun after much delay, will have equally if not more severe adverse economic consequences.

This means that when the Asian economies finally are working themselves out from the damages of the crises that began in 1997, the US economy stalls and the US dollar falls in value, ending the US as a market of last resort and the dollar as a safe haven investment. Five years after the 1929 crash, US president Franklin D Roosevelt was forced in 1934 to ease monetary policy through a 59 percent devaluation of the US dollar against gold.

The global financial crises that began in Mexico in 1995 and hit Asia in 1997 were 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. China has shown signs that it is becoming aware of this fact. Hong Kong as part of China, despite the peculiar "one country, two systems" arrangement, cannot be independent of Chinese national interests.

Next: Pegged Down