By William Pesek
Hong Kong is an economic paradox with few peers.
It's routinely ranked the world's best place to do business by the Heritage Foundation and The Wall Street Journal, which publish the annual Index of Economic Freedom. That's because of Hong Kong's free entry of foreign capital, first-world legal system, low taxes and duty-free port.
Eyed from another angle, Hong Kong should worry the libertarians out there: Its leader is picked by Beijing and a handful of oligarchs tower over the economy. It also has the only state-backed Disneyland, and it uses a pegged currency.
If Hong Kong were as free as many believe, inflation might not be surging 7.9 percent, the fastest pace since 1995. The peg to the U.S. dollar is fueling bubbles in the city's economy. Hong Kong's dollar has weakened 7 percent against the Chinese yuan in the past two years, driving inflation and a surge in property prices. Tidal waves of mainland cash are pouring in to profit from the currency mismatch.
That year-over-year jump in July consumer prices spooked markets and has hedge fund managers like William Ackman of Pershing Square Capital Management LP betting on a policy shift that markets have been trying to time for years.
Fortunes could be made by correctly timing a big upward revaluation in Hong Kong, or when the city scraps the peg it's maintained since 1983. New York-based Ackman is homing in on such a surging-dollar trade. He's buying Hong Kong dollar call options, which give investors the right to buy the currency at a set price by a specific date.
Hong Kong could always peg its dollar to the yuan. Yet that would shackle the outlook of a highly developed economy to a developing one. To reach its incredible potential, China must first avert economic overheating, keep bank loans from 2008 stimulus efforts from going bad and avoid social instability. Hong Kong may want to maintain some distance as China sorts out these and other challenges.
In the meantime, Hong Kong has a worsening inflation problem on its hands. And the answer may be quite simple: The free-est economy should give real freedom a try.
(William Pesek is a Bloomberg View columnist.)-0- Sep/16/2011 14:11 GMT