Money For Nothing

The New Year dawned in Hong Kong with the undeniable sting of sticker shock. A ride on the city's iconic Star Ferry will soon cost 23 percent more. Bus fares, tunnel tolls and taxi rides are ticking up, too, as are hospital fees and the price of luxury travel. The proximate cause is the Hong Kong dollar's long-held peg to the U.S. greenback, which has plunged over the past year as the American economy has sputtered toward recession. Yet the ultimate problem is a flood of nearly free money that is beginning to have a host of pernicious effects. In Hong Kong, as in many other parts of Asia, inflation is chief among them.

Countries with so-called managed floats, including Singapore, Malaysia, Indonesia, India and China, allow currency valuations to fluctuate somewhat but hold them in check through central-bank interventions. Those that keep their currencies far below market value—like China—invite high inflation; those that allow the most appreciation undermine export competitiveness even when the local economy has less-than-stellar growth prospects, as in Thailand. Everywhere, too much money is a problem that's likely to get much worse now that U.S. Federal Reserve chairman Ben Bernanke has announced an aggressive plan to cut interest rates.

Already, central banks of the United States, Europe and Japan have pumped billions into the global financial system to counteract the subprime-mortgage mess, putting downward pressure on interest rates. From Singapore to China and India, technocrats are struggling to keep the subsequent flows of cheap capital in check and prevent economic meltdowns.

Their options: "Let currencies appreciate, interest rates come down or … impose some capital controls," says David Carbon, chief economist at DBS Bank Group Research in Singapore. "In effect, what [some] Asian governments are saying to foreign investors is, 'Thanks very much for your interest in our economy, but we just can't absorb so much money, so don't give so much'."

Foreign reserves are piling up twice as fast as they did before the 1997-98 Asian financial crisis, and despite lower growth forecasts from groups like the Asian Development Bank and the IMF, most economists still expect that Asia will outperform the rest of the world in 2008, meaning that the tide of cheap money could rise higher before receding.

In Hong Kong, where the dollar peg mandates monetary policy that mimics the U.S. Fed's, today's ultralow interest rates, combined with huge infusions of outside funds into the city's bubbly bourse, has some analysts predicting stock and real-estate rallies in spite of the U.S. slowdown. The downside: inflation in the price of just about everything else, too. Singapore and India have struggled to prevent capital inflows from driving up inflation, but the city-state largely abandoned the effort last year and now has interest rates hovering below 2.5 percent. New Delhi boosted lending costs significantly higher, set tough limits on corporate borrowing overseas and allowed the rupee to appreciate 11 percent in 2007. Still, "the overall dynamic seems to be a strong uptick in [inward] foreign-capital flows," says Shankar Acharya of the Reserve Bank of India. The rising rupee, he adds, "does create problems, which are concentrated in labor-intensive [export] industries like textiles, garments and leather."

China's liquidity woes are the most vexing. A profusion of exports since 2003 ballooned the trade surplus to $260 billion last year and exploded foreign reserves to nearly $1.5 trillion, effectively undermining Beijing's long-held strategy of keeping its currency undervalued to boost exports. In mid-2006 inflation spiked; it now runs at close to 6.5 percent for consumer prices as a whole and 18 percent for food. In recent months the government has since shifted to a "tight" monetary policy and allowed the yuan to appreciate. Stephen Green, head of research in China at Standard Chartered Bank, says the Chinese currency could strengthen by 9 percent in 2008 with "a sustained impact on exports."

There are some positive effects from the liquidity glut. Local-currency appreciation has blunted the impact of $100-per-barrel oil. Asian spending power is on the rise like never before, which empowers Asia Inc. to grow more acquisitive. One risk is that inflation will surge as Asian economies slow, creating a complex set of problems. "It's way, way too early to start talking seriously about stagflation," says Green, "but that's the environment we're moving into." Which is why, in the end, money isn't always a blessing—even when it's free.