Soon after the Swiss shocked the world by abandoning their currency's peg to the euro, Hong Kong's Financial Secretary John Tsang hit the airwaves. His very clear message: the city's U.S. dollar peg would hold firm.
Tsang, however, has credibility issues. In recent years, he's cited Switzerland's commitment to capping its currency as inspiring his own. That sounded fine until Swiss National Bank President Thomas Jordan unexpectedly freed the franc. Speculators very quickly drove the Hong Kong dollar toward the top of its trading band.
More importantly, Hong Kong's 32-year-old peg may now be fueling social discontent. Last year's Umbrella Revolution had as much to do with surging inequality as democracy -- a problem captured most vividly by stratospheric property prices that have put homeownership out of reach for many citizens. Hong Kong's undervalued dollar has made that problem worse, by attracting tidal waves of Chinese money. (In 2013, Hong Kong received $47 billion of direct-investment inflows from the mainland, and another $342 billion from the British Virgin Islands, a favorite haven among ultrarich Chinese.)
Has the policy currency outlived its usefulness? There are many reasons to think Hong Kong won't go rogue the way Zurich did. Any decision to scrap the peg would be made in Beijing, where Hong Kong Chief Executive Leung Chun-ying's political bosses reside. And at least some of the Communist Party elite care more about ready access to Hong Kong's property market than the anxieties of the city's middle class.
Hong Kong's financial regulators are themselves a decidedly risk-adverse bunch that sees the peg as a reassuring backstop. "It can be called a magic needle for calming the sea of the Hong Kong economy," Tsang said earlier this week. It's also worth noting the differences between Switzerland (which essentially was manipulating its currency) and Hong Kong's formal lock to a specific U.S. dollar value.
But the peg also limits the government's room to maneuver. Even with curbs introduced to cool demand, real-estate prices surged 12 percent in the first 11 months of 2014 to a record. The city's 5.1 percent inflation rate is double the Asian average. While an undervalued currency isn't the sole culprit, it's surely one of the main factors driving up prices. Of course, the peg works both ways. Capping the dollar helps exports, supporting economic growth. And amid talk China may begin devaluing the yuan, Hong Kong's capital-inflow challenges may recede in the short run. They're sure to return, though.
To ease the strain, Hong Kong could try something drastic: pegging its dollar to the yuan. More realistically, it could adopt a gradualist course and link the dollar to a Singapore-like basket of currencies. Perhaps the highest-level call in recent months for the city to study its options came from Peter Wong, Asia-Pacific CEO for HSBC. Along with the above-mentioned possibilities, Wong raised the idea of letting the Hong Kong dollar float, or even naming the yuan as legal tender.
In his 2013 book, "Street Smarts," investor Jim Rogers warned Friday's Swiss shock was coming. I checked with him this week and asked if Hong Kong might be next. "It will happen," he replied, "but I keep thinking it will be after the [yuan] is completely convertible." Trouble is, there's no guarantee when that might happen, especially as China's growth slows and officials in Beijing worry about capital flight.
At the very least, the Swiss surprise should spur a public debate about the pros and cons of Hong Kong's peg. If scrapping it can help ameliorate the city's socioeconomic tensions, perhaps it's time for Hong Kong to shock the world, too.
CHARLES HUGH SMITH'S
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