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, 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.
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OTHERS OF NOTE
THE NEXT "PEG" TO FALL
The Yuan May be the Big Surprise in 2015
A collapsing Yen, Ruble, Swiss Franc Peg and now a plunging Euro are sending shocks waves around the world and destabilizing others.
The Euro weakness , which prompted the Swiss Franc 'peg'collapse, may be the domino which now forces China to move on the Yuan. This time it will be irrespective of US political pressures as everyone mobilizes for an 'all out' currency war.
CHINA HAS ITS 'BACK TO THE WALL' WITH GLOBAL SLOWDOWN & COMPETITIVE DEVALUATIONS
CHINA IS FACING A COMPETITIVE CURRENCY DISADVANTAGE!
IF YOU WERE THE CHINESE WHAT WOULD YOU DO?
This has got to really p$%^ss off the Chinese!
HAVE THEY ALREADY STARTED?
THIS ALL STARTED WITH THE COLLAPSE OF THE SWISS FRANC PEG
The drop in the Yuan over the past 2 days is the largest against the USDollar since Nov 2008 as USDCNY nears its highest (CNY weakest) since mid-2012. What is more critical is that for the first time since the new 2% CNY peg bands, USDCNY is trading at the extremes - 11.5 handles cheap to the fix. At the opposite end of the spectrum, the EURCNY just dropped below 7.00 for the first time since June 2001 with the biggest 2-day strengthening of the Chinese currency against the Euro in almost 4 years. It appears the consequences of ECB QE, SNB volatility, and now Greek concerns continue to ripple through the rest of the world.. and at a time when China faces its ubiquitous new year liquidity squeeze, that is not a good sign.
Biggest 2-day drop in the Yuan against the USDollar since 2008
With USDNCY puishing against its 2% peg band for the first time...
As the Yuan shifts to its strongest against the Euro since 2001 (almost 2000) - back below 7.000
WILL THE HONG DOLLAR FOLLOW SWITZERLAND?
HONG KONG DOLLAR
THE STORY IS LIKELY NOT YET THE HONG KONG DOLLAR
"It will happen, but I keep thinking it will be after the [yuan] is completely convertible." Jimmy Rogers
Hong Kong Dollar Peg Doesn’t Fit in Swiss Hole 01-23-15 WSJ
The sudden death of the Swiss franc ceiling set off fears that other fixed exchange rates could be next. But Hong Kong’s storied peg with the U.S. dollar is as solid as ever.
Superficially, Hong Kong faces a similar situation to Switzerland. The Swiss National Bank was buying huge volumes of euros to hold down the franc, swelling reserves and leading to rapid money creation. There was little inflation, but worrying froth in the Swiss property market. Imminent quantitative easing by the European Central Bank added to the pressure.
Hong Kong’s peg to the U.S. dollar has similarly forced the territory to import ultra-loose monetary policy from the U.S. Rock bottom interest rates in Hong Kong fueled surging property values. Critics have gone so far as to blame the peg for youth dissatisfaction in the streets.
Some investors think Hong Kong could follow the Swiss. There was a surge in the volatility of Hong Kong dollar options the day after the SNB’s move and the spot price of the Hong Kong dollar has moved toward the strong side of its narrow trading band.
But comparing the franc to the Hong Kong dollar is like putting a square peg in a round hole. The SNB’s franc ceiling was a discretionary move undertaken for a few years by a central bank that viewed the policy as one of its tools among many.
Hong Kong’s currency board, by contrast, is an institutionalized, rules-based system in place since 1983, making it harder and even riskier to change on a whim.
What’s more, while the SNB was facing a coming flood of euro liquidity, Hong Kong is now likely to see a receding tide of dollars. The Federal Reserve has stopped asset purchases and will eventually raise interest rates, letting some air out of the Hong Kong property market.
If anything, pressure on the Hong Kong currency may soon turn in the opposite direction. If the Fed keeps tightening and the U.S. dollar continues to strengthen even as China’s economy slows, speculators could start betting on devaluation.
Not that they will succeed. Hong Kong authorities have been willing to take huge levels of pain to maintain the peg. They allowed GDP to contract by 5.9% in 1998 rather than succumb to depreciation pressure. And with the domestic political situation still unsettled, Hong Kong is unlikely to abandon a policy that has anchored the financial system for decades.
In the very long term, switching the peg from the greenback to the Chinese yuan is possible. But that can only happen once the Chinese currency is a freely convertible international one, which it won’t be for the foreseeable future. Traders buying call options on the Hong Kong dollar hoping for Swiss-like capitulation should find better uses for their money.
SINGAPORE DOLLAR PUTS ADDITIONAL PRESSURE ON CHINA
Singapore's MAS announced a surprise shift in the slope of their policy band - implicitly loosening policy and so the Singapore Dollar dumped over 160 pips against the USD, the biggest drop in almost 3 years, tumbling to its weakest since Mid 2010.
Interestingly, against the Japanese Yen this move merely roundtrips SGD strength from yesterday as one wonders who the real enemy in the competitive devaluation game is...
The Sing Dollar weakened to 1.35 against the USD - the biggest single-day drop since Feb 2011...
A big drop for the SGD...
But against the JPY, it's a small move...
Raising the question of just who the currency war is against...
The current expectations are that the PBOC will cut interest rates twice this year — a 25 basis-point rate cut in the first quarter and another cut of 25 basis points in the second. It is felt that a fragile growth outlook and the narrowing yuan-dollar interest differential remain drags on the yuan in 2015.
Additionally, the PBOC has signaled it would reduce intervention in the currency market as the yuan approached equilibrium value in mid-2014. That means market forces are playing a bigger role in determining the yuan’s spot rate now.
In 2014, the yuan depreciated 2.4 percent against the dollar, while rising 6.2 percent against a basket of currencies. The yuan is therefore likely to depreciate slightly against the dollar this year under current expectations.
Most feel a big drop is unlikely as that would:
- Incur political pressure from the U.S.,
- Significant depreciation might trigger big capital outflows, which would threaten financial sector stability.
The reality is the Chinese have no choice nor will the world economy give the Yuan one. The Yuan is headed lower in 2015.
Gordon T Long
Publisher & Editor
Gordon T Long is not a registered advisor and does not give investment advice. His comments are an expression of opinion only and should not be construed in any manner whatsoever as recommendations to buy or sell a stock, option, future, bond, commodity or any other financial instrument at any time. While he believes his statements to be true, they always depend on the reliability of his own credible sources. Of course, he recommends that you consult with a qualified investment advisor, one licensed by appropriate regulatory agencies in your legal jurisdiction, before making any investment decisions, and barring that you are encouraged to confirm the facts on your own before making important investment commitments.
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