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  • Sep 22, 2014
  • Updated: 6:59am
BusinessBanking & Finance

China uptick, easy money drive demand for HKD

PUBLISHED : Thursday, 03 July, 2014, 2:08am
UPDATED : Thursday, 03 July, 2014, 2:08am

Improved economic activity on the mainland is the main driver of renewed demand for Hong Kong dollars that has forced the city's de facto central bank to intervene in currency markets for the first time in 18 months to defend the peg to the greenback.

Surging speculative inflows, fuelled by the super-easy monetary policy of the world's major central banks that has sent capital flooding into emerging markets, have put sustained upward pressure on the Hong Kong dollar.

[Speculative inflows have] been an important part of the demand

"This has been an important part of the demand," Stephen Sheung, head of investment strategy at SHK Private, told the South China Morning Post.

Sheung said the currency had been strong for several weeks and that equity analysts were upgrading their views of Chinese company profit growth. Optimism was fuelled on Tuesday by two upbeat influential surveys of purchasing managers on the mainland.

The Hang Seng Index, closed on Tuesday for a public holiday, rallied 1.5 per cent to a 2014 high of 23,549.62 points yesterday in response to the surveys, while the Shanghai Composite Index hit a nine-day high.

Data shows the Hong Kong Monetary Authority (HKMA) had bought US$2.1 billion in the past two days at HK$7.75 per US dollar, the upper limit of a convertibility range that triggers intervention.

Hong Kong pegged its currency to the US dollar in 1983 when negotiations between Beijing and London over the city's return to Chinese rule spurred capital outflows. In 2005, policymakers committed to limiting the currency's decline to HK$7.85 per dollar and capped gains at HK$7.75. When the local dollar reaches the strong end of the trading range, the HKMA buys US dollars to prevent further appreciation.

The HKMA said in a statement that commercial activity, mergers and acquisitions and upcoming dividend distribution contributed to renewed demand for the currency.


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But even though the PBOC has regained her mastery of fully independent monetary policies, the problem of very high interest cost in the real economy cannot be easily solved.
Those interest-insensitive SOE monsters (including those with excess capacities, and the local-government-supported property developers, which have the need to persistently rollover their old debts) have constantly been engulfing whatever amount of loans are available from the economy, at relatively low interest rates in the formal banking market, and at very high interest rates in the shadow banking market, with the implicit guarantee of the full backup of the local and central governments.
Because of the SOEs’ ‘soft budget constraint’, the signal from the lower short-term interest rates cannot be easily transferred to the relatively high long-term interest rates.
So far as those SOEs are concerned, expansionary monetary policies no longer work --- the problem is not a lack of credit, but an excess of capacity.
Those zombies imply a wasteful use of the country’s precious domestic savings.
The new and old monies are just empty-circling, without really benefiting the real economy.
It also looks like a problem of liquidity trap, as in Japan.
Only expansionary fiscal policies (and yuan devaluation) can solve the problems.
Meanwhile, the SMEs and SMiEs are miserably starved of funds.
Bad money drives out good.
The ultimate problem seems to be the peculiar property right structure of the country’s main enterprises.
The SOEs, a kind of commons, have caused the country to have to incur a very high cost --- another manifestation of the Tragedy of the Commons.
(g) Conspiracy theory: part of the West's Currency War to keep China from having her own independent expansionary monetary policies which cater to the needs of her real economy (the SMiEs).
'For us small exporters it usually requires increased labor costs to qualify us to apply for the tax rebate by ourselves, ...'
'According to the new policy, service trade providers are only allowed to apply for a tax rebate after being granted the right by SMEs to sell goods in the overseas market.'
Unlike Hong Kong, China has chosen a fixed exchange rate and an independent monetary policy, at the price of forsaking free capital movement, in principle at least.
In practice, since China's capital control is porous, it seems that the country has been juggling with all three, until recently, when the yuan stops revaluing, and hence the net hot money inflow into the country seems to have subsided.
China is now able to enact a relatively independent monetary policy, and expand the money supply to sustain her GDP growth, through targeted RRR cuts and a lower loan-to-reserve ratio.
But perhaps not for long, now that the hot money is coming back !
The renewed capital inflow will increase the pressure to revalue the yuan, which arguably is already overvalued.
According to the authoritative Lombard Street Research, the yuan may be overvalued by as much as one-third.
If they are correct, then the exchange rate should be 8.27:1.
Since 2005, the yuan has been revalued by 30%.
This doesn't seem much, but during the last 9 years, the country's M2 rose from 30 trillion to 118 trillion, an increase of 293%.
Adding insult to injury, the country's (minimum) wage rates have increased (much) faster than her labour productivity growth in recent years.
Which means the space for further yuan revaluation is very limited.
Also, China's trade surplus has dropped from 10% of GDP to 2.1%.
In 2013, the yearly export tax rebates was 1,051.8 billion yuan, with 103.4 billion in Shenzhen alone.
Without this rebates, the trade surplus would already have become a trade deficit.
For every 13.8 yuan of China's exports, 1 yuan is export rebate.
These rebates, seemingly subsidising China's export enterprises, are actually subsidising the foreign consumers.
Some Chinese people therefore have to fly to America to buy the cheaper goods made originally in their own country !
The tax rebates have also nurtured China’s lazy low-tech enterprises, which have no incentive to upgrade their technology, and which do not want to develop the domestic market.
The tax rebate just serves to protect all those manufacturing jobs in the tradable sector of the economy.
The effects of yuan revaluation have continuously been offset by that of the export rebates.
The correct way out is to practise rebate tapering to enable the export and import trades to attain a dynamic equilibrium, so as to reduce the pressure for further yuan revaluation.
With no more or very low trade surpluses, or even trade deficits, America's Congress will have nothing to say.
If equilibrium is more or less attained, the country’s funds outstanding for foreign exchange will gradually drop, and there will be less speculative hot money inflows.
Hence, faced with less risk of domestic inflation, the PBOC can truly enact her independent monetary policy in any way she sees fit, even though the dam of capital control is still leaking water.
(From the following Chinese article: ‘****blog.sina.com.cn/s/blog_e3be0f160102uwnz.html?tj=fina’)
While 'commercial activity, mergers and acquisitions and upcoming dividend distribution contributed to renewed demand for the currency',
these reasons do not seem as important as the simple explanation of hot money inflow,
which seems to coincide with the following observations:
(a) Janet Yellen doesn't think US's interest rates will rise anytime soon, so the game of carry trade hasn't ended yet;
(b) The DJIA has reached a relatively high plateau;
(c) The US treasury yields are at relatively low level;
(d) ECB lowers her interest rates;
(e) the coming Shanghai-HongKong through train, and the relatively cheap stocks in these two cities;
(f) Larger quota of RQFII.
According to Mundell's Impossible Trinity, Hong Kong has chosen free capital movement and a fixed exchange rate, at the price of forsaking her independent monetary policy.
(Chinese readers: ****finance.sina.com.cn/money/forex/20140703/074719594175.shtml)
Hence our city's relatively low interest rates (commensurate with that in the US), and our refuse-to-subside property market.
Our rich property developers and the banks stand to gain, while the city's bank depositors (a majority of the people) all lose out from the resulting financial repression --- real deposit rates are simply negative given the relatively high prevailing inflation rates.
Bank savers have been subsidizing the bank borrowers (including the rich people, like the property tycoons), for a very long time already.
This seems to be consistent with Piketty's claim that r (the return on capital) falls less quickly than g (growth in income).
(‘Piketty with Chinese Characteristics’, Project Syndicate)
The rich are accumulating wealth significantly faster than their counterparts in the rest of the city, thereby widening the gap between the rich and poor.
And the young people's chance of climbing up the social ladder seems to be fading.
I think this partly explains the growing discontent and street protests recently seen in the city.


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