The View

US dollar peg ensures Hong Kong’s safe-haven role

The Russians have shown that HK's US dollar link will lure overseas funds because the local currency acts as a viable substitute for the greenback

PUBLISHED : Monday, 04 August, 2014, 10:02am
UPDATED : Tuesday, 05 August, 2014, 3:11am

Have the Russians not heard about the impending Occupy Central protest movement, which will be the death knell of Hong Kong as a global financial centre?

Apparently not. Either that, or they consider a gathering of bespectacled, iPhone-cradling voting-rights advocates is trifling in the global scheme of things, what with missiles flying in Ukraine and the Middle East.

Thus Russian oligarchs are transferring funds into Hong Kong, which they view as a safe house at a time when European sanctions on Russia could freeze their funds in finance capitals like London.

It's good to know someone out there has faith in the future of Hong Kong! His name is Alisher Usmanov and, according to Bloomberg News, he has switched 40 per cent of his company's non-rouble cash holdings out of euros and US dollars and into Hong Kong dollars.

The owners of Norilsk Nickel, the world's largest producer of nickel and palladium, are also moving cash into Hong Kong dollars now.

Which, of course, brings us to the subject of the peg.

Theoretically, Hong Kong's currency board system cannot last forever. This is what everyone tells us; it is the official answer given by Hong Kong officials when asked about the future of the peg.

At some point, outsourcing monetary policy to the United States will simply be too wildly inappropriate. Because Hong Kong is next door to the world's largest developing economy, its economic growth is and will continue to be faster than that of the US. Moreover, as we are reminded by everyone, including former Hong Kong Monetary Authority chief Joseph Yam Chi-kwong, China's capital account is opening wider and wider, and so one day there will be more yuan circulating in Hong Kong's monetary system than US dollars.

This is why Yam, in an independent policy paper released a couple of years ago, suggested Hong Kong switch to a Singapore-style peg backed by a basket of currencies - advice we are sure his ex-colleagues on the treasury desk at the HKMA found very helpful (ahem).

Recent events are a reminder as to why a US dollar-backed peg will endure well past its use-by date. First and foremost, excessive dependence on China is risky. If the long-predicted great China crash does ever come, Hong Kong will want to be hedged - a monetary link to the global economy is of course an excellent hedge.

Beyond economic risk, there is political risk. Consider the continuing purge that last week bagged Zhou Yongkang, a former Politburo Standing Committee member who is being investigated on suspicion of "grave violations of discipline".

Zhou's downfall may be part of a necessary and laudable anti-corruption drive that benefits China in the long run; or it may reflect a megalomaniacal political purge that dangerously concentrates too much power in the hands of too few.

The problem is, we just don't know. Even top China experts are not completely certain what's going on.

We can see some of this uncertainty here in Hong Kong, as underlined in the paranoid, shrill pushback against the Occupy Central movement; it is as if everyone is saying; "Do not anger China, because our heads could be the next to roll."

Of course, one could argue that an alternative peg system, which relies on a basket of currencies rather than just the US dollar, would be just as effective a means of risk mitigation.

Recent events are a reminder as to why a US dollar peg will endure well past its use-by date

But note that the Russians aren't lining up to buy Singapore dollars.

Asked last week why Russian businessmen were shifting funds into Hong Kong, Bank of America's chief economist in Russia, Vladimir Osakovskiy, gave the obvious answer.

"Keeping money in Hong Kong dollars is essentially equivalent to keeping it in US dollars because of the currency peg," Osakovskiy told Bloomberg.

Singapore no doubt also attracts outsize financial flows. But nothing compares to offering a substitute for the US dollar. It is simple, clean and easy to manage.

It also slots in well with all those petrodollars that are created when the dollarised oil-producing countries, such as Saudi Arabia, sell crude; from time to time, petrodollars shift heavily into Hong Kong.

Providing a substitute for the US dollar is a pretty good niche for a global financial centre to be in. Hong Kong will not be giving up this gig for a long, long time.