Foreign exchange market

The time has come to talk of lobsters and turtles and things

PUBLISHED : Sunday, 02 May, 2010, 12:00am
UPDATED : Sunday, 02 May, 2010, 12:00am

'Launched in 2003, the Capital Investment Entrant Scheme that gives foreigners the right to stay in Hong Kong had attracted total investment in the city of HK$47 billion by the end of last year ...'

SCMP, April 22

I give you two countries, Turtleland and Lobsterland, each with its own currency. These currencies are exclusive. The turtleshell can only be used in Turtleland and the lobster shell can only be used in Lobsterland.

It turns out one day that Lobsterland decides it would like to have more foreign investment. The lobsters all scratch their heads and one comes up with a grand plan.

What we will do, he says, is tell the turtles that any one of them who brings us a minimum of one lobstershell for investment in Lobsterland will get a permanent lobster ID card so that he can live here in heaven for the rest of his life. The lobsters all applaud this genius idea and the plan is announced.

It has the desired effect. In Turtleland Tom Turtle decides he would like to live in Lobsterland. He thus goes to Turtlebank and says, 'Give me one lobstershell.'

'Go away,' says the teller. 'We don't have any lobstershells. This is Turtleland. In Turtleland we only buy and sell things with turtleshells. The lobstershell is useless here. Didn't you know that?'

'Okay,' says Tom Turtle. 'How much is a lobstershell worth in turtleshells then?'

'The exchange rate is one to one,' says the teller.

'Good,' says Tom Turtle. 'Give me one turtleshell then and I'll take that to Lobsterland.'

So he does and in Lobsterland he pitches up at Lobsterbank and says, 'I would like to invest one turtleshell in Lobsterland so that I can get a permanent lobster ID card and live in heaven too.'

'Go away,' says the teller. 'We don't take turtleshells here. This is Lobsterland. In Lobsterland we only buy and sell things with lobstershells. The turtleshell is useless here. Didn't you know that?'

'Oh, that's bad news,' says Tom Turtle. 'How I can ever get to live in heaven then?'

'Well, I have an idea for you,' says the teller. 'It turns out that Turtleland is running a similar offer to encourage foreign investment and we have a lobster here who wants to take it up. What we will do is give that lobster your turtleshell while we will give you his lobstershell. How about it? That will satisfy you both.'

It does indeed. The deal is done and heaven is replete with heaven-seekers.

I now have two questions and a surprise for you. The questions: (1) Are there any more turtleshells in Turtleland as a result of this transaction, and (2) Are there any more lobstershells in Lobsterland as a result of this transaction?

Here is the surprise. Our government says your answer is wrong. According to the bureaucrats who run our Capital Investment Entrant Scheme, Hong Kong is HK$47 billion the richer as a result of doing turtleshell/lobstershell swaps.

Stick to your guns, do you? Good for you. You're right.

These rich foreign migrants do not bring any Hong Kong dollars to Hong Kong. They bring foreign currency and their bankers then swap that currency for Hong Kong dollars. There is no increase in Hong Kong dollars at all, nor in those foreign currencies. There are only transactions across the balance of payments. Just think about it again in my turtleshell/lobstershell analogy. It holds.

All we have here is proof that our bureaucrats have no clue about how the balance of payments works, not even the mistiest understanding. The Capital Investment Entrant Scheme is pure delusion.

In fact it is worse than that. To encourage foreign investment this way is to put upward pressure on the Hong Kong dollar because the transaction is initiated by the buyer rather than the seller of Hong Kong dollars.

We have had a great deal of this sort of pressure recently with hot money flows from the mainland. As the first chart shows you, these pushed the US dollar exchange rate right up against the Hong Kong Monetary Authority's HK$7.75 intervention level all of last year and the rate is still much stronger than the official HK$7.80 peg rate.

Keeping the Hong Kong dollar in line does not come without effort. The second chart shows you how much the HKMA's issuance of bills and notes has had to shoot up since the beginning of last year to keep the peg in place under this pressure.

But, as usual, one arm of government does not communicate with the other. While the HKMA prays for the pressure to be eased, the bureaucrats behind the Capital Investment Entrant Scheme are busy piling on more of that pressure.

Well done, troopers. Clap, clap, clap, clap.