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Tom Holland

New York hedge fund manager Bill Ackman is betting against the Hong Kong dollar peg.
In a hefty 140-page presentation, the boss of US$10 billion Pershing Square Capital Management explains in great depth exactly what is wrong with Hong Kong's present exchange rate peg, which since 1983 has fixed the local currency at HK$7.8 to the US dollar.
His analysis of the problems is detailed, accurate and pretty much spot on.
It is his conclusions that are wide of the mark.
Ackman correctly points out that a peg to the US dollar made sense back in 1983, when Hong Kong was still a manufacturing centre, exporting largely to the US.
Today however, when Hong Kong has transformed itself into a service economy tied to China (see the first chart) the peg is looking increasingly anomalous. It forces the city to import US monetary policy and interest rates, even though they may be wildly inappropriate for Hong Kong's own business cycle.
Right now  to try and stimulate activity, the US Federal reserve is pursuing an ultra-loose monetary policy combining zero interest rates and successive bouts of quantitative easing; effectively printing money.
Because of the peg, Hong Kong also gets near-zero interest rates and lashings of liquidity, even though with growth zipping along at a brisk 5 per cent and unemployment at just 3.4 per cent, counter-cyclical prudence would dictate a tighter monetary setting and a higher interest rate.
 As a result, argues Ackman, low interest rates and plentiful liquidity are fuelling a painful property market appreciation, while our exchange rate link to a declining US dollar (see the second chart) is pushing up the local currency cost of imports, adding to consumer inflation.
All this is true enough, and will be familiar to most Hong Kong readers. However, Ackman goes several steps further.
He maintains that the peg is to blame for rising social tensions in Hong Kong, as the middle class young get squeezed out of the property market by sky-high prices, and the poor get hammered by rising food costs.
'The only effective way to mitigate inflation and a potential real-estate bubble is to allow the Hong Kong dollar to appreciate,' he argues. 
As a result, he believes that next year Hong Kong's new chief executive will bite the bullet, and revalue the Hong Kong dollar by 30 per cent, repegging it against the US dollar at an exchange rate of HK$6 as an interim measure pending a link to the yuan, when the Chinese currency eventually becomes fully convertible.
This move, he says, would bring the Hong Kong dollar back into line with its fair value, and would be big enough to deter speculation on any further revaluation.
He also argues that a 30 per cent appreciation would not significantly harm Hong Kong's financial system and that it would prove popular by immediately increasing the spending power of Hong Kongers' savings.
These last two points are doubtful, to say the least.
It's true that Hong Kong people have lots of Hong Kong dollar savings; the city's banks are sitting on more Hong Kong dollar deposits than they can lend.
But as a result, they lend out the surplus offshore in US dollars, offsetting their local currency liabilities with foreign currency assets. At the end of June they had net foreign currency assets - of HK$251 billion. That means a 30 per cent revaluation would knock an immediate HK$60 billion asset-liability hole in the banking system's balance sheet.
That would hurt, but the pain would be mild compared to injury a revaluation would inflict on Hong Kongers' savings. Although Hong Kong people do hold a lot of Hong Kong dollar deposits, they hold just as much in foreign currency deposits - some HK$3.7 trillion - which would instantly be worth 23 per cent less.
On top of that, at the end of last year Hong Kong's portfolio investments in the rest of the world came to more than HK$7 trillion. The vast majority of those assets were private sector investments, consisting largely of ordinary people's savings held through insurance companies, pension funds and other investment institutions.
A 30 per cent revaluation of the Hong Kong dollar would inflict an immediate HK$1.6 trillion loss on these investments in local currency terms.
Ackman might think that would prove popular, but the Hong Kong government will hardly risk finding out.



Hedge fund manager's bet on HK$ revaluation badly flawed