The value of the Hong Kong dollar has been directly linked to that of the US dollar since 1983. Photo: Shutterstock
Opinion
Macroscope
by Nicholas Spiro
Macroscope
by Nicholas Spiro
Why betting against the Hong Kong dollar peg is a fool’s errand
The Hong Kong dollar has once again come under pressure, with the Monetary Authority forced to step in and defend the local currency
Despite criticism of the peg to the US dollar, the city’s long-standing commitment to maintaining it and its special significance make it a reliable bet
In financial markets, there are some loss-making trades that investors rue more than others. One of the most talked-about ones is betting against Japanese government bonds, which has been known as the “widow-maker”. There are others that at one point appeared to be paying off but ultimately failed, such as wagers on the break-up of the euro zone.
Another trade that has proved ruinous over the years but still has its proponents is betting against the Hong Kong dollar. Its nearly 40-year-old peg to its US counterpart has withstood repeated attacks by speculators, notably by financier George Soros during the 1997-98 Asian financial crisis.
Hong Kong’s currency board, which requires the city to import monetary policy from the United States, is once again under scrutiny. This year’s dramatic rise in interest rates in the US – which has forced Hong Kong’s de facto central bank to follow suit and intervene heavily to stop the local currency falling beyond the weak end of its permitted trading band – has accentuated the divergence in economic cycles between the city and the US.
Right on cue, the peg’s detractors in markets and the Western financial media have renewed their attacks on the Hong Kong dollar. Their criticisms are the same. Maintaining a currency board in a city whose financial conditions are tied to those of the US but whose economy is increasingly dependent on China’s is ultimately doomed to fail, they claim.
The peg’s critics have seized on the sharp fall in the aggregate balance, a gauge of interbank liquidity. In the past two months, it has halved to HK$165 billion (US$21 billion) because of the Hong Kong Monetary Authority’s purchase of HK$172 billion since May 11 to shore up the currency.
Pressure on the Hong Kong dollar is attributable to “carry trade” behaviour. Sufficient liquidity has prevented local interbank rates from rising to fully match their US equivalents. This has made it attractive for traders to borrow in Hong Kong dollars to put money into the higher-yielding US dollar and pocket the difference.
Yet, the carry trade would not have come about in the first place if investors did not have confidence in the peg, as Financial Secretary Paul Chan Mo-po pointed out in an interview with the Post on July 26. Moreover, as the HKMA buys up local currency and causes domestic interbank rates to rise, the carry trade becomes less profitable, easing pressure on the peg.
Higher funding costs put Hong Kong’s property market under further strain by encouraging banks to lift their prime rates. However, prices for second-hand homes in the world’s least-affordable housing market are still only around 6 per cent below their all-time high in August 2021. Furthermore, the share of private residential stock with mortgages has fallen from more than 50 per cent in the early 2000s to 34 per cent, according to JPMorgan data.
Yet, the two main reasons the peg is secure are the credible commitment to maintaining it and, just as importantly, its special significance to Hong Kong and Beijing.
First, maintaining fixed exchange rate regimes requires a lot of discipline. The pressure often proves too much, as it did with the pound sterling, whose collapse in 1992 forced Britain out of the European Exchange Rate Mechanism.
The credibility the Hong Kong dollar has built up in the past four decades is unmatched, though. Its resilience in the face of successive speculative attacks and crises – the dramatic increase in the one-month Hong Kong Interbank Offered Rate to more than 20 per cent in August 1998 puts this year’s rise to 1.3 per cent in perspective – makes the peg a powerful anchor for financial stability.
The International Monetary Fund has commended Hong Kong for the transparency and institutional credibility of its currency board. In a report published in March, it said the peg was backed by “ample fiscal and [foreign exchange liquidity] buffers, strong financial regulation and a prudent fiscal framework”.
01:43
What is the Hong Kong Dollar Peg?
What is the Hong Kong Dollar Peg?
Second, the peg serves the interests of both Hong Kong and Beijing. It is a key underpinning of the “one country, two systems” framework that, if anything, has become more valuable to the city and China in the past two years.
For Hong Kong, the peg helps preserve the city’s status as a global financial centre at a time when the mainland is tightening its grip over the city’s institutions. Just as investors betting on the dissolution of the euro zone underestimated the amount of political capital invested in safeguarding the integrity of the bloc, those betting on the peg’s demise fail to appreciate its political and economic importance to Hong Kong.
For Beijing, keeping the city as the dominant offshore Hong Kong dollar funding centre in Asia is still hugely beneficial to mainland firms and banks. As long as China maintains capital controls and continues to be cautious in opening up its financial sector to foreign investment, the peg is secure.
While Hong Kong faces acute challenges – the two biggest ones are reopening its economy to the rest of the world and coping with the sharp economic downturn in China – its currency is not one of them. Betting against the peg is another widow-maker trade.
