Tags: Hong Kong | dollar | Russia | United States

Hong Kong May Be Signaling Next Step Down in the US Dollar Decline

By Ashish Advani   |   Wednesday, 13 Aug 2014 08:07 AM

It appears I was off by 3,500 miles when I wrote to you back on July 30 that Russia might push back against the U.S. sanctions and start dissing the dollar by conducting its trades in Australian dollars. Seems like Russians were ahead of me and north of where I expected they would go.

Starting March or April of this year, Russia appears to have started diverting its reserves to the Hong Kong dollar (HKD), as we are witnessing a huge surge in demand for the Hong Kong dollar these days.

Just as a quick refresher, the HKD is pegged (fixed) to the U.S. dollar in a tight band between HKD 7.75 to 7.85. This means that if there is a huge demand for the HKD, the Hong Kong Monetary Authority (HKMA) has to sell HKD and buy U.S. dollars to retain the artificial price of the HKD. In the past few weeks, the HKMA has had to buy $10 billion.

While we can speculate various reasons and look into the history of when the demand for HKD goes up, none of the reasons of the past resonate for us at this stage. There is often a correlation in property prices or surges in the Hong Kong stock markets that show a demand for HKD, but in this case, the usual suspects do not indicate a huge step up.

One potential reason I can see for the huge rise in demand for the HKD is the Shanghai Hong Kong Stock Connect program that is planned to be rolled out in the fourth quarter for this year. This pilot program allows for certain shares on the Shanghai stock exchange to be cross-listed and priced in HKD and vice versa. This is yet another attempt by China to float its public company shares in a regulated manner to the world via Hong Kong rather than open the Shanghai Stock markets to the world and have the world chase it up or pull it down and create chaos within China.

So between the Russians buying Chinese company stocks in Hong Kong and shifting their reserves from U.S. dollars to HKD, as well as funding sources for the Shanghai Stock Connect program, we are seeing a huge demand for HKD.

If this continues to play out or if the Stock Connect program is successful, we will continue to see the HKD be in great demand. After that, the next step will be for China to partially float the HKD or even take the bold step of fully floating the HKD by breaking its peg to the U.S. dollar. Managing the HKD through market polices is a great trial run before China can consider floating the renminbi.

The HKD's peg to the U.S. dollar is the canary in the coalmine. Its breaking of the peg with the dollar will be the first open and direct sign of the assault by China on the U.S. dollar. So far, all its moves have been behind the scenes and shielded.

Once they break the peg, we can start counting the months before the U.S. dollar is dethroned as the reserve currency of the world. While it might still be a few years away, it would behoove you to start diversifying out of the U.S. dollar in small but definite steps now and allocate part of your diversification to physical assets such as precious metals.

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