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Tags: Hong | Kong | Dollar | Float

Could the Hong Kong Dollar Float Again?

By    |   Monday, 11 February 2008 03:49 PM EST

Jim Rogers was right when he said last November that the Hong Kong dollar should disappear as soon as the Chinese currency, the yuan (also known as the renminbi) becomes convertible.

"If I were the Hong Kong government, I would abolish the Hong Kong dollar. There's no reason for the Hong Kong dollar. It's a historical anomaly and I don't know why it exists anymore."

Yes, Jim, logic tells us that the HK dollar could de-peg from the U.S. dollar in the foreseeable future and starts to float again before it could ultimately be re-pegged to the Chinese homeland currency, the renminbi.

Jim Roger's standpoint was again, without any doubt, confirmed by the just released numbers of the Hong Kong Census and Statistics Department. Highlights:

? The HK dollar effective exchange rate (trade weighted) index stood in December 2007 at 88.6, down 4.5% since November 2006 (January 2000=100).

? Hong Kong Money Supply M3, taking into account all authorized institutions, in HK dollars is up 21.1 percent and in foreign currencies up 17.2% for the period from November 2006 through December 2007.

? HK inflation is been estimated to around 4.0% for 2007 as a whole. Strong domestic demand was the primary reason for the price surge. As the economy is running at near full capacity while the U.S. economy is already in recession, inflationary pressure is likely to become even more apparent in coming months.

In addition, the pegging of the HK dollar to a "softening" U.S. dollar not only exposes Hong Kong to imported inflation but is also likely to create a negative real interest environment which could further fuel Hong Kong-based asset inflation, as local interest rates could be expected to track the downtrend of US interest rates.

It's clear from the numbers that homeland China has become Hong Kong's main trading partner.

So, that question is, will the Hong Kong authorities do again with their currency what they have done before?

In order to try to understand the future, it might be interesting to look back to the various changes the island economy has experienced in its external monetary arrangements.

In 1997, Hong Kong became a special administered region of China, after having been a British crown colony for more than 150 years. The currency-board mechanism, initially based on the British pound sterling, was abandoned in 1972 but was restored in 1983. But then it was based on the U.S. dollar.

Hong Kong had a fixed rate arrangement to the pound sterling since in 1935, when China left the silver standard and Hong Kong, which had been operating the same "Chinese silver monetary standard," was effectively forced to suspend silver convertibility.

When the British pound sterling devalued in 1967, thanks in part to billionaire financier George Soros, the Hong Kong dollar parity to the sterling was quickly adjusted, thereby moderating the devaluation effects of the Hong Kong dollar against other currencies.

Then, in July 1972, the Bretton Woods system collapsed after President Nixon had stopped the direct convertibility of the U.S. dollar to gold and the British pound sterling started to float. The Hong Kong authorities broke with the sterling peg and switched to a brief period of pegging to the U.S. dollar until they allowed the Hong Kong dollar to float in November 1974.

The HK currency board was restored in October 15, 1983 and the Hong Kong dollar was re-pegged to the U.S. dollar at a rate of HK $7.80/US dollar, which was confirmed at the reversion to Chinese administration in 1997 and is still the reference peg today.

When last summer mainland China announced its intention to allow Chinese citizens to invest in Hong Kong securities, the first question that came to mind was whether the Hong Kong dollar would start floating again before ultimately to be re-pegged to the mainland's currency.

So far, nothing has happened. But China continues to give indications that it is serious about allowing larger capital outflows while the yuan, with Beijing's blessing, continues its steady appreciation against the US dollar.

It's not impossible that global speculators betting on further appreciation of the Chinese currency could unintentionally start forcing the Hong Kong dollar to float again.

There are no fundamentals that justify a continuing peg to the U.S. dollar, which is becoming the world's new "carry-trade" currency. Nevertheless, if the Hong Kong Monetary Authority would accept a runaway inflation environment there is, theoretically speaking, no limit to defend the U.S. dollar peg as they can create money by the stroke of a pen.

Of course, as we have seen the M3 money growth trend remains way too high, the main game in town could suddenly become a yuan appreciation game that would provoke global inflows, which would be very difficult to digest for a small economy like Hong Kong's.

As U.S. interest rates are falling and China's are rising, investors will move funds into China through Hong Kong. The result will be a stronger yuan, which will help cool inflation in China but accelerate inflation in Hong Kong, if the U.S. dollar peg is maintained.

Super-easy monetary conditions because of lower moving US interest rates are likely to spawn Hong Kong property price and stock market bubbles, forces which eventually would make the HK dollar peg impossible to reasonably support.

In addition, media reports suggest that Hong Kong will post a record budget surplus in fiscal 2007-08, resulting in potential tax cuts –- perhaps up to HK $40 billion worth. The tax cut would be on income, property and a likely end to the wine duty, Bloomberg reported. It's Hong Kong's second consecutive years of budget surpluses.

All that said, I don't know when, not if, this will occur. But, to me, all serious investment portfolios should have Hong Kong dollars. For now, practically nobody is considering the possibility of the Hong Kong dollar to float or de-peg from the US dollar.

Defendable and practically risk-free Hong Kong dollar deposits and investments (minimum US $65K) are Hong Kong Government Securities like "Exchange Fund bills" of HK 500,000 (USD $65,000) that are issued on a discount basis for 91, 182, and 364 days; "Exchange Fund Notes" with fixed interest rates paid semiannually in arrears of HK 500,000 (USD $65,000) for 2, 3, 5, 7, and 10 years.

The Hong Kong Government Bond Market is one of the most developed local currency bond markets in Asia. Foreign and local investors have equal access to the securities market.

Also available are fixed term deposits at the international banks in Hong Kong that provided (more or less) the following interest rates on February 6, 2008 for large deposits (2 million $HK = USD $250,000): 1 week – 1.45%; 1 month – 1.98%; 2 months – 2.06%; 3 months -2.10%; 6 months – 2.14%.

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Jim Rogers was right when he said last November that the Hong Kong dollar should disappear as soon as the Chinese currency, the yuan (also known as the renminbi) becomes convertible."If I were the Hong Kong government, I would abolish the Hong Kong dollar. There's no reason...
Monday, 11 February 2008 03:49 PM
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