Pressure on Hong Kong to Scrap Currency Peg

Hong Kong is waging an intensifying battle against currency traders. Since April, the territory spent at least $9 billion defending its peg to the US dollar, and there is plenty more where that came from.

The city’s monetary authority is reminding speculators it has $434 billion more in firepower. Trumpeting the world’s largest per capita foreign exchange reserves is central banker-speak for “do not try us”, Nikkei reported.

But this is not another case of speculative traders like the financier George Soros in the 1990s betting against a currency peg. The pressure this time comes from economic logic. The peg is here to stay, a who’s who of Hong Kong experts assure the investment world. The 35-year-old link, pundits claim, is the linchpin of an economy often regarded as the world’s freest.

Yet as Hong Kong scuffles with short-sellers, is it fighting the wrong war? If only Chief Executive Carrie Lam and Norman Chan, who heads Hong Kong’s de facto central bank, spent as much time and resources addressing worsening inequality and social mobility.

The falling Hong Kong dollar is a distraction—more symptom than cause of the challenges bearing down on the territory. The currency is not sliding because investors lack faith in an economy growing more than 4%. Rather, Hong Kong is captive to its role linking China and the US.

In theory, the Hong Kong dollar should be surging. As the Federal Reserve ratchets up interest rates, the Hong Kong Monetary Authority is obliged to tighten in step. Its markets also are heavy recipients of cash from mainland investors moving wealth offshore.

Even so, the currency is sliding because of a massive “carry trade”. Investors are borrowing cheaply in Hong Kong to buy higher-yielding assets in the US, where 10-year treasury yields are near 3%. That is turning the “freest” economy into the world’s biggest funhouse mirror, reflecting back the confusing tensions which economies face as Chinese and US monetary policies diverge. Washington is yanking away the punch bowl of cheap money; Beijing is still in refill mode.

  Grappling With the Monetary Crossfire

Good news for President Donald Trump’s America, as those inflows into the US support a stock rally on which his presidential legitimacy partly relies. It also helps America fund a giant $1.5 trillion tax cut. Not so much for Lam and Chan, who must grapple with the monetary crossfire.

All that defending, though, affords less time to alter Hong Kong’s worrisome trajectory. Its experience back in 1997 is relevant here for two reasons. One, that was the last time markets wagered seriously, during the Asian crisis, that Hong Kong might scrap the peg. Two, economic inequality has widened markedly since then. Twenty years after the handover back to China, charity Oxfam labels Hong Kong one of the most inequitable places on the planet.

China’s cash plays an outsized role in Hong Kong’s deteriorating “Gini coefficient,” a key income-gap metric. Its 0.54 reading is the highest in four decades, and the problem has intensified since ‘97. As mainland wealth pushed up property prices, local wages stagnated. That disconnect pushed living costs out of the reach of middle-class families and, increasingly, millennials.

In February, Hong Kong announced an $18 billion fiscal surplus, an amount double that spent defending the currency. So, Hong Kong surely has the resources to get its Gini coefficient below 0.4, the inequality level regarded as dangerous.

It is best, says Paul Yip, chair of population health at the University of Hong Kong, “to face the problems and respond to them in a timely manner and while we have the money”. That means making more affordable housing a government priority, along with wider social safety nets and more affordable health care and education.

Defending the Hong Kong dollar’s peg to the US currency takes away resources from spending for a better economic future.