Few things in life are certain -- death, taxes and periodic bouts of speculation against the Hong Kong dollar peg being among them.
The currency traded on the weak side of the so-called convertibility undertaking for the first time since 2011 this week. That's approaching the level at which the Hong Kong Monetary Authority undertakes to buy the local dollar to support the fixed exchange-rate system. A measure of options volatility reached its highest since 2003 on Monday. The currency recorded its biggest two-day decline since 1992 last week.
Scary stuff. So, time to start writing the epitaph of another doomed exchange-rate regime? Not quite.
This is the Hong Kong dollar's performance over the past year:
Add a little more historical perspective and that jump looks somewhat less pronounced:
While the Hong Kong dollar is pegged at 7.8 to the greenback, the city's de facto central bank permits a little wiggle room. The currency is allowed to strengthen to a limit of HK$7.75, in which case the HKMA will sell the local dollar. This causes the monetary base to expand, puts downward pressure on interest rates and (other things being equal) discourages further capital inflows. Similarly, if the Hong Kong dollar weakens to HK$7.85, the HKMA buys the currency, causing the monetary base to shrink and driving up rates. So to gauge the selling pressure on a pegged currency, look at interbank rates. Here's the three-month Hong Kong dollar interbank offered rate, or Hibor:
Look at that leap. Those with longer memories may not be impressed, though. Run the graph back to 2003 and you need a magnifying glass even to spot this month's surge:
There are reasons to expect the Hong Kong dollar peg to come under pressure. The period of rock-bottom U.S. interest rates has come to an end. The greenback has strengthened more than 35 percent since July 2011, according to the Bloomberg Dollar Spot Index. China's economy grew at its slowest pace in a quarter of a century last year, and the yuan has been depreciating.
To conclude that pressure will lead to breakage is another matter. The peg is designed to withstand stress, and has proved its durability. The HKMA spent $15 billion to defend the link against speculative attack during the Asian financial crisis in 1998. Three-month Hibor rose to almost 16 percent in August 1998, the economy plunged into recession and deflation (where it remained for much of the next five years) and property prices extended their collapse.
Those betting against the peg in 1998 may have had in mind the then relatively recent example of the U.K., forced out of the European Exchange-Rate Mechanism on ``Black Wednesday'' in 1992. Chancellor Norman Lamont raised interest rates to 15 percent to defend the pound. Speculators calculated that the economy couldn't take the pain and were proved right when the British government conceded defeat and let the pound go. George Soros made 1 billion pounds ($1.4 billion) from the debacle.
The calculation for a small, open economy dependent on foreign trade and capital flows has always been different. Hong Kong brought in the peg in 1983 after a 30 percent plunge in the local dollar's value led to panic buying of rice and other staples. In effect, the city bought insulation from exchange-rate volatility at the cost of wider swings in domestic asset prices and economic fortunes.
It's a bargain that cuts both ways. In 2011, billionaire hedge-fund manager William Ackman bet that Hong Kong would be forced to let the currency appreciate as capital inflows inflated a housing bubble and fueled social unrest. The city's then-Chief Executive Donald Tsang told Ackman he would lose money. The peg stayed.
Nothing is forever, of course. If the gold standard and the Bretton Woods system can meet their demise, then the monetary policy of one semi-autonomous coastal city can also change. Yet having made such sacrifices to keep the peg in the past (including a period of 10 percent-plus inflation in the early 1990s that helped to augment an unsustainable property bubble), the idea that recent days portend the end looks far-fetched.
Hong Kong's foreign-exchange reserves stand at a record $359 billion and have more than doubled since the start of 2008. The monetary base has jumped fivefold in the same period. There is ample ammunition to defend the peg, and the pain hasn't even started yet. This bet is premature.
This column does not necessarily reflect the opinion of Bloomberg LP and its owners.
To contact the author of this story:
Matthew Brooker in Hong Kong at firstname.lastname@example.org
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Katrina Nicholas at email@example.com