The Hong kong Dollar

The Hong Kong dollar was pegged to the Sterling post WWII for economic reasons. It was later switched to the US dollar. Pegging a developing country’s currency to that of its largest trading partner has distinct advantages. You lock in your labour cost advantage which happens to be your greatest development asset. The negative aspect is that you lose control of your domestic monetary policy.

In the mid-Seventies, the US started a cycle of huge monetary stimulus that spawned a high inflationary spiral years later. The medicine used to combat inflation was high interest rate. This resulted in a deep recession for the early Eighties. Hong Kong made a wise decision to unpeg from the USD in 1974. It avoided the malaise that inflicted the US.

In October 1983, Hong Kong repegged its dollar to the USD. This time, it was for political reasons. Hong Kong was to be handed back to the mainland in 1997. Hongkongers were considering moving their wealth out of HKD or the place itself. So, the HK administration decided to repeg to avert such a crisis. The peg of HKD 7.80 to 1 USD has survived with minor modification, till now.

In the last one year, the USD has depreciated against the Yuan. It went from 6.83 Yuan to 1 USD to 6.47. This represents a 5.3 % appreciation of the Yuan or by corollary a 5 % depreciation of the HKD. During this same period, the SGD has moved up against the USD from 1.4 to 1.25. This is a 10.7 % improvement. So, the HKD, vis-à-vis the SGD has depreciated 10.7 % in the last one year. Does Hong Kong need this devaluation to stay competitive?

Already, many Hong Kong residents are converting their savings to the Yuan. Yuan deposits in Hong Kong now total some Y400 billion. This is expected to hit Y2 trillion by the end of 2012. Exposure to property is seen as a way of being long the Chinese currency over time. That is why the property market in Hong Kong is booming. Inflation in Hong Kong is aggravated by the lost of purchasing power of its currency.

Should Hong Kong remove the peg or peg its currency to other currencies? Its basic law requires it to peg to a freely convertible currency. Renminbi is out because it still has capital controls and does not trade freely. There is increasing support to peg to a basket of currencies like Singapore does. The Yuan can be a component of the basket and does not contradict the basic law.

Pundits think that the adoption of the basket will be done soon. When that happens, the HKD is expected to appreciate. So, keep an eye out for this.