By Alex Frangos
Hedge fund manager Bill Ackman created a stir this week with a call to go long on the Hong Kong dollar, a currency that has been linked in a in a very tight range near 7.8 to the U.S. dollar since 1983.
Why is it time for change? He thinks Hong Kong authorities will eventually relent and let its currency strengthen under economic and social pressure. By tying the Hong Kong dollar to the U.S. dollar, Hong Kong imports U.S. monetary policy, which is super loose and set to stay there for at least another two years, as the Fed recently signaled.
Meanwhile, inflation in Hong Kong hit a scary 7.9% in July and real-estate prices are above the pre-1997 Asian financial crisis bubble-of-all-bubbles peak. Mr. Ackman figures the inflation will exacerbate social tensions, and with a change in Hong Kong’s chief executive set for March 2012, the new government will be forced to let the Hong Kong dollar strengthen around 30%. A stronger currency would make all the imported goods Hong Kong relies on cheaper, ameliorating the inflation pressure.
Mr. Ackman’s doubters quickly chimed in.
Tom Holland, columnist at the South China Morning Post, noted (subscription required) that such a repegging would be painful for Hong Kong’s banks and investors. The local banking system has a surplus of deposits, some of which it converts to U.S. dollars and lends out abroad. A 30% strengthening of the Hong Kong dollar would leave a HK$60 billion (US$7.7 billion) “hole” in the banking system, he writes. And Hong Kong residents hold a substantial amount of foreign currencies in their accounts. A revaluation would cut into the value of those holdings. Then there is the nearly US$1 trillion portfolio of investments Hong Kongers hold abroad. A quick repegging would wipe out a proportional amount of that value in local currency terms.
Another skeptical voice, the analysts at research house GaveKal note that repegging would just encourage more people like Mr. Ackman to pile into the Hong Kong dollar, making defending the new level even harder. Because Hong Kong is so linked to the mainland economy, investors would think the strengthening was a precursor to Hong Kong delinking to the dollar and marrying the Chinese yuan. That would cause a massive wave of capital that Hong Kong couldn’t absorb.
“It is simply too risky because it could invite massive speculative flows,” GaveKal writes. There’s also the character of Hong Kong’s powerful bureaucracy: “Civil servants do not like to rock the boat in such a risky fashion.”
Doubters or not, in the end, Mr. Ackman’s call is in some ways an easy one to make. There’s very little downside. As Hong Kong proved during the Asian Financial Crisis, it will defend to the death against Hong Kong dollar weakness.
And unlike the yuan, which many also say is undervalued and destined to rise, the Hong Kong dollar is among the most liquid and traded currencies in the world, with none of Beijing’s restrictions or capital controls to worry about. If you have some U.S. dollars lying around earning no interest, you might as well convert them to the Hong Kong version and hope Mr. Ackman’s theory comes true. The worst-case scenario: You lose a bit on the currency-exchange fees when you give up and bring your money back into greenbacks.