The Hong Kong Peg Will Survive


Once again the Hong Kong dollar and its peg with the US dollar have been under pressure. The money has just been pouring into the territory and the Hong Kong Monetary Authority has been buying U S dollars to hold the Hong Kong dollar to its upper band of HK $ 7.75 against US 1.00. This influx of money has been attributed to the lax US monetary policy and QE3 as well as a diversion of funds from China and Japan due to the ongoing tension between these countries. Whatever the reason, the situation has been made worse by the continued appreciation of the renminbi against the US dollar, and automatically since the US and Hong Kong dollars are linked, the Hong Kong dollar. The remninbi, it should be noted was roughly 8.2 in 2005 against the US dollar but has now appreciated to 6.24. A move perhaps not enough for Mitt Romney but big enough to be noticed in Hong Kong.


This has had all kinds of effects in Hong Kong, some happy, some not so happy. First of all, the Hong Kong stock market has been rallying of late and property prices in Hong Kong continue to move upward. Nobody is angry when the stock market goes up. And those who own houses are happy when the prices of their dwellings rise. But those who do not own property are not happy. And of late the Hong Kong government has been listening to those who are not happy. To placate this group, the Hong Kong government has introduced a series of misguided measures designed to discourage unwanted foreign buyers. And by “unwanted foreign” I am not referring to gweilos (that means ghost, and is the Chinese affectionate name for Westerners). The unwanted foreigners are non-other than fellow Chinese from the Mainland. Rich Japanese descended on Hawaii so many years ago when the Japanese were gods but incurred the wrath of the locals for pushing up property prices. So today, the Mainlanders armed with lots of ever more valuable renminbi arrive in greater and greater numbers in Hong Kong each month and proceed to push up local property prices. Or so it is thought by those Hong Kong locals who don’t own property.


There widespread support in Hong Kong for limiting the numbers of Mainland visitors. As a gweilo foreigner, I am not sympathetic to the anti-Mainland sentiment. Hong Kong’s economic future is going to be increasingly tied to China and that would have been true even if the British were still running the place. Since the Handover in 1997, China has for the most part gone out of its way to support the Hong Kong economy. One wonders if the Hong Kong xenophobes would like to put up a No Chinese sign at the border.

Hedge fund wizard Bill Ackman has repeated his forecast for a changing of the Hong Kong US dollar peg and a revaluation of the Hong Kong dollar. In an ideal world and from an economic viewpoint, I think this makes sense. The US dollar peg was only instituted in 1983 and is not sacred. A peg against the renminbi is not a great idea since the renminbi is not fully convertible on capital account. But there are alternatives. For example. Singapore adjusts its currency against a basket of currencies. The system seems to work there. But Singapore has a mature, technocratic government with an outstanding record of success. And, as is well known, the Singapore government spanks you if you are bad. The value of the Sing dollar is not a subject of populist speculation and pressure in Singapore. The situation is not the same in Hong Kong. Hong Kong’s semi-democratic government is, to put it as charitably as possible, still “maturing” since the Handover. And Hong Kong does have freedom of expression. You only have to turn on a Hong Kong Cantonese TV station and watch the antics of a legislator dubbed “Long Hair” who looks like a middle aged hippy and acts like he has an anger management problem. I can’t understand Cantonese but I can just imagine Long Hair mouthing off about a floating Hong Kong dollar.

No, I would recommend that Hong Kong stay on automatic pilot and leave its currency to the US dollar peg and the technocrats at the Hong Kong Monetary Authority. And I believe, contrary to Ackman, that’s what’s going to happen. It should be noted that the CPI inflation rates in Hong Kong and Singapore are not that different although I’m not sure their circumstances are that comparable. I would also recommend that the Hong Kong government stop interfering with the real estate market. If the currency is undervalued but pegged, then domestic prices have to rise especially those for non-tradable goods as Hong Kong must inflate its money supply by buying dollars to maintain the peg. Remember Hong Kong has a currency board system (called the Linked Exchange System) and there’s no offsetting sterilization when the HKMA buys dollars. The government should stop listening to the complainers and anti-Mainland xenophobes.

For investors, that means buy Hong Kong stocks and real estate as a pure liquidity play. Macau’s currency is pegged to that of Hong Kong and for all practical purposes Macau is part of the greater Hong Kong Metropolitan area. The Macau gambling stocks, traded on the Hong Kong Exchange, represent a play on real estate and Mainland tourism. One problem with Hong Kong stocks, however. It is hard to find pure Hong Kong plays as most of the companies listed on the Hong Kong Exchange are either China companies or heavily involved in China. This is particularly true of the big real estate companies although there are a handful of HK REITs.

Chinese Stocks –Yes You Should Come Home

There are a number of things that I’ve never completely understood regarding Chinese stocks and stock markets. The first is why so many Chinese companies trade in New York instead of Hong Kong or Singapore. Yes I know the reason for the original IPO listings ten years ago was more liquidity and better valuations and, in the case of tech stocks, better understanding by the US investment community. The US is after all the world’s tech laboratory and if a US analyst for example already followed Google, Baidu, the Chinese Google, was a natural. Hong Kong investors and analysts only knew banks and real estate. Or so it was reasoned.

But times have changed. In times past if a retail US investor wanted to buy a stock in Hong Kong he or she had to call a broker and pay through the nose for the privilege. And the order had to be placed during the day during US trading hours but would only be executed at night in the US when Hong Kong was trading. So maybe coming to the US made sense. But today any US investor can buy Hong Kong or Singapore stocks cheaply in real time on line. Company web sites and conference calls are available over the internet. And the analytical community in Hong Kong in particular has grown.

But all the information technology advances notwithstanding, so many of the China stocks which now trade in the US – especially the smaller, less liquid ones – seemed to be orphans abandoned on a foreign shore. So many of these stocks are grotesquely undervalued, selling at PE multiples of less than five and with decent growth prospects and balance sheets. These stocks sometimes rally when their managements make a roadshow type of trip to the US but once they return home they are forgotten again and down they go.


It hasn’t helped of course that some have been guilty of out and out fraud and that so-called reverse merger Chinese stocks in particular have given the whole group a bad name. A virtual cottage industry of short sellers has developed in alleging fraud with Chinese stocks. The industry has made some spectacular calls but I’m not sure that this industry does not have its own ethical problems. The Chinese fraud industry exploits the fact Western investors can’t tell the good from the bad, don’t read or speak Chinese and are on the other end of the world in totally different time zones. All Chinese stocks look alike to Westerners

The passage of Sarbanes Oxley and the generally litigious nature of US society is another discouraging factor. I have heard it said that compliance with US laws each year cost companies millions of dollars. So why list in the US?

The second thing I’ve not understood is why the Chinese government has seemed so content to encourage its best companies to raise capital offshore. With its huge reserves and current account surpluses, China certainly doesn’t need the money. But the fact is that the Shanghai exchange has favored state owned over private companies. Chinese citizens, except through some limited programs like the Qualified Domestic Institutional Investor Scheme (QDII), cannot legally invest in foreign stocks including those in Hong Kong. Nor is it easy for foreign investors to directly buy stocks traded in Shanghai.

It doesn’t make sense for the Chinese capital markets to be divided into on shore and offshore compartments. Today some of the best Chinese companies including the techs like Baidu and Tencent cannot be legally bought by citizens of the People’s Republic of China. Imagine if Apple could only be bought by Chinese citizens and not those of the US. Imagine a Baidu that could trade in Hong Kong and be purchased by citizens of the PRC and the US alike. I think the valuation gain would be substantial.

The third thing I’ve not understood is Beijing’s attitude towards the Hong Kong stock exchange. Is Hong Kong part of China or isn’t it? Beijing complains when Hong Kong anti-Mainland xenophobes demonstrate with British flags and think of themselves as separate. But in fact, although it would deny this, the PRC central government sometimes treats the stock exchange in Hong Kong as if it were still a foreign entity wrapped in a British flag. Despite the kisses the two exchanges seem to be blowing at one another with a just announced modest joint venture regarding cross border stock indexes, the Hong Kong and Shanghai stock exchanges are in mortal combat with one another to see which one will be China’s Wall Street. I seem to remember former Communist Party boss Jiang Zemin saying on a visit to the US many years ago that the Shanghai exchange would be China’s Wall Street and Hong Kong would be China’s Toronto. Nobody in Hong Kong wants to remember that quote.

Of course from Beijing’s perspective Hong Kong has to be treated as separate because the renminbi is not fully convertible on capital account. Beijing worries all the capital will flow into Hong Kong and then out of China entirely. Not a good reason in my opinion. The renminbi yearns to be free. But that’s another subject.

I would expect that the recent trend of Chinese companies to delist from New York will accelerate. The recent announcement of a possible buyout and delisting of Focus Media is worth watching. Focus Media has been under attack for fraudulently cooking its books by Chinese fraud specialist Muddy Waters, charges which the company has denied. Focus Media is not a reverse merger baby which backdoored its way into New York. It’s a big tech oriented company that was brought public by (then) highly regarded Wall Street firms. The possible participants in the buyout include the prestigious (at least in Romney circles) Carlyle Group in Washington. We’ll see if this deal really goes through but if it does, look for more of the same.

-Peter T. Treadway


Dr. Peter T Treadway  is principal of Historical Analytics LLC. Historical Analytics is a consulting/investment management firm dedicated to global portfolio management. Its investment approach is based on Dr. Treadway’s combined top-down and bottom-up Wall Street experience as economist, strategist and securities analyst.

Dr. Treadway also serves as Chief Economist, CTRISKS Rating, LTD, Hong Kong.

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