Asset Allocator’s Soapbox: Dr Ana Armstrong

Dr Ana Armstrong, chairman of Distinction Asset Management, asks whether there is a future for the Hong Kong dollar.

Recently, there has been widespread debate over the future of the euro. But the currency with perhaps the least certain future is the Hong Kong dollar (HKD).
Because the HKD currency is pegged to the US dollar (USD), the Federal Reserve’s determination to keep interest rates low imposes two problems on residents of Hong Kong: rapidly increasing asset prices and a currency that is fast devaluing against most of its neighbours. Moreover, it is likely that Hong Kong will become a battleground of the currency war between US and China.

The HKD/USD peg has been one of the most successful currency pegs of the past 25 years. However, a drastic change in the Hong Kong economy, from manufacturing to the service-oriented economy, has opened a new issue. Hong Kong has transferred its manufacturing to the lower cost base in China, which is also its main trading partner. Meanwhile, Hong Kong wages have benefited from the rise in productivity in the US.

China is keen to use Hong Kong as a starting point in the internationalisation of the renminbi (RMB). However, it could well be the case that the mainland authorities soon decide that ‘one country, two currencies’ has outlived its political usefulness.
Real asset purchases from mainland China have caused one of the biggest real estate bubbles in the world with prices appreciating by almost 50% over the past two years. (Mainland Chinese accounted for 80% of new property sales in the past year).

This rally is mainly driven by liquidity, without the support of fundamentals. As a result, any sharp monetary tightening in the US is likely to result in a sharp ­correction of Hong Kong property prices. The wealth of Hong Kong residents is eroding as they are paid in HKD. They, in turn, are looking to preserve their wealth by investing in mainland China real estate. Changes in the economic and political scene raise the ­question of when and how Hong Kong will adopt the currency of its sovereign parent as the anchor for the Special Administrative Region’s (SAR’s) money supply.

However, Hong Kong as a trade-dependent economy cannot be linked to a currency that cannot freely be exchanged on both current and capital accounts. Another option is to create a peg relative to the basket of currencies represented by its main trading partners. The temporary solution might be to widen the range in which the HKD can trade relative to USD.

Hong Kong’s real economy and its financial markets are clearly driven by the mainland. As growth prospects between China and the US diverge, the relative cost of the current currency board system, in terms of the relative purchasing power of the HKD, will rise.

It could well be the case that wage levels in the SAR remain effectively anchored to US ­productivity growth, while overall productivity growth in Hong Kong becomes increasingly tied to mainland per capita GDP growth, which is expected to grow at a multiple of the corresponding US rate. From a relative wealth perspective, the accumulated wealth of Hong Kong residents, and their future income flows, could be worth more if they could follow the path of the Chinese economy and the RMB, rather than being weighed down by the performance of the US economy.

Re-pegging the HKD to the RMB would be a potential means of hedging the negative wealth effects that would occur in Hong Kong if there were a USD crisis, for example. A stronger RMB would also make property investments in Hong Kong relatively cheap for mainland buyers, fuelling the real asset bubble further. The only certainty is that the longer Hong Kong keeps on importing loose monetary policy from the US, the more radical action will be required.