Hong Kong Dollar Peg 1983-2021 RIP

The Hong Kong dollar peg has often in its history been able to lean upon Mark Twain’s famous, and possibly apocryphal, quip, “Rumours of my death are greatly exaggerated”, however our special correspondent thinks 2021 could be different – and it will have little to do with markets…

There are two ways a structure comes to its end, it simply falls into disrepair and entropy takes over, or it’s deliberately disposed of.

The Hong Kong dollar/US dollar peg has proven a remarkably sturdy structure since inception, defeating allcomers assaulting its financial and economic foundations. In 1983 peg architect, economist John Greenwood, came up with the idea at a moment of profound turmoil as the UK negotiated the return of Hong Kong to the People’s Republic of China. Its stability underpins four decades of economic success.

There is hardly a year goes by, however, without the world launching an assault on the peg, attempts to break it tend to be even more feverish when a peg elsewhere has been broken – witness the chattering about the peg in the months after the Swiss National Bank allowed, with disastrous consequences, the EUR/CHF peg to break –  but, as 2021 proceeds, it stands strong. Despite occasional calls for it to be re-based there has never been a serious discussion on its future, nor has one been needed. Certainly there is no debate underway right now, yet are we missing something fundamental?

To be clear in 1983 the peg was the financial response to political uncertainty. Hong Kong was then a very different place, China had just started its economic re-awakening and the local economy was heavily export-oriented especially towards countries linked to the US dollar. For the remaining years of British rule the peg reflected a new economic balance for HK between a rapidly developing China and the rest of the world and this worked because the renminbi was also linked to the US dollar.

In 1997 the handover brought a profound shift with the Hong Kong government adopting China-first policies economically, socially, and importantly, politically. From being China’s window to the world, Hong Kong should now be China’s front door. Ever since then this re-balancing has accelerated, and with China’s new assertiveness,  questions can be asked over the continuing utility of a Hong Kong dollar linked to an antagonistic (if you are China) and systemic rival.

The integrity of the peg may no longer be based on financial considerations but political imperatives.

The developing great power rivalry between the China and US, complete with sanctions on Hong Kong government officials that directly impact their Hong Kong dollar holdings, is bringing the peg back full circle to a time of political uncertainty. The integrity of the peg may no longer be based on financial considerations but political imperatives.

These imperatives, which are also being driven by increasing integration of the Pearl River Delta economies and both Shanghai and Singapore’s relative attraction as financial centres, is leaving the Hong Kong dollar in no man’s land. In 2020 according to the Hong Kong Trade and Industry Department, 52% of total exports were to mainland China (US 5%) and imports from China were 45% (US% 4%). Equally the trend in trade growth rates substantially favours China.

This means that the economic logic of the peg, backed by the necessary political will, is invisibly dissipating.

When the end of the peg comes it will be sudden and unexpected, governments know to their cost the ability of foreign exchange markets to do their worst. The question then becomes what happens to the Hong Kong dollar itself. Despite Hong Kong being the eigthth largest global trading economy the logic of a free float does not make sense owing to prevailing economic and political dynamics. There are too many powerful outside forces.

Given the balance between China trade and global trade the obvious replacement is a CNY peg. Such a peg could act as a convertible proxy for the renminbi, which means the next logical question is, in such a scenario, does the Hong Kong dollar itself have a long term future?

Tse-Sing Gweilo