Will the Hong Kong Dollar Peg Buckle Under Attack? Errrr, No

The high profile US Hedge Fund group Pershing LLP has recently launched an ‘attack’ (of sorts) on the HKD. Pershing has amassed significant call option positions on the HKD/USD, reasoning that the inflationary spillover from Bernanke’s ultra-loose monetary policy will not be tolerated by the monetary authorities. Pershing expects the Hong Kong Monetary Authority to either (i) revalue or (ii) abandon the peg altogether. Fat chance!

Adding to supposed pressure on the HKMA is the fact that they have been forced to add to their foreign reserves twice this month as the peg touched the upper bound of the permitted range. This means that the HKMA injected cash into the system in return for additional USD reserves, which ultimately gets ‘sterilised’ by the issuance of domestic TBills and bonds.

Will the HKMA buckle this time? We don’t think so for a number of reasons…

First, the Hong Kong government has been very open with their contentment at outsourcing monetary policy to the US Federal Reserve. Running a fully funded fixed exchange rate means that the HKMA has essentially Dollarised their economy. Hong Kong is a very small, very open economy and they are neither interested in operating an independent monetary policy nor are they set up operationally to do so.

Second, Hong Kong is no stranger to accumulating and managing significant quantities of foreign reserves. Their investments have performed very strongly over many years, and arguably has reduced the tax burden on its citizens. If accumulating significantly more reserves is the cost of the current Pershing attack then the HKMA’s attitude is simply ‘… so be it’. The Territory will benefit from the investment return that Pershing (and others) are implicitly foregoing. [Who would have imagined a transfer of wealth from a group of hedge funds to a sovereign state’s coffers? This takes the whole concept of voluntary taxation to another level!]

Put simply, the HKMA is quite content to defend the peg and it is under no pressure at all. The attackers should take their loss and move on.