From Forbes, Nov 17 issue
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In attacking the Hong Kong dollar
the speculators tried to mug the
wrong guy. Turns out he had a gun
Rock-solid Hong Kong
By Steve H. Hanke
THE MOST RECENT devaluation victim
in Asia was Taiwan, a country with
a war chest of foreign reserves to
match the mighty German
Bundesbank's. After Taiwan fell
last month, the currency
speculators put the Hong Kong
dollar in their sights. The
dramatic events in Hong Kong sent
shock waves throughout the world's
markets and probably helped
precipitate the carnage on Wall
Street.
It was a case of mistaken
identity: The speculators mugged
the wrong guy. Turns out he had a
gun.
Most speculators and pundits
mistakenly identified the Hong
Kong Monetary Authority as a
central bank. It is not a central
bank. It does not have the power
to manipulate the money supply. It
is prohibited from creating money.
Yes, the H.K. dollar is linked to
the U.S. dollar, as were so many
of the other currencies in Asia.
But there is a world of difference
between the H.K. dollar's link to
the greenback and those links that
were employed by central banks in
the region. The central banks had
pseudo- fixed or pegged exchange
rates. The central banks tried
simultaneously to manage their
exchange rates and their domestic
monetary policies, an impossible
task. You can't juggle these two
balls at the same time. So their
exchange rate and monetary
policies resulted in
contradictions- which is to a
currency speculator what soused
and elderly well-dressed gentlemen
are to muggers on dark streets. An
easy hit-as was Mexico in 1994.
In contrast, the Hong Kong
Monetary Authority has no monetary
policy-the money supply is on
autopilot-and there can be no
contradictions between its
exchange rate and monetary
policies. Indeed, market forces
act to automatically stabilize the
monetary system and avert currency
crises.
This is why, since the first
currency board was installed in
1849, none has been the victim of
a successful speculative attack.
And this perfect record includes
the furious, but unsuccessful,
attack that was mounted against
Argentina's currency board system
in 1995. While the Mexican peso
crumbled, the Argentine peso stood
solid.
All this has been missed by the
critics of Hong Kong's system.
They thought they saw an opening
in that, even though Hong Kong's
foreign reserves are five times
the amount of H.K. dollars in
circulation, the reserves cover
only about 23% of the broad
measures of money. That is, while
there are more than enough U.S.
dollars to redeem every H.K.
dollar in circulation, there would
not be enough to redeem all the
bank accounts and other forms of
money. Consequently, they figured
that the reserves would be
depleted in short order if there
were a massive run on the banking
system.
However, only about 55% of the
bank deposits in Hong Kong are
denominated in H.K. dollars, with
the remainder in foreign
currencies, primarily U.S.
dollars. If there was a general
run on the banking system, it
would affect only the H.K. dollar
deposits, and most people would
simply make a portfolio shift into
foreign currency deposits. They
would not pull this money out of
the banks.
Indeed, large portfolio shifts and
swings between H.K. dollars and
foreign deposits have occurred in
Hong Kong in the past and the
economy didn't miss a beat.
Like Argentina, Hong Kong's
currency board system will weather
the storm and the H.K. dollar will
remain rock-solid.
Does this mean that the U.S. stock
market is likely to come roaring
back? No. As I advised in my Nov.
3 FORBES column, the deflationary
forces that have been unleashed in
Asia spell trouble for U.S.
companies that compete with Asian
exporters or that export to that
region.
The real story from Asia is not
the H.K. dollar-it's deflation.
The economies in that region are
entering a deflationary slump, so
their domestic demand for goods is
drying up. They have invested
heavily in plants and equipment
over the past decade. With
domestic markets slack, these
economies will be under tremendous
pressure to export. With their
newly devalued currencies, the
Southeast Asian countries will be
fierce competitors as they try to
export themselves out of trouble.
That competitive pressure promises
to squeeze profit margins and
force price/earnings ratios down
in the U.S.
U.S. Treasury bonds look awfully
good to me right now.
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In attacking the Hong Kong dollar, the speculators tried to mug
the wrong guy. Turns out he had a gun.
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