John,
I'll try. Someone please correct me where I get it wrong.
As you know, Hong Kong's currency is pegged to the $US even thought it is freely traded. The HK Monetary Authority (HKMA) holds the Foreign Exchange Reserves that back the $HK, monitors the $HK value, and has certain actions it is required to take to maintain the peg, primarily raising interbank rates when the value begins to fall. It is non-political. In some ways it is similar to our Federal Reserve except they do not have discretion on the interest rates - action/reaction is pretty well automatic. They do have discretion over the funds they hold.
The Hang Seng is primarily banking and real estate companies. A rise in interbank rates would lower their profits and the price on their shares fall.
With the situation in Asia, large hedge funds have been shorting the banking and real estate stocks, then shorting the $HK, forcing the iinterbank rates up, effectively forcing the prices down where they cover their shorts and take profits.
The HKMA realizes what they are doing. As they are restricted by charter to raise the interest rates, they have chosen to buy stocks to keep the price up and prevent the hedge funds from taking profits. The hedge fund August shorts expire tomorrow. Many of them started rolling over their positions to September contracts so the HKMA started selling Sept. contracts to drive the price down thereby making it expensive for the funds to roll over their positions. In addition, they are trying to drive the margin rates up to make shorting more expensive.
It's a war with the hedge funds trying to take advantage of the restrictions in the HKMA charter to profit and the HKMA trying to prevent it. The hedge fund activity has been going on for a long time, but the HKMA did not step in until a little over a week ago. No one knows how much they have invested, but some are saying that the HKMA may own as much as 2% of Hong Kong's largest bank. The HKMA has repeatedly stated that they have no intentions of owning shares in the market, that this is an extreme situation they are trying to stabilize. I've seen no one claim otherwise, but many (most of them outside HK) are complaining about the HKMA's interference.
The actual value of the Hang Seng cannot find it's level due to the hedge fund activities. Some say it's overvalued becasue the real estate market in HK has fallen so much. Others say that it's fallen too far because most of the listed equities are selling well below BV. Then again, what is the true value when property prices are falling?
There have been numerous arguments about the $HK as to whether it is over valued. The HKMA holds foreign exchange reserves in excess of the amount of $HK in circulation. 60% of the reserves are in $US. The argument now is whether they should repeg to a standard other than the $US or should they go to 'dollarisation' = eliminate the $HK and use $US as their currency. Surprisingly, the PRC isn't against dollarisation. I had felt they would takethe HKMA reserves and replace the $HK with the Rmb (near the same value).
IMO - The problems Hong Kong has with the peg is the $US being so strong. Because the $US has risen, the peg has made the $HK rise. Conditions in HK are much worse than in the US because of their proxtimity to the Asian 'crisis' and they have a much smaller economy. I feel they should repeg the $HK to an international standard that would reflect the strength of the $US and the weakness of the yen.
It's a matter of HK determining their own economy or the speculators using their system against them. The government buying into a market to support it has never worked. It's being reported that the hedge funds lost hard this week due to Russia and it may make them back off in HK. I have to believe they've been hurt by the HKMA's actions.
Hope this helps,
Ron
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