Read this article on WSJ interactive and want to disagree with Mr Howell in that the Chinese will want to keep the face more than the money in their efforts to help defend the peg and by not devaluating the yuan first.
Contents of the article as follows:
Hong Kong's Peg to Dollar Is a Global-Markets Pillar
By MICHAEL R. SESIT
Staff Reporter of THE WALL STREET JOURNAL
Amid the turmoil engulfing Asia, tiny Hong Kong and its
currency "peg" have found themselves at the core of the
global financial system.
Indeed, many investors and analysts see the Hong Kong
dollar's peg -- or firm link -- to the U.S. dollar as the dam that
prevents Asia's crisis from inundating other emerging markets
and possibly even the world's major ones.
So far, Hong Kong's peg -- and that of China to which Hong
Kong's destiny is inexorably linked -- have held, and senior
officials of both have repeatedly vowed not to devalue either
the Hong Kong dollar or the yuan. Nonetheless, Hong Kong
shares, caught in the vortex of Asia's falling currency and
stock markets, have sunk 46% from their highs of August.
Traders also say that hedge funds have begun building up
speculative positions against the Hong Kong dollar.
Potential Impact
"We see removal of the Hong Kong peg as the key risk to all
global [stock] markets," says Gary Dugan, an equity strategist
at J.P. Morgan Securities Ltd. in London. "It would be the
straw that breaks the camel's back, setting in train a new
round of devaluations in Asia that would have a wider impact
on global growth."
Set up in 1983 at a rate of 7.8 Hong Kong dollars to one U.S.
dollar, the former British colony's peg is regarded as the
"Great Wall" of pegs, one that lends legitimacy not just to
Hong Kong but the entire concept that currency pegs can
work. Its collapse, predict analysts, would encourage
speculators to take on many of the world's other currency
pegs. That could destabilize not only developing country stock
and bond markets, but those in the U.S., Japan and Europe as
well.
Currency pegs can offer several advantages: a credible
monetary policy, low inflation and a predictable exchange rate
that in turn enhances trade and investment. "And if you are
pegged to a low interest-rate country -- and the peg is credible
-- you also get low interest rates," says Ravi Bulchandani, an
economist at Morgan Stanley, Dean Witter, Discover & Co.
in London.
Problems With Pegs
But pegs also come at a price. A country can run out of
money with which to defend them, and they compel a nation
to surrender policy-making flexibility to its exchange-rate
policy. Moreover, pegs create a strong incentive to borrow
foreign currency to finance domestic projects. "Pegs also
present a one-way bet to speculators, and for a long time they
can mask underlying economic problems," says Mr.
Bulchandani.
Currency pegs come in different shapes and sizes: Some such
as Hong Kong and Argentina's are hard and fast with a single
exchange rate; some are periodically adjusted to take account
of inflation differentials; others are "managed floats" that
allow currencies to fluctuate but are subject to intervention
and still others consist of trading bands with upper and lower
limits.
Hong Kong, Argentina and Lithuania maintain so-called
currency boards in which a country's monetary base is backed
by foreign reserves, either currencies or gold. For this reason,
economists regard boards as the most credible pegs. Still, no
peg is stronger than the political will of a country's citizens to
absorb the pain of defending it -- huge expenditures of foreign
reserves, high interest rates, slowing growth, increasing
unemployment, rising bankruptcies and collapsing securities
markets.
Many Nations Pull Out
Time and again, fixed-exchange-rate systems have been
unhinged by speculators chasing quick profits or investors and
companies scrambling for protection. Since late 1992,
Finland, Sweden, Norway, Britain, Italy, Spain, Portugal,
Mexico, the Czech Republic, Thailand, Indonesia, Malaysia,
the Philippines, South Korea, Taiwan and Vietnam have been
forced to abandon currency pegs.
Whether Hong Kong's is next is a hot issue, one made more
complex by the fact that the territory's fate is closely tied to
China's. And China is hurting: Asia's plunging currencies have
wiped out all the advantages China gained from the yuan's
33% devaluation in 1994. Exports, which grew 20% last year,
are expected to fall sharply; China's banks are riddled with
nonperforming loans; and millions of workers are being laid
off as state-owned enterprises close.
Money managers say a yuan devaluation would trigger panic
selling of the Hong Kong currency and stocks. Because the
yuan isn't freely convertible, speculators can't force China to
devalue. But Ray Dalio, president of Bridgewater Associates,
a Wilton, Conn., global currency and bond manager, says,
"we can count on one hand -- and have three or four fingers
left over -- the number of countries that have successfully
avoided devaluations under similar conditions."
He adds that "tying the Hong Kong dollar to the U.S. dollar is
an anachronism." Citing Hong Kong's rising interest rates,
slumping stock market and falling property prices, Mr. Dalio
says that "conditions in Hong Kong favor a devaluation."
The fallout would be widespread. "Whenever you have one
of these crises, people start to smell around to see if anyone
else is weaker than they thought," says Frederic Mishkin, a
professor at the Columbia University Graduate School of
Business. "This is part of the contagion process." Many
economists contend a Chinese devaluation would spark
another round of competitive devaluations in the region and
elsewhere. What is more, U.S., European and Japanese banks
are more exposed to Hong Kong than any other Asian country
except Japan.
Independent Strategy, a London financial consulting firm,
predicts China will devalue the yuan by 30% to 40% within
18 months. "When it does, the Hong Kong dollar-U.S. dollar
peg is doomed," the firm told clients a few days ago. "Serious
damage will be done to one of the pillars of the global
financial system."
Hong Kong's Strengths
Still, many economists expect the Hong Kong peg to hold.
Hong Kong's economy is one of Asia's strongest. And
although the Hong Kong dollar is overvalued, the impact is
mitigated by the fact only 7% of the territory's economy is
based on manufacturing. "The stuff they sell is made in
China," says Kit Juckes, an economist at National
Westminster Bank PLC in London. The territory's banks are
also regarded as some of Asia's strongest.
Meanwhile, Bernhard Eschweiler, an economist at J.P.
Morgan & Co. in Singapore, argues that China's desire to join
the World Trade Organization and avoid a trade dispute with
the U.S. will make the country "very hesitant to devalue."
Hong Kong has a hefty US$97 billion in reserves, and China
an additional US$140 billion to defend the Hong Kong dollar.
Some analysts argue China is also eager to avoid the
embarrassment of seeing Hong Kong's peg fall seven months
after the British handed back the former colony.
But Michael Howell, head global strategist at CrossBorder
Capital, a London financial consulting firm, says that "given
the choice of losing face or losing money [by defending the
peg], the Chinese will keep the money." |
