Maybe the Western press is starting to think more about the asian problem, besides the long interview pasted earlier there were three articles in Barron's this week, here is the best of the three. It is interesting that the global stock strategists who have an eye on the stock market do not think that Hong Kong will devalue/break the peg but the strategist who has his eye on the political landscape does think that there will be an adjustment with China close behind. Hmmmm... What does eveyone think?
June 8, 1998
Hong Kong Currency's Peg to the U.S. Dollar
Cuts Two Ways, but if It Goes, Stock Buyers
Beware
By Peter C. Du Bois
Amid worries about the health of Hong Kong's economy, which is in a
slump, the Hang Seng index of local shares zigzagged to a net loss of 4.1%
last week. The popular average closed Friday at 8569.47, against 8934.56
on May 29.
With local politicians calling for strong steps to counter the dual downturn, the
future of the Hong Kong dollar's peg to the greenback naturally springs to
mind. Some background:
One of the strongest weapons in Hong Kong's economic and financial arsenal
is its currency's link to the U.S. dollar. This sword cuts two ways. By tying its
dollar to the greenback, Hong Kong for many years has been able to set its
interest rates at lower levels than what might otherwise be demanded by its
inflation rate. At the same time, higher interest rates are its only weapon with
which to defend the peg against currency speculators.
Speculators Defeated, for Now
In the aftermath of a regional currency crisis that began last July with the
devaluation of the Thai baht, speculators several times have tested Hong
Kong's resolve to suffer temporarily the pain of higher rates. To date, the
speculators have been defeated.
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However, with Hong Kong real-estate prices -- which dominate local
sentiment -- tumbling, and further declines seen as likely, we asked some
investment strategists and portfolio managers the following: What could break
the peg and what if it occurs?
At first glance, one could argue that such a move would make little economic
or financial sense. On the other hand, do central bankers and politicians ever
make stupid mistakes? You bet they do.
Donald Gimbel, head of Gimbel Asset Management, believes a recession in
Hong Kong began in the first quarter of 1998 and could run for 18 months.
That said, he insists that devaluing now merely would add inflation to this
scenario (by raising the cost of importing fuel and other goods) and wouldn't
solve any of Hong Kong's structural problems.
In his view, the peg would only be broken with a simultaneous devaluation of
the Chinese yuan, which he also doubts will happen. Further, lowering the
value of the HK currency (which recently traded at 7.749 to the U.S. dollar)
by, say, 20% "logically shouldn't necessarily trigger another round of
competitive devaluations in the region." Why? The domestic financial picture in
Thailand, Indonesia and Korea, for example, "is so bad that further
devaluations won't make their economies any better."
However, "emotionally" they could follow suit. This would cause "a fair
amount of panic among global investors, and probably would seal the fate of
Asia as an investment destination for a long period of time."
James Montier, London-based global strategist for BT Alex. Brown, a unit of
Bankers Trust, believes that a yuan devaluation would precede the removal of
the peg. In his view, while Chinese economic growth is slowing, to 7% in the
first quarter of 1998 from a goal of 8%, "it hasn't yet reached crisis levels of
5%-6%." However, if China sparks another round of regional crises, this
move would trigger "a domestic-confidence crisis in Hong Kong. As people
rushed to switch out of the local dollar and into greenbacks, the peg would be
ended de facto."
Alternatively, should the HK government deliberately remove the peg,
Montier says the outlook for its economy and stock market "would be less
than joyful." Assuming a 30%-40% drop in the currency, would this help the
economy? "No. Hong Kong exports are far more dependent on the relative
economic growth rates of the U.S. and China than on the overvaluation of the
HK$, and devaluation would do little to create growth. In fact, if the peg were
removed, it's likely that interest rates would have to rise even further in the
short term to try to stabilize the currency, and there's no guarantee that rates
would fall fast."
From a stock market perspective, "this would be very bad news. With
two-thirds of the Hang Seng index accounted for by banks and property
stocks, the market would crash. Few, if any, listed firms would benefit from a
devaluation.
Looking farther ahead, "long-term investors must recognize the risks of
continued property price deflation. If there is no property price inflation, there
will be no financial asset inflation, and Hong Kong equities would be repriced
to reflect this new reality."
Alexander L. Muromcew, portfolio manager of three Nicholas Applegate
funds that invest in non-U.S. stocks, "really can't see how a devaluation would
benefit Hong Kong. It's a services economy, and the financial-services
industry demands stability. A devaluation would hurt Hong Kong's role as the
financial capital of Southeast Asia."
In his view, breaking the peg also would hurt property companies, individuals
with mortgages (many of them of the floating-rate variety) and banks,
including U.K.-based ones like HSBC and Standard Chartered.
The Hong Kong dollar "is the sterling-silver currency peg," he adds. "Were it
to go, not only would all the other Asian currencies be whacked a good
10%-20% in sympathy, but all other pegged or linked currencies, such as the
Argentine peso and the Brazilian real, probably would be broken. Another
weak currency that probably would be forced to devalue is the Russian
ruble."
As with any devaluation, "all companies with foreign currency asset-liability
mismatches would suffer. In Hong Kong, the 'red chips' [entities controlled by
Beijing] have the weakest balance sheets and the largest foreign currency
debts, mainly in U.S. dollars."
Christopher Wood, Hong Kong-based global emerging-market strategist at
Santander Investment, says the issue of maintaining a peg is a political one. He
no longer believes that Hong Kong officials can tolerate the economic pain of
high interest rates during what he sees as a two-year recession. Furthermore,
the Hang Seng index "will break through its support at 8,000 and reach 6,000
if the peg goes or doesn't."
With the yen "heading toward 160 to the dollar and beyond," in his view, from
just under 140 Friday, the Chinese yuan "also will come under growing
pressure." Hopefully, Wood adds, the adjustment of the HK$ and Chinese
currencies "will mark the end of a cycle of competitive devaluations, not the
beginning of a new one. But this is more a hope than a prediction."
Last but not least, Marc Faber, who writes the Gloom, Boom & Doom
Report, lives in Hong Kong and long has been bearish on its outlook, says the
peg "likely will be lifted in the second half of 1998. Unless the HK dollar is
devalued by about 30%, it will hardly make any sense to lift the peg system."
He also sees Hong Kong's economy remaining in recession for at least 18
months and property prices, already 30%-50% below their July 1997 peaks,
falling another 30%. The good news: "Following a 30% devaluation of the
HK$, the stock market will likely rally."
Overseas stock markets were mixed last week, with Europe (11 up, seven
off) far outperforming the Asia-Pacific region (13 off, two up, Shenzhen
unchanged). Closing at peaks Friday were local indexes in Brussels and Paris.
London rose despite an interest-rate hike. In Moscow, the RTS
dollar-denominated index of Russian shares posted a net gain of 8.5% last
week. Investors apparently were cheered by Russia's sale late Wednesday of
$1.25 billion of five-year, 12.07%, dollar-denominated notes.
In contrast, the yield on the benchmark Japanese government 10-year bond
fell to a new low of 1.115% Tuesday before closing Friday at 1.165%. The
Nikkei stock index slid 2.2% last week.
Lack of enthusiasm for a new budget sent Bombay 7.3% lower. The SET
index of Thai shares suffered a net decline. Jakarta also suffered a net loss
(2.6%) but rallied Thursday and Friday after foreign banks agreed to
restructure about $80 billion of short-term, private-sector debts.
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