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SOVEREIGN MAN

It’s “heads you win, tails you don’t lose” with this currency

May 26, 2011
Hong Kong

One of the most interesting things going on here in Hong Kong at the moment is the gradual displacement of the US dollar, and even the local Hong Kong dollar, by the Chinese Yuan.

Walking around town, the signs are obvious:  from shops that gladly accept Chinese Yuan cash for the goods they sell, to the money changers which now ALL display the Hong Kong dollar / Chinese Yuan  cross-rate much more prominently than the US dollar / Hong Kong dollar cross rate.

The Chinese Yuan Rules the Roost e1306409516880 Its heads you win, tails you dont lose with this currency

In many ways, this is a live economic experiment.

Hong Kong has long had one of the world’s freest, most sophisticated economies; residents are free to choose what currency to accept (and save), whether HK dollars, US dollars, Chinese Yuan, gold, or anything else.

Multi-currency bank accounts are the rule rather than the exception here, and you can switch freely between all of them with a few mouse clicks, or phone call.  This is one of the reasons why Simon has always been so keen to recommend banking in Hong Kong.

Yuan-denominated deposits in Hong Kong banks have more than TRIPLED this year as people look for ways to protect their purchasing power. Because the Hong Kong Monetary authority pegs its currency to the US dollar, Hong Kong ends up importing US inflationary monetary.

This is acutely felt.  Since Hong Kong is little more than a barren rock, nearly EVERYTHING is imported… so prices are rising in accordance with US dollar inflation.

To guard against this constant loss of purchasing power, many Hong Kong’s residents are converting their savings to Chinese Yuan. While the Chinese Yuan closely shadows the US dollar, it has steadily appreciated and is perceived to have significant future upside should the Chinese ever allow it to appreciate more quickly.

US monetary inflation makes it inevitable that the Hong Kong Monetary Authority will come up with some sort of a scheme to either peg the Hong Kong dollar to the Yuan (rather than the US dollar), or perhaps even replace the Hong Kong dollar with the Yuan altogether.

This would be a HUGELY popular move. Hong Kong is one of the few places on Earth with a net savings rate; the loan to deposit ratio its banking system, for example, stood at 81.7% at the end of March, meaning there are only 81.7 cents on the dollar lent out in Hong Kong for every $1 on deposit in the banks.

Consequently, savers would love to see the Hong Kong dollar revalued higher by pegging it to the Chinese Yuan at the current Yuan/dollar rate of 6.50, rather than the current HK dollar/US dollar peg of 7.80.

What’s more, a move to re-peg the Hong Kong dollar is anything but far-fetched when you consider that Hong Kong’s net savers club includes the government, which is sitting on a HUGE surplus.  So much, in fact, that the government recently announced it’s handing back HK$6,000 (US$770) to each Hong Kong permanent resident.

Bottom line, the clock is ticking on a Hong Kong dollar revaluation. The Yuan is a much better cultural and economic fit, and this brings me to the crux of today’s letter:

If you have significant expenses to meet in US dollars, you may be uncomfortable taking on currency risk by parking your money in a more volatile foreign currency such as the Aussie dollar or Canadian dollar. Let’s face it, they do have periods where they fall significantly versus the greenback.

By holding savings in Hong Kong dollars, though, you will have minimal downside risk if the HKMA keep the status quo and maintains the US dollar peg. Your Hong Kong dollars will always buy the same amount of US dollars they buy today.

But, you will have a free “call option” in case the Hong Kong dollar is revalued higher.  It’s a bit like a “heads you win; tails you don’t lose” situation, and that’s EXACTLY the kind of trade I have dedicated my professional life to uncovering.

About the author: Born to a Danish father and British mother, in Dar Es Salaam, Tanzania, Tim Staermose has led an international life since the day he was born. Growing up, he also lived in Egypt, Denmark, and Singapore, before eventually settling in Australia, where he completed his education and took out citizenship. Since then he has also lived and worked in Hong Kong, and Manila, Philippines, in the field of equity research — both for a bulge-bracket Wall Street investment bank, and for an independent investment research firm. Today, when not traveling the globe looking for investment and business opportunities for the Sovereign Man community and catching up with his diverse, multinational group of friends, he divides his time between Hong Kong, and the Philippines.

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Comments on this entry are closed.

  • Chuck B.

    Hi Tim/Simon,

    Simon has discussed the benefits of banking in Hong Kong and Singapore in past posts. From the leg work I’ve done so far, they seem very similar on paper. Both have attractive tax regimes, an efficient incorporation process and they rank at the top of business surveys every year. 
    I’ll be heading to Asia soon to put my own boots on the ground and my question:
    In your expert opinion(s), does one city have any clear advantages over the other when it comes to banking or incorporating?

  • World Source

    If the US dollar goes so does the CANADIAN dollar. Canada is the biggest trading partner with the US.

  • Jeeves

    It will be a number of years before the yuan is fully convertible, so the HK dollar isn’t going away in a hurry. But I certainly agree the HKD will have to align itself moreso with the yuan than the USD.

    Not least because the majority of producers in the Pearl River Delta – the factory epicentre of China and the world – are owned by Hong Kong interests.

    Second, the three key printers of the HKD are HSBC, Standard Chartered and BOC. The first two, obviously being ‘international’ in scope and quite cosy components of the HK Monetary Authority, wold obviously be severely reluctant to give up this privilege.

    And it is HSBC which lords it over HK, not the Bank of China.

    Don’t look for any changes overnight here.

  • Julian

    Hey as long as the USD goes down so will the HKD until the currency actually makes the switch to align with RMB or something else how can it be worthwhile to keep money in HKD which is effectively USD savings ?

  • Mmarks801

    The logic is seductive but slightly misses the point – HKD is pegged to USD while CNY is managed.  Plus the central bank has been very clear that they will continue to pursue that policy.  Yuan deposits have tripled, however I am willing to guess they are still less than 0.1% of all deposits so thats misleading.  and they would never revalue back to 1:1 – there’s just no reason – so the logic in the aritcle that you somehow go from 7.8 to 6.5 is baseless. Ultimately the other currencies make more sense, as they are undervalued and you get a carry and dont have to fight a peg.  So one day it may revalue, and maybe you make 6% that day, and everyone in that trade crows. 

  • http://www.animalsdinosaursandbugs.com/The-Future.htm Peter Legrove

    Hong Kong is a ‘used to be’ city. It used to be a great
    place to live now the mainland cities are great places to live. It used to be the gateway to China now there are many gateways. It used to be the port of China now there are many ports. It used to the financial center of Asia now Shanghai will soon be the main financial center. Hong Kong is just a pimple on
    the backside of China. China is now the place to be and the Chinese Renminbi Yuan is the currency to put your money in. With the HK$ pegged to the US$ you are in a losing currency. When you put your money in Chinese Yuan on the mainland you get over 4% interest plus the exchange rate which is running about 5% a year. So you can get around 9% while in HK the interest rate is about 1%. Also in HK deposits are only guaranteed to 500,000HK$ and I think that is only cash. I don’t think gold is covered and I don’t know if foreign currencies are
    covered. I don’t know what happens in China but you could nearly guarantee the Chinese government is not going to let the banks fail. Also HK is the ‘city of mislead’ so if you come here you will probably get screwed and banks are pretty good at screwing. Right now we have the Lehman Bros minibond screw up. Just before Lehman Bros went belly up the banks here in HK were selling minibonds and lots of people including pensioners lost lots of money. I think the government set the payout at over 90%, which is pretty good, but they had to do
    something as some people lost all their savings. If the govn didn’t do something I think a lot of money would have gone over the border into Chinese banks in China and I still think a lot of money will go that way. For pensioners I think the Postal Saving Bank is the bank to go to. Even the good old Hang Seng Bank where you buy the cheap gold is actually the Hang Seng Bank
    and Insurance Company and they could try and sell you some high priced insurance you don’t need. To be safe just stick to the mainland China banks and hopefully you wont get misled. Also you can buy gold bars there too.

  • http://wenonot.blogspot.com/ oulous

    Nice. I wrote an email to Jim Rogers a few years ago pointing this out. I wrote him that I had changed a lot of USD to HKD thinking that sooner or later they would decouple or the HKD would be absorbed into yuan. Either way I saw it as a good way to hedge my USD, glad to see other people have noticed this trade.

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