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.

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.