With a brief blog post last week, Joseph Yam reopened one of the biggest debates facing China’s economy: is it time to scrap Hong Kong’s currency peg to the US dollar.
Yam helped establish the link in 1983 and later served as chief executive of the Hong Kong Monetary Authority (HKMA). His talk of the city’s “dilemma” acting as the main conduit between China and the rest of the world turned heads partly because of the timing. This argument has raged on and off since Asia’s 1997 crisis. But the divergent paths of a rising yuan and sliding US currency is exacerbating already considerable bubble troubles.
That tension will only increase as China relaxes capital controls. As Yam puts it, Hong Kong’s “small” economy risks being subsumed by “huge” capital inflows that make Hong Kong’s housing market the world’s least affordable. Inflation pressures are rising faster than wages. Having to track US monetary policy is akin to a giant pump adding ever more air to imbalances. Real estate, for example, is already getting a big lift from mainland millionaires and billionaires spiriting cash into a city that serves as China’s financial green zone. It is no coincidence that Bitcoin and other cryptocurrencies are a big hit in China (or that Beijing is clamping down on their use).
Will the HKMA, now run by Norman Chan, scrap the dollar peg? The decision is far above his paygrade, of course. It will ultimately be made by Chinese President Xi Jinping, and let us hope he gives Chan the greenlight, and soon.
In his new book, I Do What I Do, Raghuram Rajan makes a strong case that a central bank’s most vital function is stabilizing the exchange rate. That’s precisely what Rajan did in September 2013 when he arrived at the Reserve Bank of India (RBI).
When exchange rates diverge from an economy’s fundamentals, things go awry. The massive Umbrella Revolution protests in 2014 were partly about Hong Kong’s worsening “Gini coefficient”, a measure of income inequality. Hong Kong is now less egalitarian than Singapore, the US or Britain. Blame Hong Kong’s oligarched economy: the tycoons are reaping the benefits of the 3.8% growth posted in the second quarter, while many of the city’s 7.3 million residents fall behind.
This tale of two economies even has some tycoons worried, including Li Ka-shing, Hong Kong’s richest man. In 2014, before 100,000 Hongkongers clogged the streets, Li gave a prescient speech about the perils of the Dickensian trajectory China’s green zone is on. It is high time Hong Kong recognized the dollar peg’s role in this swirl of discontent. Scrapping it is smart economics and a sign of confidence Hong Kong is ready to dispense with its 34-year-old financial training wheels. It also would fit in with Hong Kong’s reputation as the freest economy.
Frankly, Hong Kong’s capitalist bone fides are a bit complicated. Sure, Ayn Rand would have cheered its 15% corporate tax rate, unfettered capital flows, ease of doing business, rule of law and duty-free port. Yet she might abhor the pegged currency, publicly controlled property sector, opaque decision making, government-backed Disney theme park and the city’s leaders being picked by Beijing.
In June 2016, Li put on his Warren Buffett hat to broach the issue of higher taxes. Li recommending taxing companies “an extra one or two percent” to benefit the poor smacked fellow tycoons as heresy. But if Hong Kong cannot narrow inequality, its low tax rate might, indirectly, foment discontent from the ground up, bringing the Umbrella Revolution back onto the streets.
On the financial side, Yam thinks it is time for reform. In 2012, he called for a formal review of the peg, causing a spike in the Hong Kong dollar. Now, he proposes allowing local stocks to be priced and traded in yuan, too. Such a dual-currency system, Yam believes, would shield Hong Kong from today’s mismatch between the yuan, the US dollar and China’s global ambitions. To many, this smacks of a trial balloon—a step toward the bigger goal of either pegging to the yuan and having no peg at all.
While Yam has been out of the HKMA since 2009, his is a very small financial world, as are global central banking circles. In this orbit of winks, nods and secret handshakes, a former monetary guru pushing an argument naturally has traders wondering. Does Yam know something we do not? The timing makes perfect sense, too. When Beijing regained control of Hong Kong in 1997, its pledge was simple: in return for your fealty to the motherland, our economic boom will make you rich. Turns out, those riches benefited few at the expense of the many.
The irony is that as China’s rise drives Hongkongers apart, and the dollar peg exacerbates discontent, the freest economy might have to go communist.
William Pesek, based in Tokyo, is a former columnist for Barron’s and Bloomberg and author of Japanization: What the World Can Learn from Japan’s Lost Decades.
His Twitter handle is @williampesek