Monday, October 29, 2012

Hong Kong First to Feel the Force of QE Tsunami

Thanong Khanthong
The Nation
October 30, 2012

The Hong Kong dollar is feeling the heat of quantitative easing. Easy money created out of thin air at an almost zero-per-cent cost by the US Federal Reserve is flowing into the emerging markets for speculative attacks. The Hong Kong dollar has become a distinct target. In a proxy war launched by the US Fed at the height of the US presidential campaign, the speculators appear to be circling Hong Kong's currency board system to test the water. We don't know yet whether the speculators would like to tear apart Hong Kong's currency board in a repeat of the 1997 episode when they attacked Thailand's fixed-exchange-rate system with the aim of ripping it apart. Don't forget that Hong Kong is the window to China, where the yuan is the ultimate target in this galactic currency war launched in parallel with the geopolitical confrontation between the US and China. In a series of defensive moves, the Hong Kong Monetary Authority has intervened in the foreign exchange markets several times over the past week to protect the integrity of its currency board system. It has spent US$1.85 billion since Saturday to fend off the speculative attacks on the currency board by buying up the US dollar with its printed Hong Kong dollar. This is aimed at preventing the HK dollar from appreciating and breaking beyond the very narrow range within which it is allowed to move against the US dollar in a particular trading day.

The Hong Kong dollar is now pegged tightly at HK$7.80 to one US dollar.

The currency board system allows the HK dollar to move at HK$7.75 to HK$7.85 against the US dollar in daily trading.

Currently, the HK dollar is threatening to break through HK$7.75 in an appreciation trend.

The situation is the reverse of 1997's events, when the HK dollar and other regional currencies in Asia came under speculative attacks. Then, hedge funds and money managers sold local currencies - the HK dollar, Thai baht, Malaysian ringgit, Indonesian dollar - in favour of the US dollar to knock down the value of these currencies or force their devaluation. The Hong Kong Monetary Authority was forced to rely on unconventional measures, such as printing money to inject liquidity into the financial system, and also to buy up equities in the Hang Seng stock market. The Bank of Thailand defended the fixed exchange rate system until it ran out of its US-dollar reserves and was forced to seek a bail-out from the International Monetary Fund.

But this time, the hedge funds and international money managers are flooding the emerging markets with cheap US dollars by buying up the local currencies instead. Their rationale is that the US dollar is on a downward trend, along with the yen, as the US Fed and the Bank of Japan have launched quantitative easing (QE) to weaken their currencies. Therefore, they deem it impossible that currencies from the export-led economies can remain relatively cheap to boost their exports. By selling the dollar for emerging-market currencies, they are forcing the emerging market currencies to strengthen in value. Brazil has been most vocal in calling the Fed's QE a declaration of "currency war".

The ramifications of the attack on the Hong Kong dollar are as follows:

First, it will force the HK dollar to appreciate in value, hurting Hong Kong exports and its economic competitiveness.

Second, the speculation could force the Hong Kong monetary authority to adjust its currency board or abandon the currency board altogether. This might create turmoil in the regional financial markets.

Third, if the Hong Kong monetary authorities insist on defending the currency board, they will have to print the HK dollar en masse to cope with the US dollar inflow.

Fourth, increased HK dollar liquidity will drive up asset values, especially for stocks and properties, to create bubbles.

The managing director of Lycean Securities, Francis Lun, was quoted as saying that inflows of hot money are expected to continue. He recommended that Hong Kong consider linking its currency to the Chinese yuan instead of pegging it to the US dollar.

Both US presidential candidates, Mitt Romney and Barack Obama, have engaged in a battle of rhetoric over China. Romney has gone so far as to announce that he would name China as a currency speculator on day one as president.

The currency attack against the HK dollar at this juncture should be viewed within this geopolitical context, as it is a proxy currency of the shadowy Chinese yuan. The title of world's chief currency manipulator belongs, in fact, to Ben Bernanke. He insists that the Fed's QE is good for the US economy and as a result will also benefit the world economy. However, QE is not directed at helping the US economy at all. At present, the top-ranked Fortune 500 companies are sitting on an excess US$1.5 trillion in cash. They are not investing, nor are they hiring any additional workers. Banks are not lending because there are no borrowers. QE, henceforward, should be viewed as part of a financial weapon of mass destruction aimed at creating asset bubbles in the emerging markets, with China and other Bric countries as the target.

The Bank of Thailand last week sprung a surprise by cutting its short-term rate by 25 basis points to 2.75 per cent. It hoped to stimulate the economy and stem the baht appreciation - at least for a while. But in the medium term, the baht, like the HK dollar and other emerging market currencies, will be subject to attacks to create bubbles from the massive inflow of QE money. And we all know that all bubbles pop eventually.

The tsunami of money is coming. The writing is on the wall.