The complexity of Hong Kong Dollars (HKD) - personal thought

 I want to write about Hong Kong Dollars (HKD) this week. This is mainly because of the recent hype about this currency in some videos dealing with China and Hong Kong economy. 

Before I begin, I have to note here that this is my second attempt on this article, my first attempt was quite a disaster. I was looking into the fundamental of this currency and there are too many factors EVERY WHERE. In the end, I found that I was going nowhere when I wanted to include as many things into the article as possible. I have to scrap the original article, so this is my second time writing this since yesterday, entering fundamental analysis.

It started with this person Kyle Bass who twitted that he may borrow HKD to short since interest rate in US makes it more expensive for borrowing while interest rate in Hong Kong has barely changed. Kyle Bass has been bearish over China for some time and ever shorted HKD, with disastrous result.

This followed by a recent interview with Simon Lee which counter the argument from Kyle Bass. ( (10) 🔥🔥利世民：鱷魚頭巴斯狙擊 睇死港幣！警告8月玩完？ 港幣係唔係會被兌爆？脫鉤！劣幣驅逐良幣前奏跡象係咩？若爆金融銀行危機港府有冇錢救市？大陸機構在港借錢會唔會出蠱惑 答下面6條觀眾問題 - YouTube ). It argued that the Hong Kong government has sufficient funds and mechanism to prevent the unpeg of HKD from USD, including the increase of interest rate, increasing cost of shorting HKD, going against HKD is a mistake.

Before I proceed, the follow has to be established. HKD is pegged to USD with a range bound value between USD1 = HKD7.75 - 7.80. Hong Kong Monetary Authority will maintain an exchange reserve in USD to ensure every single HKD is backed by an equivalent amount of USD.  

Should there be a market sell on HKD, the government will sell USD to buy back HKD, thus avoiding further depreciation of the currency. In case of HKD becoming stronger, the government will sell off HKD and accumulate USD. To determine if it is possible to unpeg HKD, one important factor have to be considered is the size of Hong Kong Forex reserve.

Table 1. Money Supply of Hong Kong

Fig 1. Hong Kong Forex reserve

Information above was extracted from Hong Kong Foreign Exchange Reserves - June 2022 Data - 1993-2021 Historical (tradingeconomics.com) 

The Forex reserve in USD when convert to HKD is of similar amount of its Money Supply M1, which is the Commercial Bank Reserves. Does it mean that Kyle Bass has to deplete USD450Bil to break HKD? 

It is also interesting to note that the forex reserve has already fallen to USD450Bil from its peak of USD500Bil. I am not sure the reason for this drop and can only speculate that it is due to an increased number of businesses withdrawing from Hong Kong, in addition to the Hong Kongers migration outward due to its political instability. This is a drop of around 10% of its total reserve.

What is more concerning recently is an agreement struck between China and Hong Kong to currency swap to increase from HKD590Bil to HKD940Bil. while it may be normal for adjustment of currency swap due to business fluctuation. This is a staggering increase of close to 100%! I am pretty sure this is not a Hong Kong initiative since the government has just changed hands.

Table 2. China Monetary Status

Fig 2. China Forex Reserve Status

The information above is obtained from China Foreign Exchange Reserves - June 2022 Data - 1980-2021 Historical (tradingeconomics.com).

Like HKD, CNY is also pegged to USD with a narrow range of fluctuation, it is ranked 8th in trading currency due to the internationalization of the currency. Their forex reserve is in fact around 6 times that of Hong Kong. 

The only problem is that unlike Hong Kong's reserve which has just fell off their peak, China lost close to 25% of their reserve since 2014, of reason I do not know. Worse still, China has not been able to recover this gap since. Would it be because of the One-Road-One Belt initiative launched in 2013 leading to the need of spending USD?

If charting can be used on this graph, I would say that it does not look good on this reserve as it is only halfway down and has just start its second part of its journey.

There is another concern. This has to do with the personality of Chinese Communist Party with low self- esteem leading to the need to a huge ego. As such failure within the party is certainly disallowed and it has to look good externally, therefore it is crucial the number only reflect a glorious result of its leadership. 

 I tend not to trust its numbers, instead depends more on its action to determine its status.

So why the swap? I am really not sure, I have some theories myself but they are all speculation:

1) China need USD:

This was my first speculation since the only value of HKD is its USD reserve. What happened in recent years including the trade war, Covid-19 lock downs and the failure of One-Road-One-Belt is depleting China coffer and China in need of USD.

It is also known that the China economy is certainly not doing well for years with market stagnation. In recent years cracks started to show with Evergrande failure to repay its debt. Other developers have recently started to follow the same path leading to revelation of abandoned projects.

This development caused a monetary vacuum in China banks. With most of the money are transferred to housing developers (under the instruction of the local governments), banks have no money to give the people when they attempt to withdraw their money.

While the table on the money supply looks rosy, what happening in China now seems to show otherwise, it seems to in desperate need of monetary injection.

Nevertheless, even when the numbers from China may not be that trustworthy, there should still be sizeable reserve for forex, the reserve from Hong Kong will not help much due to the huge size difference. 

2) A mean to prevent currency attack:

We saw Soros and hedge funds speculate attack in 1997 caused the Asian Currency crisis. They focused their attack on Hong Kong with attempt to unpeg the HKD, they failed. 

HKD is again at its weakest point in recent months and Kyle Bass' opinion is not without justification. The swap may be a mean to defend the HKD.

While there maintain a threat of speculative attack, it may not result in the unpegging of HKD, these funds may not have sufficient ammunition to do so, unless the depreciation is of the will of the market and they are just joining in for the ride. 

3) Increase China's influence on Hong Kong:

It is a known fact that China is with intention to assimilate Hong Kong for years. They have been systematic depriving Hong Kong of its own identity, attempting to merge Hong Kong and Macao (another foreign colony returned to China in the 90s) to be part of a newly defined Greater Bay Area. 

People of whole of China can identify the city they come from, except Hong Kongers, any attempt to do so will be criticized and silenced, they can only claim that they are from China.

Removal of HKD is certainly an important step to further assimilation. Increase in CNY supply in Hong Kong can further normalize the use of this currency in Hong Kong. It is certainly not logical to have 2 different currencies when Hong Kong become part of China.

In his interview, Simon Lee mentioned that one possibility is to make CNY and HKD interchangeable, this seems to show similarity with this hypothesis, except that he fell short of the next phase, which is to make HKD irrelevant.

For the time being, based on my understanding of China, I believe control is their priority. As such (3) may be the most viable choice. 

Anyway, enough of the fundamentals, there are more than enough complexities that burn my brain cells. Let's look at what the HKD chart is showing.

Fig3. HKD Weekly Chart

I have retrieved the chart from https://finance.yahoo.com, my trading platform does not include HKD as a trading currency.

The first look on HKD shows a cyclical pattern with HKD fluctuates within a band since 2009, but instead of   HKD7.80, its upper range is around HKD7.855. The last attempt to test its limit happened in 2018, which since retreated.

HKD re-initiated its fall since beginning of 2021 and accelerated by beginning of 2022, only coming to a pause by May 2022. It went side way since then, supported by its 8-week moving average. The recent congestion while small does seem to be forming an ascending triangle. 

What does this mean to me? 

First, the steep climb in 2021 indicates momentum in direction of a weaker HKD. After stopping at HKD7.85, it stopped short of a correction, instead, going side way. As such, it is possible for HKD to be weakened further. 

I am speaking in terms of technical analysis ignoring the possibility of government intervention. Using Bollinger band as a reference, I would see the next resistance level be at HKD7.8613.  If I am to use Fibonacci projection and expansion, I am seeing a ressistance at HKD7.90. Are these levels possible, in view that there is a possible intervention at this limit?

The historical low of HKD is HKD7.8627, dated February 2006. At this moment, I am not seeing reversal and that all moving averages are in alignment in their direction. We might not see the end of HKD downward spiral.

Fig 4. HSI Monthly Chart (from Https://financial.yaoo.com)

Hong Kong has withstood a round of speculative attack from Goerge Soros in 1997. However, based on the yearly chart in Fig 4, it followed by the beginning of its economical decline. 1998 was a terrible year for all of us who been through that period of time.

The difference now is that Hong Kong was at market top at the time. It is on a down slide at the present moment. Furthermore, the erosion of the forex reserve is not due to speculation attacks but withdrawal of foreign investments. These are people who deposit HKD earlier on and now making their withdrawals. They do not need to borrow HKD to short, therefore interest rate increase will not help the exodus of USD. Moreover, it will further burden the failing property market which depends a lot on low interest rate. 

At this point, I can't help but to think, is maintain the exchange rate of HKD that important as this time?

Hong Kong has failing economy, with business heavily disrupted by the Covid-19 policies. It is the very factor driving investment away. What Hong Kong need to do is to re-open the city and devalue its currency. Holding on to a strong currency to me will do more harm than good to the city. 

Yet, after the disastrous leadership of Carrie Lam, not only that situation not improved with the new Chief Executive Officer who carried on with propaganda policies to silence and suppressed descendants, turning Hong Kong into a police state.

So far, there has been no visible action by the new administration to stimulate the economy, instead we witness appointment of officials through relationship instead of capability, maintaining focus on carrying out orders laid down by the Chinese Communist Party to turn Hoong Kong red.

In conclusion, will any attack on Hong Kong currency lead to unpeg of HKD? It will not, it may however cause a spike due to a reactive behavior. The decision to unpeg can only be made by the government itself, by itself, I am referring to China. If it considers the process of assimilation of highest priority, then we will see the unpegging process realized much sooner.