Having failed to preside over a collapse in the yuan, hedge-fund manager Kyle Bass has a new target: the Hong Kong dollar peg. He’s wrong about that, too.
Bass is shorting the Hong Kong currency and is “very long dollars,” the founder of Hayman Capital Management told Bloomberg TV in an interview Tuesday. The Hong Kong Monetary Authority has spent 80% of its reserves over the past year defending the peg, he said in an investor letter on the city’s “impending crisis.” That prompted a riposte from the de facto central bank, which said his analysis was based on a misunderstanding.
“Once depleted, the pressure on the currency board will become untenable and the peg will break,” Bass wrote in the letter, reproduced on the Zerohedge website.
Well, not quite. What Bass calls excess reserves is better known in Hong Kong as the aggregate balance. This can go to zero and stay there for years without the peg breaking. It is, in fact, how the currency board mechanism works.
Hong Kong fixed the value of its currency at 7.8 to the dollar in 1983 and has kept the system, with some minor adjustments, ever since. As the HKMA gently explains to Bass, when the aggregate balance shrinks, then local interest rates rise. Higher rates reduce the incentive for investors to sell the Hong Kong dollar. Bass’s breathless analysis points to the “staggering” 80-basis-point gap between Hong Kong’s interbank rate U.S. Libor and concludes that investors will switch into the higher-yielding currency. This is exactly what is supposed to happen.
If anything, the aggregate balance is still too big. Hibor has been subdued because banks kept on depositing cash with the HKMA, even at zero interest. As Bass correctly observes, Hong Kong benefited hugely over the past decade from inflows triggered by the Federal Reserve’s quantitative easing and the city’s proximity to China’s credit boom. The aggregate balance is still higher than before the Lehman bust and needs to fall further so that Hibor can rise.
The hedge fund manager is on firmer ground when he says that Hong Kong rates will spike if the aggregate balance goes to zero. More questionably, he goes on to say that this could cause the banking system to collapse, prompting a Chinese government bailout that may leave foreign depositors of overseas-based institutions such as HSBC Holdings Plc and Standard Chartered Plc in the cold.
Well, probably not. Hong Kong banks still have plenty of money sitting idle. The loan-to-deposit ratio, while on the rise, stands at 87.8%. Even if Hong Kong dollar liquidity gets tight, the monetary authority can simply stop rolling over its issuance of Exchange Fund bills. It’s amassed a stockpile of more than HKD1 trillion ($127 billion), over five times as much as in the pre-Lehman days.
There are plenty of other objections to Bass’s analysis, which market participants have been quick to leap on. He’s right about some things, though. Banking systems that became overly large relative to the size of the local economy were crisis markers for Iceland and Cyprus. Hong Kong’s total banking assets have ballooned to 850% of GDP, from about 460% at the end of 2002.
More importantly, there’s the threat that the U.S. could stop treating Hong Kong as a separate customs territory because of the erosion of the city’s autonomy by China – a risk heightened by the government’s attempt to push through a controversial bill that would allow fugitives to be extradited to the mainland. That’s an Armageddon prospect for Hong Kong, though remains a low-probability event.
But what’s most striking about Bass’s doomsday warning is the lack of historical awareness. After dubiously asserting that the Hong Kong handover triggered the Asian financial crisis, he notes that overnight rates jumped to 20% (one-month Hibor reached 27% at its peak in 1997) and real estate prices tumbled about 70 percent. Yet not a single bank went under. And the peg held.
To bolster his case, Bass invokes… Argentina, whose currency board collapsed in the early 2000s. Argentina? The South American country has been defaulting on its international obligations since the 19th century. Hong Kong, with its serial budget surpluses, has no such problems with its fiscal image. We can almost hear the guffaws from Hong Kong foreign-exchange trading floors.
Those who cannot learn from history are doomed to repeat it, as the philosopher George Santayana is reputed to have said. If Bass wants to brush up on the history of bets against the Hong Kong dollar peg, he could consult Bill Ackman. Shuli Ren & Matthew Brooker, Bloomberg