The signs are there — an A-share market meltdown, a sharp renminbi devaluation, turmoil in the Hong Kong stock market and a falling Hong Kong dollar.
So, are we seeing a replay of the 1997-1998 Asian financial crisis?
Probably not, but there’s too much coincidence to let this pass without comment.
That reminds us of a time in 1997 — in fact the second day after the handover of Hong Kong to China — when Thailand depegged its currency from the US dollar, triggering a financial tsunami that would sweep through Southeast Asia.
Speculators took short positions on the Hong Kong dollar, betting on an impending divorce from the greenback, amid a round of competitive devaluations in other regional currencies.
The theory was that the Hong Kong government would raise interest rates to prevent any capital outflow.
But the increase in capital cost could sink the stock market and drag on the economy, so speculators shifted to shorting stock futures.
The thinking was that if the government devalued the Hong Kong dollar, the punters would win on the foreign exchange gain.
Or if the government defended the exchange rate, higher interest rates could lead to a rout in property stocks and the wider equity market.
Between the Hong Kong dollar and the stock market, the government chose to sacrifice the latter.
In the years after the financial crisis, Hong Kong entered a period of deflation.
The stage was set in the early 1990s when continuous capital inflow pushed up foreign exchange rates across the region and drove up home prices.
People who got carried away by the sudden burst of prosperity forgot that it was built on sand.
International speculators accelerated the speed of the market collapse.
Today, the Chinese economy is no longer the powerhouse it used to be. That’s one less excuse for investors to park their money in it.
Money is flowing to the United States after it raised interest for the first time in eight years.
Meanwhile, the Hong Kong dollar has fallen to 7.83 from 7.75 against the greenback, marking the end of one-way inflows.
That followed a rally which saw the local unit gain 25 percent in the past 18 months.
Still, some continue to think deflation will be limited to the mainland and affect only Chinese companies.
However, the renminbi devaluation in August created conditions that made imported deflation a possibility in Hong Kong.
That has adverse implications for Hong Kong corporate earnings.
If that grim prospect undermines household income, will property counters, let alone the stock market, remain attractive?
The rapid growth of the mainland economy flooded Hong Kong with a lot of liquidity, bringing the stock market a lot of really good days.
The renminbi is not the target of international speculators who know that China can fight back with an enormous war chest backed by US$3.3 trillion in foreign exchange reserves.
The Hong Kong dollar is.
The Hong Kong government holds nearly US$360 billion in foreign exchange reserves and is determined to defend the Hong Kong dollar peg to the greenback.
It’s unlikely the Hong Kong dollar will depreciate but investors know the stock market will continue to experience some big shocks.
Economic and political risks are likely to increase if oil prices continue to fall.
If prices fall below US$20, oil producers and new energy firms could go bankrupt.
Central banks in China and the US will step back from any more market intervention.
If the Hong Kong dollar comes under speculative attack, all we have to rely on is the wisdom and capability of our financial officials.
This article appeared in the Hong Kong Economic Journal on Jan. 22.
[Chinese version 中文版]
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