YES, WE KNOW !
THIS IS THE MOST OUT-OF-THE-BOX CALL THAT YOU WILL HEAR IN THE FINANCIAL MARKETS TODAY AND WE ARE PROBABLY THE ONLY STRATEGISTS TO MAKE SUCH A CALL …
PARTICULARLY AT A TIME WHERE US PRESIDENT JOE BIDEN IS WARNING CORPORATIONS ABOUT DOING BUSINESS IN HONG KONG.
2020, the year of the Political Integration
The past two years have been dramatic years for the Hong-Kong Special Administrative Region, with social unrests, a severe economic downturn, and a staunch political clampdown by China in 2020, leading to the resignation of the opposition lawmakers from the legislative council, and close to 1 million Hong-Kongers choosing to emigrate to more palatable jurisdictions for their taste.
All this is leaving a sour taste in the collective mind of people in the West and certainly with the youth of Hong Kong and there has been significant calls for condemning China and imposing sanctions as Donald Trump did in 2020.
However, one needs to understand what is happening before making short-term judgements and what is taking currently taking place will probably open a new era of prosperity for Hong Kong
We have been going to Hong Kong since 1987 and to China since 1989 and, as the only non-Chinese individual to have been a CEO of a Chinese State-owned bank, we have been well acquainted with China, its political system, its philosophy and its governance.
Let’s have a rational and not irrational analysis of the Chinese – Hong Kong situation and state a few facts.
HongKong has never been a Sovereign Nation
Clearly, China’s 2020 political clamp down on Hong Kong has triggered a lot of criticism from the West and calls for democracy in Hong Kong, but the truth is that Hong Kong has never been independent or Sovereign, it is an integral part of China
Prior to the 1997 handover and under the 150 years rule of Britain over Hong Kong, the territory was NOT and has never been a sovereign Nation.
It was ruled by Britain as a Governorate and its Legislative Council only had advisory functions. Hong Kong citizens did not have the same rights as the British citizen residents in Hong Kong and were never represented in the British Parliament.
The sovereignty of the territory as a nation or of its citizen as a people was never recognised by the United Kingdom or any international organisation. Hong Kong is not a member of the United Nation, of any International Treaty or even of any Trade Agreement.
Hong Kongers never had a Hong Kong passport, but a British passport with no right of abode in the UK.
Since the June 30 1997 handover, that we actually witnessed personally there, the sovereignty over the territory was transferred from the United Kingdom to the People’s Republic of China and the territory took the official denomination of Special Administrative Region as an integral part of China, in accordance with the Basic Law of the Hong Kong Special Administrative Region, a Chinese Law.
In the One country-Two systems organisation, exactly the same powers were maintained by China who replaced Britain as the ultimate policy decision-maker.
Hong Kong’s sovereignty has never been recognized and there is no democratic constitution giving or recognising any Sovereignty to its People.
The Constitutional rule of Hong Kong is China’s Basic Law of the Hong Kong Special Administrative Region which allows a certain level of autonomy in the governance of the internal affairs of the territory.
The Government of the Hong Kong Special Administrative Region , commonly known as the Hong Kong Government or HKSAR Government, was formed in July 1997 in accordance with the Sino-British Joint Declaration of 1983, an international treaty lodged at the United Nations and replaced the former British Hong Kong Government (1842–1997).
The Basic Law designates a system of governance led by a Chief Executive and an Executive Council, with a two-tiered system of semi-representative government and an independent judiciary
The Chief Executive is the head of the Region and he heads the government of Hong Kong.
The Chief Executive is elected by an Election Committee, a 1200-member electoral college consisting of individuals and bodies themselves designated and not elected.
The Legislative Council kept its advisory role and decisions are made by the Government of Hong Kong under the supervision and approval of Beijing as was the case with Britain before the handover.
Hong Kongers are issued a Hong Kong Special Administrative Region passport issued to permanent residents of Hong Kong who also hold Chinese citizenship. Since the transfer of sovereignty on 1 July 1997, the passport isissued by the Immigration Department of the Government of Hong Kong under the authorisation of the Central People’s Government of the People’s Republic of China.
As the official languages of Hong Kong are Chinese and English, the passport is printed bilingually in both Chinese and in English.
When looking at it from the Chinese side, Hong Kong is an integral part of China and its citizens are Chinese.
When looking at it from the International Law’s perspective, Hong Kong is ALSO an integral part of China and its citizens are Chinese citizens as well.
But as a Special Administrative Region of the People’s Republic of China, it benefitted from an extended autonomy and continues to applies British Common Law for a transitory period that is determined in the basic Law.
It has its own currency and its own Monetary Authority and the Hong Kong Dollar has been pegged to the US dollar since 1983.
For decades, it has been in the best interest of China to maintain the one-country-two systems formula. Hong Kong has been the primary gateway for China’s good to the rest of the world in the 1980’s and 1990’s and the main Chinese financial hub until the development of the Chinese domestic capital markets in the 2000s and 2010s.
Over the past four decades, the size of the Hong Kong Economy has been dwarfed by the phenomenal growth of mainland China and the weight of the economic exchanges between Hong Kong and China has become predominant, slowly but surely replacing Hong Kong’s international trade and business.
Two Factors made the situation evolve in recent years
1. America’s increasing fear of the rise of China – The Theucydides Trap
As we highlighted in our strategic paper titled THEUCYDIDES TRAP in December 2019, and contrary to the general feeling in the West, up until the election of Donald Trump as US President in 2016, China’s international and growth strategy was one of collaboration and exchange with the West and the rest of the world.
For millenias – 5000 years in fact – the Middle Kingdom has always been polarised by its own well-being and security and has resisted and avoided the temptations of conquest, despite their superior technologies, economic might and political might.
Chinese sailors probably discovered most of the world centuries before Vasco de Gama, Magellan and Christopher Columbus and the travels of Marco Polo to China between 1271 and 1295 are here to testify of the economic and technological prowesses of China then.
China is rightly convinced that the 21st Century will see its economic might surpass the might of America. Its economic growth rate, rapid increase in GDP per capita and exploding consumer market will make it overtake the USA in nominal GDP by 2028, according to the latest IMF projections. In Purchasing Power Parity Terms, China’s economy is already larger than the the US at US$38 Trillion equivalent
China’s phenomenal economic, social, technical, and educational successes in the 45 years since 1978 also convinced the Chinese leadership that their Governance system was superior to the Western democracies political organisation.
And frankly, looking at all the factors of development, there is no doubt that their political system has been extremely efficient.
The most striking illustration of that efficiency is the widening gap between India’s democracy and Communist China when measured in terms of living standards, infrastructure, GDP growth, fixed capital formation, education and poverty.
These are facts and data series and they are not contestable.
What the West contests is “Political Freedom” in the western sense of the concept. “Democracy” as we know it in the West was born in 1776 in America as a reaction to the old monarchist system and the perceived tyranny of the King of England.
“We the People” put the citizens at the center and at the helm, designating its leaders, and changing them regularly through general elections. Freedom of speech, of criticism, of involvement into politics are all at the center and were put to paper in the 1789 Declaration of the Rights of the Man and of the Citizen, followed by the Declaration of Human rights in 1948.
But what made the success of the Western Democracies is not their political model, but their model of private Governance which created massive wealth by giving individuals the freedom to invest and enrich themselves. And that model started in 1600, way before the American or French revolutions and was actually at the core of the might of the British Empire in the 19th century.
Today, there are many countries around the world that are actually proving that “non-democratic” systems – i.e. leaders are not elected by the citizens but by qualified people – are extremely successful in terms of human, social and economic development, including individual happiness.
Dubai and the UAE for one are a striking example. People living in the UAE are free, happy and thrive, even if they are not allowed to get involved into politics, and even less on the public scene or through social medias. Does that make them less happy ? Not sure …
We have highlighted many times that the Chinese Model of Governance is actually modelled on the Western Private Governance system and not on the Western Public Governance system, and the Western Democracies are living in a schizophrenic state of affairs where their success comes from a Private Governance system where the CEO of companies are NOT elected by their Clients – the People – but by shareholders, Boards of Directors and a raft of extremely experienced people, as is the case with China’s Communist Party running the affairs of the country and designating its executive.
Governing is about long term planning and implementing strategies, as is the case with private corporations. No one would invest in apple if Tim Cook had to be elected by all the owners of iPhones every four years.
Most Western democracies are prejudiced by the lack of efficiency and short termism induced by their electoral system and constant change of elected leaders.
In China, as in Dubai, Politics is left to professionals and citizens are free to do what they want, within the limits of the Law, save for getting involved in politics or criticising the powers on the public place.
Ever since the historic trip of Richard Nixon to China in 1972, and particularly after Deng Xiao Ping took over in 1978, China has been thriving WITH the West and not AGAINST the West.
Indeed, it abandoned communism as an economic system, encouraged free-enterprise, reformed its legal and administrative systems, modelled its corporations on the Western system, gave its citizens the freedom to invest and work to get rich, imported and developed its own technologies – legally or not – while becoming the world’s largest manufacturing center thanks to its vast and hard working population.
Hong Kong was central in this entire phenomenon and China succeeded at changing its own eco-system by creating a Special economic zone in ShenZhen, the province adjacent to Hong Kong, modelled on the Hong Kong system, a politically Communist version of the Western capitalist economic system. And then, it extended it to the entirety of China.
The Hong Kong handover in 1997 accelerated the phenomenon and China’s admission to the WTO in 2001 crowned the efforts of the past decades by making China part of the global club of free trade and exchange.
Up until very recently, globalisation and the concept of “Chimerica” – a China-America partnership – were the key tenets of China’s growth and development.
But when Donald Trump was elected, the attitude of America – and the West at large – vis a vis China changed considerably. Granted, tensions had been building beforehand on issues such intellectual property, control of the populations, the Uigur’s issue but the main issue of contempt has been the phenomenal rise of economic might.
China has become a threat in the eyes of the West, despite all its efforts to open its own markets, adapt its legislations, reform its judiciary and Civil Codes, recognise property rights and allow foreign corporations to fully own their Chinese subsidiaries.
Fear took over and it is striking how quickly the anti-Chinese and anti-Asian sentiment has developed in America in the past few years. I myself was shocked when spending time at Harvard with the top brass of the US administration to see how fearful, critical and sometime ill-informed my colleagues were.
The recent report about the World in 2040, just published by the CIA’s National Intelligence Committee is striking. It is all about the fear of China and of its system considered and expected to be doomed. They could end-up being surprised.
To be honest, it is also the most pessimistic global report of that nature I have ever read, and it leaves the feeling that it is more a reflection of America’s own problems than the actual problems of the world at large.
Aggressiveness had become the name of the game . Donald Trump engaged in an ill-conceived Trade War with tariffs and sanctions in 2018. Donald Trump was advised by Peter Navarro, a self-proclaimed specialist of China who wrote a book titled “Death by China” without having ever set foot in China before 2018…
HuaWei was attacked in 2018 for its potential data collection capabilities, the US forgetting quickly the amount of data collected by its own companies and freely transmitted to the US intelligence services, let alone the listening capabilities of the NSA.
Many other corporations were targeted, ByteDance had to envisage selling its Tik Tok business in the US, Chinese companies were banned from listing in the US or threatened to be delisted, US Corporations were asked to stop importing or manufacturing in China, etc. etc.
Access to key technologies was banned particularly in the field of semi-conductors and chips, despite the extreme reliance of US corporations on China manufacturing capabilities and the strategic importance for these corporations to access the Chinese massive consumer market.
The deterioration in the US-Chinese relationship under the Trump era has no equivalent in history… And the US news networks and social media inflamed the anti-Chinese and Anti- Asian sentiment there..
The obvious and predictable consequence is that China realised that it could no longer rely on an integrated world anymore and decided to go its own way, putting technological, economical and financial independence as strategic objectives.
Very few people in the West realise how the global sentiment of the Chinese vis a vis the West has changed over that period of time. From having an admiration for the West and America in particular, sending their kids to University there and cherishing the American Way of Life, the Chinese suddenly felt unjustly attacked and a Chinese Nationalistic sentiment took off in a widespread manner.
All along the Trade War, Xi Jing Ping kept a muted response, always opening the door and refusing to retaliate tit for tat. His speeches were all about fair cooperation and competition and wishing the world would avoid the proverbial Thucydides trap whereby competition between the rising power and the existing power would lead to major wars such as the first World War.
Up to this day, there are no examples of China imposing sanctions on American corporations, targeting any of them or preventing them from operating within China…
But Xi Jing Ping also asserted his own principles in terms of its zone of influence, sovereignty, and National interests, pushing against the aggressiveness of America.
In his recent address on the occasion of the 100 year celebration of the Chinese Communist Party, Xi Jing Ping warned the world that anyone attacking China would be broken against a Chinese Wall of Steel and flesh…
These comments have been taken as extremely aggressive by Western commentators, reminiscent of the Cold War between the US and the Soviet Empire, but the use of the term “Chinese Wall” says it all.
Already 280 years before Christ, China built the only earth structure visible by human eyes from space to “protect” itself, not to attack…. Walls are immovable by nature, they are not expansionistic, they are defensive by nature, and the message of Xi Jing Ping to the world is the following : We have no intention to attack or conquer, but don’t try to attack us or our National interests….
And this is where Hong Kong and Taiwan come into play…
In the Chinese understanding of their own Nation, Hong Kong is an integral part of China and Taiwan is still a secession territory… In exactly the same way Argentina considers the Falkland Islands as part of its Nation, Russia took over Crimea from Ukraine or Japan and Russia are disputing their sovereignty over the Kuril Islands.
The close links of Hong Kong with the UK and the US, the peg of its currency to the US dollar and the influence of the American financial institutions and Social Media in the Special Administrative Region of Hong Kong became a threat rather than the benefit it was in the past..
2. The 2019 Social unrest in Hong Kong
What triggered China’s 2020 clampdown was the 2019 unrest in the streets of Hong Kong, following the implementation of an extradition Law towards China.
The trigger was relatively benign, and took by surprise the Chinese as much as the Hong Kong authorities themselves. What needs to be understood is that from the Chinese point of view, if Hong Kong is an integral part of China and not a sovereign state, the ability of the Government to bring to justice who they deem to be criminal or seditious is a fundamental right. This is why neither the Chinese apparatus nor the Hong Kong Executive Council saw the storm coming.
There is no instance in International Law where the ability of a State to question or judge its own citizens is questioned or limited by foreign countries.
British governors could send any Hong Kong Chinese to Britain for trial on the simple signature of the Governor and no one would have ever questioned those powers then.
Hence the surprise of Beijing when the unrest gained steam and the youth of Hong Kong adopted revolutionary slogans.
Like any Nation, Beijing cannot tolerate insurrection on any part of its territory.
At the beginning, they allowed the Executive Council to deal with the issue, but after many months of unrest and inability to handle the situation they moved in directly.
Spain did not do anything different with the Catalan Separatist movement in 2019, its leaders are now in prison, and no Government in Europe or the US ever thought on imposing sanctions on Spain because of its handling of the Catalan separatist movement.
Today, the leaders of the Hong Kong insurrection are in prison and the “democratic” opposition lawmakers resigned from the Legislative council and are being indicted for inciting the population to break the Basic Laws, encouraging public unrest and calling for insurrections.
Not much different from what happened in the US with the 6th January 2021 insurrection.
The problem in fact is that in the West, when it comes to the One Country – Two Systems issue, The West refuses to think in terms of the ONE COUNTRY element of the equation and focuses on the preservation of the TWO SYSTEMS:
But the transitory nature of the One-Country – Two systems equation is about the Two Systems , not the One Country.
Today, China has realised that it could not let those street movements develop endlessly…. Besides the issue in Hong Kong itself, questioning the Law and Order that prevails all across China is a no go, in exactly the same way Spain cannot accept to have its own constitution questioned.
The need to integrate Hong Kong further has become a priority and working on the understanding by the Hong Kongers that they are NOT an independent Nation, but an integral part of China has become an objective.
From now on, Hong Kong will be more integrated politically into China.
2021, the Year of Economic Integration
The Chinese have their own way of doing things and one of their priorities over the centuries and millenia was to make their people happy as can be, even at the expense of personal freedom of expression.
Over the past 50 years, China could have very well used force to try to re-conquer Taiwan or even impose its rule over Hong Kong. It never did…
Today, it feels the need to integrate Hong Kong politically into the greater China, but it will also integrate it further economically, ensuring that Hong Kongers end up benefitting from the integration and derive benefits from the new eco-system.
What is truly striking today, is that there are not much differences in the day to day life of people in Hong Kong and the day to day life of people in most China’s large cities, save for political aspect of things.
In fact, in many cities of the mainland, people live better than in Hong Kong as real estate, housing and day to day costs of living are lower and value for money better.
ShenZhen – Hong Kong Integration, a strategic priority
On August,18th 2019 China’s State Council officially called for greater development of the southern city of Shenzhen and the integration of its culture and economy with neighboring Hong Kong and Macau
In a landmark speech commemorating the 40th anniversary of the establishment of the Shenzhen special economic zone on October 14th 2020, President Xi Jing Ping made broad statements reiterating China’s commitment to improving the business environment and opening further to foreign enterprises, while indicating how Hong Kong might be integrated more into the mainland.
Shenzhen, the special economic zone is home to technology giants such as Huawei and Tencent. It was the pioneering of the new Communist/ capitalist system of China with business-friendly practices that have now been deployed through most of the country.
In addition to favorable government policies, Shenzhen has benefited from its proximity to local factories and the financial center of Hong Kong. In less than 40 years, Shenzhen has surged into the ranks of the top three Chinese cities by gross domestic product.
By 2018, Shenzhen’s gross domestic product surpassed that of Hong Kong based on the annual average exchange rate, according to official calculations. Shenzhen’s GDP was at 2.422 trillion yuan that year, compared to 2.4 trillion yuan in Hong Kong, state-owned media China Daily reported.
Hong Kong’s economy fell into recession in 2019 amid protests that turned increasingly violent. In the wake of the unrest, Beijing strengthened its control of the region with a new security law that has added to international concerns about the growing power of the central government.
In his landmark October speech, Xi Jinping elevated the role of Shenzhen, giving the city a historic mission to further implement the “one country, two systems” through integrated development with the Hong Kong and Macao special administrative regions.
The Chinese leader said there should be more cooperation within the Greater Bay Area to attract young people from Hong Kong and Macao to the mainland and so “increase their sense of belonging to the motherland.”
Shenzhen’s new role could also help Hong Kong address its social and economic woes following unrests that threatened the city’s stability and further integrate it economically and financially into the mainland, giving a new dimension to the one country-two system formula.
The roles of the two neighboring cities – Shenzhen and Hong Kong – have profoundly changed over the years. Forty years ago, Hong Kong was a window for the Chinese mainland to learn from advanced technologies and modes of production in the Western world. But now, Shenzhen has become a pioneer and by being a forerunner in adopting China’s path to modernity, it has outperformed its tutor.
“The new mission bestowed upon on Shenzhen to allow it to play a bigger role in ‘one country, two systems’ is about expanding the scope of the principle. It means Hong Kong will be further integrated with the mainland through Shenzhen,” Tam Yiu-chung, Hong Kong’s delegate to the National People’s Congress Standing Committee, told the Global Times on Wednesday.
Carrie Lam, chief executive of the Hong Kong SAR, was on stage with her two predecessors Tung Chee-hwa and Leung Chun-ying, when Xi delivered the speech.
This brand-new positioning of Shenzhen gives it a major leading role in the whole Greater bay area with the mission to integrate Hong Kong, and become China’s hub for technology and finance.
ShenZhen Stock Exchange
The ShenZhen stock market was the first mainland bourse and it opened its doors in 1991, way before Shanghai. 2490 companies are listed there in two categories of shares: B-shares and A-shares Its market capitalisation is RMB 37 trillion or US$ 5.7 trillion.
As a matter of comparison, the US Russell 2000 market capitalisation is only 3.5 trillion.
Hong Kong Stock Exchange
The Stock Exchange of Hong Kong is the “Western” world’s largest bourse in terms of market capitalization, surpassing Chicago-based CME. As of the end of 2020, it had 2,538 listed companies with a combined market capitalization of HK$47 trillion or US$ 6 Trillion.
Are listed in Hong Kong domestic Hong Kong companies with 58 of them regrouped ion the Hang Seng Index, and Chinese listed H-shares regrouped in the HSCEI Index.
What is truly striking is the difference in valuation of the domestic shares and the Hong-Kong listed shares, with the HSCEI index being the cheapest of all equity markets traded.
Part of the difference between ShenZhen’s 28x PE and the HSCEI 9.2x PE lies in the fact that the former is mainly high growth technology stocks while the latter is mainly old economy corporations.
However, when comparing apples with apples and the valuatoon of the same companies listed in mainland China and in Hong Kong, A-shares trade at a 40 % premium when compared to the shares of the same company listed in Hong Kong.
The following chart plots the performance of the China CSI300 Index, the ShenZhen Composite Index and the Hong Kong traded HSCEI Index since 2008.
The difference in performance is striking with the ShenZhen Index up +227 %, the CSI 300 up 122 % and the HSCEI up only 29 % in the past 12 years.
Now clearly, both the outperformance and the difference in valuation come from the fact that Shenzhen is composed mainly of growth technology stocks while the Hong Kong HSCEI is far more about old economy stocks.
ShenZhen- Hong Kong Connect
The Shenzhen-Hong Kong Stock Connect program was launched in December 2016. It is another major plan mapped out by the CPC Central Committee and the State Council for the reform and opening up of China’s capital market, marking Chinese capital market a sound step towards internationalization and market-oriented development.
The launch of Shenzhen-Hong Kong Stock Connect program was destined to increase the scale of mutual market access between the Mainland and Hong Kong.
The eligible shares for Shenzhen Connect include the constituents of SZSE Component Index and SZSE Small/Mid Cap Innovation Index with a minimum market capitalization of RMB 6 billion, and SZSE-listed A shares of A+H companies, but excluding shares that are put under risk alert, suspended from listing, or in the pre-delisting period.
The latest periodic adjustment review of the relevant indices shows that 881 shares meet the criteria under Article 16 of the Measures, including 267 SZSE Main Board-listed shares, 411 SME Board-listed share and 203 ChiNext-listed shares, of which 17 are A+H shares.
Currently, the above-mentioned A shares have an average market capitalization of RMB 17.4 billion, representing 74 percent of the total market capitalization of Shenzhen market and accounting for 68 percent of the average daily trading value.
The eligible shares of Hong Kong Connect under Shenzhen-Hong Kong Stock Connect include the constituents of Hang Seng Composite LargeCap Index, constituents of Hang Seng Composite MidCap Index, constituents of Hang Seng Composite SmallCap Index with a minimum market capitalization of HKD 5 billion, and SEHK Main Board-listed H shares of A+H companies.
However, the eligible shares of Hong Kong Connect exclude H shares of A+H companies whose A shares are put under risk alert by SZSE, or are suspended from listing by SZSE, or have entered the pre-delisting period or the H shares of A+H companies whose A shares are traded on the Risk Alert Board of SSE, neither.
The latest periodic adjustment review of the relevant indices also shows that there are 416 eligible shares for Hong Kong Connect, including 89 A+H shares. Currently, the above-mentioned shares have an average market capitalization of HKD 47.5 billion, representing 87 percent of the total market capitalization of SEHK-listed shares and accounting for 92 percent of the average daily trading value.
As the above shows, great disparities exist within the Chinese stock markets and listings and the further integration of Hing Kong into mainland China means that ultimately, the disparities between H-shares and A-shares will disappear, and with them the 40 % discount of Hong Kong listed shares.
The recent moves by the Chinese Government to prevent Chinese corporations to list in the US are all about directing them to list in Hong Kong rather than in the US.
A widening of the ShenZhen – Hong Kong connect will also entice Domestic investors to buy H-shares more frequently and arbitrage the two markets.
We expect announcements to take place in the second half of 2021 to that effect.
2022, the Year of Monetary integration
One Country – two Systems, One Country – two currencies
On 17 October 1983, the Hong Kong dollar was officially pegged to the US dollar at a rate of HK$7.8 = US$1.
The peg of Hong Kong dollar to the US dollar took place in the context of Sino-British negotiation regarding the future of Hong Kong after 1997.
Due to the lack of public confidence in the talks, on 24 September 1983, Hong Kong dollar was devalued by 15% over 2 days to a historical low at HK$9.6 to US$1. Public panic set in and there were runs on foodstuff on this Black Saturday (1983).
Amidst the monetary crisis, John Greenwood, an economist who was later dubbed the “architect of the Linked Exchange Rate System” in Hong Kong, advocated the proposal to peg the Hong Kong dollar to the US dollar.
The proposal received support from two government officials within the Monetary Affairs Branch of the Hong Kong Government, namely, the Deputy Secretary for Monetary Affairs Tony Latter and the Government Economist Alan McLean as a practical way to restore confidence in the Hong Kong dollar.
After discussions between London and Hong Kong, the Financial Secretary of Hong Kong Government John Bremridge announced to peg the Hong Kong dollar with the US dollar at a rate of HK$7.8 to US$1 in a currency board fashion on 17 October 1983.
Then, the issue was a purely British issue and a way of dealing with a crisis of confidence. China was still very much viewed as a Communist country and Hong Kong investors were duly worried.
After the 1997 handover, the Basic Law of Hong Kong and the Sino-British Joint Declaration provided that Hong Kong retained full autonomy with respect to currency issuance.
Currency in Hong Kong is issued by the government and three local banks (HSBC, Bank of China and Standard Chartered) under the supervision of the Hong Kong Monetary Authority, which was an semi-independent public body established in the early 1990s to regulate banks and manage exchange funds and serves until now the territory’s de facto “central bank”.
Banknotes are printed by Hong Kong Note Printing Limited. A bank can issue a Hong Kong dollar only if it has the equivalent exchange in US dollars on deposit.
The currency board system ensures that Hong Kong’s entire monetary base is backed with US dollars at the linked exchange rate. The resources for the backing are kept in Hong Kong’s exchange fund, which is among the largest official reserves in the world. Hong Kong also has huge deposits of US dollars, with official foreign currency reserves of US$491 billion at the time of writing.
The Financial Secretary together with the HKMA in the Hong Kong SAR Government are re responsible for the Monetary policy of the Special Administrative Region .
There has been numerous insiders reports acknowledging the heavy and direct influence of the Federal Reserve of the United States on Hong Kong’s monetary policy under the currency peg, but legally and factually, the peg is a pure Hong Kong’s choice and the HKMA does not require any permission from Washington or anyone else to continue or discontinue the peg.
In practice, the exchange rate of HK$7.80 = US$1, is strictly controlled by the Hong Kong Monetary Authority in the foreign exchange market by controlling supply and demand of Hong Kong dollars in order to influence the exchange rate being fixed.
By this arrangement the HKMA guarantees to exchange United States dollar into Hong Kong dollars and vice versa, at the rate of 7.80.
When the market rate is below 7.80, the banks will convert United States dollar for Hong Kong dollars from the HKMA, Hong Kong dollars supply will increase, and the market rate will climb back to 7.80. The same mechanism also works when the market rate is above 7.80, and the banks will convert Hong Kong dollars for United States dollars.
By this arrangement, the Hong Kong dollar is today backed by foreign exchange reserves, that are on average over 7 times the amount of money supplied in circulation.
Renminbi peg debate
Following the Internationalisation of the renminbi, the inclusion of the Renminbi in the special drawing rights, there has been numerous debates to peg the Hong Kong dollar with the Renminbi, instead of the United States dollar.
With the planned political and economic integration of Hong Kong into China, the question of the re-pegging of the Hong Kong Dollar to the RenMinBi is no longer an “If” but a “When “
Technically, at current exchange rates if the Hong Kong dollar were to be re-pegged to the Renminbi, it would need over 3 trillion Renminbi to replace the HKMA’s US$500 billion in foreign reserves.
In fact, China’s Central Bank, the PBOC could very well issue RMB 3 Trillion in exchange for the USD 500 Billion of HK foreign exchange reserves.
When adding together the foreign exchange reserves of Hong Kong ( US$ 500 Billion ) and the foreign exchange reserves of China ( US$ 3.2 trillion), the PBOC has ample, and probably the biggest war chest not only to prevent any devaluation of the HKD, but even force its appreciation towards the USD 6.45 rate of the RMB, a 16 % appreciation from here.
Politically, a successful integration of Hong Kong would lead to a new HKD / RMB peg at 1 for 1, in exactly the same way the British Pound and the Scottish Pound are trading at 1 for 1.
Such a monetary integration would relieve the HK Monetary Authority from having to defend the peg and accumulate foreign exchange reserves, leaving the PBOC to manage the competitiveness of both currencies.
In the current environment of competition between the world two largest economy and with the prospects of China becoming the world’s largest economy by 2028, the issue is becoming a pressing issue.
THIS MAJOR DEVELOPMENT WILL TAKE PLACE IN 2022 IN OUR VIEW, AFTER MORE DEREGULATION OF THE STOCK EXCHANGES HAVE BEEN COMPLETED.
THIS WILL LEAD TO MASSIVE APPRECIATION OF THE HONG KONG LISTED CHINESE SHARES TO WHICH A POTENTIAL ADDITIONAL 16 % CURRENCY APPRECIATION WILL HAPPEN.
Why are we publishing this analysis now ?
Because of the Chart below ….
Since its March peak, the HSCEI Index has retreated to the long term uptrend of a massive consolidation triangle in place since 2005.
This constitutes a massive buying opportunity and we doubt that any further weakness will persist.
The triangle will come to an end in 2023, but we expect the index to break out of it in 2022, unleashing a spectacular secular bull market fueled by arbitrage between A-shares and H-shares and a massive re-rating of the H-shares.
The current level of the index below 10’000 is probably the lowest investors will see for many years.
Positioning themselves now is highly recommended
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