Saturday, June 30, 2012

Does China’s Special Currency Test Zone Signal the End of the Hong Kong- US Dollar Peg?

China’s government plans to open direct lending access between Hong Kong banks and China based companies through a special currency “test” zone

Reports the CNN/Financial Times

China plans to create a special zone to experiment with currency convertibility in Shenzhen, the city where it introduced key economic reforms three decades ago.

The measure will enable Hong Kong banks to lend renminbi directly to companies in Qianhai Bay -- a new economic zone on a peninsula across the water from Hong Kong -- according to Chinese state media.

Bejing will unveil the details on Friday as Hu Jintao, Chinese president, visits Hong Kong for the 15th anniversary of the handover of the city from Britain.

Analysts say the experiment could prove as critical to eventually dismantling capital controls as Deng Xiaoping's reforms were to opening China to the world.

The Qianhai experiment follows a series of steps taken by the Chinese government to move towards making the renminbi a convertible currency that analysts believe could one day vie with the US dollar for pre-eminence in global markets.

Over the past two years, Chinese companies have been allowed to settle most of their international trade in renminbi. This has provided a conduit for the currency to flow abroad for the first time in large volumes.

Foreign institutions have also been given a limited but growing array of investment options for their renminbi holdings, such as Hong Kong's dim sum bond market and a programme for buying Chinese equities.

In addition, the proposed measures includes cross listings of their respective stock exchanges.

Again from the same article,

Separately on Friday, the stock exchanges of Hong Kong, Shanghai and Shenzhen said they would create a joint venture index company to give investors access to companies listed in all three cities for the first time and boost their capital markets.

Charles Li, chief executive of the Hong Kong Exchange, said it would create its first cross-border indices by the end of the year and launch derivative products and exchange traded funds based on the indices and stocks next year.

The thrust to make the yuan convertible has widely been painted as a challenge to the US dollar standard as evidenced by this assertion “could one day vie with the US dollar for pre-eminence in global markets”.

While this is true, I would say that a more important issue could be about the insurance role played by the yuan against the growing risks of a currency crisis.

My suspicions seems to be highlighted by the latest proposal by Prof Joseph Yam, the former head of the Hong Kong Monetary Authority (HKMA) and who is one of the architects of Hong Kong-US dollar peg through a monetary board, to alter Hong Kong’s monetary system by shifting from US dollar peg towards China’s yuan or through a basket of other currencies.

Notes the BBC

When asked why he was making such a dramatic public reversal of opinion, Prof Yam told Hong Kong media it was because times had changed.

The US dollar peg had contributed to inflation and asset bubbles in Hong Kong because of the policy of quantitative easing the US Federal Reserve adopted following the global financial crisis, he said.

This direct Hong Kong-China currency “test” zone seems like an icebreaker to the inevitable end the Hong Kong dollar-US dollar peg.

As I observed in August of 2009

In my view, the Hong Kong dollar's pegged days seems numbered. And so as its existence, as the Yuan could displace it sometime in the near future.

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