The Perils of Yuan Parity

When I was living in Hong Kong, the Chinese currency was treated almost like Monopoly money. Stores usually didn’t accept it for purchases (and in any case there were relatively few Chinese visitors).

If you went across the border to Shenzhen and paid for something in Hong Kong dollars, you often paid a premium. It was assumed that by the mere fact of holding Hong Kong money you could afford to pay more.

Renminbi (literally “people’s money”), also known as yuan, was for peasants.

So it must have been something of a blow to the Hong Kong escutcheon when, in late November, the yuan achieved parity with the Hong Kong dollar. On Nov 27 the yuan traded at 7.84 to the US dollar, virtually the same as the Hong Kong dollar.

For ten years the yuan was also pegged to the greenback at an official rate of 8.24. Then on July 21, 2005, Beijing re-linked the currency to a basket of currencies and allowed it to rise slowly. Since then it has appreciated by about 5%.

Beijing, of course, has been under a lot of pressure to revalue the yuan much higher. US Secretary of the Treasury Henry M Paulson and Federal Reserve Chairman Ben Bernake will undoubtedly make this pitch again when they visit Beijing next week.

The yuan has been steadily appreciating in value for the past several weeks, possibly in anticipation of the Paulson visit.

The Hong Kong dollar has been pegged to the greenback since 1983, yet one seldom hears complaints about the territory manipulating the currency to boost cheap exports. But then Hong Kong ceased to be a manufacturing center long ago.

China’s economy is growing considerably faster than Hong Kong’s, the latter being a well developed and mature economy, so it is a given that the renminbi will soon rise in value above the territory’s currency.

So Hong Kong faces the prospect of hordes of Chinese visitors, people that Hong Kongers used to look down on as country bumbkins, flooding the territory flashing their stronger currency around the stores.

Well, there are worst prospects. And while some Hong Kong imports, such as food stuffs, may become more expensive, more Chinese tourists will be happy to patronize the territory’s many malls and fashion boutiques.

Chinese visitors to the territory have increased astronomically since the handover to China in 1997 and especially since Beijing relaxed regulations and permitted Chinese to visit as individuals and not just in tour groups.

The question that naturally arises is whether Hong Kong should abandon its traditional peg to the US dollar and re-link it to the Chinese renminbi. This makes a certain amount of sense. After all, they are part of the same country.

The economies of Hong Kong have also become greatly intertwined in recent years, as Hong Kong people moved their factories across the border but kept their headquarters in Hong Kong.

There are, of course, many technical reasons for keeping the US dollar peg intact. The yuan, despite its recent strength, is still not fully convertible and thus it cannot meet Hong Kong’s foreign reserve requirements.

In any case, the “peg” is almost sacrosanct in Hong Kong. It has survived numerous shocks, ranging from the Black Monday stock market crash of 1987, the run on major banks in 1991 to the Asian financial crisis of 1997.

So any re-pegging is unlikely in the near future. Such a drastic step would call for some compelling real-world crisis, and there is none on the horizon. Hong Kong people will just have to get over the idea that they are somehow losing out.