Sunday, September 21, 2008

The Hong Kong Precedent

The unprecedented plan by Secretary of the Treasury Henry Paulson to intervene in the U.S. financial markets to buy up bad mortgages and other depressed holdings of America’s major financial institutions, brings to mind another famous intervention almost exactly ten years ago.

For two weeks in August, 1998, Hong Kong stunned the world by a massive intervention in the stock market. In the space of those fourteen days, the Hong Kong government spent $15 billion buying up stocks on the Hong Kong stock exchange, becoming in the words of one analyst, “the world’s biggest punter.”

The decision by the then finance secretary (now chief executive) Donald Tsang came against the backdrop of the Asian financial crisis that had broken out a year before and against an extremely weak property market in Hong Kong that had seen home values plummeting.

However, the precise circumstances that triggered the intervention were different from the U.S. A “cabal”, to use the government’s phrase, of international hedge funds was determined to exploit the peculiar synergies between the stock exchange and the mechanism for maintaining the Hong Kong dollar peg to the US dollar to make big profits.

Called the “double market play,” it involved dumping large quantities of the Hong Kong dollar, driving up interbank interest rates and depressing the stock market. Then the speculators profited on the declining stock market by selling stocks short.

The plan was perfect except that they made one miscalculation. They assumed that the Hong Kong government would sit quietly by and let the market take its course. In a sense they had swallowed perhaps too deeply the hype about Hong Kong’s unfailing dedication to the unfettered free market.

Tsang’s decision to intervene massively thus shocked everybody. Within two weeks the Hong Kong government had spent about $15 billion and owned about 15 percent of the publicly traded shares. This figure would be in the trillions of dollars in the US considering that Hong Kong has a GDP of about $50 billion and the US $13 trillion.

Many were aghast and condemned the intervention as an outrageous violation of free-market principles. The late Milton Friedman, who has long praised Hong Kong as the model for free markets, called the intervention “insane.” The government claimed that speculators constituted a conspiracy against the Hong Kong economy and said the move was necessary to “protect the broader financial structure” a phrase that sounds familiar these days.

After draining the reserves of about $15 billion, the government’s buying spree came to an end, but it succeeded in blocking the speculators. The Hong Kong dollar peg held, and the market over time regained its strength as the value of individual stocks, including those held by the government, rose.

There may be one major difference between Hong Kong then and the USA now, however. The assets that the government bought were basically strong. For a while it was the largest stock holder in the Hong Kong & Shanghai Banking Corp, the territory’s largest bank. Later the government sold off its large stock holdings at a profit.


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