Hong Kong’s Economy Is Going Strong

Doubters raise concerns about debt levels, but the currency board has imposed financial discipline.

June 24, 2019 • Commentary
By John Greenwood and Steve H. Hanke
This article appeared on The Wall Street Journal (Online) on June 24, 2019 .

The recent mass protests in Hong Kong have fanned the flames of speculation against the Hong Kong dollar. In recent months, doubters have warned of a looming crisis, comparing Hong Kong with Ireland and Spain. They have even questioned whether its independent currency would survive. The alarm has been bolstered by a stream of baseless claims about Hong Kong’s economy, its banking system, and its currency board.

Let’s first look at the myths about Hong Kong’s economy. The bears assert that Hong Kong’s economy is the most leveraged in the world. This is simply not true. The leverage of its household, corporate and banking sectors have been reined in since 2009, when the Hong Kong Monetary Authority imposed the first of eight major macroprudential measures. The loan‐​to‐​value limits on lending for housing and commercial mortgages have progressively tightened. Purchases of property require a down payment of 40% in cash, with leverage limited to 60% of the property’s value.

For households, debt‐​to‐​GDP in Hong Kong stood at 72.2% at the end of last year. This is below the 76.3% figure for the U.S. And for context, these leverage levels are well below the U.S. peak of 98.6% in 2007.

Nonfinancial corporations in Hong Kong registered a debt‐​to‐​equity ratio of 37.2% at the end of last year. This is way below the comparable 259.9% leverage ratio for the S&P 500 nonfinancial corporations in the U.S.

When it comes to banks, the accepted and proper way to measure leverage is with capital ratios. Since the Banking Ordinance of 1986, Hong Kong’s banks have been required to maintain high ratios. Accordingly, Hong Kong’s banks met the international Basel III financial‐​stress standards long before they are due to take effect in 2022. The capitalization of Hong Kong banks is well above the minimum international standards, with the consolidated capital ratio of locally incorporated banks standing at 20.3% at the end of last year. This is almost double the U.S. capital ratio of 11.3%.

Despite all this, speculative bears continue to claim that excessive debt has left Hong Kong vulnerable to disturbances, such as the recent outcry against the extradition bill. They assert that capital outflows will force the HKMA to use up its reserves. When that occurs, they say, the peg to the U.S. dollar will break, and the Hong Kong dollar will sink like a stone.

Many speculators claim the day of reckoning is right around the corner because, as they see it, the HKMA has blown through a large share of its reserves in the past year. Yet, the actual decline has been in the reserves of banks held at the HKMA that appear on the HKMA’s balance sheet as liabilities, not as the currency board’s foreign assets. The rundown of banks’ excess reserves was appropriate and desirable as the interest rates in Hong Kong dollars, known as Hibor, had been consistently below comparable U.S.-dollar rates, or Libor.

The HKMA’s assets, mostly foreign‐​exchange reserves, totaled $438 billion in May 2019 and have barely declined from their peak of $442 billion in January 2018. Under the Exchange Fund Ordinance, the regulation that provides the currency board’s mandate, all HKMA assets, including accumulated fiscal reserves and surpluses, are available to support the exchange rate.

In practice, these assets will never be required in any significant quantity in normal times. That is because as people exchange Hong Kong dollars for U.S. dollars and the HKMA’s foreign reserves decrease, interest rates in Hong Kong will rise, putting the brakes on funds flowing out of the HKMA. Currency boards operate on autopilot and exchange only domestic currency, which is fully backed by foreign anchor‐​currency reserves, for their anchor currency at a fixed rate.

A properly constituted currency board always has adequate reserves. No currency board has ever been broken. Even the North Russian currency board, which was designed by John Maynard Keynes and operated during the Russian Civil War, never faltered. It redeemed all of the obligations presented to it before closing in 1920.

Since it first pegged its dollar in 1983, Hong Kong has embraced currency‐​board orthodoxy. This can be difficult to see because the HKMA performs many functions that go beyond its narrow currency‐​board responsibilities. For example, the HKMA provides clearing services to Hong Kong’s banking system. It also acts as the government’s banker and holds its fiscal reserves. During the Asian financial crisis in 1998, the HKMA used those reserves to intervene in the stock market on a massive scale.

To appreciate the HKMA’s currency‐​board orthodoxy, investors should inspect its balance sheet and focus on its segregated currency‐​board account. Its currency‐​board operations remain passive and automatic. They reveal why speculative attacks on the Hong Kong currency board have been and always will be futile.

About the Authors
Mr. Greenwood is chief economist at Invesco in London. Mr. Hanke is a professor of applied economics at Johns Hopkins.