Hong Kong carefully built its sterling reputation (pun intended) over many years and decades. Through mostly careful rule and careful adherence to rules, there was no imbalance too big or too tough that the HKMA could not readily handle or absorb. The result was a condition that every central bank and monetary authority should strive for.

As I wrote back in July:

Its solution was simple and orthodox; peg the Hong Kong dollar to the US dollar. Over the years, the HKMA was tested a few times, especially during the Asian flu of 1997 and 1998. Unlike its Asian neighbors, Hong Kong never came close to devaluation and economic destruction, even as China took over sovereignty amidst its own Asian flu symptoms.

It earned the HKMA and its HKD currency a quality that is so often unappreciated in modern times: boring. The peg had been successfully instituted and defended to get the exchange value to around 7.8 HKD to 1 US$. From there, it floats in a limited range now settled between 7.75 and 7.85.

It appears more and more possible that there was, in fact, one factor even the mighty HKMA could not overcome: China. It’s a bit odd to make that claim now, with HKD trading above 7.80 for the first time in months. The Hong Kong dollar has been moving in the right direction for seven weeks, so things are surely getting better (subscription required)?

So now you’ve borrowed a bunch of “dollars” on behalf of Chinese banks and the mainland central bank, committing yourself to continual rollover risk since it isn’t likely you will be able to say no once you’ve said yes to the PBOC. Then the cost of obtaining these “dollars” for Hong Kong banks suddenly rises, meaning the premium paid for them (in FX) spikes in the form of HKD “devaluation.” At some point, no matter how beholden to the PBOC, you have to cry foul and try to make it stop.

Let’s assume that the mainland central bank hears your pleas as well as surely those of others in the same situation and grants your reprieve. They let China’s onshore banks back to fend for themselves, closing down or decompressing the ad hoc Hong Kong eurodollar pipeline. HKD starts to rise again, CNY to fall. That’s it, right?

  Well, no.

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