Speaker 1: Hello, and welcome to another episode of the Odd Lots Podcast.
Speaker 1: I'm Joe Wisn'tal and I'm Tracy allowit. So, Tracy, you're
Speaker 1: in Hong Kong. Obviously we've been talking about some recent
Speaker 1: episodes about some of the reemergence of the virus there,
Speaker 1: but also virus aside, this is just a sort of
Speaker 1: a big moment in time for Hong Kong. Previous reason, Yeah,
Speaker 1: there's no shortage of news slow here in Hong Kong.
Speaker 1: Aside from the virus. We've had a year of unrest
Speaker 1: in the form of the big protests against extradition law,
Speaker 1: and now most recently in the past month, we've had
Speaker 1: the imposition of a new national security law which gives
Speaker 1: China sweeping powers. I guess you'd say over Hong Kong. Right,
Speaker 1: So I remember thinking, like, you know, a year ago.
Speaker 1: You know, it's probably because a year ago, by now,
Speaker 1: the sort of like the protests had really gathered steam,
Speaker 1: Like it was like last summer when we really saw
Speaker 1: the re acceleration of the protests, and you and I
Speaker 1: would be on meetings pretty regularly and you'd have to
Speaker 1: talk to us about how you were getting into work
Speaker 1: and so forth and things like that. Hmm yep, that's right,
Speaker 1: So you must be pretty exhausted. Yeah, I mean, look,
Speaker 1: there's a lot going on in the world, um, but yeah,
Speaker 1: definitely a lot going on in Hong Kong. And like
Speaker 1: the mood is, the mood's pretty um morose at the moment,
Speaker 1: I gotta say. And then beyond that, of course, we
Speaker 1: have the economic situation, which is that Hong Kong just
Speaker 1: can't catch a break. So we already saw the Hong
Speaker 1: Kong economy affected by the protests. Lots of mainland tourists
Speaker 1: and shoppers stopped coming into the city. And then of
Speaker 1: course we had the virus cases is beginning to really
Speaker 1: build up earlier in the year. Now we have the
Speaker 1: third wave, so that continues to hit the economy. And
Speaker 1: now we also have the National Security Law. And again
Speaker 1: the question there is slightly different to viruses and protests,
Speaker 1: which you know sort of hit the retail sector. Of
Speaker 1: the hardest question about the National Security Law is whether
Speaker 1: or not it's going to impact the international character of
Speaker 1: Hong Kong as a financial center and international financial center. Right.
Speaker 1: So obviously, seeing we've seen all this pressure build on
Speaker 1: Hong Kong, which reminds me or which calls to mind
Speaker 1: that essentially, for the last decade, I feel like every
Speaker 1: year or every two years or something, there's some new
Speaker 1: hedge funder coming out that predicts the imminent severing of
Speaker 1: the link between the Hong Kong dollar and the US dollar.
Speaker 1: And for those who don't know, for a long time,
Speaker 1: the Hong Kong dollar has been pegged to be uh
Speaker 1: stable with the U. S Dollar. What's it peg dot again?
Speaker 1: Do you remember since nine eight three? And you know
Speaker 1: I remember that because it's my birthday. I am the
Speaker 1: same age as the Hong Kong dollar peg. So what's
Speaker 1: a pet? Oh? What is it peg? Debt? Oh? Sorry,
Speaker 1: I thought you said when was it pegg? I think
Speaker 1: it was pegged between um seven point seven five to
Speaker 1: seven point eight five something like that. There is Do
Speaker 1: you have all these hedge funders and every year they're like, oh,
Speaker 1: this is the year that the Hong Kong dollar peg
Speaker 1: is finally gonna break. But as you point out, since
Speaker 1: nineteen eighty three, it's a health quite front. Yeah. There's
Speaker 1: been a couple of voices who have been especially vocal recently.
Speaker 1: One of them is Kyle Bass, who I think has
Speaker 1: actually started a whole new fund dedicated to betting on
Speaker 1: a collapse in the peg. And it's an interesting one.
Speaker 1: I feel like whenever you have a dollar peg, I
Speaker 1: feel like people are always talking about the potential for
Speaker 1: it to break for obvious reasons. When I was in
Speaker 1: Abu Dhabi and do you buy, you know, there was
Speaker 1: talk about the peg, the ua E that was always
Speaker 1: under pressure and on the verge of collapse according to
Speaker 1: some people. But the Hong Kong peg, it's an interesting one.
Speaker 1: It is, and we're gonna be talking about it today.
Speaker 1: And you know, obviously it's you know, we can't even
Speaker 1: in the set up here and talking about all the
Speaker 1: pressure on Hong Kong from various angles. You know, there's
Speaker 1: all kinds of reasons to argue that the peg is
Speaker 1: going to break, but we almost never hear the other side,
Speaker 1: which is that the peg has been very durable and
Speaker 1: why the peg won't necessarily break. Um. So that's what
Speaker 1: we're going to discuss on the episode today. We're going
Speaker 1: to be talking with Chris wigand he is the c
Speaker 1: i O and co founder of Royal Bridge Capital, a
Speaker 1: hedge fund. He used to be at Soros. So we
Speaker 1: can talk about that, and we're going to talk about
Speaker 1: the Hong Kong dollar peg, why why it's so stable,
Speaker 1: and why the those betting on its imminent collapse may
Speaker 1: have to wait. Awhile, So, Chris, thank you very much
Speaker 1: for joining us. Oh Joe, thank you for Tracy, Thank
Speaker 1: you for having me. So, Chris, let's talk a little
Speaker 1: background from your perspective. And Tracy mentioned that the PEG
Speaker 1: was established year for birth. I'm looking at a chart
Speaker 1: of it right now. It's pretty remarkable. It's basically done nothing.
Speaker 1: You know, the peg has been extremely solid since ninety three.
Speaker 1: Why was it established in the first place. So the
Speaker 1: peck was originally established in as Tracy said, and kind
Speaker 1: of fall of of eighty three, largely because the currency
Speaker 1: had started to come under pretty serious devaluations, slight depreciatory pressure.
Speaker 1: As Lady Thatcher and then Chinese leader Don Jo Ping,
Speaker 1: we're starting to talk about the handover of Hong Kong
Speaker 1: back to China when the UK's year Least agreement extended.
Speaker 1: And so those conversations had started in either late eighty
Speaker 1: two or early eighty three, and they started to filter
Speaker 1: out into the public domain over the course of three
Speaker 1: and understandably, there started to be concerns in the marketplace
Speaker 1: about whether China would maintain Hong Kong's rule of law,
Speaker 1: whether the English common law system which underpinned all of
Speaker 1: Hong Kong's contracts and made it such a uh an
Speaker 1: important destination for international finance and trade, would be maintained.
Speaker 1: And so you started to see risk premium wide in
Speaker 1: UH in that manifested itself in a weaker Hong Kong dollar.
Speaker 1: Hong Kong dollar depreciated ground numbers from something that was
Speaker 1: sort of six and a half six sixty in the
Speaker 1: summer all the way up to something that was about
Speaker 1: eight fifty eight against the US dollar in a in
Speaker 1: a pretty short period of time. And the UK decided
Speaker 1: that as in an effort to try to restore stability
Speaker 1: and and help underpin confidence in in Hong Kong, that
Speaker 1: it would try to reap that it would try to
Speaker 1: set a specific band for the currency against US dollar,
Speaker 1: and it did. Um it's set seven eight is the
Speaker 1: midpoint in a in a type band between seven seventy
Speaker 1: five and five, and it's been successful now for almost
Speaker 1: thirty seven full years. M I have a stupid question,
Speaker 1: but when someone decides to create a currency peg, how
Speaker 1: how did they actually go about doing it? Because nowadays,
Speaker 1: when we talk about currency pegs in existence, whenever there's
Speaker 1: pressure on them, we talk about, you know, the city
Speaker 1: or the monetary authorities spending their reserves in order to
Speaker 1: support the peg. So how does that work when they're
Speaker 1: initially setting it up. Well, so it's it's a it's
Speaker 1: a it's a very good question. And the answer is
Speaker 1: it depends if if the market believes that the central
Speaker 1: bank or the Finance ministry is committed to that peg.
Speaker 1: It's possible that just the announcement effect could be successful
Speaker 1: in in releveling that. I mean, we've seen that very recently,
Speaker 1: UH in many respects with the reserves announcement that it
Speaker 1: would start to purchase corporate bombs back in late March,
Speaker 1: when it announced that it would it would buy bonds
Speaker 1: of investment grade companies, the market immediately normalized without the
Speaker 1: Federal reserve spending a single penny until recently, and so
Speaker 1: UH in in the Hong Kong situation, you did get
Speaker 1: a lot of um a sort of announcement effect as
Speaker 1: it's often called, that helped to relevel the currency at
Speaker 1: around the seven seventy band, and then there needed to
Speaker 1: be some maintenance along the way in the early days
Speaker 1: and at different points in time to h to maintain
Speaker 1: that band. But the announcement effect is can be very
Speaker 1: very powerful. Now, if you're a country like let's not
Speaker 1: pick on Argentina, but you know, if they've had a
Speaker 1: currency board in the past and they used to have
Speaker 1: an arrangement similar to what Hong Kong has, and if
Speaker 1: Argentina today tried to re establish a peg at a
Speaker 1: at a stronger currency versus the US dollar than it
Speaker 1: is now, in all likelihood that would be totally unsuccessful
Speaker 1: because they don't have any credibility. But presumably, I mean
Speaker 1: there needs to be more than credibility, right, You need
Speaker 1: to have the balance sheet, You need to have reserves
Speaker 1: so that you can go out into the market and
Speaker 1: make purchases if your currency starts to weaken. You mentioned
Speaker 1: the Fed corollary offering to buy bonds and not needing
Speaker 1: to spend any money. But no one disputes that the
Speaker 1: Federal Reserve has all the US dollars it needs to
Speaker 1: buy bonds because it creates you can create U S dollars.
Speaker 1: Presumably the credibility of a currency board also needs to
Speaker 1: be accompanied by some level of actual casualty, oh absolutely, absolutely,
Speaker 1: And it needs to be accompanied by some level of
Speaker 1: firepower to maintain to maintain the link and for long
Speaker 1: periods of time. You also need underlying fundamentals in the
Speaker 1: in the macro economy to help be supportive of of
Speaker 1: the PEG value now and and Hong Kong has benefited
Speaker 1: from that in part because it has run a current
Speaker 1: account surplus for decades um. Now it's straight straight positions
Speaker 1: which we can get into have have shifted notably and
Speaker 1: have become much more reliant upon exports of services to
Speaker 1: help to maintain its international position. And that's a that's
Speaker 1: an important potential weakness moving forward. But you need announcement
Speaker 1: effect credibility, You need the firepower in the form of
Speaker 1: reserves or other equivalents that can be turned into reserves.
Speaker 1: And you need favorable underlying fundamentals that are consistent with
Speaker 1: where you've where you've set the band for your for
Speaker 1: your currency. And for thirty years, Hong Kong has been
Speaker 1: able to you know, has largely had all of those
Speaker 1: to maintain to help to maintain the pack. I mean
Speaker 1: it hasn't been a smooth ride. That there was the
Speaker 1: late nineteen nineties when there was the attack on the
Speaker 1: on the currency and there was a lot of pressure
Speaker 1: downward on the currency and required massive intervention to maintain
Speaker 1: the peg. But again they had the firepower to do
Speaker 1: so at that point and the commitment and the commitment
Speaker 1: to Can we talk a little bit about the rate
Speaker 1: differentials that you just mentioned, So when you set up
Speaker 1: a currency peg, you're basically tying your fortunes to another
Speaker 1: country's currency, and therefore it's monetary policy, and you know,
Speaker 1: maybe the economic situation in your own country doesn't match
Speaker 1: up with what's happening in the US at the same time.
Speaker 1: How has that played out for Hong Kong and Hong Kong.
Speaker 1: Of course, I guess the situation is even more complicated
Speaker 1: because it's monetary policy is tied to the US, but
Speaker 1: at the same time it's right on the doorstep of China,
Speaker 1: which is growing at a very very different rate to
Speaker 1: the US over the past few decades. No, that that's
Speaker 1: that's right, And so you know, from a historical perspective,
Speaker 1: you know, Hong Kong has sat in the middle of
Speaker 1: the two most powerful trends that we've seen in economics
Speaker 1: and finance for the past thirty years. Trend one being
Speaker 1: that um U S interest rates have fallen secularly from
Speaker 1: low double digits to zero, and so Hong Kong is
Speaker 1: effectively imported UH those interest rates and in monetary policy,
Speaker 1: helping to create a very favorable UH financial conditions in
Speaker 1: Hong Kong. And Hong Kong has sat at the doorstep
Speaker 1: is is you mentioned Tracy to China and has been
Speaker 1: key in China's early development as its key southern port,
Speaker 1: as its outlet for financial capital both into China and
Speaker 1: out of China. And so it's reaped, it's uniquely reaped
Speaker 1: the benefits of both of those major trends. Huge development
Speaker 1: in China which has leaked into Hong Kong and been
Speaker 1: very profitable, and the secular decline in interest rates um
Speaker 1: in the United States, which has also leaked into Hong Kong.
Speaker 1: And so what you've seen is you've seen a phenomenal
Speaker 1: period of growth and development in Hong Kong by sitting
Speaker 1: in the middle of those two trends. Hong Kong has
Speaker 1: my most estimates, about the same number of billionaires as
Speaker 1: New York City, does. For instance, it's per capita income
Speaker 1: is nearly sixty thou among the highest and in the world.
Speaker 1: But the downside of that is that you've started to see,
Speaker 1: especially in the past decade, as rates in the US
Speaker 1: were very low and you had a spectacular credit boom
Speaker 1: in China that kept leaking into Hong Kong both overtly
Speaker 1: and indirectly, you started to see misallocations start to form,
Speaker 1: and in my judgment, in the Hong Kong economy, for instance,
Speaker 1: property prices have surged since UH two thousand a property
Speaker 1: prices on a per square meter basis we up roughly
Speaker 1: two in the past ten to twelve years. Hasn't seen
Speaker 1: a surge in credit and the non financial sector on
Speaker 1: financial debt to GDP and Hong Kong is something like
Speaker 1: three now up by more than a hundred and fifty
Speaker 1: percentage points since the end of two thousand and eight.
Speaker 1: So while Hong Kong has been able to reap a
Speaker 1: lot of these benefits, it's also creating misallocations now, at
Speaker 1: least in my judgment, potentially pretty serious misallocations in its
Speaker 1: housing and UH housing and credit markets. Chris can, can
Speaker 1: you give a slightly more color on the leakage points.
Speaker 1: So the idea that you know, excess capital from China
Speaker 1: sort of leaks out into Hong Kong, because I feel
Speaker 1: like this is something that's quite unusual about Hong Kong specifically,
Speaker 1: and not a lot of people who are living outside
Speaker 1: of the area necessarily understand it. Sure, So, so there's
Speaker 1: so it's happened in a variety ways. You know, let's
Speaker 1: talk about sort of the the shadow ways first and
Speaker 1: then and then get into the more legitimate ways. So
Speaker 1: early on in the past decade kind of two thousand, ten, eleven, twelve, thirteen,
Speaker 1: and even fourteen UM, when Hong Kong was still an
Speaker 1: incredibly important export destination for export upport for for Chinese products,
Speaker 1: you would see a lot of what what was often
Speaker 1: described as over invoicing of UM export orders. So there's
Speaker 1: no issue from with it's perfectly legal for mainland Chinese
Speaker 1: company two move capital outside of China if it's being
Speaker 1: done in the context of international trade. But what you
Speaker 1: would see is a way to try to get money
Speaker 1: out of China UM and into Hong Kong, where there
Speaker 1: was the more traditional Western rule of law and possibly
Speaker 1: the easier ability to move the money from Hong Kong
Speaker 1: to elsewhere, be at the US, Canada, UH, Singapore, whatever.
Speaker 1: You would see a lot of over invoicing of of
Speaker 1: exports and imports. In other words, you know, maybe there
Speaker 1: was the dollar value of goods moving was was ten
Speaker 1: million dollars, but on the invoices it would be marked
Speaker 1: for fifteen million dollars, so that you could basically keep
Speaker 1: find a way to get five million extra dollars beyond
Speaker 1: which you were actually trading. You can get that money
Speaker 1: legally out of mainland China into Hong Kong and then
Speaker 1: send it elsewhere. Now the mainland Chinese eventually caught authorities
Speaker 1: eventually caught on and started to close that gap. But
Speaker 1: that was one way that you saw tremendous kind of
Speaker 1: leakage from mainland China with his close capital account into
Speaker 1: Hong Kong in a in a sort of shadow way.
Speaker 1: Then there's some more direct, explicit above boardways. As China
Speaker 1: has become wealthier and wealthier, there's been more and more
Speaker 1: increase in sophistication and financial services being offered to mainland
Speaker 1: China Chinese people. So there's not much in the way
Speaker 1: of life insurance in mainland China that's a only market
Speaker 1: in Hong Kong where Hong Kong is able to sell
Speaker 1: life insurance products to mainland Chinese. Asset management companies, both
Speaker 1: stayed owned and privately owned have sprunt up in in
Speaker 1: Hong Kong with the idea of servicing this huge population
Speaker 1: in mainland China. So money is coming out of um,
Speaker 1: out of the mainland into Hong Kong, and those asset
Speaker 1: management programs again both totally above board, but also in
Speaker 1: other ways to seek returns that are in non h
Speaker 1: CNY type assets. So there's lots of things, you know
Speaker 1: like that where because of the trade relationships and Hong
Speaker 1: Kong's importance a support for China, both export and import,
Speaker 1: there was a lot of sort of shadow ways that
Speaker 1: the business people we find ways to get money out
Speaker 1: of the country and into Hong Kong. And now there's
Speaker 1: these these more traditional ways where Hong Kong is is
Speaker 1: really pivoting from being a what has been mostly international
Speaker 1: facing city, the one that's trying to take advantage of
Speaker 1: the financial the better financial wherewith all of the mainland
Speaker 1: Chinese people, and there's money that comes totally legally, and
Speaker 1: then there's money that you know, continues to try to
Speaker 1: leak aboard because of the perception that you can get
Speaker 1: money from Hong Kong to other parts of the world
Speaker 1: more easily than you can from mainland China. So if
Speaker 1: I'm listening to you, and let's just say like I'm
Speaker 1: your sort of typical macro tourist, kind of hedge fund guy,
Speaker 1: I don't know. And I listened to that, and I say, oh, well,
Speaker 1: part of the story with a big part of the
Speaker 1: story with Hong Kong has been these ever decrease in
Speaker 1: US rates and that's creating this huge potential boom in
Speaker 1: um private sector dead and it's crazy housing market bubble.
Speaker 1: And then on the other side, it's like, okay, Hong
Speaker 1: Kong has benefited for years as being this destination for
Speaker 1: Chinese capital in part because of the Western style rule
Speaker 1: of law people wanting to get their money out of
Speaker 1: un denominated asset. We have the National Security law, and
Speaker 1: so maybe that's going to weekend, Okay, great time to
Speaker 1: bet against the Hong Kong dollar peg. It looks like
Speaker 1: all of these things are coming together and it's uh
Speaker 1: that the clock must be ticking now. So what would
Speaker 1: I be getting wrong in that formulation? Because the way
Speaker 1: you set it up. I could certainly tell a story
Speaker 1: for why this must be rough times ahead for the DOT,
Speaker 1: for the PEG. No, I think it's I think it's
Speaker 1: a very easy story to tell, in a very um
Speaker 1: simple story to comprehend as as you laid it out,
Speaker 1: and I think qualitatively got a lot of merits to it.
Speaker 1: And let me stay right up front, you know, I've
Speaker 1: been very surprised that in the past month or so
Speaker 1: since the new National Security Law went into effect, that
Speaker 1: the Hong Kong dollar has consistently traded on the strong
Speaker 1: side of the band. It's been more or less at
Speaker 1: at seven UM or thereabouts for the entire month, and
Speaker 1: there's been no signs of depreciation pressure on the currency. Now,
Speaker 1: some of that's probably that the dollar has been weak,
Speaker 1: but still so, I think the situation, the circumstances are
Speaker 1: are a lot more nuanced than um the high level
Speaker 1: items that you know that you laid out, Joe, You know,
Speaker 1: one we really don't know. No one knows what exactly
Speaker 1: the new National Security Law is ultimately going to look like.
Speaker 1: There's plenty of reasons to be very concerned about what
Speaker 1: it implies for the rule of law. UH in contract law,
Speaker 1: mare broadly in Hong Kong. But the reality is no
Speaker 1: one self included UM has any idea how it's going
Speaker 1: to actually manifest itself. And I think until you see
Speaker 1: some signs that contract law is actually being challenged in
Speaker 1: Hong Kong, that there probably will continue to be sort
Speaker 1: of a sense of complacency. That's that's That's one point.
Speaker 1: The second point is that right now there's still you know,
Speaker 1: can Hong Kong still runs a current account surplus. That's helpful,
Speaker 1: uh for the for the stability of the currency. One
Speaker 1: thing to watch very very closely, and it ties in
Speaker 1: closely with h with the National Security Law slash contract
Speaker 1: law is what happens to exports or services. Hong Kong's
Speaker 1: services exports have become a key part of its balance
Speaker 1: of payments, and in particular one third of its services.
Speaker 1: Exports can be broken into financial services, insurance and pension services,
Speaker 1: and other business services so things like legal. If those
Speaker 1: services start to decline again because of things that you
Speaker 1: mentioned or other factors, then all of a sudden, the
Speaker 1: balance of payments equation becomes a little bit trickier, and
Speaker 1: I would start to expect to see some depreciation pressure
Speaker 1: on the currency. But but the h k m A
Speaker 1: still has tools, and we've seen them use them, including
Speaker 1: in episode when there was tremendous noward pressure on the
Speaker 1: Hong Kong currency. Reserves are four and fifty billion dollars now.
Speaker 1: Not all of those are available for um for defending
Speaker 1: the currency, but a large junk of them are. And
Speaker 1: there's a large wild card in that, with safe up
Speaker 1: in Beijing stitting on more than a trillion in NFX reserves,
Speaker 1: if mainland China, and if Beijing believes that defending the
Speaker 1: Hong Kong peg is is critically important, that there's also
Speaker 1: those funds that could theoretically be be deployed to h
Speaker 1: k m A and provide a massive amount of firepower
Speaker 1: to lean against appreciation depreciation pressure. And then of course
Speaker 1: there's the there's also the higher rates. You know we
Speaker 1: saw where high bard Uh, the Hon Kong equivalent of
Speaker 1: live war has has been has been pushed up very
Speaker 1: sharply by the HKm A to make holding short currency
Speaker 1: positions more expensive, to change the relative rates of return
Speaker 1: on capital more in favor of holding Hong Kong dollars
Speaker 1: versus other currencies. I think that would actually be counterproductive.
Speaker 1: And if we start in the current situation, if we
Speaker 1: start to see meaningful pressure on the Hong Kong dollar
Speaker 1: because of what it would do to the property market. Um,
Speaker 1: most Hong Kong mortgages are all Hong Kong mortgages are floating, right,
Speaker 1: and an overvalued property market and an over leveled private sector.
Speaker 1: Of all of a sudden, you hiked interest rates by
Speaker 1: thousands basis points um to defend the currency, you would
Speaker 1: have other problems that you would surface. So there's a
Speaker 1: lot of fragility here. But it's more likely, in my opinion,
Speaker 1: to be sort of a slow motion UM type development,
Speaker 1: with the folk from being how does the market perceive
Speaker 1: the new National Security law and its implications on contract
Speaker 1: law and what that implies for the sanctity of of
Speaker 1: assets in Hong Kong. That could happen very fast once
Speaker 1: there's a trigger. It could also take an elongated time.
Speaker 1: I think it's it's one of those situations where there
Speaker 1: are imbalance is there's a potential trigger, but you need
Speaker 1: another sort of catalyst to um crystallize the imbalances into
Speaker 1: some sort of capital flight UM episode. I want to
Speaker 1: press you on on what that catalyst might actually look like.
Speaker 1: But before we do UM, you mentioned capital outflows. So
Speaker 1: we we have the four fifty billion of foreign reserves
Speaker 1: held by the Hong Kong Monetary Authority, plus you potentially
Speaker 1: have all the firepower held by safe in China, you
Speaker 1: have the possible lure of higher rates. But what about
Speaker 1: just sort of stopping capital outflows and and plugging those
Speaker 1: holes before they really get started. Is that something that
Speaker 1: could be done in Hong Kong or would it just
Speaker 1: be an atama to Hong Kong status as an international
Speaker 1: financial center. So it's a great question. It's something that
Speaker 1: can be done, likely would be done, and based on
Speaker 1: UH anecdotes, I want to emphasize that their second hand,
Speaker 1: but based on anecdotes. You know, we've already been hearing
Speaker 1: about for the past twelve to eighteen months that UM,
Speaker 1: the Hong Kong banking authorities or the Hong Kong certain
Speaker 1: Hong Kong banks themselves have made it harder for capital
Speaker 1: to be moved abroad. As a for instance, you know
Speaker 1: our fund UM has a number of Hong Kong LPs
Speaker 1: in it, and we have heard that they have the
Speaker 1: Hong Kong select Hong Kong banks have made it difficult
Speaker 1: to move money out of Hong Kong in in one transfer,
Speaker 1: but basically putting a lot of sand in the gears
Speaker 1: to to move money out of Hong Kong to to
Speaker 1: the United States as a for instance. So that's already
Speaker 1: going on to some extent um. It seems like it's
Speaker 1: more concentrated in the Chinese banks as opposed to the
Speaker 1: Western banks, But that's already taking place to some extent,
Speaker 1: and that could easily be ratcheted up. The mainland Chinese
Speaker 1: have authorities have have been able to slow capital outflows tremendously,
Speaker 1: and Hong Kong could do it also by by limiting
Speaker 1: wires outside the country. Now, I do think that that
Speaker 1: would certainly damage it's it's position as an international financial
Speaker 1: center in a crisis. Slowing that down or or putting
Speaker 1: a moratorium on capital outflows from banks, I think it's
Speaker 1: something that absolutely could happen. So from a reserve's cash standpoint,
Speaker 1: there's no reason to think that there is a firepower shortage.
Speaker 1: I guess the two the two components of a bet
Speaker 1: on an ending the peg. Obviously there's the firepower, but
Speaker 1: then also the commitment. Do you see anything in the
Speaker 1: sort of short medium term with the changing legal structure
Speaker 1: that would cause you to think that the commitment would
Speaker 1: go with No, I don't think so, not not not
Speaker 1: not in the in the short term. I think there
Speaker 1: is this more do not think. I'm convinced there's this
Speaker 1: more medium term issue of if Hong Kong is going
Speaker 1: to be as Hong Kong is absorbed more into mainland China,
Speaker 1: and if Hong Kong is going to become very imperfect analogy,
Speaker 1: you know, Chicago, where Shanghai is New York for mainland
Speaker 1: China and Hong Kong becomes, for instance, Chicago, then there
Speaker 1: is the more existential question of why is the currency
Speaker 1: peg to the U S Dollar at seventy five eighty five,
Speaker 1: and why do we why do we need that, why
Speaker 1: do we have that, Why are we spending our time,
Speaker 1: you know, maintaining that relationship. And I think that's a
Speaker 1: very real dynamic that will have to be dealt with
Speaker 1: and will be dealt with by the Chinese. But is
Speaker 1: that a twelve months, a five year, a tenure. Honestly,
Speaker 1: who knows. But this is current to me, this current
Speaker 1: situation where the Hong Kong dollars pack to the U. S. Dollar,
Speaker 1: it's current rate. It's not something that's going to prevail forever.
Speaker 1: It's just a question of of what are the circumstances
Speaker 1: that force it to change? Is fundamental economic issues? Is
Speaker 1: that active policy choice by Beijing. These are all things
Speaker 1: that are very hard to foresee, to be sure. So
Speaker 1: I guess the suggestion is if you have a sort
Speaker 1: of slow grind towards an alternative system, like a currency
Speaker 1: basket regime like they have in Singapore, or I guess
Speaker 1: the dual currency system like in Macau, like, you could
Speaker 1: have that path, but you could also have something major
Speaker 1: that happens that really keeps pressure on the PEG and
Speaker 1: causes policymakers to reconsider it in the short term. What
Speaker 1: would be the thing that caused that outcome? Of course,
Speaker 1: the honest answers who knows one never knows in advance
Speaker 1: what the what the ultimate catalyst would be. Who would
Speaker 1: have thought that the U S authorities would let Leaven
Speaker 1: Brothers fail and would would trigger off the the mass
Speaker 1: contagion recognizing they need to, you know, think about this
Speaker 1: and have some sort of sense. I think the biggest
Speaker 1: thing would be that if you started to see major
Speaker 1: global corporations UM starting to pull out of Hong Kong,
Speaker 1: that that would be a pretty strong catalyst for the
Speaker 1: potential for other capital flight, both human and financial, and
Speaker 1: that that is the most likely trigger in the sort
Speaker 1: of three to twelve month horizon. Now, so far, we've
Speaker 1: seen none of that, right, and in fact, the global
Speaker 1: business community that has large presences in Hong Kong UM
Speaker 1: has either been silent or welcome the new National Security
Speaker 1: law because they would they think it will help calm
Speaker 1: the political tensions in the city and they want to
Speaker 1: continue to do business with mainland China. But I think
Speaker 1: if you saw something like that, that that would start
Speaker 1: to be a that would be a potential flashpoint for
Speaker 1: for capital flight again both human and and financial, and
Speaker 1: that would be a potential trigger. So I have one
Speaker 1: more question, which is we started out this podcast, well,
Speaker 1: Joe mentioned this idea that throughout history or the past
Speaker 1: three decades, there have been speculators who have at various
Speaker 1: times bet against the Hong Kong dollar peg, the most
Speaker 1: recent or the most high profile being Kyle Bass. What's
Speaker 1: the lure of betting against this particular peg. I know
Speaker 1: we kind of went through the narrative earlier, but it
Speaker 1: seems to happen over and over and over. And secondly,
Speaker 1: how do you speculators actually go about betting against it?
Speaker 1: And how expensive is it to keep that position going? Yep,
Speaker 1: not great question. So so the lure or the attractiveness
Speaker 1: is for the hot betting against the Hong Kong peg.
Speaker 1: It's not this similar from petting against any peg currency.
Speaker 1: History has shown that they're very hard to maintain. Number one.
Speaker 1: Number two that the volatility in the currency, because it's
Speaker 1: in a PEG band is very low, and so if
Speaker 1: slash win the peg breaks, you're going to have an outside,
Speaker 1: very disorderly move that's likely going to include not just
Speaker 1: an outsized move and percentage terms from the band, but
Speaker 1: potentially an explosion and volatility. So if you have some
Speaker 1: sort of derivative strategy on, you're able to make both
Speaker 1: money from um significance amounts of money from the delta
Speaker 1: I either move in the percentage move, but also in
Speaker 1: the volatility component. And so it offers the potential for
Speaker 1: if it happens spectacular reterms. I think that is you know,
Speaker 1: the the the appeal is no more complicated than that.
Speaker 1: And then in the Hong Kong case, at least currently
Speaker 1: it's augmented by the fact that, again as I mentioned earlier,
Speaker 1: you've you've got an overvalued housing market and you've got
Speaker 1: a huge build up in debt and interest rates are
Speaker 1: at zero. So if there's any forced rise in interest rates,
Speaker 1: it's gonna put pressure on on the housing market, on
Speaker 1: that service, etcetera, etcetera. So but again really that in
Speaker 1: a nutshell, it's fixed exchange rate possibility for very large returns.
Speaker 1: The same reason people who are betting against the Saudi
Speaker 1: peg or the Middle Eastern pegs. Uh, you know a
Speaker 1: few a few years ago. In terms of you know,
Speaker 1: being able to monetize it, it's not easy being law on. Uh.
Speaker 1: You know, basically being law puts on the on the
Speaker 1: currency is is a negative carry trade, and if you're on,
Speaker 1: and you're on for a consistently long time, you're going
Speaker 1: to bleed away your option premium um and end up
Speaker 1: end up losing money. You know. The other alternative is
Speaker 1: to have a huge cash position in the currency and
Speaker 1: with things that the strong side of the band, there's
Speaker 1: you know, there's some merit merit to that, but if
Speaker 1: the band doesn't break make money by soaking it, you're
Speaker 1: gonna take up a lot of your balance sheet or
Speaker 1: your fund from moving from seven seventy five to The
Speaker 1: returns are not that appealing, So it's very hard to
Speaker 1: to structure trades that you can carry uh and not
Speaker 1: to end up bleeding away a lot of your investors
Speaker 1: money and maintain the maintain the option value of this break.
Speaker 1: It just sounds like, you know, you have this situation
Speaker 1: in which, if you get it right, you can make
Speaker 1: an unbelievable amount of money in a short period of time.
Speaker 1: And the stories are so good between and everything that
Speaker 1: you've talked about about sort of these great narratives potentially
Speaker 1: coming to an end, but pretty killer holding a position
Speaker 1: waiting for it to happen. It's it's definitely tricky. And again,
Speaker 1: you know, let me you know, let me be let
Speaker 1: me be clear that with the fundamentals and the narrative
Speaker 1: and the currency at the straw end of the band,
Speaker 1: things are all really aligned for some sort of movement
Speaker 1: at least to the weekend of the band. If it's
Speaker 1: going to go beyond that, though, we're gonna need to
Speaker 1: get something along the line. So one of these triggering
Speaker 1: events that we've talked about, Chris before we go. I mean,
Speaker 1: I want to just sort of get your bigger perspective.
Speaker 1: Hong Kong aside and mentioned during the last crisis, you're
Speaker 1: a strategist, strategist the three years that a Soros fund management.
Speaker 1: What are sort of the big things you're thinking about
Speaker 1: right now in terms of how this crisis is either
Speaker 1: similar or different to the trading environment from about a
Speaker 1: decade ago. I think the biggest difference. The two biggest
Speaker 1: differences are are as follows. One. The crisis in in
Speaker 1: oh eight was a financial crisis, and if you it
Speaker 1: was very easy to understand the banks were bankrupt, we
Speaker 1: had an event that forced the US government to save
Speaker 1: the banks, and once the banks were saved, had a
Speaker 1: pretty good understanding that there would be a recovery, recognizing
Speaker 1: no one knows what it will look like in advance,
Speaker 1: and asset prices had collapsed, and we're really attractive here.
Speaker 1: The nature of this crisis is vastly different because it's
Speaker 1: a public health crisis and no one, you know, I mean,
Speaker 1: you know, even the world's leading you know, scientists don't
Speaker 1: know how this is going to evolve over the next
Speaker 1: one three, six, nine months, And so that's a huge
Speaker 1: source of opacity UM for thinking about managing investor investor
Speaker 1: capital you know, through that period and requires intense focus
Speaker 1: on on the downside and protecting downside tails. On the
Speaker 1: other hand, the Federal Reserve and other entities central banks
Speaker 1: around the world have crossed over red lines that frankly
Speaker 1: I never thought they would. They would cross over the
Speaker 1: backstopping of the corporate bond market, for instance. You've got
Speaker 1: these kind of competing issues of huge opacity and large
Speaker 1: left side tail risk UM from the virus and what
Speaker 1: it does to behavior, both business behavior consumer behavior you'r
Speaker 1: and then you know or whatever it takes approach from
Speaker 1: central banks that makes Mario drags whatever it takes in
Speaker 1: look small by comparison. So you know, you're trying to
Speaker 1: kind of balance, you know, those two things and and
Speaker 1: find and find assets that, um you know, are are
Speaker 1: likely to offer pretty attractive risk adjusted returns without a
Speaker 1: lot of downside. And what does that mean. I think
Speaker 1: it means that, you know, companies with near monopoly power
Speaker 1: tech type companies they're going to continue to do well.
Speaker 1: Companies with fortress balance sheets, they're going to continue to
Speaker 1: do well. Companies that have to issue debt with um
Speaker 1: special security pledges, i e. Where they're pledging collateral against
Speaker 1: specific bond issues at high intertrates. That stuff pretty pretty appealing,
Speaker 1: and so you've got to be very selective, I think
Speaker 1: in terms of thinking about how you're allocating cap little
Speaker 1: in this environment because of the opacity and the and
Speaker 1: the unknown about that flows from the public health public
Speaker 1: health crisis. Chris Wigan is a great chatting with you.
Speaker 1: I think I've in my mind I've had all kinds
Speaker 1: of questions for years and years about the Hong Kong
Speaker 1: Dollar Peg, and I feel like I haven't heard any
Speaker 1: sort of better explanation of all the things involved with
Speaker 1: it than that. I really appreciate it coming out. Well,
Speaker 1: thanks so much for having me on. There's a real pleasure.
Speaker 1: Thanks Chris. That was really good. Thank you, Tracy. I
Speaker 1: feel like after that conversation, a I really grasp why
Speaker 1: people for years have bet that the peg was going
Speaker 1: to end, and also I grasped why they've been wrong
Speaker 1: all this time. It's true, it's one of those things
Speaker 1: where you could see the logic of it, but I guess, uh,
Speaker 1: it's it's sort of like you don't want to necessarily
Speaker 1: go up against the might of four fifty billion in reserves,
Speaker 1: plus potentially everything that's safe is holding. That'd be kind
Speaker 1: of crazy. I feel like it markets in general, there's
Speaker 1: just a lot of trends that have been called prematurely
Speaker 1: over over for the last like several decades. I mean,
Speaker 1: it's interesting that the PEG came out in the early eighties,
Speaker 1: but there's so many other things, you know, whether it's
Speaker 1: just the relent interest rates, short j g B s,
Speaker 1: the grind lower in US interest rates, the incredible you
Speaker 1: know now surge, and tech stocks, which again Chris actually
Speaker 1: mentioned there in that last answer about you know, this
Speaker 1: sort of re acceleration of the money into high tech,
Speaker 1: strong balance sheet companies. It's like, one day, maybe a
Speaker 1: bunch of these trends are gonna reverse. But you can
Speaker 1: lose a lot of money getting that timing wrong. Yeah,
Speaker 1: in the meantime. But I guess the flip side of
Speaker 1: that is that you can make your name and become
Speaker 1: instantly famous and very very wealthy if you managed to
Speaker 1: call a reversal of one of those long run trends correctly. Yeah.
Speaker 1: I mean that's a good point. I mean, you think
Speaker 1: about like the few handful of people who nailed it
Speaker 1: on the housing market. US houses were another one of
Speaker 1: those multi decade trends where it's like houses always go up,
Speaker 1: and a couple of people got h fabulously rich, sort
Speaker 1: of betting that that was going to be unsustainable. It's
Speaker 1: interesting that one of the people who scored huge on
Speaker 1: the downtown housing was Kyle Bass and as you mentioned
Speaker 1: during the discussion, obviously he could reap or sort of
Speaker 1: repeat that performance and reap another huge windfall if he
Speaker 1: gets it right on the Hong Kong dollar. Yeah, but
Speaker 1: it's going to be a really fascinating one to watch.
Speaker 1: And I think even if we don't get that thing
Speaker 1: that instantaneously breaks the peg or forces policymakers to make
Speaker 1: some sort of decision, Even if we don't get that,
Speaker 1: just watching a oh development of potentially an alternative currency
Speaker 1: regime is going to be really interesting. And there are
Speaker 1: a lot of questions around what even that would look like.
Speaker 1: You could get a basket like in Singapore, a dual
Speaker 1: currency system like in Macau. You could, I guess this
Speaker 1: is a remote possibility, but Hong Kong could just let
Speaker 1: the dollar float. Um, It's going to be really fascinating. Yeah,
Speaker 1: that point he made about well, Hong Kong become China's Chicago,
Speaker 1: And it does raise a question, if you know, as
Speaker 1: the two economies become more similar and the two legal
Speaker 1: systems become more similar, doesn't make sense to have one
Speaker 1: of the really important economic areas, uh, just use this
Speaker 1: different currency regime At some point maybe that just won't
Speaker 1: make any sense, But again, who knows when? Yeah, exactly,
Speaker 1: all right, shall we leave it there? Let's leave it there.
Speaker 1: This has been another episode of the All Thoughts podcast.
Speaker 1: I'm Tracy Halloway. You can follow me on Twitter at
Speaker 1: Tracy Halloway and I'm Joe Wisntal. You can follow me
Speaker 1: on Twitter at the Stalwart. Follow our producer on Twitter,
Speaker 1: Laura Carlston. She's at Laura M. Carlson. Follow The Bloomberg
Speaker 1: had a podcast Francesca Leaving at Francesca Today and check
Speaker 1: out all of our podcasts onto the handle at podcasts.
Speaker 1: Thanks for listening.