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Introduction to Trading the Hong Kong Dollar

hong kong dollarIn many ways, the Hong Kong Dollar (with its Forex code HKD) is an unusual global currency, being almost a “tracking stock” for the Hong Kong city state which is officially a part of China, but which is permitted to be independently run in numerous respects. The HKD is also one of only a few currencies that are likely to enter obsolescence at some point in the future, as long as free trading of the Chinese Renminbi is eventually permitted, as there would no longer be any point in trading the Hong Kong Dollar. At the present time, however, the Hong Kong Dollar is still one of the the most important global trading currencies, being the eighth most traded on the Forex market. Even though it is Asia’s third most traded currency, the Hong Kong Dollar is still not a significant reserve currency. The HKD is not permitted to trade freely, and is under the administration of the Hong Kong Monetary Authority. At present, its exchange rate regime is a Linked Exchange System, which means that it is traded within a very narrow band against the USD. The interest rate of the HKD is based on an automatic mechanism designed to maintain the exchange rate’s stability. As it is only possible to issue Hong Kong Dollars if there are equivalent United States Dollars held on deposit with the issuing banks, the outstanding issuance of HKD is effectively backed  by the USD.

Facts About the HKD

In 1841, Hong Kong was established as a port for free trade, and at that time foreign currencies were freely in circulation, with no single currency for the country itself. Although the British government attempted to introduce its own coinage to the colony, it gave up the idea in the 1960s, and by 1863, London issued a special coinage to use in Hong Kong inside the Dollar system. By 1935, Hong Kong had abandoned the silver standard and introduced a crawling peg to the British Sterling currency, marking the moment at which the Hong Kong Dollar became a distinct unit of currency in its own right. When the country was occupied by the Japanese during the 1940s, the Japanese Yen became the only legal tender in Hong Kong; but following liberation, the local currency was reissued once more. The HKD became pegged to the US Dollar in 1972, and again in 1983 after a short period of free floating.

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The Economy of Hong Kong Behind the HKD

Although Hong Kong has been a part of China for many years, it is still largely operated as an autonomous region with a small economy of its own, which is ranked 39th in the world according to its GDP. The GDP growth of Hong Kong has been fairly volatile in the last 20 years; however, overall it has usually been over 5%, and occasionally as high as 10%. Rates of inflation have also been erratic – up to 10% during 1995, but actually being negative for over 4 years at the turn of the century. In recent times, the interest rates of the HKD have been pretty low. However, real estate developers’ debts, which are underwritten by the nation’s banks, are a volatile and significant influence on Hong Kong’s economy. For a long time, Hong Kong has been a key financial and trading hub in Asia thanks to its low taxes. Almost every significant securities house and global bank has housed an office in the country, and the Hong Kong Stock Exchange is rated the sixth largest in the world by market capitalisation. Unsurprisingly, the nation’s economy is heavily services-based and, although manufacturing does take place in Hong Kong, over 80% of the workforce is employed in the service industry, including hospitality, financial services, retail and trade. There is a school of thought that says that as Shanghai is becoming more important as a financial centre, Hong Kong must eventually become less significant.  There is, however, no sign of this happening yet.

Which Factors Drive the Hong Kong Dollar?

As the Hong Kong Dollar is somewhat different to other currencies, its economic drivers are also different. While economic data such as GDP, current accounts, trade balances and inflation do have some importance, they are significant only up to a point, as the Hong Kong Dollar can only trade within a narrow band. Also, as the Chinese and Hong Kong economies are so closely linked, any type of Black Wednesday-type raid on the HKD would inevitably fail. The HKD is not a particularly tradable currency, as although major banks with powerful computers may be able to make some profit from the fractional moves within the currency’s prices, the narrowness of the range deters the majority of small speculators from investing. The majority of trades using the HKD are therefore solely for business transactions, or as part of a carry trade. The Hong Kong Dollar has a low interest rate at present, and this makes it an appealing currency for carry traders. It is possible to borrow Hong Kong Dollars cheaply and then use the money to buy a higher yielding debt in a country such as New Zealand or Australia.

There is a reasonable chance that in the long term, the HKD will no longer be relevant, and could even become extinct. Eventually, there may come a point when the currency control over the Chinese Yuan is lifted or loosened significantly, and at such a time, the HKD will have no future key role to play.

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