The world’s most undervalued currency is the Hong Kong dollar. Most of what I said in my previous post about the undervalued Japanese yen applies to an even greater degree for the Hong Kong dollar.
Hong Kong is a special administrative region of China. This means that China is responsible for Hong Kong’s defense and foreign policy while Hong Kong provides its own legal system, law enforcement, monetary system, and other domestic policies. Hong Kong was originally a territory of China that later was taken over by the British in the 1840s and the Japanese in the 1940s during World War II. After World War II, Hong Kong went back to British rule. In 1997, Hong Kong was handed back to China.
According to the Economist magazine’s Big Mac Index, a Big Mac costs an average of $3.41 USD here in the USA and an average of $12 HKD in Hong Kong. If the USD and HKD were at Purchasing Power Parity, $1 HKD would be worth 28.4 cents in USD. Based on the actual exchange rate, $1 HKD is worth 12.8 cents USD. This means that the Hong Kong dollar is selling for only 45% of Purchasing Power Parity against US dollars. That’s a steal! In fact, based on current exchange rates, no other currency is as cheap on a Purchasing Power Parity basis as the Hong Kong dollar.
It is amazing that the Hong Kong dollar is so incredibly cheap given all the factors that should make it sell at a premium to Purchasing Power Parity against the US dollar. Like Japan, the United States, Australia, Canada, and western Europe, Hong Kong is a rich First World economy with a high standard of living, stable government, and high wages. Natural resources are scarce in Hong Kong, and most of its food, energy, and other supplies must be imported.
Land is especially scarce in Hong Kong, especially after you consider that much of its small land area is too rugged for agriculture and other uses. According to the CIA World Factbook, Hong Kong’s population density is 6740 people per square km (7,018,636 people on 1042 square km of land), compared to 340 people per square km for Japan, 33.2 people per square km for the United States, 2.70 people per square km for Australia, and 3.65 people per square km for Canada. Thus, Hong Kong is not a place where you’d expect land, rents, wages, grain, beef, or other costs of running a McDonald’s restaurant to be cheap.
Why is the Hong Kong dollar cheaper than so many Second World and Third World currencies even though it belongs to a First World economy where wages, rents, commodities, and other costs are expensive? Since 1983, the Hong Kong dollar has been pegged to the US dollar at the rate of $1 USD=$7.8 HKD. Without the peg, the Hong Kong dollar would be considerably higher against the US dollar. The Hong Kong Monetary Authority uses Hong Kong dollars to purchase US dollars to artificially hold down the value of the Hong Kong dollar.
This currency peg will not remain forever. Every day that the Hong Kong Monetary Authority maintains the currency peg, it cedes control of its monetary policy to the US Federal Reserve. While the anti-inflationary Paul Volcker was the US Fed Chair when Hong Kong began the peg in 1983, the pro-inflationary “Helicopter Ben” Bernanke is the US Fed Chair today. Something will happen that will make the Hong Kong Monetary Authority to cease outsourcing monetary policy to Helicopter Ben. Perhaps the upward pressure on the Hong Kong dollar will become so strong that the Hong Kong Monetary Authority will no longer be able to hold down the value of its currency. Or perhaps the day will come when the costs of maintaining the currency peg exceed its benefits. Indeed, the Hong Kong economy is becoming increasingly linked to that of mainland China. Hong Kong may decide to drop the dollar peg in favor of a peg to the Chinese renminbi, another undervalued currency (only 46% of Purchasing Power Parity).
Why did I use an Everbank foreign currency CD to buy the Hong Kong dollar? Again, I am avoiding FOREX brokers due to doubts about their stability and lack of insurance as well as the fact that they are geared for hyperactive traders. Unlike the case with the Japanese yen, there is no Hong Kong dollar ETF. The Everbank foreign currency CD is the only way for reasonably conservative investors to purchase Hong Kong dollars. Everbank’s foreign currency CDs are FDIC-insured. Everbank is a conservatively run bank.
I am confident that when the current peg is dropped, the Hong Kong dollar will at least double in value. It won’t happen right away, but it will happen. Even if it takes a few years, it will be well worth it. A double in 2 years means an annualized return of 41.4%, a double in 3 years means an annualized return of 26.0%, a double in 4 years means an annualized return of 18.9%, and a double in 5 years means an annualized return of 14.9%. A double in 10 years means an annualized return of 7.2%, far better than what US Treasury Bills are likely to return.
