A Potential Fatal Flow in Bill Ackman's HKD Trade?

Yesterday, I posted about Bill Ackman's HKD trade, and mentioned that I was pretty impressed and at the same time, pretty sure he would be wrong. Yet, the idea is compelling and the trade very tempting as the risk is close to zero and the potential gain enormous.

I have been thinking — not too much but still — and I think I might have found a flow in the trade: basically, the point that Bill makes is that the HKD is undervalued due to its peg against the USD and that high inflation has been imported as a consequence. So he believes that a 30% revaluation of the HKD against the USD has a probability of 6:1.

Now, here's the flaw: what about the case where the USD rallies 30%? huh? Given that a major USD rally is in the docks — at least according to my forecast, which have been right so far — then what happens to the HKD revaluation?

In such a case, the commodities would get hammered, and inflation would drop dramatically. I am sure that you would get the results Bill Ackman mentioned the HK government should be aiming for, and this would happen without any need for difficult and dangerous revaluation. Note that if you play the FX, your loss would be minimal in this case. But if you play would options, it's likely that you would lose about 100% of your premiums. Caveat Emptor!

I will hence not consider playing this with options. I might look at playing it with FX, but will first wait for the USD to show us what it where it wants to go and whether the rally will be enough or not to prevent this revaluation idea.

What do you think?


Anonymous said...

I think you should do your homework.
First, simple reading comprehension: he is not suggesting a 1:6 probablility but a revaluation to a USD exchange rate of 1:16 - see slide 112 of the pres.
Second, you say that the USD may "rally by 30%". against what?
A) Against a basket of all all other currencies? In that case, HK would still face the same issues of food inflation - it imports a significant share of its food from the chinese mainland, and the yuan is de facto also pegged against the dollar. Hence, the price differential would be the same and HK's poor would still be struggling to pay for food.
B) [Which you seem to imply in your post] The dollar may rally 30% against commodities [judging by the context of your post, you mean food related commodities]. First off, if you meant to say that, it would have been more accurate to say you expect commodities to fall in value by 23% (commodities are exchange traded in USD) vs the dollar. In that case, I agree - there would be less pressure to change the peg. But where would a 23% drop in price of a real, non GDP growth related asset come from in an environment of increasing risk aversion and a strong incentive of developed economies to monetize their sovereign debt?
I appreciate you are just "thinking - but not too much" about this trade, but I would really suggest you think through ideas like these a bit more before you post them in such a public forum with a sensationalist headline.
- Not linked to Pershing Square but in a similar field of work

Anonymous said...

Just to clarify - 2nd sentence of course should read "USD exchange rate of 1:6" instead of 16.

pej said...

Hi Not-linked-to-Pershing-Square-but-in-a-similar-field-of-work Anonymous commentor :-)
Sorry for the reading comprehension issue. Mea Culpa. It doesn't change anything about the overal picture though.

A1) Against most currencies indeed. It doesn't really matter how you define that basket in my opinion as I see no currency which will be able to resist the rise of the USD in the short to mid-term. Maybe the JPY, but the collapse of the JPY is also getting nearer and nearer. One thing you seem to not have properly grasped is that the Yuan's pseudo-peg to the USD is not a free lunch. It requires active buying/selling of USD/CNY by the Chinese central bank. So, if the USD rallies and China wants to keep the peg (at some point, they will probably give up on that, as their currency is overvalued in my opinion...) then the effect will be highly deflationary in China. In this case, I believe that prices would fall in China in CNY terms, in HK in HKD terms and in the US in USD terms: if you want your currency to rise, you have to sell your reserves and buy back your currency, and remove it from circulation.
A2) You also need to remember that the inflation problem is a far bigger problem in China, and there has been many reports showing that people from Mainland China are traveling to HK to do their grocery shopping! I admint that I don't know what China will do, but I'm guessing they will have to act before HK.
A3) The problem in HK has less to do with price food price inflation that real estate bubble and massive monetary expansion lead by the banks' credit expansion. This will not be solved by a revalution of the USD peg.
B) I don't mean just food commodities, I mean oil, copper, etc. on top of softs/grains/etc. It looks like you are on the wrong side of the inflation/deflation debate. Monetary+Credit inflation is clearly behind us now, and a global Japanification has already started, but with sovereign defaults on top.

I don't consider that I am way off based. I think the raise of the USD and its consequences have not been properly factored into Bill's assumptions, and it's a fatal flaw into his inputs. The trade remains a low risk high gain one, but the probability of making the profits are not as high as Bill seems to believe.

I'm happy to discuss with you online or offline, it's always interesting to have different views and exchange ideas.