Speculators: The Play Is a Fantasy; Traders are betting that the Hong Kong dollar will come unstuck from the greenback, but we've seen this fail before.(foreign exchange outlook)(Cover Story)

Byline: George Wehrfritz (With Alexandra A. Seno in Hong Kong)

They're back! Those soulless movers of hot money who toppled Asian currencies in 1997 are again betting that the Hong Kong dollar will abandon its long-held peg to the greenback. Most analysts say the gamblers could get slammed as hard as they did when the government aggressively defended its currency in 1997. Nonetheless, speculation has prompted a real debate on the Hong Kong dollar's future, with implications for the city's financial independence and the pace of its integration with a rising China.

For now, Hong Kong's dollar remains a rock. Pegged at 7.78 to one U.S. dollar when the city's former colonial rulers abandoned a floating rate to quell runs on local banks in 1983, it hasn't budged since. Nonetheless, billions in hot money have coursed into Hong Kong's banks, stocks and real estate of late on the logic that the local dollar is now a proxy for China's yuan. With Chinese exports booming, the thinking goes, Beijing could soon succumb to foreign pressure to lift its artificially weak currency, perhaps by 5 to 6 percent. Since they can't buy the protected yuan, traders are buying the Hong Kong dollar on the hope that it would follow the yuan upward.

Most leading economists reject that analysis. Andy Xie of Morgan Stanley calls it a "fantasy trade" and predicts a rerun of 1997, when traders lost billions betting that the Hong Kong dollar would collapse. Xie blames hedge-fund managers in places like New York who "look at a map, see that Hong Kong is next to China and bet long on the Hong Kong dollar." He adds: "That sounds like a farce, but it's true." Dong Tao of Credit Suisse First Boston says that "while the market considers the Hong Kong dollar a proxy, I don't," citing "very different fundamentals." While ...