Hong Kong's Link to the US Dollar

Hong Kong's Link to the US Dollar: Origins and Evolution

John Greenwood
Copyright Date: 2008
Pages: 320
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    Hong Kong's Link to the US Dollar
    Book Description:

    Hong Kong's Link to the US Dollar covers the origins of the city's currency crisis in 1983, the initial resolution of the crisis by creation of a traditional currency board, the subsequent problems leading to the Asian financial crisis of 1997-98, and the later reforms. The epilogue traces Hong Kong's monetary developments between 1990 and 2005. This valuable compendium of articles, originally written in the bimonthly journal Asian Monetary Monitor during the years 1981-89, includes the key article that formed the basis for the Hong Kong government's decision in 1983 to peg the currency to the US$, as well as other important documents of historical record. The main contribution of the book is its detailed monetary analysis of Hong Kong's unique financial system before and after the currency crisis of 1983. The book explains the collapse of the floating HK$ under the pressure of capital outflows during the Sino-British negotiations (1982–84) over the future of Hong Kong, the fascinating story of the introduction of the linked rate system pegging the Hong Kong dollar to the US dollar, and the subsequent gradual process of reform and refinement of the currency board mechanism (1988–2005). Each chapter is preceded by an introductory narrative that puts the analysis in its historical context and places the economic argument in perspective. Hong Kong's Link to the US Dollar will enable readers to obtain a comprehensive picture of why the linked rate system was put in place, how it works, and why it has been strengthened over the years.

    eISBN: 978-988-8052-34-9
    Subjects: Business

Table of Contents

  1. Front Matter
    (pp. i-iv)
  2. Table of Contents
    (pp. v-vi)
  3. List of Appendices and Boxes
    (pp. vii-viii)
  4. List of Charts, Tables and Figures
    (pp. ix-xii)
    (pp. xiii-xvi)
    Charles Goodhart

    The monetary crisis in Hong Kong, starting in September 1982, following Mrs. Thatcher’s failed visit to Beijing, and culminating in September/October 1983, threatened both the economic and the political identity of this unique city. It was, of course, primarily a politically induced crisis. Mrs. Thatcher had gone to meet Deng Xiaoping to try to renegotiate and to extend the lease on the New Territories of Hong Kong. She was turned down. Without the New Territories it was generally agreed that Hong Kong would not be a viable entity; so the ending of the lease, in 1997, would effectively mean the...

    (pp. 1-4)

    This book contains a selection of articles written in the bimonthly journal Asian Monetary Monitor during the years 1981–89. The focus of the journal, as its title implies, was the analysis of contemporary monetary issues in the East Asian economies from Japan down to New Zealand and across to India. The particular selection in this book concentrates on Hong Kong’s monetary crisis and its solution during the decade of the 1980s. Chapters 1 to 5 focus on the developing crisis in Hong Kong during the years 1981–83. Chapters 6 to 10 trace the initial resolution of the crisis...

    (pp. 5-14)

    Starting in January 1977 the trade-weighted index of the Hong Kong dollar began a persistent decline lasting almost four years, interrupted only by a brief upturn in 1979–80. This shows that the currency depreciation began long before the Sino-British negotiations over the future of Hong Kong in 1982–83, and could not be due simply to a flight of capital following Margaret Thatcher’s visit to Beijing in September 1982. Considering the contrast with the sustained strength of the Hong Kong currency between 1972 and 1976, the depreciation posed some serious questions: was there something fundamentally wrong with the Hong...

    (pp. 15-36)

    Between the publication of this article and the preceding one the HK$ had fallen further against the US currency. There could now be no escaping the conclusion that there was something seriously amiss with Hong Kong’s monetary arrangements. But, far from addressing the causes of the problem, the authorities appeared to be tackling only the symptoms by intervening in the foreign exchange markets to support the local currency. Normally such intervention ought to succeed if it was supported by other policy measures, but it was quite clear to me that — given Hong Kong’s institutional structure — such measures could not possibly...

    (pp. 37-50)

    Between 1980 and 1982 the developed world experienced two back-to-back recessions, with the US having recessions from January 1980 to July 1980, followed by another from July 1981 to November 1982 according to the National Bureau of Economic Research. Not surprisingly this led to a sharp downturn in Hong Kong’s external trade, as reflected in the original title of this next article. Of more significance, perhaps, from the standpoint of elucidating the monetary mechanism at work in Hong Kong was that the trade downturn was accompanied by an abrupt slowdown in monetary growth. If previous articles had given the impression...

  10. CHAPTER 4 HONG KONG’S FINANCIAL CRISIS History, Analysis, Prescription (November–December 1982)
    (pp. 51-100)

    In September 1982 Margaret Thatcher made her infamous visit to Beijing to discuss with Deng Xiao-ping and other Chinese leaders the future of Hong Kong after June 30th 1997, when the British government’s lease over Hong Kong’s New Territories was due to expire. From the viewpoint of the people of Hong Kong the visit went badly. Not only had Margaret Thatcher tripped and fallen on the steps of the Great Hall of the People in Tiananmen Square — an ill omen in Chinese eyes — but following these discussions Sir Geoffrey Howe, the British Foreign Secretary, had confirmed in Hong Kong that...

  11. CHAPTER 5 HOW TO RESCUE THE HONG KONG DOLLAR Three Practical Proposals September–October 1983
    (pp. 101-136)

    This is the article written at the height of the HK$ currency crisis in September 1983 that ultimately formed the basis for the government’s plan for a return to a currency board mechanism in October 1983. As a development of the arguments previously put forward in AMM for a reform of Hong Kong’s monetary system (e.g. in Chapter 4), the main innovation is the fuller treatment of the case for a currency board arrangement — the third proposal (called 2B in the article).

    One part of the story concerns the origins of the third proposal (for a return to a fixed...

    (pp. 137-168)

    This chapter looks back on how the HK$ was stabilised in October 1983. The six appendices (pp. 157– 167) reproduce some of the key documents of record in the stabilization process, and a memorandum from the author addressed to the Financial Secretary dealing with arrangements that might have been necessary if the new scheme had been implemented immediately with “full convertibility” for the public of their HK$ deposits into US$ (or other currency), instead of waiting three weeks and not providing convertibility to the man-in-the-street.

    The main body of the article presents a combination of theoretical discussion and historical narrative...

    (pp. 169-182)

    By late January 1984, three months from the implementation of the new currency board in October 1983, the linked rate system for the HK$ had settled down and appeared to outsiders to be working tolerably well. The spot exchange rate was holding close to the official parity of HK$7.80, HK$ interest rates had fallen below those for US$, and renewed confidence in Hong Kong was shown by a resurgence in the demand for HK$-denominated money supply. It was therefore appropriate to step back and examine more deeply how the new mechanisms were working, and to examine some possible scenarios for...

    (pp. 183-202)

    This article presents an analytical view of the bene fits and costs of the move to a fixed exchange rate in October 1983, and then deals with three alternative proposals intended to solve Hong Kong’s monetary problems. Implicitly the point is that no system is perfect — there are costs and benefits in any monetary system. One box discusses partial convertibility versus full convertibility (on pp. 188– 190), and another offers an early critique of the interest rate agreement (pp. 192–194) as it operated at that time. The interest rate discussion follows on from the statement in the final paragraph...

  15. CHAPTER 9 ADJUSTING TO THE LINK July–August 1985
    (pp. 203-216)

    This article, written two years after the linked rate had been established, attempted to provide an overview of how the economy was adjusting to the new framework. Section 1 addresses the adjustment of prices in Hong Kong relative to prices in the US and the OECD as a whole. Section 1 makes the claim that within about 18 months most of the price adjustment to the new exchange rate had been achieved. Interestingly, in view of the divergence of CPI inflation in Hong Kong and the US that came later, the discussion omits any mention of the Balassa-Samuelson effect, the...

  16. CHAPTER 10 NEGATIVE INTEREST RATES A Comparison of the Hong Kong and Swiss Schemes January–February 1988
    (pp. 217-226)

    It was not only the contributors to AMM who worried about the performance of the restored currency board mechanism. The authorities were clearly troubled by some elements of the new system. Although broader performance measures of the economy such as economic growth and inflation were satisfactory, in the foreign exchange market the system was not producing an exchange rate that was either stable enough or close enough to the official HK$7.80 parity to be able to leave things entirely to market forces.

    In 1986–87, partly due to the variability of the spot rate for the HK$/US$ relative to the...

  17. CHAPTER 11 INTERVENTION REPLACES ARBITRAGE The July Package of Monetary Measures July–August 1988
    (pp. 227-248)

    The July 1988 package of new accounting arrangements for the Hong Kong monetary system represented the first major change in the design of the system since 1983. These measures were the official response to some of the defects in the original template as set out in AMM, but they also set a new direction. In the early years after 1983 the authorities and the Hongkong and Shanghai Banking Corporation (HSBC) had cooperated in intervening to support the HK$ market exchange rate, but if the design of the system had been adequate in the first place, such intervention should not have...

    (pp. 249-258)

    This final article from AMM describes the response of the currency board mechanism in Hong Kong, as amended by the new accounting arrangements of July 1988, to the crisis in Beijing surrounding the Tiananmen Square demonstrations of May/June 1989. Using the terminology of Chapter 7, there was both an “internal drain” (in the form of a withdrawal of funds from the Bank of China) and an “external drain” (an outflow of funds through the sale of HK$ for foreign currencies). The article provides detail about how these events impacted the Hong Kong monetary system — the response of the authorities, interest...

    (pp. 259-292)

    The selected AMM articles in chapters 1–7 showed how the fundamental flaws in Hong Kong’s monetary system in the 1970s and 1980s were identified, brought to the notice of academics, bankers, investors and the Hong Kong authorities, and eventually addressed after the dangerous run on the currency in September 1983. Chapters 8–12 traced some of the subsequent debate about why the automatic adjustment mechanism did not appear to be acting as efficiently as had been intended in keeping the free market rate for the HK$ at or close to the official parity of HK$7.80 per US$, and the...

  20. Index
    (pp. 293-304)