> Curiously, the United States, the world's largest debtor nation
>(carrying US$20,000 of national debt per capita), with two-thirds of all US
>currency being held overseas, with chronic budget deficits until this year
and
>a history of volatile fluctuations in the floating exchange rates of its
>currency, is considered the safest haven from economic turmoil because of
its
>perceived political stability and the size of its domestic economy. On
the
>opposite end, Hong Kong, with its huge foreign exchange reserves, perennial
>budgetary surpluses and zero sovereign debt, has repeatedly seen its
>solidly-backed currency under relentless attack in a market artificially
fixed
>by a peg to the US dollar.
That's not curious, but represents the crucial factor. The US and other large developed countries enjoy a level of confidence that Asian ones do not. This may in part be irrational, but it also reflects the fact that most international investors are based in US and Europe, are much more familiar with their economies and political systems, and attach a higher "country risk" to places they don't know well.
>Hong Kong's currency board mechanism is itself an open admission of no
>confidence in its own currency. With a currency board mechanism, Hong Kong
>pledges to exchange HK dollars at a fixed rate to the U.S. dollar and holds
>110% equivalent US dollars in reserve for each HK dollar in circulation.
In fact, 800% (and without considering the land fund, recently merged with the exchange fund).
> This
>currency peg requires local interest rates to track U.S. rates, plus a
country
>risk premium which is determined in part by the market's view of the
economic
>viability of the peg rate. The Hong Kong government also holds most of its
>surpluses in US dollar-denominated instruments. These arrangements
represent a
>loud and clear declaration that the US dollar is a sounder currency than
the
>Hong Kong dollar. One can expect such a discriminatory attitude from the
>former British colonial government, but one is at a loss to understand why
a
>new Hong Kong SAR under Chinese sovereignty would feel the need to hang on
to
>such a self-defacing political posture.
Aw come on, this is empty economic nationalism (that Lenin, for one, would seriously frown upon...). Remember that the issue presently tackled is reassuring the foreing investors, not inflating the domestic nationalistic pride: of which, thankfully, the average Hongkonger seems to think much the same as Dr. Samuel Johnson ("the scoundrel's last resort").
[...]
> De-linking only means that the HKMA will become a true central
>bank, free to manage HK?s monetary policy to suit the needs of Hong Kong,
by
>setting interest rates and liquidity independent of other government
policies.
>Market conditions will then set the proper value of the HK dollar in
response
>to the monetary policy and economic fundamentals of Hong Kong.
Or to the political pressures "du jour".
>Taiwan and Singapore both devalued their currencies early in the currency
>turmoil in 1997, by approximately 18%. Timely devaluation gave both these
>governments more flexibility in dealing with the impact from the crises in
the
>region. As a result, the economies of Taiwan and Singapore are less
adversely
>impacted by contagion. China is impacted less directly and immediately
because
>its economy is not open, but Chinese export will be adversely affected.
Hong
>Kong, being open and liquid with a fixed currency peg, is experiencing the
>beginning of an inevitable meltdown that will continue until the peg is
>abandoned.
Henry, Taiwan has currency controls, and Singapore is, in terms of asset deflation, in bigger trouble than Hong Kong. Besides, the real difference is that both have a sizeable manufacturing sector whose competitivity is enhanced by devaluing; Hong Kong does not, as most of its factories are now located in China.
[...]
>In contrast, Hong Kong export of $197.2 billion constitutes 121% of its GDP
of
>$163.6 billion (1996), and HK import of $217 billion constitutes 130% of
its
>GDP. It is obvious that a rupture in world trade will impact Hong Kong
>differently than the U.S. While Hong Kong has no viable alternative to
total
>dependence on trade, it should bear in mind that it is now part of China,
and
>that Hong Kong's national interest is part and partial of that of China
where
>the issue of trade policy in relation to national independence has not been
>definitive resolved.
Half of China's exports pass through Hong Kong: that's why HK needs China, and China needs HK. Henry, you have been living for many years abroad, and appear to have a romantic view of the relationships with your country: sometimes succumbing to the nationalistic humbug that the Chinese government is using as main claim to legitimacy, since they mothballed communism. But let me tell you that, from what I see here, the real relationship between HK people and the government of China is based on healthy doses of cynicism on both sides. It reminds me of Shakespeare, Sonnet CXXXVIII:
When my love swears that she is made of truth I do believe her, though I know she lies, That she might think me some untutor'd youth, Unlearned in the world's false subtleties. Thus vainly thinking that she thinks me young, Although she knows my days are past the best, Simply I credit her false speaking tongue: On both sides thus is simple truth suppress'd. But wherefore says she not she is unjust? And wherefore say not I that I am old? O, love's best habit is in seeming trust, And age in love loves not to have years told: Therefore I lie with her and she with me, And in our faults by lies we flatter'd be.
>When capital is mobile, governments are able to enjoy the benefits of fixed
>exchange rate stability only if they are willing to forego the empowerment
of
>managing the economy through the setting of domestic interest rates and the
>supply and liquidity of money. This means when global capital flow into a
>country, local interest rate will fall, sometimes to negative rates,
distorting
>the orderly development of the affected economy. For example, beginning in
the
>mid-1980's, Hong Kong's currency board mechanism created persistent
negative
>local interest rates, causing abnormal investment flows into the property
>sector, resulting in unrealistic price inflation that became a major
problem in
>the current downturn.
Negative _real_ interest rates. Nominal interest rates were still positive.
> Conversely, when investors begin to pull out of a country
>or sell its currency, local interest will have to rise to counter the flow
in
>order to maintain the exchange rate peg.
No they don't "have to": they rise only if there is resistance to the conversion from local currency and reference currency. Open the tap, and the differential of pressure drops to almost zero. HK may afford to open the tap, with reserves eight times M0: and that's precisely what happened after the "seven measures" in September (and would have happened before if only the HKMA hadn't deviated from a pure currency board arrangement).
> This invariably weakens the banking
>and financial system, eventually causing bank failures and institutional
>bankruptcies. This happened to Hong Kong in October 1997, with disastrous
>long-term consequences that are yet to unfold fully. Hong Kong will be
plagued
>by excessively high interest rates until the currency board mechanism is
>abandoned or until the US dollar falls. There will be no sustainable
long-term
>economic recovery for Hong Kong until the HK Monetary Authority regains its
>power to set monetary policies.
This is much too pessimistic: it's just because Hong Kong has an economy overwhelmingly based on external trade and financial services that domestic Keynesian stimulus is useless. Instead, investors confidence is of paramount importance, and the line followed so far is proving succesful in that direction: the stockmarket has recovered sharply and the property prices are inching up again. In any case, no commercial bank has failed yet. Some brokerages and investment banks did, but the largest case (Peregrine) was caused by Indonesia's devaluation, not to HK's peg.
[...]
>One way for a country to deal with currency risks is through sensible
>macroeconomic management by adopting sound monetary and fiscal policies. By
>maintaining the fixed peg of its currency to the US dollar through a
currency
>board mechanism, Hong Kong, and other economies that maintain a peg, closes
>theirselves on this option of monetary autonomy.
But as I said, macroeconomic management (in our case, pump-priming the domestic demand) requires a sizeable domestic economy. And that's not HK's case.
>The second way is make sure banks are well regulated and capitalized. In
this
>area, Hong Kong claims to have a well regulated banking system although the
>financial sector in Hong Kong consists of large numbers of non-deposit
taking
>institutions that are only minimally regulated by the HKMA.
Well, as the biggest offenders are ITIC's and similar mainland entities, this issue should be best resolved north of the border (I must say that some cleaning work is now being initiated, kudos to Mr. Zhu). Besides, M3 in HK is not much bigger than M2, which makes me think that non-bank deposits aren't that large (at least, the registered ones ;-) )
>The third way is to restrict the opening to international capital flow. As
an
>international financial center, this is not a viable option for Hong Kong.
Yet
>as part of China, Hong Kong has a responsibility to coordinate with China,
its
>largest trading partner (36.3%), to effectuate a capital flow regime that
best
>serve the national interest.
But it is! China has been keeping the Renminbi pegged to the USD for several years, so HK should peg as well, no?
> The peg worked for Hong
>Kong in the last 14 years because British colonial Hong Kong was an outpost
of
>the American sphere of influence during the Cold War, and as such, was part
of
>the American economic system.
In fact, the reason why John Greenwood suggested the USD in 1983 was that the US were then the largest trading partner. Nowadays China is - but as supplier, not buyer. Chiana is also a substantial investor, but a sort of captive one, in a sense: if they don't show confidence in HK, who will?
> That geopolitical context has changed since July
>1, 1997. Hong Kong's leaders need to acknowledge this fundamental change
in
>order to lead Hong Kong into a self-determining future in which the people
of
>Hong Kong can prosper by controlling their own destiny and by casting their
lot
>and keeping their faith with their brothers in the rest of Asia.
Then, why does China keep her currency pegged to the USD ?
Enzo