Panic in Hong Kong – Architect Proposes De-Pegging US & HKG Dollars

In the last 24 hours, Hong Kong has descended into panic. There’s no epidemic. There’s no natural disaster. Judging by the number of front page headlines and panicked writing, it is much, much worse.

Yesterday the former chief of the Hong Kong Monetary Authority proposed Hong Kong de-peg its currency from the US Dollar. Joseph Yam ran the central bank of Hong Kong for 16 years, and retired from the role in 2009. Today he is a professor at Chinese University in Hong Kong – one of the nation’s top institutions.

What he suggested is considered by many to be heresy.

Prior to the early 1980’s the Hong Kong Dollar was unstable . This led to many demanding payment in US Dollars and an overall decline in trust in the local currency. At the time negotiations between Britain and China over the future of Hong Kong led to investor flight. Money was flowing out of the city due to uncertainty. In 1983 the value of the Hong Kong Dollar was pegged (or fixed) to the US Dollar at an exchange rate of US$1.00= HK$7.78.

This stability is achieved by direct market intervention by the Hong Kong Monetary Authority. If the Hong Kong Dollar is depreciating they will step in and purchase large amounts. If it appears to be increasing in value, they will sell large quantities. This commitment ensures traders don’t bet against the Hong Kong dollar. They know any rise or fall is going to be met by government intervention.

This has its side effects. When the US Dollar plunges in value then Hong Kongers find trips abroad and imported European items more expensive. Of course a rising US Dollar makes Hong Kong a more expensive city for tourists.

But despite the rises and falls, the link between the two currencies have provided a degree of stability. So yesterday’s suggestion was the equivalent of a large rock in a small pond. Nobody saw it coming.

“There is a need to address the question as to whether the monetary system of Hong Kong, as currently structured, can continue to serve the public interest of Hong Kong,” Yam wrote in an academic paper titled ‘The Future of the Monetary System of Hong Kong.’

Yam argues that a link to the US Dollar may be out-of-date. Unemployment and plunging US house prices make that country an unsuitable partner given Hong Kong’s location and connections to Chinese and Asian economies.

As one example, the Federal Reserve in the USA has kept interest rates close to 0.0% for the past few years. That was meant to prompt investment in American homes. Meanwhile in Hong Kong the economy is doing very well, thank you. But due to the currency peg, local banks offer home loan rates at levels meant to tempt Americans. It’s caused local home prices to rise by 80% in the last three years.

Yam has re-opened a debate that happens to get resurrected every few years. In 2009 economists called for the Hong Kong Dollar to be pegged to China’s Renminbi. Some called for it to be replaced by China’s currency. Yet in the midst of global market uncertainty yesterday’s recommendations caused havoc.

The research paper findings were delivered in a press conference and news was embargoed until 5:00 pm. Even before the embargo expired local politicians, bankers and Monetary Authority officials were declaring their support for a continued peg. Even the International Monetary Fund threw its support behind the peg.

“The system is ‘simple, credible, transparent, is widely understood, and merits continued support,’ according to an emailed statement.” (Source: Bloomberg)

Professor Joseph Yam published a scholarly research paper yesterday. In that he hoped to open discussion on the future of the Hong Kong currency. Yet given his long-term role as the nation’s central banker, many took his word to be gospel. In the chorus of responses his solo was all but drowned out.

Judging by the near-hysteria that greeted a call to de-peg the Hong Kong and US Dollars, I think we’ll be safe with the current system for a few more years to come.

“The Linked Exchange Rate System has served Hong Kong well over the years, and there is no need for the Government to change it,” Financial Secretary John Tsang, Hong Kong

Caption: Hong Kong Financial Secretary John Tsang in a hastily called press conference supports a continued peg between the US and Hong Kong Dollars.

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