Hong Kong resists breaking the dollar peg
If it ain’t broke, don’t fix it. That’s the reaction in Hong Kong to the suggestion by Joseph Yam that the territory should consider breaking its currency’s 28-year-old peg to the US dollar.
Mr Yam, who ran the Hong Kong Monetary Authority for 16 years until 2009, made waves on Tuesday by proposing that the Hong Kong dollar could be managed in a more flexible fashion against the dollar, renminbi, or a basket of currencies.
Abandoning Hong Kong’s currency board would give policymakers the freedom to adjust monetary policy “to serve the public interest better”, Mr Yam wrote in a paper.
This is quite a statement from a man who spent the bulk of his career defending the peg, which fixes the Hong Kong dollar against its US counterpart at a rate of HK$7.80 and has provided the foundation for sustained economic growth over almost three decades.
For investors and people in Hong Kong, the question is whether Mr Yam’s suggestion will have any bearing on government policy.
On Wednesday, financial markets delivered a clear verdict: no. The Hong Kong dollar did not fluctuate more than usual against the US dollar within its narrow trading band from HK$7.75 to HK$7.85.
Leung Chun-ying, incoming Hong Kong chief executive, said on Tuesday: “The peg has served well to stabilise the financial market and the economy in our small and open economy… there is no need to change the current peg in any way.”
Officials are baffled as to why Mr Yam would question the peg so publicly. Mr Yam said he was simply trying to stimulate debate, although he admitted he was “aware of the possible market sensitivity of my openly raising the subject”. The adviser to the People’s Bank of China said he had not consulted Beijing before publishing his paper.
Few traders doubt the Hong Kong government’s commitment to the peg.
Sacha Tihanyi, currency strategist at Scotiabank, said Hong Kong dollar options volatilities moved higher on Wednesday “but not to the degree of anything that could be considered an unprecedented ‘extreme’ event.”
Erik Lueth, an economist at RBS, said the peg was likely to remain for at least the next 7-10 years. “Yam’s intervention should be read as the views of a man that misses the limelight,” he said.
Critics of the peg dislike the fact that it forces Hong Kong interest rates to follow those in the US – even when the local economy is completely out of sync with the American one.
In recent years, the Federal Reserve’s loose monetary policy has caused Hong Kong inflation and property prices to soar. A decade ago, debate about the peg flared up for the opposite reason: the strong US dollar was forcing prices to deflate in Hong Kong.
But even so, almost everyone in Hong Kong argues that the US dollar peg is the best system for the territory’s small, open economy and that all the potential alternatives have flaws.
No one wants the Hong Kong dollar to float freely, since that would expose the city of 7m people to destabilising foreign exchange volatility. That was why Hong Kong introduced the dollar peg in the first place, back in 1983. The US dollar was chosen as the anchor because it was used – and still is – for the majority of international trade and investment.
Many people expect that one day the renminbi will become the dominant currency in Hong Kong. But pegging to the renminbi is not possible at the moment, because the Chinese currency is not yet fully convertible.
And while Hong Kong’s economy has become increasingly integrated with the Chinese mainland in recent years, it is still more closely correlated with the US and global business cycle than the mainland one.
Analysts say the only realistic alternative to the status quo would be for Hong Kong to adopt a similar regime to Singapore and peg to a basket of currencies, perhaps including the renminbi.
“The problem is that HKMA has no experience and track record in running such a currency arrangement,” says Mr Lueth of RBS. “The transition is therefore a risky undertaking that could invite speculative attacks.”
Advocates of the peg also argue that there is little evidence that adopting a more flexible exchange rate regime would help Hong Kong policymakers tame inflation, the most commonly cited justification for such a move.
Take Singapore. While the island state has a flexible currency regime controlled by policymakers, inflation rates in the city state have been just as high as those in Hong Kong in recent years.
Allowing Hong Kong politicians to alter the exchange rate and monetary conditions would also go against the laissez-faire principles on which the former British colony has built its success.
If Mr Yam’s intention was to stir up debate, he has succeeded. But it has been one-sided. By common consensus, the peg will prevail.