Wednesday, June 13, 2012

Hong Kong's currency peg

The Hong Kong dollar is "pegged"* to the US dollar at the rate of HKD 7.80 = USD 1.00 since 17 October, 1983.

From time to time the peg has been put under pressure - either upwards (as happened a few years ago) or downwards (as happened in the Asian crisis. Given the size of Hong Kong's fiscal reserves relative to the size of the economy, it is a reasonably safe bet that if the peg is ever removed (or adjusted) it will most likely be a voluntary action on the part of the Hong Kong government rather than something imposed by market forces.

But from time to time calls are made for the peg to go with the usual argument being that the peg has the effect of raising inflation (during the Asian crisis/SARS it was blamed for deflation). While the peg does (obviously) affect inflation in Hong Kong, to my mind that is a cheap price to pay for the volatility that would come from a freely floating currency. Joseph Yam (former head of the HKMA) is the most recent person to call for the removal of the peg. (A number of people have commented that his comments on the peg are a weak attempt to divert attention away from the misguided political criticism he took in connection with the minibond saga, but that is another story).

My own HK$0.02 worth is that Hong Kong has benefited from the peg and it is better to keep it - stability, low interest rates, financial safe harbour status and other benefits all flow from the peg. The impact (upwards or downwards) on CPI is a very small price to pay for these benefits.

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