The exchange rate system in Hong Kong

1
The exchange rate system in Hong Kong

• Linked exchange rate system

2
Hong Kong is a

• Trading Centre
• International Financial Monetary Centre
• What is the reason make Hong Kong so Successful?
• The Linked exchange rate system

3
History of Exchange Rate System in Hong Kong
Date Exchange rate regime Reference rate
1863 4 Nov 1935 Silver Standard Silver dollars as legal tender
Dec 1935 Link to Sterling 1 HK16 (Dec 1935 Nov 1967)
Link to Sterling 1 HK14.55 (Nov 1967 Jun 1972)
4
History of Exchange Rate System in Hong Kong
Date Exchange rate regime Reference rate
6 Jul 1972 Link to the US dollar with 2.25 intervention bands around a central rate US1 HK5.65 (Jul 1972 Feb 1973)
Link to the US dollar US1 HK5.085 (14 Feb 1973 Nov 1974)
5
History of Exchange Rate System in Hong Kong
Date Exchange rate regime Reference rate
25 Nov 1974 Free float Exchange rates on selected dates US1 HK4.965 (25 Nov 1974) US1 HK9.600 (24 Sep 1983)
17 Oct 1983 Link to the US dollar US1 HK7.80
6
History of Exchange Rate System in Hong Kong
7
What is Linked Exchange rate System?

• Currency broad system
• Pegged the Hong Kong Dollar to the USD at the
  rate of 7.80
• Two exchange currency markets in HK (Exchange
  Fund and open market )

8
Ways to fixed the exchange rate at HK7.8 US1

• Arbitrage activities
• Different in the price of a good in different
  market
• Buy the product at the lower price market
• Sell it at the higher price market
• Two kinds of arbitrage activities in exchange
  rate system
• Interest rate arbitrage
• Currency arbitrage

9
Interest rate arbitrage

• Determined by demand and supply
• Speculation against HK Dollar
• Demand for HK Dollar would then decrease
• HK Dollar would depreciation against USD in open
  market
• Domestic interest rate would rise and this would
  attract back the funds
• Demand for the HK Dollar would rise
• Exchange rate would be stabilized

10
Interest rate arbitrage

• Speculation for HK dollar
• Demand for HK dollar would rise
• Exchange rate of HK dollar to US dollar would
  increase in open market
• Domestic interest rate would then fall
• Demand for HK dollar would fall
• Exchange rate of HK dollar would be stabilized

11
Currency arbitrage

• Exchange rate of HKD fall in open market
• Exchange rate fixed in the close market
• Different of HKD to USD in open market

12
How does bankers gain profit?

• Sell USD for HK Dollar in open market
• Sell HK Dollar for USD in Exchange Fund
• Exchange rate of HK Dollar for USD would be
  stabilized

13
Why the linked exchange rate system important to
HK ?

1. Suits the needs of a highly open economy such as
   Hong Kongs
2. Enables Hong Kong to adjust to shocks without the
   damage and volatility of a sudden currency
   collapse

14
Why the linked exchange rate system important to
HK ?

• Provides Hong Kong with a firm monetary
• Reduces the foreign exchange risk faced by
  importers, exporters and international investors

15
The effectiveness of the Linked is helped by a
number of economic attributes enjoyed by Hong
Kong

1. The structure of Hong Kong economy is flexible
   and responsive
2. Hong Kongs banking system is strong and solvent,
   and well able to deal with the fluctuations in
   interest rates

16
The effectiveness of the Linked is helped by a
number of economic attributes enjoyed by Hong
Kong

1. The Hong Kong Government pursues a prudent fiscal
   policy
2. Hong Kong possesses ample foreign currency
   reserves for supporting the Linked Exchange Rate
   System

17
Advantages of the Linked Exchange Rate System

• Provides a stable, predictable and well
  understood monetary system
• Suited to Hong Kongs highly external and
  flexible economy
• To its position as an international financial
  centre

18
Advantages of the Linked Exchange Rate System

• Enables Hong Kongs economy to adjust to external
  shocks without the damage
• Volatility of a sudden currency collapse
• Provides Hong Kong with a firm monetary anchor
• Reduces the foreign exchange risk

19
Advantages of the Linked Exchange Rate System

• The Hong Kong dollar exchange rate has remained
  stable in the face of various shocks
• Unaffected by the 1987 stock market crash

20
Advantages of the Linked Exchange Rate System

• Stable Hong Kongs economy in the face of
  external shocks without the damage and volatility
  of a sudden currency collapse

21
Advantages of the Linked Exchange Rate System
22
Advantages of the Linked Exchange Rate System

• the price level of Hong Kong has been
  exceptionally stable
• There had been an increase more than 10 in price
  level five times (1973, 1974, 1979, 1980 and
  1981) a year within the twenty years

23
Disadvantages of the Linked Exchange Rate System

• Ties Hong Kong to US monetary policy
• The economy of Hong Kong is directly affected by
  the monetary policy of US and US Dollar
• The business cycle of Hong Kong and US might not
  be indifferent

24
Disadvantages of the Linked Exchange Rate System

• In 1998, Hong Kong was facing a depression and a
  high unemployment rate
• Hong Kong Government might increase the money
  supply of Hong Kong Dollar
• Reduce the price of goods in Hong Kong

25
Disadvantages of the Linked Exchange Rate System

• To increase the export and decrease imports
• Theoretically, flexible exchange rate system
  should be used

26
Disadvantages of the Linked Exchange Rate System

• But, US Dollar was appreciating
• Restricted Hong Kong government to change the
  money supply
• Obstructed the speed of recovering in Hong Kong
• A great matter when Hong Kong and US are in alien
  business cycles

27
Disadvantages of the Linked Exchange Rate System

• Reduces Hong Kong's ability to deal with external
  shocks
• HKMA surrenders its power to adjust the
  territory's monetary policy to the U.S. Federal
  Reserve
• The currency crisis in Southeast Asia in 1998,
  could lead to excessive financial market
  volatility whenever there are speculative attacks
  on the Hong Kong dollar

28
Forecast
29
Should the exchange rate system be changed to
float?

• For
• The HKMA can get back the independence of
  monetary policy
• HKMA can use suitable policy to stabilize the
  Hong Kong economy
• The Hong Kong monetary policy has to follow that
  of US under the linked
• Use the same monetary policy may cause serious
  problems

30
Should the exchange rate system be changed to
float?

• Against
• The economy in Hong Kong may greatly fluctuate
• Price level fluctuated greatly in 1970s 80s
• Lots of money flows in Hong Kong everyday

31
Should the exchange rate system be changed to
float?

• HKMA does not have necessary monetary instruments
• The policy of controlling money supply

32
Should the exchange rate system be changed to
float?

• The necessary conditions of changing the system
• HKMA has the full necessary monetary policy
• Do not let the market entirely freely operate
• Notice the change suddenly

33
Conclusion

• The exchange rate system of Hong Kong has been
  improving
• Stabilize the Hong Kong economy
• Brings a basis of being an international
  financial centre
• There will not be a change in the system in the
  following few years

34
The End