Foreign Exchange Market

Yam stirring up a hornets' nest

PUBLISHED : Wednesday, 13 June, 2012, 12:00am
UPDATED : Wednesday, 13 June, 2012, 12:00am

Since 1983, when pegging the Hong Kong dollar to the US dollar helped soothe frightened members of the public, some of whom had started to demand payment in US dollars, the linked exchange rate mechanism has been sacrosanct.

For many in Hong Kong, changing the peg would be like repainting the ceiling of the Sistine Chapel or turning the Taj Mahal into a shopping mall.

From the time that financial secretary John Bremridge announced that the Hong Kong dollar would be pegged at HK$7.8 to US$1 on October 17, 1983, his successors over the past 29 years have stood by it. This includes current Financial Secretary John Tsang Chun-wah, who yesterday insisted that the government was 'fully committed to maintaining the linked exchange rate system'.

As a result, a call yesterday by former Hong Kong Monetary Authority (HKMA) chief executive Joseph Yam Chi-kwong for a review of the peg stirred up a hornets' nest - particularly since Yam never suggested the need for such a review during his 16-year reign at the helm of the HKMA, which ended in 2009.

'A fixed exchange rate cannot be an end in itself, although it can be an effective tool for achieving a monetary environment that serves well the public interest,' Yam said in an academic paper.

The city's emphasis on maintaining the peg since 1983 boils down to one word: certainty. Although it meant Hong Kong lost control of interest rates and had to follow the US Federal Reserve's every move, businesses and investors have liked the security that the peg offers - particularly during the Asian crisis.

The Hong Kong dollar has had a colourful past. Early last century, it was linked to the value of silver and then to the British pound before being allowed to float freely until the introduction of the peg in 1983.

The peg was born at a time when public confidence was at a low ebb, with many concerned about the possible outcome of Sino-British talks over the future of the-then British administered city after July 1, 1997.

Jitters over a mainland takeover sparked a wave of selling, weakening the local currency to a low of HK$9.50 to US$1 at one point in 1983. Some businesses even refused to accept Hong Kong dollars, insisting on US dollars instead.

Fears of a currency collapse caused shoppers to flood supermarkets to stock up on everything from rice to toilet paper on fears that the weakening exchange rate would bring inflation, pushing up prices.

Back then, Yam was one of the Hong Kong government officials that helped design the peg and has always backed it - until yesterday.

During his time at the head of the de facto central bank, any suggestion that the peg was flawed brought a swift and incisive response from Yam, who vowed there was no need to change the mechanism.

The peg came under renewed fire in 1998, when it helped make Hong Kong an attractive target for speculators at the height of the Asian crisis. Speculators, who had already driven down currencies in Thailand and Indonesia, turned their sights on the Hong Kong dollar by shorting the blue chip Hang Seng Index to spook investors and shake confidence in the currency.

But Yam and Donald Tsang Yam-kuen, who was then financial secretary, spent HK$212.6 billion buying in the underlying Hang Seng Index, effectively squeezing out the speculators, who were sent packing.

After the crisis, the most common criticism has centred on the inflation that the peg inevitably brings because of a weakening US dollar.

Several investment banks speculated in 2008 that inflation might force the HKMA to abandon the peg so that it could set interest rates to choke off inflation.

But at that time, Yam hit back in a weekly column on the HKMA website. In April 2008, he vowed not to change the linked rate system.

'The peg was not the only reason for rising inflation,' Yam wrote, pointing to soaring labour costs as a bigger factor. He said a study by the HKMA had shown that a 10 per cent fall in the US dollar against all currencies would only cause Hong Kong domestic prices to rise 0.82 per cent in the short run and 1.61 per cent in the medium term.

Those words seemed forgotten yesterday, when Yam questioned the peg, and whether the city might be paying too high a cost. 'This is particularly so, when, as widely recognised, inflation in Hong Kong has, at times, been uncomfortably high, and asset bubbles have been a feature of Hong Kong's economic development,' he wrote in his paper.

With inflation hovering around 5 per cent as a result of quantitative easing by the US Federal Reserve, the peg 'must now be questionable'.

David Webb, editor of, said it might be time to change, and either just use the US dollar or eventually the yuan as legal tender when it is fully convertible - although Beijing would probably not allow 'dollarisation'.

Andrew Fung Hau-chung, executive director at Hang Seng Bank, said the peg had helped keep Hong Kong's financial markets stable, rejecting calls for linking the HK dollar to a basket of currencies.