Foreign Exchange Market

Yam's call to ditch the HK$ peg doesn't stand scrutiny

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


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Joseph Yam Chi-kwong thinks Hong Kong should ditch its long-standing currency peg to the US dollar.

Instead, the former Hong Kong Monetary Authority (HKMA) boss is proposing that the Hong Kong dollar should be managed in a flexible 'corridor' against either the US dollar, the yuan, or perhaps an undisclosed basket of currencies.

For someone who spent 26 years of his career defending the peg against all comers, this is quite a turnaround.

As a result, Yam's suggestions, outlined in a paper published yesterday by Chinese University, are certain to spark a fresh debate about the future of the Hong Kong dollar.

Yet dig a little deeper into Yam's arguments for a change, and it soon becomes apparent that they don't stand up well to close scrutiny.

Frankly, you'd expect tighter reasoning from someone whose salary as HKMA chief executive was greater than those of the chairman of the US Federal Reserve, the president of the European Central Bank, the governor of the Bank of Japan and the governor of the Bank of England combined.

In his paper, Yam laments that Hong Kong's currency peg ties the HKMA's hands, preventing it from tinkering with the city's monetary policy settings in pursuit of low inflation, full employment and stable economic growth.

Yet there is no reason to believe that abandoning the peg would help us achieve any of those objectives.

Despite what Yam says, ditching the peg - which prizes exchange rate stability to the exclusion of other policy objectives - in favour of a monetary regime, which pursues domestic price stability, is unlikely to do anything to bring down our inflation rate.

If you don't believe that, just take a look at the chart below, which plots Hong Kong's consumer inflation rate against Singapore's.

Now, as it happens, Singapore operates exactly the sort of currency regime that Yam is suggesting for Hong Kong: a managed float against an undisclosed basket of currencies, with a trading band that is adjusted periodically to try to contain imported inflation.

And guess what - as the chart shows, over recent years Singapore's inflation rate has hardly differed from Hong Kong's.

(Yes, I know there was a nasty spike upward in the middle of last year, but that was caused almost entirely by the Hong Kong government's ham-fisted attempts to alleviate inflation. Strip those out and the correlation is even closer.)

Much the same goes for growth and employment. It's true that over recent years unemployment in Singapore has tended to be a fraction lower than in Hong Kong, and growth slightly higher, but the difference is due to demographic factors. On the whole, there is little to choose between the two cities.

So Yam's assertion that Hong Kong could benefit by ditching the peg and adopting an independent monetary policy simply doesn't stand up to examination.

His other main objection to the peg - that it is incompatible with Hong Kong's role as an offshore financial centre for China - doesn't make much sense either.

The yuan may be increasing in importance as a currency for trade settlement. But financial flows dwarf trade flows, and in financial terms, the yuan is a pygmy.

The US dollar, meanwhile, is a giant, used in 85 per cent of international financial transactions, according to the Bank for International Settlements. As a result, it makes far more sense for Hong Kong, as a financial centre, to hitch its currency to the US dollar than to the yuan.

That may change in the long run. But even so, Hong Kong's existing peg would still have one other great advantage over Yam's suggested alternatives: it operates on automatic pilot, free from political interference. That lends it enormous credibility.

Given that decisions to change exchange rate regimes are always political, ditching the peg in favour of another mechanism would severely undermine international confidence in Hong Kong as a financial centre free from political meddling.

As a result, we can only hope that Yam's suggestions for replacing the peg meet with as much success as his last big idea: backing Henry Tang Ying-yen as Hong Kong's next chief executive.