Is ditching US peg a basket-case idea?
To peg, or not to peg? Would a basket really be better? What about a free float?
Former Monetary Authority (HKMA) chief executive Joseph Yam Chi-kwong put a cat among the pigeons when he called for a review of Hong Kong's linked exchange-rate mechanism.
While government officials were quick to defend the 29-year peg of the Hong Kong dollar to the US dollar, Yam's comments reignited debate over whether it was time for a change - even possibly following the trail blazed by arch-rival Singapore and pegging our dollar to a basket of currencies.
Critics say the peg means Hong Kong has to follow the lead of the US Federal Reserve, and cannot lift interest rates to squeeze out inflation if the Fed is keeping rates low.
But Yam's replacement, HKMA chief executive Norman Chan Tak-lam, for one, does not like the Singapore model, saying Singapore has a problem with inflation despite using a basket.
Tim Condon, ING Bank's Asia research head and a former external adviser to the HKMA-funded Hong Kong Institute for Monetary Research, agrees.
Singapore and Hong Kong had the highest inflation in Asia, at 5.6 per cent and 5.2 per cent despite their starkly different currency regimes, he said.
'The currency-basket approach is of doubtful value to Hong Kong,' he said.
'It requires the central bank to be actively intervening in the foreign exchange market. Central banks prefer the quiet life - and active intervention in the foreign exchange market is not the quiet life.'
Early last century, Singapore's currency was pegged to the pound, then linked to the US dollar in the 1970s before opting for a fixed and undisclosed trade-weighted basket of currencies from 1973 to 1985.
Since 1985, the Singapore dollar has been allowed limited movement within an undisclosed band.
Hong Kong also pegged its currency to the pound early last century, moved to a free float in the 1970s, and adopted the peg in 1983.
If Hong Kong were to ditch the peg so it could set its own interest rates, Singapore should not be its model, Condon said.
In theory, Singapore has the freedom to set its own monetary policy. In practice, its hands are largely tied because of the currency basket. Low interest rates in the US mean low rates in Singapore, not just Hong Kong.
'Linking a currency to a basket is a terrible idea. It has absolutely no sound logical basis,' said veteran banker Chan Tze-ching, former Hong Kong head of Citibank and now a consultant to Bank of East Asia.
For example, most people would say that the currency weightings in a basket should be linked to trade, but 90 per cent of the value of a country's currency was tied to capital, not trade flows, he said.
Chan doubted whether a basket would have made things easier for Hong Kong, given the problems that the peg has sometimes caused over the past 29 years.
'I have never seen a 'basket-linked' currency regime work effectively. In most cases, it is only a smokescreen to disguise policymakers' manipulation of the value of their local currency for political and economic purposes. I have never seen a case of a currency basket that is not arbitrary, inconsistent and secretive,' he said.
But Chan agreed with the need for regular reviews of the Hong Kong dollar peg, because market, economic and political realities changed from time to time.
'It does not mean that change must happen as a result of the reviews, but the exercise avails a platform for rational, educated discussions and debates to take place,' Chan said.
Hang Seng Bank executive director Andrew Fung Hau-chung said using a basket would inevitably mean including the euro in the basket because of the sheer size of the euro zone 'and there is no need to explain why not to peg with the euro'.
'Changing the peg by different options will result in different advantages but with the same risk of uncertainty and unexpected consequences,' Fung said.
He said that when the yuan was freely convertible or enough yuan accumulated in Hong Kong that it was a dominant component of the city's money supply, it would make sense to re-peg the Hong Kong dollar to the yuan or let it float freely.
'It's not possible to peg the dollar to the yuan just yet,' Fung said.
ING's Condon said monetary policy autonomy would be desirable for Hong Kong in times of global or mainland economic downturns.
'I think the fear of floating, of wide swings in the exchange rate, is overstated,' Condon said.
'People seem to able to live with them. What they can't live with is high inflation.
'The modern system seems to be able to deliver low, stable inflation, even with big swings in exchange rate.'
He also argued that a departure from the peg could add to Hong Kong policymakers' toolkit to deal with shocks, like the instability in the euro zone, and further slowing of China's economic growth.
Condon said Hong Kong could not assume that US monetary policy would also be the most appropriate one for Hong Kong. For example, when Hong Kong was battling the Asian financial crisis in 1998, the then Fed chairman Alan Greenspan talked of 'irrational exuberance' in the US economy. He had no intention of easing monetary policy, although that's what Hong Kong needed.
But Singapore was able to weaken its dollar when necessary. In the 2008 global financial crisis, it depreciated the Singapore dollar against the basket by about 3 per cent.
Principal Financial Asia head Rex Auyeung said the peg had served Hong Kong well. 'But we shouldn't compare it to other markets because Hong Kong is unique. We should be asking what's best for Hong Kong rather than saying we have to follow someone else's example.'