HK dollar pegged to an economic concept well past its use-by date
'There is no such thing as a fixed exchange rate system, it is only a question of how often it changes and with what suddenness.' Joseph Stiglitz, 15 March 2005, Hong Kong
JOE STIGLITZ is a very, very smart guy. If you doubt that, take a look at his CV - all 51 pages of it.
In his time he has been professor of economics at Columbia, Stanford, Princeton, Oxford and Yale, among others. He was chairman of the US council of economic advisers, a job which got him a seat at president Bill Clinton's cabinet table, and chief economist at the World Bank. Oh yes, he also picked up the Nobel prize for economics in 2001 (an honour which rates a mention on only page three of his resume, between fellow of the American Philosophical Society and executive director of the Initiative for Policy Dialogue).
You get the picture: Joe knows his economic onions. So when he says there is no such thing as a fixed exchange rate system, Donald Tsang, Joseph Yam and the rest of the gang would do well to sit up and listen.
If Joe is right - and the historical evidence is certainly on his side - Hong Kong will abandon its currency board one day. The annals of finance are littered with the wrecks of similar pegs, most spectacularly the collapse of Argentina's currency board in 2002. Ditching the peg may be inevitable, but the adjustment need not be as traumatic as Argentina's. It is all a matter of timing. If Hong Kong dumps the peg only when it is forced to, like Argentina, the shockwave will wreak economic catastrophe. But if Hong Kong delinks at a time of its own choosing, when conditions are right, the switch could turn out to be highly beneficial.
The world has moved on since the peg's introduction in 1983. The linked exchange rate may have meant stability then, but today, in the age of globalised financial markets and international speculators out for quick returns, it leaves Hong Kong vulnerable to exaggerated boom and bust cycles.
Take the example of the past couple of years. As expectations grew of a Chinese revaluation, money flooded into Hong Kong from speculators using the local currency as a proxy for the yuan.
Under Hong Kong's currency board, that cash went straight into the banking system, where the weight of liquidity pushed interest rates below equivalent US dollar rates (see chart). As bank lending rates fell, mortgage rates sank to record lows at just a shade above 2 per cent. With financing so cheap, Hongkongers have plunged back into the property market, pushing prices up by 70 per cent since their August 2003 low. The risk now, according to Tim Condon, chief economist for Asia at the Dutch bank ING, is that another bout of yuan speculation will prompt fresh inflows. That would keep mortgage rates low, encouraging further property market speculation just as the authorities would like to cool things off.
'With this amount of hot money floating around looking for a target, a peg is the wrong way to go,' he says.
In another economy, the central bank could simply tap on the market's brakes by raising interest rates a little. But as long as Hong Kong is shackled by the currency board, the authorities will remain powerless to check speculative bubbles in the asset markets and prevent the inevitable subsequent busts. Retaining the peg condemns us to suffer 1997-style crashes over and over again, until the day the exchange rate link is forcibly broken.
Mr Condon argues that the way to ensure stability would be for Hong Kong's government to ditch the peg and float the currency. With command over interest rates re-established, the Hong Kong Monetary Authority could emulate other central banks around the world by adopting a specific inflation target as its core monetary policy aim. The result, he says, would be low and stable inflation, and considerable popular acclaim.
This is a fantasy. Donald Tsang and Joseph Yam earned their laurels defending the peg against speculative pressure back in 1998. There is no way they are about to abandon it voluntarily.
That is a shame, because now will be a good time to dump it. According to the International Monetary Fund, the best time to dismantle fixed exchange rate regimes is when international foreign exchange markets are relatively tranquil, the domestic economy is strong, and when pressure on a currency is for it to appreciate, not fall.
The responsible thing will be to seize the opportunity now, not regret missing it later.