John Greenwood, the currency peg architect, reveals biggest challenges
John Greenwood, architect of the peg, tells the Post of the biggest challenges it has faced
The biggest challenge has been to cope with periods when economic activity and other economic conditions in China and the US have deviated very widely - and not just China, but China and the Asian region.
So in the late 1980s and early 1990s, there was a considerable divergence of inflation and growth in Asia versus the US and then there was the Asian financial crisis in 1997-98, which imposed recession and deflation in Hong Kong at a time when the US was very buoyant.
Then more recently we've obviously had the global recession, from which China initially bounced back very quickly and created buoyant economic conditions in Hong Kong.
There was a considerable divergence of inflation and growth in Asia versus the US
But because the US recovery has been more ponderous, there have been interest rates in the US which are too low to be appropriate for Hong Kong, so Hong Kong has had to supplement its normal monetary mechanisms with a variety of what we call macro-prudential controls.
We've had five or six rounds of tightening of loan-to-value ratios and other conditions surrounding mortgage lending in order to restrain credit growth at these very low interest rates which are a product of the pegged rate at a time when ideally Hong Kong would have higher rates of interest rates compared with what is going on in the US.
Those three episodes are typical of the biggest challenges that the pegged rate faces.
The similarity between 1997 and today is that like Thailand, Malaysia, [South] Korea and other economies, both India and Indonesia today have let their discipline slip in the aftermath of the global recession.
Because the balance sheets of the households and companies in those countries - Indonesia and India - were not damaged or in bad shape, those countries were able to lower interest rates quickly in the face of the recession and they bounced back pretty quickly. The banks responded with a very rapid growth of credit, which showed up on the other sides of their balance sheets as a rapid growth in deposits and money.
Both Indonesia and India had rates of money growth in excess of 25 per cent per annum since 2010 and the problems they have encountered are very largely the consequence of that.
If you have excessive growth of money and credit, then you get excess domestic demand and you get consumption and spending in excess of production and a current account deficit. Those countries have had all of that and the sharp weakening of their currencies is a reflection of that. They've also had double-digit inflation.
All of that is a predictable consequence of the failure to maintain a monetary anchor.
In sharp contrast, countries like Korea and Taiwan have not allowed that to happen this time.
Korea, like Hong Kong, has imposed a whole series of macro-prudential controls, though of a different kind, particularly related to the import of capital, and therefore they have prevented a build-up of money and credit and so you have not seen a sharp depreciation in those countries like we have seen in Indonesia and India.
The problems they are facing are in a sense self-imposed because when the global recession happened and interest rates remained very low in the developed countries, there was a flood of money into the emerging countries. The countries that opened their doors and then failed to control the monetary credit growth were in effect asking for trouble and that's just what they have got.
