Jake's View | From a currency board to a banana republic manipulation

Under the peg, the [Hong Kong Monetary Authority] will use its HK$3.3 trillion Exchange Fund to intervene whenever the currency edges close to 7.75 or 7.85.

Business, January 22

The nature of our link to the US dollar has changed a good deal over time. It started as a currency board, an automatic adjustment mechanism. It now looks like a banana republic manipulation.

In 1983 the government’s Exchange Fund committed itself to exchanging US dollars in cash transactions with the two note issuing banks – The Bank (need you ask) and Standard Chartered – at a fixed rate of HK$7.80 to US$1. This was the peg.

The way it then worked is that if there was a big demand for HK dollars, the note issuing banks could print all they wished provided they always paid by placing an equivalent amount in US dollars with the Exchange Fund at a rate of HK$7.80.

If there was a sudden rush out of HK dollars, the two banks would buy in their banknotes, turn them over to the Exchange Fund and get their US dollars back. It’s called interest rate arbitrage.