So is this 1983 all over again? The currency breaks, property prices plunge and banks default? Despite protests of prudence, the Government ends up a major shareholder in the local finance industry. Hong Kong is dazed by the speculative onslaught of the past two months. Suddenly, anything seems possible. The mini-run on the International Bank of Asia shows the fragility of confidence in the financial sector. Asset deflation has begun in earnest as the price of defending the peg. Few appreciate just how much it will hurt. With attention focused on speculators and daily market movements, the economic damage from interest rates above 10 per cent is almost lost in the noise. The silver lining remains improved competitiveness from reduced property prices and wage growth. Even in flexible Hong Kong, wages rarely go down. The risk is that the cleansing corrective process gets out of control, threatening the banks. It might yet happen. Hong Kong property prices represent an economic perception of indeterminate value. Easy money pushed them to giddy levels. The new order of high interest rates is a move into the unknown. Good reason to flee the banks? Despite protests of Exchange Fund support, the Government has consistently refused deposit insurance. Hong Kong residents have bad memories of the Bank of Credit and Commerce International collapse. Should property prices fall 50 per cent, bank balance sheets would begin to look ugly. The point is, we are not there yet. IBA has a firm capital base, insignificant Asian currency exposure and a solid mortgage book. Without large-scale mortgage defaults, local banks' asset quality should remain solid. Bank profits might be mauled by high funding costs and reduced loan demand, but insolvency is not yet a possibility. Since 1983, supervision has dramatically improved. The Hong Kong Monetary Authority constantly monitors banks through the real-time gross settlement system. Two weeks ago, it required a detailed breakdown of liquidity positions. In short, regulatory failures in other Asian countries have been avoided. For sure, official statistics might be economical with the truth. The much quoted 47 per cent exposure to property is almost certainly understated. But the threat of large corporate defaults looks slim, given low local gearing. The hard choices have yet to be faced. While currency attacks continue, local solidarity to maintain the peg should hold. The defend-at-all-costs mantra is especially compelling when the parasitic forces of international speculators apparently lurk at every turn. More interesting will be the aftermath. Assuming a permanent 5 per cent risk premium over US rates, Hong Kong banks could face a grim operating environment in three months. With falling property prices, reduced investment and deteriorating asset quality, a less emotive defence of the peg could emerge. Inevitably, in any complex economy, different groups have divergent interests. The question is how much pain can Hong Kong take. Thailand showed that interest rates do not have to stay high for long before commitment from local business elites wanes. In Hong Kong, the argument runs that capital flight and banking instability would follow a de-coupling. In any case, we are a service centre that does not rely on a competitive exchange rate. Perhaps, but, faced with the prospect of wrecking the economy, the jury is out on how long a united front lasts. Imagine a bank facing a loan portfolio going under water as property prices slumped. Region-wide, floating exchange rates have become the standard. The chance of a one-time cut in interest rates by abandoning the peg would be undeniably alluring. Hong Kong does not face a banking crisis. The safety cushion of lending controls and strong balance sheets will support the sector. But with the peg apparently immutable, the trouble might only be beginning.