Forecasting financial markets is all but impossible. Given the wild volatility of the Hang Seng Index, any pundit who in 1997 dared predict its level on the 10th anniversary of the handover - or the rental value of top-notch office space in Central or HSBC's prime lending rate - would almost certainly have ended up with egg on his face. But if that same pundit had attempted to forecast the exchange rate of the HK dollar in 2007, the chances are he would have been bang on. Because mainland authorities left the monetary system well alone, Hong Kong's exchange rate today is almost exactly where it was 10 years ago, within a whisker of HK$7.80 to the US dollar; locked in place by the currency board mechanism the city introduced in 1983. If official pronouncements can be believed, that is also where Hong Kong's exchange rate will be in 10 years' time. Not everyone is so sure, however. As Hong Kong's economy has become more and more integrated with the mainland's, suspicions have grown in the city's financial community that the government is preparing to abandon the link to the US currency and peg the Hong Kong dollar to the yuan. Officially, Hong Kong authorities give the idea short shrift. In May, Joseph Yam Chi-kwong, chief executive of the Hong Kong Monetary Authority (HKMA), reiterated his position that 'the Hong Kong government has no intention to use the renminbi as the anchor currency for the Hong Kong dollar'. The view of the government, and many private-sector economists, is that Hong Kong's currency board has served the city admirably over the years and that it should remain in place for the foreseeable future. Introduced in 1983 as a quick fix to halt a plunge in the Hong Kong dollar, the currency board guarantees that all notes and coins in circulation are backed by US dollars held by the HKMA, which promises to exchange them at a fixed mid-rate of HK$7.80 to the US dollar. According to its admirers, the resulting currency stability, together with Hong Kong's commitment to the free movement of capital, has been the crucial factor in the city's rise to prominence as an international financial centre. Through crisis after crisis, including the 1987 stock market crash, the Tiananmen Square crackdown of 1989, the 1997 Asian economic meltdown and the Sars outbreak of 2003, the Hong Kong dollar hardly budged and confidence in the city's monetary system remained high. Yet the peg's critics point out that Hong Kong has paid a heavy price for this stability. By adopting a currency board system, the Hong Kong government chose to surrender all control over domestic interest rates, which tend to move broadly in line with US rates. Unlike central banks elsewhere, the HKMA has no freedom to stimulate the local economy in a downturn by cutting interest rates. Nor can it raise rates to rein in rising inflation or to deflate asset market bubbles. That inability to tweak policy has hurt. Compared with Singapore, which manages its exchange rate in pursuit of price stability, over the past 20 years Hong Kong has suffered higher inflation, higher interest rates and higher unemployment because of the peg, according to research by the Basel-based Bank for International Settlements. During the mid-1990s, for example, Hong Kong's interest rates remained relatively low at around 5 per cent, in line with US rates, despite a booming local economy. The upshot was an inflation rate of 10 per cent and asset bubbles in both the stock and property markets. Then in the late 1990s, following the Asian crisis, the US tightened monetary policy, pushing Hong Kong's interest rates up to around 9 per cent when other Asian economies were cutting their own. The result was a prolonged property market depression, an unemployment rate as high as 8 per cent and almost six years of debilitating deflation. Some economists have argued the city should ditch its link to the US dollar and adopt a different exchange rate system. 'A peg is the wrong way to go,' says Tim Condon, chief economist for Asia at the Dutch bank ING. Many currency traders and investors assume the obvious alternative would be to peg the Hong Kong dollar to the yuan. But that would be economically disastrous: the yuan is not fully convertible. That means it would be impossible for the HKMA to back a peg to the yuan with the same guarantees it offers now under the US dollar link. International confidence in Hong Kong's financial system would be seriously undermined, if not destroyed. If Hong Kong is to operate an exchange-rate link, it can only be to the US dollar, maintains John Greenwood, chief economist at asset management company Invesco and original architect of the currency board. 'The right thing is to peg to the currency of the country that drives the global business cycle, and that is unquestionably the US dollar,' he said. The other option would be to float the Hong Kong dollar and manage its exchange rate against a trade-weighted basket of currencies, in much the same way as Singapore runs its monetary system. That would allow the HKMA to operate an independent monetary policy, and to iron out the worst ups and downs of Hong Kong's economic cycle. But shifting to a managed float would involve major institutional upheavals. The HKMA would have to be vested with all the powers of a full central bank, and most likely Hong Kong's commercial banks would have to be stripped of their right to issue bank notes. That would seriously risk undermining domestic confidence in the currency. In the end, changing Hong Kong's exchange rate regime would be a political decision, and under the current chief executive the chances of a switch are negligible. In 1998, in the depths of the Asian crisis, then financial secretary Donald Tsang Yam-kuen laid his career on the line when he ordered the HKMA to intervene in Hong Kong's stock and currency markets to defend the peg. Though widely condemned at the time, the move was a triumph. It decisively saw off the speculators targeting Hong Kong's markets and even earned the government a handsome profit on the stocks it acquired. More to the point, the intervention was instrumental in setting Mr Tsang on his way to the chief executive's office. With his own political rise so closely linked to the defence of the peg, there seems little chance that Mr Tsang would voluntarily abandon it now. The likelihood that any successor would either seems scarcely greater. As a result, predicting the value of the Hong Kong dollar in 10 years' time is as safe a bet as any in international financial markets. It will probably be just where it is today: somewhere between HK$7.75 to HK$7.85 to the US dollar.