If a reminder were needed that a pegged exchange rate can be a demanding discipline and test of nerve, it has come in recent days with the sustained surge in demand for the Hong Kong dollar, driven by a buoyant local market for stocks and initial public offerings. The currency strained against the upper limit of its trading band with the US dollar, leading to speculation about the future of the peg. This prompted the Hong Kong Monetary Authority to intervene by selling the local dollar to keep it within the trading band and reaffirm the determination to defend the peg.
Continued pressure on pegged currencies from the weakness of the US dollar may trigger further action to inject liquidity into the market in the not too distant future. As an externally exposed economy, Hong Kong is vulnerable during periods of international financial volatility. The peg means that local monetary conditions are influenced by American trends. We can import inflationary pressures or interest rates that are not driven by domestic circumstances. But that is the price we pay for a system that remains an anchor of stability in uncertain times, ensuring the exchange-rate certainty crucial to Hong Kong's role as a hub of international trade and finance.
The recent pressure on the Hong Kong dollar shows it does not take much to start talk about how long the link to the US dollar is likely to last. The answer is the peg will be with us for a long time to come, despite speculation about changes ranging from widening the trading band against the greenback, to a managed float against a basket of currencies, to linking the Hong Kong dollar to the strengthening yuan.
It is arguable that the peg might not be the best way of fixing the value of the Hong Kong dollar and, with hindsight, that a trading range against a basket of currencies - similar to Singapore's arrangement - would have provided greater flexibility. The adoption of the HK$7.75 to HK$7.85 trading band went some way to addressing that.
To change the system now would be like changing horses in midstream. It would give rise to economic stress and uncertainty and encourage fresh speculation against the Hong Kong dollar - if it can be changed once, it can be changed again.
At the same time, the peg is not fixed in concrete forever.
