bodyType

customContents

entityId

entityUuid

articlePageQuery

filter

article

articleBaseAdvertisingInfoArticle

articleListArticle

articleSeoArticle

helpersCheckIsPostiesArticle

hooksArticleAcknowledgementGateOverlayArticle

hooksTrackPageViewArticle

hooksContentInterestArticle

articleLinkingDataContent

articleSchemaContent

liveArticle

advertZone

sentiment

contentLock

topics

types

sections

moreOnThisArticles

urlAlias

commentCount

authorLocations

authors

paywallTypes

corrections

sponsorType

displaySlideShow

multimediaEmbed

printHeadline

seriesContainer

socialHeadline

headline

flag

firstTopic

glossary

flattenTypeIds

publishedDate

additionalInfoBoxes

images

image

relatedLinks

relatedNewsletters

__typename

createdDate

sponsor

factSheets

seriesReverseOrder

series

disableOffPlatformContent

published

updatedDate

summary

subHeadline

body

keywords

copyrighted

customTimezone

liveContents

Tom Holland

The downgrade last week of the United States' credit rating has prompted a whole new round of questions about the future of Hong Kong's currency peg to the US dollar.
'How about dropping the peg to the US dollar completely and pegging the Hong Kong dollar to the yuan at the current exchange rate of about HK$1.2 to the yuan?' asks one reader.
Other readers have different ideas. 'Perhaps what Hong Kong should consider is a peg to a basket of currencies,' offers one.
He's not alone. In recent days both the chief executive of HSBC and the chairman of Bank of East Asia have also suggested switching to a basket mechanism.
'Hong Kong would be better advised to move to some kind of managed float against a basket of currencies,' said HSBC's Stuart Gulliver, according to reports.
'I personally support linking the Hong Kong dollar to a basket of currencies,' added David Li Kwok-po, from Bank of East Asia. 
So intense has the speculation become that Hong Kong Monetary Authority chief executive Norman Chan Tak-lam even felt obliged to defend the current peg to the US currency. 'The Hong Kong dollar peg has been working well since its adoption in 1983. It's the foundation for the stability of the currency and financial system in Hong Kong so we have no intention to make any change,' he said yesterday.
The natural reaction to Chan's statement is to think: 'Well, he would say that wouldn't he?' After all, even if the HKMA were considering a change of policy, it would hardly signal its intention to the market in advance.
In this case, however, we can be confident Chan means what he says - the HKMA really doesn't intend to change the peg to the US dollar.
There are two big reasons for this. The first is political. Hong Kong Chief Executive Donald Tsang Yam-kuen made his name in 1998 by defending the US dollar peg, and Chan at the HKMA is very much Tsang's man. 
That means official talk of change is out of the question as long as Tsang occupies the chief executive's office. The second reason is practical. The US dollar peg has its weaknesses. For one thing, it makes Hong Kong prone to asset bubbles and subsequent deflationary busts. 
But the suggested alternatives to the peg have major drawbacks too.
The main problem with pegging the Hong Kong dollar to the yuan is that the mainland's currency is not freely convertible, and won't be for many years to come.
Strangely, the yuan's restricted convertibility wouldn't actually be an obstacle if all you wanted to do was fix the exchange rate. 
The HKMA would find it no problem to intervene in the US dollar-Hong Kong dollar market in order to keep the Hong Kong dollar within a target range against the yuan. But the US dollar peg provides Hong Kong with much more than just a fixed exchange rate. Because both the US dollar and the Hong Kong dollar are freely convertible, the resulting arbitrage opportunity ensures that Hong Kong's interest rates track US rates.
In other words, the US dollar peg provides Hong Kong with a monetary anchor that a link to the yuan could not. Without that anchor, the danger of local currency interest rate volatility would be too great to risk.
There are problems, too, with the idea of managing the Hong Kong dollar against a basket of currencies.
It's a mechanism that has worked reasonably well for Singapore, which steers its currency higher or lower against an undisclosed basket in an attempt to keep imported inflation low and to safeguard the economy's competitiveness.
But the trouble with a Singapore-style solution is that it would be both complicated and too vulnerable to political meddling.
The complexity of the mechanism means that even if the Hong Kong dollar were stable against the overall basket, it could still be volatile against major trading currencies like the US dollar, which means Hong Kong firms would suddenly be forced to manage unpredictable exchange rate risks.
And a basket system would be vulnerable to meddling because decisions about when to switch the direction of crawl, say from a tightening bias to a neutral or loosening bias, could have a big short term impact on living standards in the city. That means they would be the subject of intense political pressure, something which the HKMA is ill-equipped to resist and which would seriously threaten the much-prized credibility of Hong Kong's monetary system.
As a result, although there are drawbacks to the existing US dollar peg, the problems with each of the suggested replacements look even greater. For the time being at least, we are stuck with the US dollar.



Despite US downgrade, dollar peg is still best option for HK