Hong Kong dollar peg: why the city’s linked exchange system is an important buffer against financial crisis

Ongoing anti-government protests have led to some speculation that Hong Kong could be forced to sever its peg to the US dollar

But the city’s de facto central bank has stressed the importance of the linked exchange system, which was introduced in 1983 to avert a financial crisis

4-MIN READ4-MIN

Months of anti-government protests have caused some observers to speculate on the future of the Hong Kong dollar peg. Photo: KY Cheng

Published: 6:00pm, 9 Dec 2019Updated: 12:46pm, 14 Jul 2020

This is the first article in a three-part series looking at the outlook for Hong Kong's dollar peg system under the city’s current political uncertainty. You can read the second story in the series here and the third story in the series here.

Hong Kong’s dollar peg has been thrust into the spotlight as a result of six months of anti-government protests that have roiled the semi-autonomous city. The protests, which were sparked by a now-withdrawn extradition bill but morphed into wider calls for democratic freedoms and an investigation of alleged police brutality, have taken a sharp toll on the local economy.

Some economists have suggested that a prolonged political crisis could spell the end of the peg. But the Hong Kong Monetary Authority (HKMA), the city’s de facto central bank, says in a time of crisis, it is more important than ever.

“The monetary policy objective of Hong Kong is currency stability,” said a spokesperson for the HKMA. “The LERS (Linked Exchange Rate System) has proved to be highly resilient, weathering many economic cycles and crises, and has continued to operate smoothly notwithstanding massive fund inflows and outflows in the past decade.”

The LERS has proved to be highly resilient, weathering many economic cycles and crises, and has continued to operate smoothly notwithstanding massive fund inflows and outflows in the past decade

HKMA

Why was the Hong Kong dollar peg introduced?

On a sweltering hot summer day in September 1983, a long queue of people stood outside a Hong Kong supermarket waiting to snatch whatever groceries they could get their hands on. The scene, complete with its empty supermarket shelves and frustrated customers, was another sign of plummeting public confidence in Hong Kong’s financial system and underlined the challenges that the government faced in restoring it.

On September 24, 1983, months of consumer and investor anxiety over the rapid depreciation of the Hong Kong dollar, coupled with concern over Chinese and British negotiations about the city’s return to mainland rule, culminated in the so-called “Black Saturday” crisis. Panic selling of the local currency drove its value to an all-time low of 9.6 per US dollar, down from 6.5 per US dollar at the start of the year, under the floating exchange rate system. Shops began to quote prices in US dollars and refused to accept Hong Kong dollar notes.