The HKD peg

I have a general interest in economics and financial markets, so every now & then i'll share my views on a few topics, starting with the Hong Kong Dollar currency peg.



Hong Kong has had a long history of pegging its currency.  In the early 20th century it was pegged to Silver, following this it was pegged to GBP. After this, there was around a decade of free floating in the 1970s,  and for the past 30 years it has been pegged to the USD.

In general i think the current peg has served HK well, bringing relative economic stability through a wide range of local & global events.  Using USD as a peg also makes a lot of sense for an economy so focused on international trade, given the dominance of USD in trade settlement.  I also think the HK Monetary Authority has done a good job in maintaining the peg, based on the USD backing of the currency and through passive intervention under the currency board mechanism.  This strong monetary & economic management is vital in giving confidence to the financial markets & mitigating speculative pressures on the currency.

There are a couple of scenarios we have seen recently in HK that a pegged system does find challenging.

Firstly, when the economic cycles of the 2 economies are out of line, the prevailing monetary policy may not always be best suited to both parties.  For example, the last few years have seen the US operate a policy of monetary easing, keeping interest rates low to stimulate growth.  However, with the HK economy performing relatively better, the combination of low rates and growth have led to local inflationary pressures which become more difficult to manage without monetary flexibility.

Secondly, a currency board system would typically be self correcting, with a central bank selling the pegged currency as demand for that currency increases, in order to ease pressure on the peg.  This should drive down local interest rates, reducing the original demand for the pegged currency and restoring a relative balance in value.   However, when all interest rates are already close to zero, unless rates turn negative, it may not be possible to remove demand from the pegged currency in this way, resulting in excess liquidity.

I think we may have seen this in HK, which could to some extent be a contributing factor for the increases in real asset prices such as the local stock market and property, as this surplus liquidity is invested.  It is unclear at this stage if, when and to what extent such valuations and fund flows may reverse, although the government's property cooling measures do seem to be slowing the market.

Whilst these consequences may at times be uncomfortable for the local economy, i generally believe the advantages of maintaining the status quo in HK would outweigh any challenges at this stage.

We'll have to see what the longer term future holds, which may to some extent be influenced by the internationalisation of RMB, and its impact on the local and wider economy.