For nearly 40 years, Hong Kong has been well served by nailing its currency to the Stars and Stripes.
The US dollar peg was created in the wake of a huge (and now mostly forgotten) financial crisis in 1983, when the territory was wracked by inflation and speculative attacks on its currency. The peg to the greenback delivered Hong Kong instant stability, moderated its inflation, and positioned the territory for the boom in global trade that was just underway.
This arrangement has come under increasing scrutiny in recent years, and most dramatically now, following the global financial crisis. Hong Kong, to put it too simply, is now importing Chinese economic growth and US expansionary monetary policy. It’s been brilliant for Hong Kong’s landed classes (and not so wonderful for renters), but at some point the territory risks overheating.
Hong Kong can’t simply switch its peg to the renminbi. The territory’s Basic Law stipulates its currency be “linked” to the currency of a developed country with an open financial system. China is not going to fit the bill for quite some time.
Nor can Hong Kong emulate Singapore and adopt a trade-weighted currency basket. Singapore’s basket includes plenty of dollars, yen and other regional units, in rough proportion to its trade links.
Hong Kong’s trade links are mostly to mainland China, so if it created a basket of currencies to match its trade flows it would end up with a majority in renminbi. This is counter to the Basic Law’s proviso, and would only saddle Hong Kong with the worst of the renminbi’s inflexibility with no upside.
Over time, of course, Hong Kong is playing a critical role in China’s efforts to internationalise its currency. Historically, countries have tended to focus on their currency policy: do they peg, float, or run a managed compromise? China’s approach is to focus first on getting other countries and actors to trade, settle, issue and invest in renminbi, and build a gradual momentum that will make an eventual capital-account opening less difficult.
In other words, it’s not clear that Beijing would want to see Hong Kong ditch a currency peg, because its interests are served by keeping Hong Kong as an open centre of global capital flows.
This doesn’t mean, however, that Hong Kong is permanently tied to Uncle Sam, at least until that day when the renminbi becomes freely convertible.
At AsianInvestor and FinanceAsia’s seminar earlier this week on the RMB, Adrian Foster, head of Asia-Pacific financial markets research at Rabobank International, floated the idea (excuse the pun) of switching the Hong Kong dollar’s peg to the Australian dollar.
The suggestion elicited a stream of nervous laughter from the audience, a reliable indicator of good, if unorthodox, ideas.
But think about it. Hong Kong must link to the currency of a developed country with a freely convertible currency and a mature financial system. It would do well to be linked with a country whose economy is in sync with China’s. America and Europe are all mired in deleveraging and slow growth, while Chinese growth gallops ahead. Australia’s the only developed country that meets all of these conditions. And it’s in the right timezone to boot.
Foster admits that, as an Australian, his pitch is a little self-serving, and he cautioned that it was meant half in jest. But half in jest means half seriously, and he makes the point that Hong Kong and Chinese officials do have options.
Hard as it is for your American editor to imagine Hong Kong leaving Uncle Sam for Bruce and Sheila – strewth! – it’s something the mandarins ought to have a look at.