The exchange rate system in Hong Kong Linked exchange rate system.

The exchange rate system in Hong Kong

Linked exchange rate system

Hong Kong is a……Hong Kong is a……

Trading CentreInternational Financial &

Monetary CentreWhat is the reason make Hong

Kong so Successful?

The Linked exchange rate system

History of Exchange Rate History of Exchange Rate System in Hong KongSystem in Hong Kong

Date Exchange rate regime

Reference rate

1863 – 4 Nov 1935

Silver Standard

Silver dollars as

legal tender

Dec 1935 Link to Sterling

£1 = HK$16(Dec 1935 – Nov 1967)

Link to Sterling

£1 = HK$14.55

(Nov 1967 – Jun 1972)



Reference rate

6 Jul 1972 Link to the US dollar with ±

2.25% intervention

bands around a central rate

US$1 = HK$5.65

(Jul 1972 – Feb 1973)

Link to the US dollar

US$1 = HK$5.085

(14 Feb 1973 – Nov 1974)



Reference rate

25 Nov 1974 Free float Exchange rates on

selected datesUS$1 =

HK$4.965 (25 Nov 1974)

US$1 = HK$9.600 (24

Sep 1983)

17 Oct 1983 Link to the US dollar

US$1 = HK$7.80

What is Linked Exchange What is Linked Exchange rate System? rate System?

Currency broad system Pegged the Hong Kong Dollar to the USD at the rate of 7.80Two exchange currency markets in HK (Exchange Fund and open market )

Ways to fixed the exchange Ways to fixed the exchange rate at HK$7.8 = US$1rate at HK$7.8 = US$1

Arbitrage activities • Different in the price of a good in

different market• Buy the product at the lower price

market • Sell it at the higher price market

Two kinds of arbitrage activities in exchange rate system

a) Interest rate arbitrage b) Currency arbitrage

Interest rate arbitrage Interest rate arbitrage

Determined by demand and supply Speculation against HK DollarDemand for HK Dollar would then decrease HK Dollar would depreciation against USD

in open market Domestic interest rate would rise and this

would attract back the funds Demand for the HK Dollar would rise Exchange rate would be stabilized

Interest rate arbitrageInterest rate arbitrage

Speculation for HK dollarDemand for HK dollar would rise Exchange rate of HK dollar to US

dollar would increase in open market Domestic interest rate would then fall Demand for HK dollar would fallExchange rate of HK dollar would be

stabilized

Currency arbitrage Currency arbitrage

Exchange rate of HKD fall in open market

Exchange rate fixed in the close market

Different of HKD to USD in open market

How does bankers gain How does bankers gain profit?profit?

Sell USD for HK Dollar in open market

Sell HK Dollar for USD in Exchange Fund

Exchange rate of HK Dollar for USD would be stabilized

Why the linked exchange Why the linked exchange rate system important to HK rate system important to HK

??1. Suits the needs of a highly open

economy such as Hong Kong’s2. Enables Hong Kong to adjust to

shocks without the damage and volatility of a sudden currency collapse

Why the linked exchange Why the linked exchange rate system important to HK rate system important to HK

??3. Provides Hong Kong with a firm m

onetary4. Reduces the foreign exchange risk

faced by importers, exporters and international investors

The effectiveness of the Linked The effectiveness of the Linked is helped by a number of is helped by a number of

economic attributes enjoyed by economic attributes enjoyed by Hong Kong:Hong Kong:

1. The structure of Hong Kong economy is flexible and responsive

2. Hong Kong’s banking system is strong and solvent, and well able to deal with the fluctuations in interest rates

The effectiveness of the Linked The effectiveness of the Linked is helped by a number of is helped by a number of

economic attributes enjoyed by economic attributes enjoyed by Hong Kong:Hong Kong:

3. The Hong Kong Government pursues a prudent fiscal policy

4. Hong Kong possesses ample foreign currency reserves for supporting the Linked Exchange Rate System

Advantages of the Linked Advantages of the Linked Exchange Rate SystemExchange Rate System

Provides a stable, predictable and well understood monetary system

Suited to Hong Kong’s highly external and flexible economy

To its position as an international financial centre


Enables Hong Kong’s economy to adjust to external shocks without the damage

Volatility of a sudden currency collapse

Provides Hong Kong with a firm monetary anchor

Reduces the foreign exchange risk


The Hong Kong dollar exchange rate has remained stable in the face of various shocks

Unaffected by the 1987 stock market crash


Stable Hong Kong’s economy in the face of external shocks without the damage and volatility of a sudden currency collapse


the price level of Hong Kong has been exceptionally stable:

There had been an increase more than 10% in price level five times (1973, 1974, 1979, 1980 and 1981) a year within the twenty years

Disadvantages of the Linked Disadvantages of the Linked Exchange Rate SystemExchange Rate System

Ties Hong Kong to US monetary policy

The economy of Hong Kong is directly affected by the monetary policy of US and US Dollar

The business cycle of Hong Kong and US might not be indifferent


In 1998, Hong Kong was facing a depression and a high unemployment rate

Hong Kong Government might increase the money supply of Hong Kong Dollar

Reduce the price of goods in Hong Kong


To increase the export and decrease imports

Theoretically, flexible exchange rate system should be used


But, US Dollar was appreciatingRestricted Hong Kong government

to change the money supplyObstructed the speed of recovering

in Hong KongA great matter when Hong Kong

and US are in alien business cycles


Reduces Hong Kong's ability to deal with external shocks• HKMA surrenders its power to adjust the

territory's monetary policy to the U.S. Federal Reserve

• The currency crisis in Southeast Asia in 1998, could lead to excessive financial market volatility whenever there are speculative attacks on the Hong Kong dollar

Should the exchange rate Should the exchange rate system be changed to float?system be changed to float?For:

•The HKMA can get back the independence of monetary policy ― HKMA can use suitable policy to

stabilize the Hong Kong economy― The Hong Kong monetary policy has

to follow that of US under the linked― Use the same monetary policy may

cause serious problems

Should the exchange rate Should the exchange rate system be changed to float?system be changed to float?Against:

•The economy in Hong Kong may greatly fluctuate

• Price level fluctuated greatly in 1970s – 80s

• Lots of money flows in Hong Kong everyday

Should the exchange rate Should the exchange rate system be changed to float?system be changed to float?

HKMA does not have necessary monetary instruments•The policy of controlling money

supply

Should the exchange rate Should the exchange rate system be changed to float?system be changed to float?

The necessary conditions of changing the system•HKMA has the full necessary

monetary policy•Do not let the market entirely

freely operate•Notice the change suddenly

ConclusionConclusion

The exchange rate system of Hong Kong has been improving

Stabilize the Hong Kong economyBrings a basis of being an

international financial centre There will not be a change in the

system in the following few years

The EndThe End

The exchange rate system in Hong Kong Linked exchange rate system.

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