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China's other exchange rate
By Gary LaMoshi
HONG KONG - It's an old story: Chinese government officials are receiving
criticism for keeping their currency artificially pegged to a fixed exchange
rate to benefit local industries. But the currency in this particular story is
not the Chinese yuan; it's the Hong Kong dollar, and the local industries
benefiting from the government's manipulation are banking and currency trading.
Oddest of all, the actions of Hong Kong's currency board are promoting
speculation and uncertainty about the exchange rate, precisely the blights a
currency peg is supposed to eliminate.
Like mainland China, Hong Kong keeps its currency exchange rate fixed to the US
dollar. Despite its free market reputation, Hong Kong's government has
controlled the exchange rate for all but nine years since 1863. The last
adjustment came in 1983, when the government pegged the rate at HK$7.8 to US$1.
Peg o' my heart
The peg is backed up with more than talk. For each $7.8 Hong Kong dollars in
circulation, the Hong Kong Monetary Authority (HKMA) has one US dollar in the
vault. The peg has good and bad sides for Hong Kong's economy, but its role in
maintaining stability in the years leading to the 1997 handover from Britain to
China was vital. The peg, backed with billions in Hong Kong's foreign currency
reserves, kept confidence high and helped ensure a smooth transition.
Ironically, the collapse of other Asian currencies in 1997 brought hard times
that Hong Kong has struggled to put behind it.
When the currency peg was reinstituted in 1983, officials worried about a
weakening Hong Kong dollar (ie, it would take more HK dollars to buy US dollars
or other currencies). The HKMA pledged to buy Hong Kong dollars at the official
rate of 7.8 for one US dollar, but it did not pledge to sell Hong Kong dollars
for US dollars at that rate. This asymmetrical situation effectively set a
floor under the Hong Kong dollar's value but no ceiling. The HKMA's chief
executive, Joseph Yam, called the policy "constructive ambiguity".
Normally, the Hong Kong dollar exchange rate in the spot market would not stray
far from the pegged rate. The exchange rate guarantee and HKMA's balancing of
supply and demand for Hong Kong dollars would keep the currency value stable
and interest rates roughly on par with US rates. Currency flows would smooth
out any differential between interest rates - deposits would flow to the
currency with higher rates, and those changes in money supply would cause rates
to converge - based on confidence in the peg.
However, over the past 18 months, the Hong Kong dollar has remained
persistently stronger against the US dollar than the official rate, and Hong
Kong's interest rates have remained lower than those in the US. Those low
interest rates helped fuel Hong Kong's economic rebound after the SARS (severe
acute respiratory syndrome) outbreak of early 2003. Some observers also say the
low rates have fueled a new speculative housing bubble.
The strength in the Hong Kong dollar is attributable in part to the speculation
about revaluation of the mainland renminbi, based on the assumption, most
likely faulty, that a stronger renminbi would mean a stronger Hong Kong dollar.
"Constructive ambiguity" also made Hong Kong dollar holders reluctant to cash
out at the official rate and contract the money supply when a higher rate could
be had in the spot market, with the possibility of an even higher rate in the
future encouraging the continued holding of HK dollars despite the interest
differential. Since the whole idea of a peg is to eliminate currency rate
uncertainty, "constructive ambiguity" seemed at odds with the HKMA's mission.
Going both ways
The HKMA appeared to see the light last month, declaring a rate for converting
US dollars to Hong Kong dollars, thus setting an upper limit for the strength
of the HK dollar. Since the conversion rate was set at 7.8 for HK dollars to US
dollars, you'd expect that the HKMA would set it at the same level going the
other way. But that would be too simple. Instead, the authority created a "zone
of convertibility" between 7.75 (the strong side limit) and 7.85 (the weak side
limit). Oddly, the HKMA's announcements on the change to two-way convertibility
didn't give a compelling (or even sensible) reason for setting a range rather
than a single peg rate.
Notes from the May 13 meeting of the HKMA's Exchange Fund Advisory
Committee Currency Board Sub-Committee hint at the motive for setting a range
instead of a single rate:
Members considered that the actual width between the two Convertibility
Undertakings should be set having regard to the desire, on the one hand, to
avoid excessive exchange rate volatility by imposing too great a width, and, on
the other hand, to avoid displacing foreign exchange business involving the Hong
Kong dollar by imposing too small a width. (italics added)
If that's not clear enough, here's how HKMA Chief Executive Yam put it in a
speech in January last year:
There is a further consideration and this is the impact of a two-way
convertibility undertaking on the jobs of all those employed in the dealing
rooms of banks trading the Hong Kong dollar against the US dollar... In the
extreme case when there is no spread and we buy and sell both at the level of
7.80...there would be much less [of] a need for dealers that live on market
volatility. Obviously, this is not something that any of us would wish to
see... In other words, Yam's reason for avoiding a single
exchange rate was to save the jobs of people who trade the Hong Kong dollar
against the US dollar. "Mr Yam is essentially arguing that we should keep some
uncertainty in the HKD/USD exchange rate so that people can be employed to
speculate on it," investment banker turned investor rights activist David Webb
wrote on his Webb-site.com. "Jobs for jobs' sake, and economic inefficiency for
the sake of intermediaries. It's like arguing that we must keep some crime or
there wouldn't be any jobs for the police." The concern about trading jobs is
also misplaced, since a single rate would still preserve active markets in
every other currency besides HK-US dollar transactions.
Welfare for bankers
HKMA's range also allows banks - and Hong Kong's slowly unraveling officially
sanctioned banking cartel is yet another market-avoidance mechanism in this
alleged beacon of free markets - to skim a little additional profit from every
HK-US dollar transaction. If there was a single rate, then banks would have to
change customers' money at that rate. The range gives banks scope to convert at
rates that shortchange customers by as much as 1.29%.
In fact, Hong Kong authorities meddling with markets is nothing new. Despite
the Heritage Foundation’s "world’s freest market" label, Hong Kong has its
newly manipulated government mandated exchange rates, government control of the
property market, and US$15 billion government stock market portfolio, not to
mention the government’s majority stake in the new Disneyland.
What's amazing in this case is how blatant and unapologetic HKMA is about this
subsidy to bankers and traders. When asked for the reason for the zone of
convertibility rather than a single point, a spokesman for HKMA didn't hint at
any economic or monetary benefit. Instead he pointed to the portion of Yam's
January 2004 speech quoted above, and quoted back the explanation from the May
Sub-Committee meeting.
What matters most to the HKMA isn't exchange rate certainty, economic
efficiency and lower transaction costs for businesses and consumers, it's
making sure that insiders get theirs. That's one thing in Hong Kong that's
firmly fixed, with no ambiguity or wiggle room. If this is the world's freest
market, then maybe we'd be better off under the Communists. Oh, wait...
Gary LaMoshi has worked as a broadcast producer and print writer and
editor in the US and Asia. Longtime editor of investor rights advocate
eRaider.com, he's also a contributor to Slate and Salon.com.
(Copyright 2005 Asia Times Online Ltd. All rights reserved. Please contact us
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