Of Peso, pegs and a basketcase for the HK$ (SCMP April 23)

It's time to be worrying again about currencies. Keep an eye on the troubles of the Argentinian peso pegged like the HK dollar to the US currency. And wonder how the US can adequately cut its trade deficit without abandoning its strong dollar policy.

Argentina's peg to the dollar has caused a recession which has been exacerbated by low commodity prices and the devaluation in Brazil, a major trading partner. Part of the response of Finance Minister Domingo Cavallo, the original architect of Argentina's dollar peg who has been brought back to government to save the peso,has been to propose that the peg be shifted to a dollar/euro mix. This will only happen if the euro reaches parity with the dollar but such a 10% gain is quite likely in the next few months. Cavallo's logic is that a dual currency peg would avoid extreme overvaluation, and would be especially beneficial as Argentina trades more with Europe than with North America.

It is debateable whether such a move can now do much to rescue the peso and avoid the devaluation which could hurt Argentina, which has a partly dollarized economy, as badly as the Baht collapse hurt Thailand in 1997 and have international ramifications. But the idea of moving away from a single currency peg is worth considering by Hongkong.

Back in 1983, before the HK/US peg was established I suggested that a peg to a basket of major currencies was the best option for Hongkong. Though the dollar peg has worked, a basket would have left HK less vulnerable to the credit inflation of the mid-90s and the deflation of the past three years. Hongkong's exchange reserves and small debt mean that it is not vulnerable to the pressures now assailing the peso.But that does not obviate the argument for a broader based peg.

For a start, we know that China is intending to move to a more flexible currency regime once it joins WTO.So the certainty of the fixed HK$/US$/Yuan rate which has existed since 1994 will disappear anyway. It must be assumed that the Peoples Bank of China will move to a managed float which takes some account of yen and euro. That is already the case wih the NT$ and Won, the baht and Singapore dollar are influenced by yen and euro, and Malaysia seems likely to abandon it dollar peg if that can be achieved without appearing as a devaluation.

The other factor we need to be thinking about is the consequence of a US policy U-turn on the dollar. The dollar has been remarkably strong in recent months considering the state of the economy and trade balance. It has been helped by some exaggerated notions by western analysts and forex dealers of Asian and especially Japanese weakness. Most of these "experts" are too young too to remember the Plaza accord in 1985.

Then the news US Treasury Secretary, James Baker, now a Bush adviser, made a 180 turn, reversing the strong dollar policy of his predecessor and engineering a dramatic weakening of the dollar against the yen and European currencies to improve the US trade position. Subsequently too the Korean won and Taiwan dollar were forced by US pressure - unveiled threats of trade curbs - to allow their currencies to appreciate, dramatically in the case of Taiwan.

History could repeat itself this year, either because of a policy shift or because markets suddenly lose faith in the greenback. Already the national Association of Manufacturers in the US is starting to pressure Treasury Secretary O'Neill on the currency. And pressure from union and corporate lobbies could escalate if by the end of the summer Greenspan's interest rate cuts fail - as seems quite likely - to do more than moderate the economy's downward slide.

Economies with dollar pegs like Hongkong will eventually benefit if that happens but dollar based stockmarkets could suffer more in the short term as funds move to stronger currency areas. But it is also possible that, as in 1985, countries with fixed dollar rates and huge trade imbalances with the US will come under US pressure to abandon such links and allow some appreciation. Top of the list would be China. Such threats may be unfair but are less damaging to trade than the likely alternative - the barrage of anti-dumping and other import barriers that may otherwise happen, and will likely be threatened.

China is vulnerable because it now seems unlikely to be finally in WTO and able to shelter under its rules, till late this year at best. The US meanwhile is also pushing freer trade with the Americas, so the neighbours with large surpluses, Mexico and Canada, will benefit relatively. (The weekend Americas summit has underlined Washington's increased commitment to the hemisphere and the growing influence of Hispanic interests in US politics).

Given what is happening in global trade and with currency markets as volatile as they have ever been it is time for Hongkong to look at replacing it dollar peg with a broader peg which better reflects its commercial links and its Asian location.That would not only contribute to economic stability but would be in line with what has happened in Korea and Taiwan and will sooner or later happen in China. ends




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