and other pegs: politics beats science
05/02 by Japanese monthly Sentaku)
The Hongkong dollar peg has been one of the most successful
examples of a fixed exchange rate to the US dollar operated on a currency
board basis. However, the circumstances which both gave birth to this
peg in 1983 and sustained it through the 1997/98 Asian crisis were peculiar
to Hongkong. Thus it is important not to draw too many conclusions from
it about the desirability and sustainability of such arrangements in
Nor should conclude that the fact that it has now been
in existence for 18 years that it is permanent. Hongkong had had a floating
rate since the early 1970s. Previously, fixed rates once to Sterling
and then to the US dollar, had broken down in the face of the relative
strength of its currency at a time when the dollar was very weak.
Hongkong followed other currencies to a free floating
rate. This was destroyed by a combination of monetary and political
circumstances. A stock and property boom in 1979-82 led to a huge, self-feeding
increase in credit. There was no anchor for money supply as there was
no central bank, no targets for inflation rates or currency. Money could
be created by the banks simply by depositing Hongkong dollars against
note issues. The Hongkong dollar began to weaken. This might have proved
only temporary and have corrected itself. However, the collapse of the
asset bubble coincided with and was partly caused by serious difficulties
in Sino-British negotiations over the future of the territory.
A crisis in those talks precipitated a flight of capital
and a collapse of the Hongkong dollar. This was eventually stemmed by
announcement of the peg at a 7.80 - a highly competitive rate - and
the introduction of the currency board. In future all Hongkong dollar
notes issues would have to be backed by foreign currency deposits with
the Exchange Fund (now operated by the HK Monetary Authority). A return
of confidence and reduction of interest rates gradually became possible.
However, it is likely that without an improvement in the
political outlook the exodus of capital would have picked up again,
threatening the new peg. Indeed, the currency crisis was an important
factor in persuading Britain to give way to Beijing on an important
issue in the negotiations. The peg was also possible because Hongkong
had large fiscal reserves held in foreign currency. Though not in theory
part of the currency board system, their existence helped underpin confidence.
Hongkong was also helped by support from its sovereign power, Britain.
At the time there were some who argued - before as well
as after the US peg was established - that Hongkong should peg to either
a trade weighted basket, or to the SDR. However, this was rejected on
grounds that it was too complicated and might not be understood by the
man in the street.Given lack of foreign exchange controls and the high
level of household savings in the deposit base, the authorities believed
that certainty and clarity were more important than economic efficiency.
That view prevails to this day, when the economic costs
of a peg to a very strong US dollar are all too apparent after three
years of deflation. From time to time there were calls for a re-pegging
or a renewed float. Although the peg survived the mid-80s period of
dollar strength without undue stress. Likewise the currency had only
temporary strains during the 1987 stock crash, which saw the temporary
closure of the stock and futures markets, and the 1989 crisis in China.
But the post-Plaza period of increasing dollar weakness added to the
build-up of inflationary forces in Hongkong.
A period of rapid economic growth partly linked to the
shift in manufacturing to China and the rapid growth of China trade
should have been accompanies by tighter monetary policy. But this was
not possible under the fixed rate regime. After 1992, reform and opening
up took a leap forward in China. The 1995 nadir of the dollar coincided
with the approach of the handover to China in 1997. Growing optimism
about the political future helped by an influx of mainland money and
foreign institutional portfolio flows similar to those happening elsewhere
in emerging Asian markets created another property and stock bubble.
Further spurring credit growth was the ease with which
large local companies could borrow US dollar confident, they thought,
that the peg had largely eliminated exchange risk. US dollars were cheaper
despite the peg partly because the very rapid growth of demand for HK
dollar loans for housing offered banks lucrative above-prime ending
opportunities. Secondly, the under-developed state of local bond market
meant that big companies went offshore for fixed rate borrowings.
As a result of these various factors, HK dollar money
supply rose annually by 15-20% for several successive years helping
feed wage inflation as well as asset prices. Thus when the Asian crisis
broke, Hongkong exhibited a few of the characteristics of countries
with less formal links to the US dollar - a high credit to GDP ratio,
with credit concentrated in the illiquid property and finance sectors,
and partly in US dollars, and a currency which was, arguably, now overvalued
against a revived US dollar.
The danger to the currency board lay in the fact that
the system relied primarily on interest rates to prevent money supply
shrinking in the event that depositors demanded a high risk premium
for holding HK dollars. Switching was particularly easy for retail depositors
because many in HK already had foreign currency accounts. The property
sector, which accounted for almost 50% of all lending in Hongkong, roughly
divided between home loans and loans to developers, could not withstand
a sustained period of very high interest rates.
Any major defaults could have a cascade effect on the
banking system - as had happened after previous property bubbles in
Hongkong. The danger to the system, and inherent weakness in the currency
board theory, was evident to international hedge funds and other market
players. A few of these had made money shorting the baht prior to its
collapse in July 1997.
Hongkong was much less exposed to foreign currency debt.
Nonetheless, the close links between interest rates and the stockmarket
were a separate threat to the peg. In the prevailing nervous climate,
shorting stocks, especially the Hang Seng index futures, increased the
risks of a broader fall in values, pushing up interest rates and thus
further weakening the stockmarket. Abandoning the peg could have resolved
the problem. But it could also have created a sense of panic, and would
have further damaged the balance sheets of local companies with US dollar
debt and HK dollar income.
The most important factor in sticking to the peg was the
government's self-image. To be forced off the peg so soon after the
handover, was regarded as politically impossible. The government's first
answer was a massive stockmarket intervention. It spent almost HK$200
in a massive buying of index stocks. Within a few days it accumulated
some 10% of the Hang Seng index stocks - and a higher proportion of
the free float. This market intervention effectively forced shorts to
cover and that in turn took the pressure off the currency and interest
rates. The buying also involved using foreign exchange reserves to buy
For the longer term, the government also established
a new relationship between the banks and HK Monetary Authority which
increased money market liquidity and so made it easier for the HKMA
to stabilise short term interest rates. To currency board purists this
was a form of central bank intervention rather which obstructed the
use of interest rates to stabilise Money supply without official intervention.
But it worked.
Hongkong was able to defend its peg for three reasons:
· It had massive fiscal and foreign exchange reserves
at its disposal.
· In extremis it proved willing to abandon free market
and currency board principles with direct intervention
· The move had the backing of China which itself had
committed itself to not devaluing again, and had large foreign reserves
to support Hongkong of necessary.
Since 1998, Hongkong's economy has suffered from anaemic
economic performance in large part due to the peg at a time when other
Asian and European currencies have been weak. It has lost competitiveness
vis a vis neighbours and failed to take full advantage of China's growth.
There have as a result been repeated suggestions that a new system be
However, there has been no further attack on the local
currency and interest rates have been much in line with those in US
dollars. Over the past year in particular sharp falls in interest rates
have helped improve the position of property companies in particular.
Nonetheless, the peg has resulted in a sustained period
of deflation with the inevitable result of depressing investment and
consumer demand. Given the stable conditions in the foreign exchange
market, this might have been a good time to float the currency again,
or perhaps re-peg to a basket. There was discussion that Hongkong could
take the opportunity of China moving to a more flexible rate regime
for Hongkong to do the same.
However, if Beijing had such plans - and it received
plenty of advice in favour of flexibility - they were put on hold by
the events of September 11, fears of the impact of a global recession
on China's exports, and a new period of pronounced Yen weakness causing
the Won and NT dollar to slip and causing some discussion of another
round of contagion or competitive devaluation.
For Hongkong a floating rates would most likely mean a
fall of 10-15% while for China the more likely direction would be upward.
Hongkong will remain very cautious. However, the Financial Secretary,
who is from the private sector and took office last year, has acknowledged
the possibility of change sometime in the future. When is another matter.
Possibly the US dollar will turn around soon and take
the pressure of overvaluation off Hongkong. Possibly the authorities
will look to achieving parity with the Yuan so that the HK dollar would
become a fully convertible version of China's currency. What we do know
is that the peg is now in scant danger from the forces which destroyed
the Argentine equivalent. But that owes more to Hongkong's particular
circumstances than to theory.
Pegs can be made to work if other factors are favourable.
But there is nothing automatic, nor is there much evidence that the
peg for Hongkong has been economically useful, either now or in the
1990s. It will remain however until political circumstances, whether
vis a vis China or Asian regional relationships, dictate a change. ends
Rights: Only for Hongkong developers
inordinate power of property developers and their ability to bend the
Government to their interests is a familiar enough topic. It was evident
enough before 1997 and their power appears to have been increased by
the subsequent collapse of the real-estate bubble.
else can one explain the public suggestion by one prominent member of
the Real Estate Developers' Association that the cartel which it represents
should conspire to boycott land applications to create a shortage and
so push up prices, to the detriment of the public and of government
revenues? In many countries that would be a criminal offence.
one cannot blame developers for wanting to maximise their profits. Some
blame for property-developer power attaches to the erratic policies
towards land and housing that the Government has pursued in recent years.
Some is also due to the close connections between top officials and
his selection as Chief Executive, Tung Chee-hwa was a partner of Li
Ka-shing and others in real-estate development.
blame must certainly go to the way numerous senior public servants have
retired to cosy jobs in the property sector. And some is due to a naive
but common belief in government that strong property prices are a good
in themselves, rather than being the outcome of broader economic success.
must also go to the lack of transparency in government procedures which
may encourage interested parties to seek back-door approaches. The way
the CyperPort project was able to bypass all known development routes
may have been an exceptional case.
as revealing has been the recent court case of Nina Wang Kung Yu-sum
and her fight against the Government for penalising her company, Chinachem,
$550 million for late development of a site. Chinachem's original plans
had been rejected on height grounds. A key figure in the case is Executive
Council convenor Leung Chun-ying, a property expert who previously represented
major developers, including Ms Wang, in their dealings with the Government.
his evidence, Mr Leung asserted that the then-secretary for planning,
environment and lands, Bowen Leung Po-wing, now Hong Kong's representative
in Beijing, made a verbal commitment to him that Chinachem would not
be penalised. Bowen Leung has denied it, saying that it was ''extremely
impossible''. At least he was contrite. He admitted that, ''I should
have told them, `Don't come to me''', but added that they kept coming
the rights and wrongs, the case is a poor commentary on government procedures,
as it shows the informal access, on more than one occasion, that Leung
Chun-ying and Ms Wang had to Bowen Leung, bypassing formal procedures.
Everywhere in the world, lack of transparency and bypassing of proper
procedures in dealings between government and the private sector is
a major contributor to corrupt practices, as is lack of adherence to
right to know is not only due to the public for its own sake, it is
the sunlight which keeps systems disinfected. Just how obscure and untransparent
development procedures can be I have myself just discovered at first
the Apple Daily newspaper published a list of developments which had,
it said, been approved by the Buildings Department in September. It
included the building where I live and of which I own one-twelfth (there
are 12 flats in it). This was the first I or my owner-occupier neighbours
had heard of the apparent attempt by the owner of one half of the building,
which shares common areas and access, to redevelop his half of it without
the knowledge or consent of the other half.
went to the Buildings Department to find out more, but despite persistence,
I was confronted by a wall of silence. Officers would neither confirm
nor deny the newspaper list of approvals and refused to provide any
information. They advised that a brief account of September building
approvals would be published in due course on the department's Web site
but I had no right to see any drawings or other details.
were described as the ''copyright'' of the developer and his architect.
This seemed to me an extraordinary abuse of the law of copyright. It
appears just a cover for secrecy and for untransparent dealings between
a developer and the department.
what can a member of the public do in the face of such refusal of government
departments to be responsible to the public? If the department is correct
in saying it has no obligation to give me information about a development
which affects my own property rights directly, and the public indirectly,
there can be no way of knowing whether the design is in accordance with
the plot ratios and lease terms of the land.
information means no oversight. Are we expected to trust government
departments with an appalling record of losing public money to developers?
I do not.
my experiences of the past few days, it comes as even less of a surprise
to find out how often ''technical mistakes'' by officials concerned
with land and buildings can cost the public purse huge sums, to the
profit of developers. The latest government audit report revealed a
reserve price undervaluation, amounting perhaps to $1 billion, due to
''loopholes in building classification'' on a site acquired by Sino
Land, which was able to increase the developable floor area by 20 per
coup brings back memories of the notorious 1994 case of Coda Plaza in
Garden Road. Li Ka-shing's Hutchison group found a way to put up a 24-storey
building on a site intended by the Planning Department for seven storeys.
I remember all too well writing in the early 1980s about a ''small mistake''
in the pricing of the land premium on a Central office development -
what is now Fairmont House.
government auditor looked into the case and found that hundreds of millions
of dollars in land revenue had been lost
the value of development rights in Hong Kong, the need for transparency
in applications, approvals and changes in zoning, plot ratios, land
use rights etc is absolute and imperative. The secrecy of the Buildings
Department is outrageous, but may be all too typical.