Costs And Benefits Of Hong Kongs Currency Board Finance Essay

The Hong Kong Currency Board System is basically the Linked Exchange Rate System and has been in being since October 17, 1983. It requires that the pecuniary base of the economic system be to the full backed by foreign militias therefore the Hong Kong dollar has been linked to the US dollar since the constitution of the Link. It is officially linked to the US dollar at the rate of 7.8 Hong Kong dollars to 1 US dollar.

This Link guarantees the stableness of Hong Kong ‘s dollar against other universe currencies. It uses an automatic involvement rate accommodation mechanism which ensures that the stableness of the Hong Kong dollar exchange rate is maintained.

Currency boards are a signifier of fixed exchange rate system and can be considered a stronger signifier. Rather than rely on foreign exchange controls, they depend on their market forces to repair their exchange rate. Like a Central Bank, a Currency Board is a state ‘s pecuniary authorization that issues notes and coins at a fixed exchange rate with a foreign currency but unlike the Central Bank, it is non the loaner of last resort nor is it a authorities ‘s bank, that is to state that it is non influenced by pecuniary governments. It can work entirely or parallel to a Central Bank but the latter is rather uncommon.

BACKGROUND ON HONG KONG ‘S ADOPTION OF THE LINKED EXCHANGE RATE SYSTEM

For Hong Kong, a fixed exchange rate system is an advantage instead than a disability to their economic system. Whereby most economic systems that have adopted the currency board did so to command some signifier of rising prices, Hong Kong requires the currency board to supply a house and stable clasp for the external value of its currency because of its really unfastened economic system.

The Link, which was the solution, was a alteration of the bing currency board system which had been in consequence since 1935 to 1972. Prior to the acceptance of the Link, Hong Kong operated a floating exchange rate system for nine old ages from 1974 to 1983. This period was non without its ups and downs but the absence of an efficient pecuniary clasp was a major disadvantage of the system.

The determination to follow the Link and nail down the Hong Kong dollar to the US dollar was taken chiefly to regenerate the populace ‘s assurance in their currency which had degenerated and led to a currency crisis when the Hong Kong dollar suffered a sudden dip of approximately 15 % in the foreign exchange market within merely a twosome of yearss in the early 80 ‘s, seting the governments under force per unit area to happen a despairing solution to rectify the state of affairs. Lending to this crisis besides were the equivocal political alteration in Hong Kong as a consequence of the Sino-British struggle, the uncertainness of the stableness of some Bankss and the belongings bubble explosion.

THE LINKED EXCHANGE RATE SYSTEM AND ITS BENEFITS

The advantages of associating to one currency as opposed to a host of others are the simpleness, transparence and easy apprehension of the system for the populace. The pick of the US dollar was influenced by the factors that it is the chief international currency in which most of Hong Kong ‘s trade is carried out and US is besides the chief trading spouse of Hong Kong.

For historical grounds, currency boards do non publish currency notes. It is the commercial Bankss that issue these notes. Besides, the banking system ‘s glade balances were non on the balance sheet of the currency board therefore doing the Certificate of Indebtedness the lone pecuniary base instrument of the currency board ‘s balance sheet and that to which the nexus is applied.

In the early yearss, the forces of demand and supply of course still controlled the exchange rate in the foreign exchange facet. However, in state of affairss whereby the exchange rate suffered dazes, intervention in the foreign exchange and money markets proved to be uneffective in rectifying or stabilising these dazes.

The economic growing of Hong Kong under the Linked Exchange Rate System has been rather impressive since its constitution in 1983. A cardinal component is the ample financial and foreign modesty which has grown over clip since the constitution of the Link.

Hong Kong operates a really unfastened economic system, a factor which makes the Linked Exchange Rate System extremely suited for its demands. It gives Hong Kong the ability to defy dazes while protecting the economic system from the effects of a sudden clang in its currency.

The Linked Exchange Rate System besides keeps Hong Kong ‘s pecuniary base and economic system stable every bit good as cut downing its foreign exchange hazard. It had the benefit of directing force per unit area off from the exchange rate to other countries of the economic system therefore supplying a important secure base. This is a good suitable advantage as the nature of Hong Kong ‘s economic system being a really unfastened 1 with a reasonably big fiscal sector makes it extremely susceptible to dazes in the fiscal sector which could ensue from instabilities in the external markets.

It is pertinent to observe that certain properties of the Hong Kong economic system have aided and contributed to the effectivity of the Linked Exchange Rate System:

First, because of the flexible nature of the Hong Kong economic system i.e the speedy antiphonal nature of markets such as the existent estate and labor markets, this leads to alterations in internal construction of costs and monetary values which induce matching alterations in external competition doing it unneeded for Hong Kong to fiddle with its exchange rate.

Second, because of the strong nature of the Hong Kong banking system and their ability to manage and pay up all their debts, they easy accommodate any alterations in the involvement rates which may come up.

Third, the ample financial and foreign modesty of Hong Kong which grew over clip since the constitution of the Link is a cardinal component and added support to the Link. Hong Kong has one of the highest foreign currency modesty degrees in the universe.

Since the acceptance of the Link, Hong Kong ‘s economic system has and continues to execute positively with existent GDP and rising prices turning on an norm of about 5 % to 6 % yearly.

Furthermore, in order to advance the transparence in the system, the Hong Kong Monetary Authority publishes on a real-time footing, the Aggregate balance prognosis alterations, the Central Bank history monthly and the pecuniary base including its constituents on a day-to-day footing. A sub-committee made up of members of the Hong Kong Monetary Authority every bit good as the private sector has been set up to oversee the operations of the currency board under the exchange fund consultative commission and to propose manners of beef uping the currency board arrangements even more.

Despite assorted economic catastrophes and unfavorable fortunes over the old ages, for illustration, the 1990 Gulf War and Stock Market clang of 1987 amongst others, the Linked Exchange Rate System has proven dependable and effectual for the Hong Kong economic system as it has enabled the Hong Kong dollar withstand the dazes and remain stable since its constitution.

THE ASIAN FINANCIAL CRISIS

The Link was put to prove during the Asiatic fiscal crisis of July 1997. Branch currencies fell while Bankss faced major liquidness jobs in settling their foreign exchange minutess as they had sold far more Hong Kong dollars than the balances they had, to the Hong Kong Monetary Authority. This led to uncertainness in the supply of liquidness in the economic system and as a consequence, Bankss over bided in the market and really caused the over-night rates to flip projectile by over 300 % at a peculiar clip.

The automatic involvement rate accommodation mechanism under the currency board agreement managed this escape but non without some effects i.e the after-effect on the market.

A old state of affairs had put the Link to some trial though ; when after the Mexican crisis in 1995, there was addition in the gross revenues force per unit area of Asiatic currencies which included the Hong Kong dollar. The state of affairs nevertheless did non last long as involvement rates increased within a short period and the exchange rate stabilized.

COSTS AND LIMITATIONS OF THE LINKED EXCHANGE RATE SYSTEM

Every pecuniary policy has its advantages and disadvantages and while the Linked Exchange Rate System has been a preferable and sure system for Hong Kong, it comes with its restrictions and challenges every bit good.

In every bit much as its pecuniary sector has remained stable over the past figure of old ages, Hong Kong is still vulnerable to unstable capital flow hazards as it operates a little but really unfastened economic system.

The Link does non use motions of the Exchange Rate as a manner of accommodation and therefore does non function as a good or dependable step of the instabilities in the economic system. A sudden clang in the external competitory or internal markets taking to dazes in the economic system would necessitate more alteration or alteration than if the exchange rate system were free to travel. That is non to state that internal alteration does non proffer more permanent solutions but it is a much slower procedure than if the exchange rate adjusted itself.

The accretion of foreign militias despite being a major advantage constitutes jobs in Hong Kong doing the most of their assets that is, taking advantage of and doing adequate returns in periods of domestic rising prices on their foreign assets.

Besides, in the wake of the crisis, it took a piece for internal loans to get down to retrieve and turn steadily once more from a drawn-out period of subdued demand while on the external portion, ruin in the growing of the international market had a negative consequence on Hong Kong ‘s trade public presentation.

Since the Hong Kong dollar is pegged to the US dollar, this may convey about a struggle of involvement in a instance whereby the economic state of affairss of both states are non on the same way. For case, if the US dollar, in a command to control its rising prices decides to increase involvement rates, this might adversely impact the state of affairs in Hong Kong at that peculiar point in clip thereby go forthing small room for the accomplishment of the Link ‘s chief aim of monetary value stableness or even in the long tally, economic growing.

Another of import point to see is the likely cost of Hong Kong stoping the nog in the hereafter. There should be a positive balance between keeping short-run stableness and long-run flexibleness because as more assurance is developed in the fixed exchange rate system, the more the economic system would hold to give, if the demand of all time arises to alter the system.

Decision

Despite every-day challenges in the fiscal universe which the nature of its economic system, being a high degree unfastened one with a really big fiscal system every bit good as a non-existent exchange rate control, do it all the more susceptible to ; Hong Kong has successfully operated a contemporary currency board for a comparatively long period of clip. Because of its very flexible economic system, Honk Kong easy adapts to any alteration or daze to its fortunes. The velocity of Hong Kong ‘s economic recovery is besides cogent evidence of the Link ‘s ability to set the economic system to dazes and therefore it is extremely suited with the Linked Exchange Rate System.

The Link has and still continues to brace Hong Kong ‘s pecuniary economic system since its constitution. It has seen Hong Kong withstand assorted dazes including the Global Financial Crisis in 2008/2009. The clear committedness of the Hong Kong Monetary Authority, which is Hong Kong ‘s cardinal bank, to the Link is besides an added advantage as Hong Kong can escalate the Link through its cardinal bank competently supported by its really big international modesty. There are times nevertheless, that the advantage of the Link is doubted and other exchange rate systems are suggested including ; associating to the US dollar at another rate, associating to a host of currencies, associating to an alternate currency and Dollarization, which is a system whereby the domestic currency is substituted by a foreign one ( normally the US dollar ) as a unit of history, medium of exchange and shop of value ; amongst other options. No individual exchange rate system is perfect for all economic systems in any period but the Link has fitted good into the overall workings of the Hong Kong economic system and has been the best option so far for Hong Kong.