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A lot of pegged exchange rate systems don't stay pegged for so long (e.g. because the central bank run out of reserves to maintain their values)

So far I understand that the HKD is 100% backed by the USD. How does this become a really good peg?

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  • $\begingroup$ There are three issues: (1) all bank notes in Hong Kong, from the four issuers, are backed by holdings of US bank notes; (2) interest rates in Hong Kong are allowed move so as to stabilise the USD exchange rate; (3) the Hong Kong Monetary Authority has extremely large reserves of US Dollars and uses these to intervene to achieve the USD peg in either direction. Whether the peg is "good" is another question: the USA is not Hong Kong's main trading partner $\endgroup$ – Henry Aug 6 '17 at 18:31
  • $\begingroup$ Are you going to accept my answer? $\endgroup$ – M3RS Aug 23 '17 at 8:16
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To maintain the currency peg, the Hong Kong Monetary Authority (HKMA) has to buy HKD and sell USD when the currency comes under depreciation pressure and sell HKD and buy USD when the currency comes under appreciation pressure.

Depreciation pressure: The HKMA operates a currency board, which means that more than 100% of outstanding HKD is backed by USD reserves. It cannot run out of reserves and the peg could be maintained indefinitely in the face of depreciation pressure, if this was the only goal the HKMA wished to pursue.

Appreciation pressure: The HKMA can print more HKD and sell it. There is no limit to this in theory (although the Swiss National Bank chose to abandon its peg in 2015). The peg could be maintained indefinitely in the face of appreciation pressure as well.

However, as long as the HKMA is committed to maintaining the peg, it can't run an independent monetary policy suitable for Hong Kong. (The HKD is sold/bought to maintain the peg instead of being sold/bought to stimulate or rein in economy.)

If the Hong Kong economy slowed, the HKMA would maybe prefer to simulate the economy by injecting more HKD into the system (printing more money). It might not be able to do so though if the HKD was under depreciation pressure. It would actually have to BUY the HKD to maintain the peg. This is the exact opposite of what would help the economy.

At the moment, Hong Kong is importing US monetary policy by pegging its currency to the USD. This has worked as Hong Kong is a small open economy in sync with the global economic cycle and the US is a main driver of that very cycle.

Nonetheless, some speculate that the peg will eventually be abandoned in favour of a peg to the Chinese renminbi as Hong Kong is more and more linked to the Chinese economy and US monetary policy is becoming less suitable for Hong Kong.

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