Mr Joseph Yam's letter to Mr Alan Greenspan, Chairman of Board of Governors of the Federal Reserve System


17 Sep 1998

Mr Joseph Yam's letter to Mr Alan Greenspan, Chairman of Board of Governors of the Federal Reserve System

Joseph Yam, Chief Executive, Hong Kong Monetary Authority

Mr Alan Greenspan
Board of Governors of the Federal Reserve System
20th Street and Constitution Ave NW
Washington, DC20551

I was surprised and indeed somewhat hurt by your reported comments on Hong Kong yesterday at the House Banking Committee. This is particularly so when you have been so very supportive on Hong Kong and on the work of the Hong Kong Monetary Authority (HKMA), and your support has been very important to all of us here.

Allow me to put to you the Hong Kong government's argument in support of its involvement in stock and futures markets. What was done was not for the purpose of jacking up the stock market, as you put it. We are prepared to accept and bear the pain of asset price adjustment necessary under even the toughest of circumstances. What we were trying to address is price manipulation. And we did so on the one hand by frustrating those manipulative plays through counter activities in the markets and on the other hand following through with reform measures to ensure that our markets are less susceptible to manipulation.

As you may be aware, we have a rather efficient RTGS payment system in our financial infrastructure. It is so efficient that, in the absence of reserve requirements, the aggregate balance of the banking system held in the clearing accounts maintained with the HKMA is a very small number (about US$250 million). This part of the monetary base is of course crucial to our currency board arrangements. We are very transparent about it, and its size, which goes up and down in response to capital inflows and outflows strictly in accordance to the discipline of the currency board system, is published on the screen with almost real time updating. The efficiency of our payment system, our high degree of transparency and our strict adherence to the currency board discipline have unfortunately made our money market very susceptible to manipulation.

We have reason to believe that those wishing to manipulate our markets have since the beginning of this year accumulated over HK$30 billion by entering into swaps, through financial intermediaries, with multilateral institutions such as the World Bank and the Asian Development Bank who have issued one and two-year Hong Kong dollar debt. We have reason to believe that they have at the same time accumulated very large short positions in stock index futures. Taking advantage of a spate of bad news and rumours, they sold the Hong Kong dollars they had accumulated to the HKMA, who had to take them in accordance with the currency board discipline, and sent interest rates sharply higher and stock prices sharply lower. This enabled them to make huge profits in their short stock futures positions.

This manipulation across financial markets was increasingly being conducted with little regard to economic fundamentals. Wherever the market level is, the down side risk to this play is limited but the up side is huge, for as long as stock prices and short term interest rates are inversely correlated. This play has been repeatedly deployed recently and with greater intensity. The danger for us is therefore that the deflation process, which is already painful, may be grossly exacerbated, with markets seriously overshooting in panic, undermining the viability of the whole financial system including of course the banks. This is what we were trying to address. And I hope, with this background, our action makes at least a little sense to you.

You know that Hong Kong is one of the freest markets in the world, if not the freest. The free market philosophy is very much in our blood. But a free market does not mean that it can be freely manipulated. It needs to be a fair market as well. Furthermore, if such a firm believer in free markets is pushed into doing things that are considered unconventional and controversial, is it possible that there is something seriously wrong with the international financial system that needs to be urgently addressed? I believe so, and I am looking forward very much to world leaders like you to steer all of us out of this global financial storm that has been wrecking many economies, weak or strong.

Meanwhile, you may wish to note that our follow through measures to strengthen our currency board arrangements to make our system less susceptible to manipulation have been working well. I am confident that this will obviate the need for us to continue to be involved in the stock and futures markets as a market participant.

It is my turn today to face our own version of your House Banking Committee. And ours I am afraid behaves a little different from yours. I hope your good wishes on Hong Kong are still there. I need them.

With best regards,

Yours sincerely,
Joseph Yam
Chief Executive
Hong Kong Monetary Authority

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Last revision date : 17 September 1998