The Linked Exchange Rate remains the best way to achieve financial stability in Hong Kong.
What is it about the last week in September? As I sat down to write this piece about the introduction of the Linked Exchange Rate system, and the financial crisis that led up to it, I found myself having to deal with another emergency twenty-five years to the day after that one. Of course there are differences: that crisis was very much a Hong Kong matter, while this is an international one with its origins in the developed economies, particularly the US, although of course Hong Kong is affected. There is also an important similarity: once again confidence is the main issue. Then it was confidence in the future of Hong Kong and in the value of its currency; now it is confidence in the global financial system. And confidence is what the Linked Exchange Rate system is all about, which makes this an appropriate time to remember those days twenty-five years ago.
For many young men and women today, assuming they were born before September 1983, impressions of what happened in Hong Kong twenty-five years ago, around the end of September 1983, are probably not vivid. But over the years their parents have probably described to them their experiences at that time: the shelves in supermarkets nearly empty of daily necessities, particularly rice, toilet paper and diapers; and the nervous queues at ATMs and even the branches of one or two banks. The newspaper headlines were all about the currency and banking crises in Hong Kong. One newspaper, I recall, showed the exchange rate of HK$9.60 to the US dollar in very bold font, occupying almost half of the front page, although I cannot remember whether that was on Saturday the 24th of September or either of the following two days.
Interestingly, I found out recently that my diary for the period around the above dates was blank, other than an entry showing "4.30 – 5.30 pm RTHK Radio Programme" on 23 September 1983, as if nothing had happened. But the truth was I did not even have the time then to open my diary. I recall worrying about a financial meltdown and frantically making myself useful around the office, which included tracking the movements of the exchange rate (it depreciated by 15% in two days), getting market updates from the banks, attending meetings to discuss what to do (or what little we could do) and drafting a policy paper about a proposal to take over an ailing local bank. It was a stressful time.
I wonder whether the monetary and banking crises could have been avoided. Even with effective control over money, which we did not have at the time, the tight monetary conditions that would have been necessary to stabilise the exchange rate would have been so harsh that they would have crippled the economy and led to a banking crisis. But on balance, I would of course rather have effective monetary control in any circumstances than not have it, hence the monetary reforms introduced over the past twenty-five years.
Confidence in our currency is of the utmost importance for the stability and prosperity of our society. And it does not come easily. Some say, rather superficially, that you can leave it all to the market. But they must understand that there is always a need for monetary control, or more precisely, control of the supply or price of money, or both. While accepting this, others say that to achieve maximum credibility, the control should be a non-discretionary one that does not involve public officers taking decisions. I think it is a matter of degree. The rules of a rule-based system can sometimes be exploited at the expense of the public interest. Transparent and inflexible monetary rules, together with guaranteed freedom for the flow of money in and out of a relatively small but highly liquid market, are an invitation for market manipulation. And the dynamics of international finance are changing all the time, partly thanks to financial innovation. Currency stability requires a robust currency system, and robustness can only be achieved when the system can cope with dynamic changes in financial markets, on both the domestic and international dimensions. And there is an increasing need for market expectations to be managed if destabilising shocks are to be minimised.
Twenty-five years on, we have lived through many different economic cycles and financial crises. Over the years the Linked Exchange Rate system has provided us with a much needed anchor for currency stability. In the face of increasing uncertainty and volatility brought about by the current financial turmoil, we will remain vigilant and continue to improve our system to enable us to deal as best as we can with shocks facing our monetary and financial systems.
Joseph Yam
25 September 2008
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