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Recent financial crisis in Argentina, while
highlighting the drawbacks of the
currency board system, gave rise to a
distrust of sustainability of such system.
Although there exist many similarities of
the currency board system practiced in
Argentina and Hong Kong since the
system is resurrection of what happened
in their histories, however, the presence
of the Mainland of China makes the case
of Hong Kong unique, in addition to its
own sound monetary and banking system.
Differences between Two
Cases of Currency Board
Fixed exchange rate
Argentina
US$1 : Peso 1
backing the issue by a
66.67% reserve fund
with Central Bank
Hong Kong
US$1 : HK$7.8
backing the issue by a
100% reserve fund
without Central Bank
“Escape clause” to cope
with extraordinary events
Argentina
peg rate can be
revalued but not
devalued.
Hong Kong
No explicit escape
clause
Domestic interest rate
Argentina
Argentina > USA:
High domestic interest
rate hurts investment,
economic growth, and
worsen fiscal budgets.
Domestic loans are
dollarized.
Hong Kong
Hong Kong <USA:
Hong Kong’s interest
rate has been lower
than that of US most of
time except during
1997-1999.
Domestic loans are
usually extended in HK$.
Financial efficiency
Argentina
Non-leading financial
center
Less efficient to raise
fund
Hong Kong
Asian financial center
Highly efficient to raise
fund
Neighbor’s exchange rate
policy
Argentina
Hong Kong
Brazilian devaluation of
its currency by 40% in
1999!
Argentinean exports to
Brazil accounts for 30%
of its total exports.
The Mainland China
has kept its currency
stable.
Hong Kong’s exports to
the Mainland accounts
for 30% of its total
exports.
In case of speculative
attacks and financial crises
Argentina
Hong Kong
Difficult negotiations
with IMF and USA,
which likely destroyed
public confidence.
Argentina must accept
harsh packages to cut
its budge deficits and to
contract its economy.
The Mainland China
always voices its strong
support.
More than 25% of HK$
deposits are held by the
Mainland institutions.
China has not yet freed
its capital account
convertibility.
It is a whimsy to believe that the currency
board would automatically guarantee the
credibility of the fixed rate peg. As Jeffrey A.
Frankel (1999) put it, “little credibility is
gained from putting an exchange rate peg
into the law, in a country where laws are not
heeded or are changed at will.” Without
backing from the Mainland of China, Hong
Kong SAR would have many difficulties to
manage its currency board system.
Both “dollarization” and “currency
board” fall into the category of “superfixed” exchange rate regime. Both are
historically adopted by very small
territories, colonies, and self-governing
regions. Both are strong measures that
tend to be applied in extreme
circumstances when everything else
has failed.
The de facto transaction of Hong Kong dollar in
the “off-shore market” in the Mainland, which
accounts for 30 percent of the total issues of
Hong Kong dollars, will exert an adverse impact
on the stability of Hong Kong’s economy. The
expectation of yuan devaluation would drive the
Mainland residents to hold more assets
denominated in Hong Kong dollars, and thus
outflows of Hong Kong dollar would deteriorate
Hong Kong’s trade balance, whereas yuan
revaluation would reshuffle the assets structure,
and return of the currency would add the
inflation pressure in Hong Kong SAR.
The Hong Kong dollar and RMB have been
pegging on US dollar, with one being a
currency board and the other being fluctuated
within 0.0001 bands. US dollar serves as a
common anchor and will make two currencies
converge in the long run. According to the
statistics in 1999, every Hong Kong dollar
(M0) in circulation is backed by the reserve of
US$6; likewise, every RMB in cash (M0) is
supported by the reserve of US$0.95, almost
at 1:1 ratio.
It is not practical to “yuanize” Hong Kong
dollar in short run not only because the
Chinese yuan is not yet fully convertible
under the capital account but also Hong
Kong’s economy is deeply involved in the
Asian economy. Although the optimal
currency area in Asia is regarded as a remote
vision, however, the one in Pearl River Delta
can be enlarged.