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Web-only Exclusives
November 30, 2000

From Our Correspondent: Hirohito and the War
A conversation with biographer Herbert Bix

From Our Correspondent: A Rough Road Ahead
Bad news for the Philippines - and some others

From Our Correspondent: Making Enemies
Indonesia needs friends. So why is it picking fights?

Asiaweek Time Asia Now Asiaweek story

CURRENCY CRISIS

Hong Kong should delink from the greenback -- but not now


HONG KONG IS FACING its first real post-handover crisis. As stock markets tumble worldwide, how China's new special administrative region (SAR) manages the ferocious attack on its currency is important for several reasons. At stake is Hong Kong's future as an economic powerhouse and international financial center -- as well as its vaunted autonomy from Beijing. The issue will also impact upon the crisis of confidence that has engulfed most East Asian economies. When the first wave of currency devaluations swept through Southeast Asia starting July, Hong Kong easily weathered it. But last week, the second wave hit the SAR where it hurts. On Oct. 23 the Hong Kong stock market plunged more than 10%. The decline, subsequently worsened by big drops on Wall Street and in Europe, was triggered by the SAR government's decision to raise short-term interest rates to defend the local dollar against currency speculators.

The Hong Kong unit has been linked to the greenback since 1983, when troubled Sino-British negotiations on the territory's future sent its currency plunging to nearly HK$10 per U.S. dollar, sparking panic. Other countries, of course, have linked currencies, but perhaps nowhere else has "the peg" become so sacrosanct. "It is a very visible symbol of the 'one country, two systems' concept, under which Hong Kong retains autonomy from China," says Robert Broadfoot of the Hong Kong-based Political and Economic Risk Consultancy. To ordinary Hong Kongers, the link has also become an emblem of the economic -- and therefore the ultimate -- stability of the SAR itself. That is one reason Hong Kong officials' promises to defend the currency to the death are more credible than similar pledges from most other central bankers.

The current crisis presents China with a dilemma. Beijing publicly backs the U.S.-dollar link as an important guarantor of confidence. With $130 billion in foreign reserves, China can bring a lot of defensive firepower to bear against speculators. Yet open intervention by Beijing in the SAR's first major crisis may be seen to undermine Hong Kong's autonomy. For the moment, Beijing has stayed properly aloof, expressing its confidence in the ability of local authorities to maintain currency stability while indicating its readiness to help if needed.

Hong Kong has many strengths in its battle against the speculators. It has no net foreign debt and no current-account deficit. Its reserves total $88 billion, third-largest in the world. And the budget is perennially in surplus. Its weakest spot is stellar real-estate prices. They not only trim competitiveness but have also made the stock market, heavy with property counters, vulnerable to attack. So long as SAR authorities use higher interest rates to defend the peg, business will suffer and asset prices will be hurt, shrinking Hong Kongers' wealth on paper. Doubts have naturally arisen about the wisdom of maintaining the currency link.

Despite the pain, there is little question that Hong Kong must hang on to its peg -- for the moment. To delink now would be calamitous. Such a move would leave too many businesses exposed to the vagaries of the currency markets, especially under the present volatile conditions. It would cause rapid devaluation and massive capital flight into other currencies, further depressing stocks and property prices. Social unrest is likely. And that, in turn, would deepen Beijing's dilemma over intervention.

But when the typhoon passes, Hong Kong has reason aplenty to reconsider the peg. In the short term, keeping the link means the SAR's competitiveness will suffer relative to its Southeast Asian neighbors with their devalued currencies. In the longer run, as the SAR's economy integrates further with the mainland's, it would be an anomaly for such a key part of China to have its interest rates effectively set by the U.S. Federal Reserve System through the dollar link. Moreover, the local dollar would remain vulnerable to speculative assault.

The peg was originally instituted to protect Hong Kong's economy from political uncertainty. With the handover to China and Beijing's restrained approach to SAR affairs so far, much of that anxiety has dissipated. Indeed, as essential as it has been, the political insurance provided by the peg had huge costs. As the U.S. dollar declined steeply against other major currencies in the 1980s and early 1990s, the link ensured that Hong Kong's scrip was similarly debased. Moreover, the peg hindered the local government's ability to fight inflation by adjusting interest rates. That means Hong Kong's cost of living has been higher than it could have been, which further erodes the value of citizens' earnings. The relatively low interest rates produced by the peg also meant cheap money for borrowers and inflated asset prices.

If Hong Kong has a choice, the best time to delink would be a few years from now. Preconditions include a local economy that has recovered a good measure of its vitality, stable development in China and calm world market conditions. Then the SAR will be able to come into its own not just as China's financial center but also a global one, with its own independent currency and monetary policy. First, though, Hong Kong needs to make it through the current turbulence.


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