Hong Kong’s exchange rate policy

Hong Kong currently undergoes what is known as a linked exchange rate system. A linked exchange rate system is a type of exchange rate regime that pegs the exchange rate of one currency to another. This system is implemented by Hong Kong to fix the exchange rate between the Hong Kong dollar and the United States dollar. This is similar to a fixed exchange rate system the main difference is that the government/central bank does not actively interfere in the foreign exchange market by controlling demand and supply of their own currency through the use of interest rates and reserves. Instead, the exchange rate is maintained by an exchange mechanism whereby the Hong Kong Monetary Authority authorizes note-issuing banks to issue new banknotes provided that they deposit an equivalent value of US dollars with the Hong Kong Monetary Authority. If the exchange rate begins to shift too much from the established, fixed ratio, currency is added to or removed from circulation by a central bank to bring the ratio back into the acceptable range. The currency being managed may be issued only when there are reserves in the linked currency to back it up.

One US dollar is agreed and fixed to be worth 7.8 HK dollars.

There are several advantages of having such a system. Firstly, the system is simpler and situational compared to a fixed exchange rate system as there are normally less policies and calculations involved. The linked exchange rate system stabilizes both currencies and works to keep inflation low. Additionally, the linked system can in many cases bring about greater economic prosperity and growth, domestic Hong Kong firms can focus on their own business and need not spend as much on hedging the risk of currency fluctuation. This can also bring about greater business and consumer confidence as they know their currency will not fluctuate against the USD. The rule-based money supply policy involved in the Linked Exchange rate system also makes the note-issuing system far more transparent. The fact that the Hong Kong dollar has been linked with U.S. dollar for more than 30 years has also contributed greatly to Hong Kong’s development into an international financial center.

However, there are several drawbacks and limitations too. The unchanging link with the USD means that the Hong Kong economy is greatly dependent on the US economy as the international value of the Hong Kong dollar varies according to the performance of the USD. This means that if the US has an economic downturn or suffers recession, Hong Kong’s economy will suffer too. Furthermore, having such a rigid exchange rate system and policy means that should Hong Kong suffer economic downturn themselves they cannot manipulate their own exchange rate to improve imports and/or exports.

Overall, I would say that, historically speaking, looking at the past 30 years, such an exchange rate system has definitely benefited the Hong Kong economy considerably, allowing them to benefit from American economic growth and stability. However, futuristically speaking, it may not necessarily be the most optimal exchange rate system. As the economic and political situation in both Hong Kong and USA complicates, being overly reliant on the US economy in light of things like the Trade War may not be the best policy going forward. This is especially so as the Chinese economy is considerably greater than what it was 30 years ago offering support and alternatives for Hong Kong.

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