CHAPTER THREE: The Linked Exchange Rate & The Peg
3.1 Background & History of the Hong Kong Currency Board System
In terms of finance and economic structures, Hong Kong has a lengthy history with respect to running a modern-day currency board. A fixed exchange rate is an exception in many countries but has typically been the norm in Hong Kong. Hong Kong exhibits an extremely externally-oriented economy, one that uses the external value of its currency as an anchor (Chiu 2). From the 1930s to the 1960s, Hong Kong demonstrated a classical colonial currency board, but the banks not the government issued currency. In the late 1960s, Hong Kong switched to a U.S. dollar anchor in place of the British pound that was undergoing forced devaluation. This move also involved changing the Exchange Fund’s assets from pound-denominated securities to dollar-denominated securities.
During the 1970s the U.S. dollar fell sharply. The United States government made the decision to let the dollar float, and the government of Hong Kong adopted the same policy with its own currency. Hong Kong currency floated for a nine year period from 1974-1983, with the economy showing average growth of more than 10% with moderate inflation of 4-6% during the mid-to-late 1970s (Chiu 2). Despite such impressive performance however, by the late 1970s various factors prompted the economy to become overheated. Public construction projects, a booming property market, growth of broad money supply and domestic loans, a rise in inflation to 15%, and the depreciation of the Hong Kong dollar by more than 20% from 1979-1982, prompted the restoration of the currency board in 1983 (Chiu 2).
The restored currency board meant an end of floating exchange rates. In 1983, the Hong Kong government made the decision to peg its currency to the U.S. dollar at a conversion rate of 7.8 to 1.0 (Kasa 3). During the early years of currency board operation, liquidity in the...