Crony Central Banking in Hong Kong

Project Syndicate  |  Jun 8, 2009

By Sin-ming Shaw

HONG KONG – Joseph Yam, the head of the Hong Kong Monetary Authority (HKMA) and a career civil servant, is retiring. Ordinarily, that should not be a newsworthy event, yet it is, and for good reasons.
Donald Tsang, Chief Executive of Hong Kong’s government, has the opportunity to restore integrity and proper governance in one of the most important statutory bodies in the territory by choosing a person solely on the basis of unimpeachable honesty and competence.
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Yam remains a hero to many in Hong Kong, including journalists unschooled in international finance. To them, he is the guardian of the Hong Kong dollar, which has been fixed at 7.8 to the US dollar for 26 years.
During the 1998 financial crisis, devaluation would have hurt those who owned local real estate but had little earnings or assets in US dollars. Not surprisingly, Hong Kong’s oligopoly of property tycoons opposed changing the peg despite the currency’s gross overvalue at the time. The 7.8 exchange rate was maintained at the cost – borne by all citizens – of six years of economic stagnation.
The currency was in theory governed by a rules-based Currency Board, which the British invented for their smaller colonies. It tied the local currency to the British Pound, giving local authorities no discretion in monetary policy.
While imperial in origin, the rationale behind the Currency Board was sound. Colonies were short on expertise. Freedom in money creation or in interest-rate policy could mean economic disaster – as, indeed, it did in many ex-colonies following independence.
Yam was always frustrated by the lack of policy freedom under the Currency Board. Before the crisis struck in 1998 he put in place measures giving him room to manipulate liquidity and interest rates. His deviation from the system also created loopholes that he did not know about or thought irrelevant.
This was precisely what the British empire-builders had wanted to prevent. When, during the 1997-98 Asian financial crisis, global investment professionals turned their attention from Thailand and Korea to Hong Kong, they quickly spotted structural weaknesses in the way the currency was managed. Local experts had previously warned Yam about this, but he dismissed their argument in a way that one economist who was present at a meeting with him described as “demeaning and contemptuous”. Moreover, they left in shock in realizing Yam, and the financial secretary, Donald Tsang, nominally his boss but without real power, didn’t really understand the experts’ economic reasoning.
Hong Kong ’s government, led by the HKMA, launched an unprecedented intervention, buying up local shares to “defeat” the speculators, but failed to stop the stampede by global investors, including conservative pension and mutual funds.
Finally, with the government about to exhaust its entire foreign reserves, Yam realized that he had to change course. He wisely accepted his critics’ suggestions, fixing the problems that he had denied existed. He was awarded the highest public-service medal by the then Hong Kong Chief Executive Tung Chi-wah, who was later ousted by Beijing for incompetence.
At this writing, Yam is widely criticized in Hong Kong for failing to protect small investors against the dishonest sales tactics of a number of banks in their selling of toxic Lehman Brothers derivatives disguised as bonds. He denies any responsibility, even though the HKMA oversees all financial institutions.
Yam is the highest-paid civil servant in the world, earning US$1.5 million last year. His salary is seven times that of the chairman of the US Federal Reserve and nearly 3 times higher than that of his own superior, the Hong Kong Chief Executive. He claims that he should be rewarded as a fund manager supervising a multibillion-dollar fund in the private sector. But, whereas private-sector professionals are fired or have their salaries reduced for poor performance, Yam wanted private-sector pay with none of the downside risk.
The HKMA’s Compensation Committee had the sole responsibility for setting Yam’s salary. But, during his 16-year tenure, Yam put his own appointees on that committee, choosing them from the financial sector that he regulates. The Committee routinely rubber-stamped his salary demands.
Yam’s retirement presents an opportunity for Hong Kong’s government to redress a major issue of governance. It should replace the compensation structure by the same civil-service scale applied to the government of which the HKMA is an integral part.
Hong Kong ’s civil servants are already the best paid in the world. Anyone seeking to compare a public-service job with the private sector in negotiating an employment contract should simply seek work in the private sector rather than for the public good. Anything else merely opens the door for corruption.
There is much speculation that Hong Kong Chief Executive Donald Tsang is about to appoint a generalist civil servant better known for his personal loyalty than for his financial expertise. Nor is there any sign that the entire HKMA pay scale should be scrapped.
Either outcome would mean that the Chief Executive has missed an opportunity to send the right signal that Hong Kong stands for good public governance rather than cronyism.

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