Lower peg to boost economic recovery

South China Morning Post  |  Sep 1, 2001

By Sin-ming Shaw

Byline: Keeping the Hong Kong dollar `overvalued' will force our economy to stagnate, says Sin-ming Shaw

FINANCIAL SECRETARY Antony Leung Kam-chung said last week that the Hong Kong dollar's peg to its United States counterpart was one of the obstacles to economic recovery, but that changing it would result in undesirable currency speculation.

The South China Morning Post's Jake van der Kamp then took him to task for saying this in his column last Saturday, insisting that the peg is not an obstacle. On the contrary, he claims, a regime of free-floating exchange rates is detrimental to an "efficient economy" while the peg would enforce "needed disciplines" on the Government without which the bureaucrats would run amok in fiscal profligacy.

These gentlemen are two of the most seasoned veterans of Hong Kong's world-class financial community. I have high and equal respect for both, although I know Jake far better and have liberally picked his fertile brain about the state of the world over the past 20-odd years.

But on the question of the peg, both of them cannot be right. So who is wrong? Neither is entirely right, but Mr Leung enjoys a very clear edge.

Let's be careful with definitions. Our exchange system is not just any peg whereby the Government ensures, by hook or crook, that the rate stays pegged. Instead, ours is a currency board where the local unit is linked at the rate of 7.8 to a greenback. It is a system whereby the Government, if it sticks to the rules, has really only one important role to play: that is to issue a sovereign guarantee of convertibility of the banking reserves kept by the banking system at 7.8. Nothing much else.

A pegged rate - I use the term "peg" to mean "link" as that is what it is conventionally called - does not in any way eliminate "speculation" that it will change to a higher or lower rate. Anyone can try and does. Without it, a market cannot exist. Mr Leung errs on this point. He should know "speculation" as a term is largely meaningless in a free market. However, a pure currency board is essentially foolproof in defeating those who wish to "break" it deliberately. It does not require government fiddling. Indeed, intervention invites more speculation, not less.

It is important to understand that a currency-board rate promises only one thing: the fixed rate can stay at that level forever barring a cosmic disaster. It promises nothing else. In particular, it does not promise economic nirvana.

Jake is wrong to say a pegged rate imposes fiscal disciplines although a freely floating exchange regime provides a free hand to the Government to finance white elephants. Jake, what do you call Cyberport and Disneyland? Blue elephants? How would you describe Monetary Authority chief Joseph Yam Chi-kwong's $4 billion purchase of harbour-front office space in the name of supporting the currency while the whole of Hong Kong suffers? A white hyena? Incidentally, America enjoyed the largest fiscal surplus on record under Bill Clinton's presidency while its currency went up and down and up.

Argentina has a currency board pegging one peso to a dollar. It has enormous public debt and fiscal deficits, the sources of its economic crisis. But the exchange rate is still one peso to a dollar even as its high double-digit interest rates are killing the economy.

The tanking of the economy is the implicit price to pay for a pegged over-valued exchange rate, for all the economic adjustments must be borne by the real economy, and none by the exchange rate. In plain words, if you want a fixed rate, you can have it but be prepared to suffer very badly if the currency becomes grossly overvalued.

How much must the economy adjust? That depends on how overvalued the exchange rate is and how inflated the local assets and wages are? No one really knows until the adjustments run their course to reach some equilibrium. Anyone who claims to know when the adjustment should stop is either ignorant or bluffing. Usually both.

That was what the Hong Kong Government did in 1998 when it massively intervened in the share and property markets, by buying $118 billion in stocks and freezing government land sales, while claiming the adjustment was being overdone.

Had the officials not been so arrogant, panicky or ignorant and had instead allowed the market forces to work, Hong Kong would have found a far more solid footing from which to grow again.

Instead, we are forced to go through a slow Chinese water torture. Our economy will stagnate the way Japan has been for the past 11 years because Japan's ruling elite never had the courage to get the painful adjustment over with quickly. It still does not.

The worst consequence of the 1998 official intervention has been to create an "entitlement" culture in Hong Kong among those who suffer from "negative equity", whereby the current market value of their property is less than the outstanding mortgage. At no time in the entire history of Hong Kong prior to 1998 did carriers of negative equity lobby the Government to support the market in order to reduce their private losses. The 1998 incident marked a historic watershed. It sent a message to the public: we can and will override market forces if the paper losses of your assets become "too big". For this gross error, the community will pay dearly.

Mr Leung was entirely correct in saying the peg was an obstacle because he was stating a simple truth - our currency is overvalued. But Jake was also correct in saying that even if the rate is an obstacle, which he apparently does not believe is the case, the Financial Secretary should not be saying so publicly and loudly, as Mr Leung's position is no longer that of a private banker. As Hong Kong's highest official in charge of the monetary system, he is effectively the personification of the currency.

I should say emphatically, however, that if the Government decided to re-peg the local dollar to a lower level, which it should, it should do so overnight.

As usual, the Government is behind the public. "Everybody" knows the dollar is overvalued. Just look at the cross-border traffic. The people of Hong Kong are telling the world with their feet and their pockets. Keep the currency board by all means but lower the peg, now. By how much? Any number from 10 and 12 to a greenback would be fine. The lower the peg, the faster Hong Kong's economy will recover.

`What do you call Cyberport and Disneyland? Blue elephants?'

Sin-ming Shaw (smshaw@attglobal.net) is a writer and private investor who was formerly a regional economist for Chase Manhattan Bank

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