Hong Kong may take a hard look at dollar peg

As the only developed state linked to the greenback, Hong Kong will strongly feel the effects of the next round of US quantitative easing on its property sector

Powered by automated translation

As the only developed state linked to the greenback, the Chinese territory will strongly feel the effects of the next round of US quantitative easing on its property sector

As old certainties and the US dollar crumble in financial markets around the world, one thing has been solid for nearly a generation.

It is the fixed exchange rate of the Hong Kong dollar to the greenback at HK$7.80.

But now, as Hong Kong bears the brunt of "hot money" flows from the US as the Federal Reserve prints dollars, there are renewed calls for the Chinese special administration zone to remove its peg.

Many feel it should peg to the Chinese yuan, which is considered the strong currency of an emerging super power.

Hong Kong is the only developed economy in the world with a fixed exchange rate. It is a curious policy for one that is otherwise praised for allowing market forces to rule the economy.

Why Hong Kong, often voted as the most "market friendly" economy in the world, should have a fixed exchange rate can be traced back to its history as a British colony until 1997.

Uncertainty started gripping Hong Kong in the early 1980s as anxiety about what would happen to the free market paradise once communist China assumed sovereignty. One has to remember that China in the 1980s was visibly communist and the fears of capital flight was based on more than paranoia.

The pegging of the Hong Kong dollar to the US dollar was a response from the authorities to calm the situation and prevent capital flight.

The authorities thought that would be a simple way to guarantee the investment of companies and the savings of the middle classes, and reassure investors that they have the choice of pulling out of Hong Kong at any time without an exchange rate risk.

The policy of the Hong Kong-US peg has been a spectacular success in maintaining investor confidence and financial stability in this small, open economy through many ups and downs, such as the SARs crisis and the Asian financial slump of 1997.

Since it has been an anchor for Hong Kong for so long and it is simple to operate, the government is loath to tinker with it.

But the world is a very different place from the one in 1983. There is no serious possibility of China expropriating from the capitalists in Hong Kong now. More important, the US dollar, far from being a storehouse of value, is falling to new lows and many are predicting the yuan may well emerge as the new reserve currency for the world.

So for Hong Kong, which after all is part of China, to continue to peg its currency to falling the dollar rather than the rising yuan seems to be an outdated policy.

Tying the Hong Kong dollar to the greenback also means the territory has to follow the interest rate policy of the US, whether or not it suits local conditions.

Hong Kong's property market is overheating and needs to be cooled down with higher interest, but the government has to passively follow the low interest rate policy of the US, adding fuel to an asset bubble.

Influential voices, including those of investment banks such as Barclays, are calling for the peg to be abandoned.

With nearly US$500 billion (Dh1.83 trillion) in reserves, the Hong Kong government has the reserves to back its currency.

On the other hand, if the US continues printing money for too long and the greenback loses any pretensions of being a storehouse of value, Hong Kong may eventually be forced to change its policy.

If that happens, and the possibility remains very small indeed, one more certainty in the world financial markets will disappear.