Self-serving nonsense about the peg and reserves

SCMP August 10, 2014

According to evidence in the ongoing trial of Rafael Hui Si-yan and executives of Sun Hung Kai Properties, the Kwok brothers had once considered hiring Norman Chan Tak-lam but thought the cost not worthwhile. Sun Hung Kai's consequent gain has been Hong Kong's loss as bureaucrat Chan went in quick leaps from a stint at Standard Chartered Bank to Donald Tsang Yam-kuen's office manager to head of the Hong Kong Monetary Authority, replacing its long-time incumbent, the arrogant but very competent Joseph Yam Chi-kwong.

Perhaps the appointment of Chan should have been no surprise, given his close relationship with Tsang and Tsang's affinity with Standard Chartered, where Tsang's sister Katherine Tsang King-suen rocketed from a human resources role to heading the bank's Greater China operations.

But if Chan actually believes his own public statement, Hong Kong is in for a rough passage the next time its value vis-à-vis the US dollar or the Chinese yuan becomes an issue in the marketplace - and it surely will.

Chan recently claimed that all of the government's net assets in the Exchange Fund were needed to defend the dollar peg. That is a ridiculous statement on several counts.

Firstly, it ignores the basic principle by which a peg of this sort is supposed to operate if under strong downward pressure - the contraction of base money and the consequent rise in interest rates to the point where outflows cease.

Reserves can help smooth that process but committing all reserves to defence of a peg is sheer lunacy, particularly given that banking assets are 12 times those of the reserves.

If an exchange rate is perceived to be wildly out of line with reality, it will collapse, as surely as did the Thai baht and other Asian currencies in 1997.

Foreign currency reserves and fiscal reserves are two separate concepts and have very different goals. Conflating them just because most of Hong Kong's fiscal reserves are held in foreign currencies is dangerous.

Nor are these foreign exchange reserves of the slightest use if the problem is extreme upward pressure on the Hong Kong dollar. This is a far more likely scenario given that for a long time the currency has remained near the top of its peg band despite intervention by the HKMA.

It is anyone's guess when the next round of global currency turmoil will break out and in what direction it will push the Hong Kong dollar.

But you can be sure that because of the ever greater links between Hong Kong and the mainland, and the greater international role of the yuan, the local currency will be in play. Whatever happens to the yuan, its rate against the dollar will become more volatile as China liberalises its currency regime.

As Yam himself has intimated, Hong Kong needs to be thinking of its currency arrangements given the role of China in this economy. This writer has - from before the peg was introduced during the panic of 1983 - been in favour of a managed float against a basket of currencies, of the sort long implemented by Singapore. A basket composed of just dollars and yuan would provide much greater stability than one composed entirely of one currency.

But civil servants of the Chan ilk and his deputies - civil servants with scant experience in the private sector or financial markets - seem incapable of doing more than repeating shibboleths about the peg and using it to justify excessive reserves. That the peg has lasted 30 years in no way assures that it is permanent.

Currency issues have always been problematic in Hong Kong. In the early colonial days, this arose from Britain operating a gold-based currency while China was silver-based. The relative values of gold and silver fluctuated. The period from 1966 to 1975 saw no less than three systems - a sterling peg, a dollar peg, each punctuated with a revaluation, and then no peg at all.

Of course, Chan may be thinking ahead and not telling anyone. But in that case why this stupid talk about the necessity for keeping those existing reserves, other than to head off demands for some of them to be dedicated to providing pensions for citizens other than our featherbedded civil servants and associated bodies?

Does anyone compute the cost to the economy of investing these huge surpluses mostly in short-dated paper and low yielding foreign government bonds?

Why should the HKMA be entrusted with such huge resources when they could be put to better use by their owners, the citizens of Hong Kong?

The in-crowd of bureaucrats purports not to trust Hongkongers' ability to manage their own affairs. But meanwhile these same officials show themselves incapable of managing the public purse, resulting in vast cost over-runs for their favoured projects, several of which had no economic justification even at the original cost.

It is hard not to come to the conclusion that inane remarks like those of Chan are simply a way of ensuring that the maximum amount of money remains at the disposal of bureaucrats, thereby cementing the links between government and favoured big businesses, a group now including some mainland state enterprises.

ends