1. Currency Board in Hong Kong

2. Recent financial crisis in Argentina, while highlighting the drawbacks of the currency board system, gave rise to a distrust of sustainability of such system. Although there exist many similarities of the currency board system practiced in Argentina and Hong Kong since the system is resurrection of what happened in their histories, however, the presence of the Mainland of China makes the case of Hong Kong unique, in addition to its own sound monetary and banking system.

3. Differences between Two Cases of Currency Board

4. Fixed exchange rate Argentina Hong Kong US$1 : Peso 1
backing the issue by a 66.67% reserve fund
with Central Bank
US$1 : HK$7.8
backing the issue by a 100% reserve fund
without Central Bank

5. “Escape clause” to cope with extraordinary events
Argentina
Hong Kong
peg rate can be revalued but not devalued.
No explicit escape clause

6. Domestic interest rate
Argentina
Hong Kong
Argentina > USA:
High domestic interest rate hurts investment, economic growth, and worsen fiscal budgets.
Domestic loans are dollarized.
Hong Kong <USA:
Hong Kong’s interest rate has been lower than that of US most of time except during
Domestic loans are usually extended in HK$.

7. Financial efficiency Argentina Hong Kong Non-leading financial center
Less efficient to raise fund
Asian financial center
Highly efficient to raise fund

8. Neighbor’s exchange rate policy
Argentina
Hong Kong
Brazilian devaluation of its currency by 40% in 1999!
Argentinean exports to Brazil accounts for 30% of its total exports.
The Mainland China has kept its currency stable.
Hong Kong’s exports to the Mainland accounts for 30% of its total exports.

9. In case of speculative attacks and financial crises
Argentina
Hong Kong
Difficult negotiations with IMF and USA, which likely destroyed public confidence. Argentina must accept harsh packages to cut its budge deficits and to contract its economy.
The Mainland China always voices its strong support.
More than 25% of HK$ deposits are held by the Mainland institutions. China has not yet freed its capital account convertibility.

10. It is a whimsy to believe that the currency board would automatically guarantee the credibility of the fixed rate peg. As Jeffrey A. Frankel (1999) put it, “little credibility is gained from putting an exchange rate peg into the law, in a country where laws are not heeded or are changed at will.” Without backing from the Mainland of China, Hong Kong SAR would have many difficulties to manage its currency board system.

11. Both “dollarization” and “currency board” fall into the category of “super-fixed” exchange rate regime. Both are historically adopted by very small territories, colonies, and self-governing regions. Both are strong measures that tend to be applied in extreme circumstances when everything else has failed.

12. The de facto transaction of Hong Kong dollar in the “off-shore market” in the Mainland, which accounts for 30 percent of the total issues of Hong Kong dollars, will exert an adverse impact on the stability of Hong Kong’s economy. The expectation of yuan devaluation would drive the Mainland residents to hold more assets denominated in Hong Kong dollars, and thus outflows of Hong Kong dollar would deteriorate Hong Kong’s trade balance, whereas yuan revaluation would reshuffle the assets structure, and return of the currency would add the inflation pressure in Hong Kong SAR.

13. The Hong Kong dollar and RMB have been pegging on US dollar, with one being a currency board and the other being fluctuated within bands. US dollar serves as a common anchor and will make two currencies converge in the long run. According to the statistics in 1999, every Hong Kong dollar (M0) in circulation is backed by the reserve of US$6; likewise, every RMB in cash (M0) is supported by the reserve of US$0.95, almost at 1:1 ratio.

14. It is not practical to “yuanize” Hong Kong dollar in short run not only because the Chinese yuan is not yet fully convertible under the capital account but also Hong Kong’s economy is deeply involved in the Asian economy. Although the optimal currency area in Asia is regarded as a remote vision, however, the one in Pearl River Delta can be enlarged.