Linked Exchange Rate System
In the face of rising inflationary pressure in Hong Kong, some people have suggested that the Linked Exchange Rate system is the root cause of the situation and that the Hong Kong dollar should no longer be linked to the US dollar. The Financial Secretary already stated in his blog on 14 August that the Link continues to be the most appropriate exchange rate arrangement for Hong Kong. I will elaborate further on a few related issues.
Many people who advocate un-pegging the Hong Kong dollar from the US dollar claim that the recent downgrade of the sovereign credit rating of the US would inevitably lead to a substantial depreciation of the US dollar. They argue that Hong Kong’s risks of high inflation and an asset price bubble will heighten if the Hong Kong dollar continues to be linked to the US dollar.
I do not agree with this proposition. As I have explained to the media on 8 August, the US dollar remains the most important international reserve currency as well as the main currency in which financial and trade transactions are denominated and settled. These roles can hardly be replaced overnight. So the downgrade of the US does not necessarily lead to one-way depreciation of the US dollar. In fact, the exchange rates among the major international trade and reserve currencies (the US dollar, the euro, the Japanese yen and the British pound) are the relative value of one currency against another. While the US economy might slow down and the US government has not yet fully solved its fiscal problems, the euro area, Japan and the UK are facing similar, or to some extent more severe, problems. Relatively speaking, the US economy has shown more vitality and stronger capability for adjustment. For example, the labour market in the US is more flexible than those in many European countries, and it has a younger population too. While the exchange rate of the US dollar will inevitably fluctuate in the short term, there is not enough evidence to support the view
Many people who advocate un-pegging the Hong Kong dollar from the US dollar claim that the recent downgrade of the sovereign credit rating of the US would inevitably lead to a substantial depreciation of the US dollar. They argue that Hong Kong’s risks of high inflation and an asset price bubble will heighten if the Hong Kong dollar continues to be linked to the US dollar.
I do not agree with this proposition. As I have explained to the media on 8 August, the US dollar remains the most important international reserve currency as well as the main currency in which financial and trade transactions are denominated and settled. These roles can hardly be replaced overnight. So the downgrade of the US does not necessarily lead to one-way depreciation of the US dollar. In fact, the exchange rates among the major international trade and reserve currencies (the US dollar, the euro, the Japanese yen and the British pound) are the relative value of one currency against another. While the US economy might slow down and the US government has not yet fully solved its fiscal problems, the euro area, Japan and the UK are facing similar, or to some extent more severe, problems. Relatively speaking, the US economy has shown more vitality and stronger capability for adjustment. For example, the labour market in the US is more flexible than those in many European countries, and it has a younger population too. While the exchange rate of the US dollar will inevitably fluctuate in the short term, there is not enough evidence to support the view