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C H A P T E R 2 TIME TO BLOW THE WHISTLE July–August 1981 Between the publication of this article and the preceding one the HK$ had fallen further against the US currency. There could now be no escaping the conclusion that there was something seriously amiss with Hong Kong’s monetary arrangements. But, far from addressing the causes of the problem, the authorities appeared to be tackling only the symptoms by intervening in the foreign exchange markets to support the local currency. Normally such intervention ought to succeed if it was supported by other policy measures, but it was quite clear to me that — given Hong Kong’s institutional structure — such measures could not possibly succeed in halting the slide in the currency. It was therefore time to “blow the whistle” on Hong Kong’s monetary arrangements, pointing out as forcefully as possible the inherent weaknesses of the prevailing structure, and to insist again that reforms were necessary if the currency slide was to be stopped and inflation was to be avoided. The article that follows is in some respects a comprehensive restatement of previous ideas and proposals published in AMM in 1979 and 1980, but it also contains two critical additions to previous arguments which considerably sharpened the critique — (1) a list of the steps that the authorities had taken in 1972 that had undermined their ability to hold the exchange rate steady at some specified nominal rate against the US$, and (2) the tabular presentation of a series of transactions from the T-form balance sheets of the Exchange Fund, the commercial banks and the non-bank public. These proved conclusively that foreign exchange intervention by the authorities under these arrangements was futile. It should be noted that at this time I was still thinking in terms of a central bank as the only feasible alternative to Hong Kong’s prevailing monetary arrangements — not a reformed currency board system. In this connection there are two boxes in the article: one that critiques the government’s case for maintaining the status quo (“Central Bank or No Central Bank?”), and points out the key differences between the accounting arrangements of Hong Kong’s monetary system versus other monetary systems, and another that explains how a monetary authority can operate without government debt (since this was often cited as a reason why Hong Kong could not have a central bank). An interesting sub-plot in this article is that the government, by adopting mistaken remedies to deal with 16 Hong Kong’s Link to the US Dollar symptoms resulting from monetary problems, threatened to damage the wider economy of Hong Kong, for example imposing rent controls to suppress rising rents. If the authorities were to continue to hold out against the arguments in AMM they would now have to prove that the principles demonstrated in “Time to Blow the Whistle” were incorrect in logic. It was not long before they showed their cards. As author of the article I received a call requesting that I attend a meeting with the Financial Secretary, John Bremridge, at 4.30 p.m. on Monday October 12th 1981. Also present was Douglas Blye, Secretary of Monetary Affairs, who did most of the talking. He said that the article was destabilizing to Hong Kong, and contained serious mistakes. When asked for specifics he pointed out a couple of factual errors (subsequently corrected), but when asked if the principles underlying the relationship between the Exchange Fund and the banking system were wrong, I received no answer. The stand-off was to continue for two more years. A S I A N M O N E T A R Y M O N I T O R Vo l . 5 N o . 4 J u l y – A u g u s t 1 9 8 1 During the recent precipitate slide of the Hong Kong dollar from around HK$5.40 per US$ towards HK$6.00, there were several occasions on which it was reliably reported that the Hong Kong government had intervened to support the local currency on the foreign exchange market. Such intervention, when carried out by a central bank in an orthodox banking system, can be effective in supporting the local currency. But in the case of Hong Kong’s peculiar and unorthodox banking structure such intervention is utterly pointless and futile. To understand why this is so it is necessary to see (a) how a normal...

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