Question 7 20 marks 20 marks Currently Hong Kong is practici

Question 7 (20 marks) (20 marks) Currently, Hong Kong is practicing the linked exchange rate system, which is a fixed exchange rate system that pegged the Hong Kong dollars to the US dollars. Do you agree that Hong Kong should continue to adopt the linked exchange rate system? Provide four arguments with detail explanations to support your view.

Solution

The Hong Kong dollar, the biggest loser among a dozen Asian currencies against the euro last year, weakened to 7.8499 per US dollar on Wednesday, the weakest level since 1983.

Overview of the situation:

History of the Hong Kong dollar peg?

The current peg between the Hong Kong dollar and the US dollar has been in place since 1983. On 17 October 1983, the currency was pegged at a rate of HKD 7.8 to USD 1. Since 18 May 2005, the currency floats between HKD 7.75 and HKD 7.85 per USD. The currency is also used in Macau.

Disadvantages to the pegging of HKD to USD:

The current exchange rate system has served the economy well, but local residents have to cope with periods of contracting wages and falling property prices, and also periods of rapid inflation. These price and pay swings happen because Hong Kong imports US monetary policy via the peg, even though the US and Hong Kong economies may not be moving in tandem.

Why not remain pegged with USD:

An important reason to question the peg is Hong Kong’s growing integration with China. In the past most of Hong Kong\'s trade and financial dealings were done in US dollars. But since trade with China is growing and the renminbi is gradually playing a more important role in local transactions, a peg with the Chinese currency is more reasonable than one with the US dollar. Hong Kong\'s financial and economic links are increasingly dominated by mainland China, and previous concerns about the openness of China\'s capital account are slowly receding. If China continues to open its capital account, the peg could shift from US dollar to renminbi.

Affects of change in pegging system:

A change of the peg will probably not have very large effects on businesses. The Chinese and US currencies are also tied to each other in a crawling peg. While this may change to a free floating exchange rate in the next few years, Chinese monetary authorities will still mitigate large fluctuations. Thus the foreign exchange risk for foreign firms operating or investing in Hong Kong will not change significantly. It may have more effect on Hong-Kong based firms. Competitiveness would not be affected, but the increased security that a peg to the renminbi would bring would benefit Hong Kong businesses more than a USD peg.