Alternatives to peg too risky, warns Greenwood

The resilient Linked Exchange Rate System remains Hong Kong’s best option, the economist widely regarded as the chief architect of the dollar peg said, as he warned alternative proposals would introduce greater risks and instability.

John Greenwood dismissed options such as a peg to the yuan, a currency basket and a free-floating Hong Kong dollar as “unrealistic and destabilizing” in a recent interview with think tank Chartwell Institute. 

Greenwood sees pegging the local dollar to the yuan as “infeasible” because the latter is not fully convertible and China’s financial system operates under different regulations and state controls.

If the two currencies are pegged, “some might argue that financial conditions in Hong Kong and China are more closely aligned” and there would be “anomalies and distortions that would spill over to Hong Kong,” Greenwood said.

He added that the ups and downs of China’s economy, such as the current mainland property downturn, would have an even larger impact on the territory if such a peg were adopted.

A currency basket similar to Singapore’s system would add more complexity and reduce transparency, Greenwood argued. Even adopting a dual currency peg, such as one tied to both the US dollar and yuan, would introduce difficulties in determining appropriate weighting and create uncertainty in monetary policy, he pointed out.

For a small, open economy like Hong Kong, allowing its currency to be free-floating is not a panacea and the financial hub learned that lesson very painfully before the peg was adopted in 1983, Greenwood said. 
A floating Hong Kong dollar would be subject to speculation and external shocks, leading to even greater uncertainty in interest rates and monetary conditions.

“Every time there was a political or economic event, the exchange rate would become a major source of instability,” he warned.

So far, tensions from US-China trade disputes, past episodes of inflation and significant interest rate divergences have not undermined the peg and it would take an extremely drastic situation — such as a geopolitical crisis — for it to be seriously threatened, Greenwood noted.

AIDEN HE