【明報專訊】The Hong Kong dollar is officially linked to the US dollar at the rate of 7.8 HK dollars to one US dollar. The linked exchange rate (聯繫匯率) system, which has been in existence since 17 October 1983, is the cornerstone of Hong Kong's financial system.

1. Currencies in early Hong Kong

In the 19th century, the British colonial government tried to introduce the use of the pound (GBP) in Hong Kong. It was not widely accepted because the currency was in short supply.

In 1863, a silver standard was adopted in Hong Kong, and its own coins were issued in 1866. The Hongkong and Shanghai Banking Corporation became Hong Kong's first note-issuing bank.

A disadvantage of a silver-based system was that the price of silver was unstable.

In 1935, the silver standard gave way to the pound sterling (英國貨幣) standard in Hong Kong. The rate was then 16 HKD to one GBP.

After WWII, the pound depreciated, and the HK dollar was repegged to it at HK$14.55 to one GBP.

2. The HKD-USD peg

In 1972, the UK government decided to float the pound. That meant the exchange rate of the pound could change from time to time. The Hong Kong government thus had the HK dollar pegged to the US dollar. However, the rate was unstable and the peg was removed in 1974.

In 1983, the public lost confidence in Hong Kong's future beyond 1997 as talks between the UK and China went sour. Fearing the currency would become defunct as it did during the Japanese occupation, crowds grabbed daily supplies from store and supermarket shelves. The Hang Seng Index plunged 30% from 1102 to 758 in two months. People lost confidence in the HK dollar and converted their money into US dollars.

In response, the government looked at the possibility of fixing the HKD-USD rate. On 15 October 1983, Sir John Bremridge, who was then Financial Secretary, announced that the HK dollar would be linked to the US dollar at the fixed rate of

HK$7.8 to US$1.

3. Linked exchange rate system

It was then that the linked exchange rate system was introduced. The government does not actively interfere with the market.

Therefore, a note-issuing bank may decide on its own how much paper money should be printed, provided that it deposits with the Hong Kong Monetary Authority (HKMA) an equivalent sum of US dollars.

The HKMA issues Certificates of Indebtedness as backing for banknotes. When one pays in Hong Kong dollars, the value is guaranteed by the HKMA with the same amount of foreign currency in the Exchange Fund. The linked exchange rate system stabilised the HK dollar and bolstered people's confidence in it.

However, there are disadvantages of the system. The HKMA, the de facto central bank of Hong Kong, does not act as the lender of the last resort because its reserves come mostly from the note-issuing banks.

The peg means Hong Kong's monetary system is influenced by the financial policies the US adopts (eg, interest rates in the US), and the prices of imported goods in Hong Kong depend very much on the value of the US dollar.

4. Future of the HKD

Because of the disadvantages of the linked exchange rate system, some suggest abolishing the peg or pegging the Hong Kong dollar to another currency.

But replacing the anchor currency (the US dollar) would undermine the credibility of the system and trigger an outflow of money.

Some has proposed linking the HK dollar to a basket of currencies. Although the local economy would be less prone to changes in a single currency, the system would be more complex and much less transparent.

As Hong Kong has reverted to Chinese sovereignty, some think the yuan should be used in the territory, but others refute (反駁) that the value of the yuan is still unstable, adding that it is not yet widely used in the world.