The Evolution of the Hong
Kong Currency Board
Catherine R. Schenk
Origins and Early Evolution
Hong Kong’s adoption of Colonial Currency Board
System
• Part of British colonial monetary system: ensure stability of
local note issue – automatic link to sterling
• Hong Kong is latecomer – Importance of relations with
mainland China
• Exchange Fund established 1935 after currency instability
in China due to collapse of silver: China moves to peg to
sterling and USD (de facto sterling peg)
• Unusual arrangement with note-issuing banks rather than
direct issue by crown agents for the colonies
• Sterling pegged exchange rate successfully defended.
Challenges in the Post-War Decades
•Occupation by Japan: duress note issue reduces foreign
exchange cover below 100% (restored by 1949)
• Rise of Hong Kong as an International Financial Centre with
free foreign exchange market
–
expansion of domestic banking system (M2 and M3)
–
expansion of domestic industry
• Gradual loss of global confidence in external value of
sterling leads to regular crises of confidence during 1960s
• HKD appreciates against sterling in November 1967 (follows RMB)
• Exchange Fund provides forward cover for banks from 1968
• Exchange Fund issues HKD denominated paper
• Foreign exchange cover for note issue falls below 80% in 1974
• Importance of sterling link for Mainland China erodes
• Sterling’s instability
• Political and Economic Rapprochement with the USA in early 1970s
Foreign Exchange Cover for Note Issue 1966-74
Foreign Exchange Cover for Note Issue (percent)
150
140
130
120
110
100
90
80
70
1966
1967
1968
1969
1970
1971
1972
1973
1974 (Sept)
Monthly sales of sterling to Mainland Banks
1957-73
70
60
40
Total
Bank of China
Bank of Communications
30
20
10
Monthly
19
73
19
72
19
71
19
70
19
69
19
68
19
67
19
66
19
65
19
64
19
63
19
62
19
61
19
60
19
59
0
19
5
19 7
58
Sterling Million
50
The End of the Currency Board Rules
Collapse of the International Monetary System poses
challenges for Hong Kong as an IFC increasingly integrated
with Mainland China
•July 1972 peg shifted from £ to USD after sterling begins a
floating regime: importance of stable RMB/HKD rate
– Note issue against HKD balances rather than foreign exchange held
outside the banking system
–USD unstable, causes difficulties for countries that shifted peg
• November 1974 HKD floats and loses monetary anchor: no
serious adverse effects until late 1970s inflation and
depreciation against RMB, 1980 HKD begins to depreciate
against USD
Nominal HKD Exchange Rates
Nominal HK$ Exchange Rates (Dec 1973=100)
end month
160.00
HKD Float
Nov. 1974
Sept 1981
July 1979
Oct 1982
140.00
Sept. 1975
Nov. 1977
120.00
U.S. dollar
RMB
100.00
80.00
Currency
Board
Reinstated
Oct 1983
60.00
1983
1982
1981
1980
1979
1978
1977
1976
1975
1974
1973
Daily Exchange Rates 1981-1984
HKD per USD - Daily Rates NY Jan 1981- Dec 1984
9
23 Sept 1983
8.5
8
7 June 1983
7.5
13 Sept 1983
26 Oct 1982
7
1 Oct 1981
6.5
6
5.5
5
4.5
4
28 Dec 1982
May-August 1983: Re-adopting the
Currency Board
– May 1983 Banking Advisory Committee discusses Latter
proposal to reduce liquidity in the banking system to constrain
inflation and speculation against the HKD
–July/August 1983 Latter: ‘Monetary Policy in Hong Kong a
Personal View’
• ‘Hong Kong has been lucky to escape with as few monetary crises in recent
years as it has in fact experienced. I think it would be foolish to continue to
chance our luck indefinitely’
• Dismisses return to fixed exchange rate or foreign currency backing for note
issue in favour of Govt intervening in money market; HSBC to hold its
clearing account in the EF: ‘putting the govt firmly in the driver’s seat’
HSBC counters with Exchange Fund CD as a specified liquid asset:
object to HSBC as fulcrum for govt control and don’t believe Latter’s plan will
work (Patel and Gray take leave until 23 September, debate suspended)
HK Exchange Rate May to October 1983
HK per USD 2 May to 31 October 1983
9
3 Oct
1 June
1 July
1 Aug
1 Sept
8.5
8
7.5
26 Sept
7
6.5
17 October
September – October 1983
HKD sinks

8 September Blye (Sec for Mon.Affairs) and Bremridge (F.S.) call
for rise in interest rates to 3% - rejected by banks incl. HSBC : ‘Blye
remonstrated most strongly’ that HSBC did not support Govt
 14 Sept. Blye to John Hammond, Dep. Chairman HSBC
– ‘you
may have recognised some similarity between Latter’s analysis and that of
John Greenwood, who some regard as a competent analyst of HK’s monetary
affairs. It is of course easy to sneer at these academics’

25 Sept. ‘The Emperor’ Greenwood proposal (drafted 16/9?):
– Bank
of England, EF and Govt all guarantee £ or USD value of HKD, £ and
USD to be flown into HK, return to currency board based on sterling.
Latter/Greenwood ‘A Plan for stabilising the Exchange Rate’
discussed 25-26 Sept. – USD based currency board
Market advised to expect new measures and interest rates
increased, steadying the market. Renewed speculation 3/10

Re-adoption of Currency Board 17 October
HSBC views (DK Patel, John Hammond) 28 Sept.
– some merit, ‘the problems we are facing are politically
induced’ and require immediate action, ready to cooperate,
but doubts about Govt’s ability to hold pegged rate
convertibility for deposits as well as note issue
DKP: ‘to the best of my judgement a fixed exchange system is impossible to
operate efficiently without exchange controls’
– JH to Blye: ‘Frankly I have no better alternative…but it is essential that we all
know what we are letting ourselves in for before we start the scheme’
–
– 15 October draft Telex announcing currency board
– 17 October HSBC agrees to trade at 780, Banks open USD
settlement accounts with HSBC, demand for USD leads them
to be overdrawn against clearing accounts at HSBC, charged
penalty inter-bank rates of 20-40%: confidence restored