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Linked Exchange Rate system - quotes and memories Some interesting quotes from before and after October 1983. Last month the Hong Kong Institute for Monetary Research organised a conference called "Banking and Monetary History of Hong Kong: Hong Kong¡¦s Current Challenges in Historical Perspective". As the name of the conference suggests, historical factors have been quite important in shaping the development of the monetary and banking systems of Hong Kong. This probably applies to other jurisdictions as well. Seldom do we have a clean slate to write on when introducing reforms. While all stakeholders in the monetary and financial systems accept that we need to change with the times, political considerations, whether at the macro or micro levels, always have to be taken into account in making decisions, sometimes leading to outcomes that may not necessarily be ideal or to delays in the reform process. One aspect that has always featured prominently in discussions on monetary and banking reform is the strong opinion held by many that letting the free market take its own course will solve most problems. This is understandable and borne out by Hong Kong's long and successful history of reliance on the free market. Partly as a result, it took a particularly long time, and a monetary crisis, for the authorities to come around to realising that in monetary management it is essential to have effective control over either the quantity or the price (internal or external) of money, or more precisely the monetary base. For historical and other reasons, it took the authorities a long time to acquire such control, taking cautious and small steps along the way. Again, this is understandable because Hong Kong was facing a political transition, which meant that two sets of people at the political level had to be convinced that the reform proposals were necessary and good for Hong Kong. Recently I managed to extract a few quotes from the records that give vivid impressions of the thoughts of those involved at the time. I would urge readers to refrain from hasty judgements about whether the opinions expressed were right or wrong. This would be unfair to the individuals concerned, even though they are not named here. A private-sector research bulletin published an article in the summer of 1981 (two years before the monetary crisis of September 1983) entitled "Time to blow the whistle" (on monetary arrangements in Hong Kong). After being asked to read the article, a senior government official commented: ¡§What the article lacks is any serious attempt to tell us why whistles have to be blown. He strikes me as a confirmed regulator for whom regulation is a worthy end.¡¨ How often does one see the private sector calling for regulation and the official sector resisting it? Of course, not all shared the view of that senior government official. Another government official, two months before September 1983, said: "I do not believe that any worthwhile improvement to our monetary armoury can be achieved without first establishing a mechanism to give government some control over the Hong Kong dollar resources of the banking system, and hence leverage over its balance sheet." Incidentally, The Linked Exchange Rate system, as designed and implemented in October 1983, did not do that. As the worst monetary crisis in the history of Hong Kong broke out in September 1983 and the Government announced that monetary reform measures were being considered, an economics academic offered his views at the end of September 1983: "I simply cannot accept the arguments of those who claim that our present system is grossly defective." "If money at all matters, then few can deny that our present system possesses rather definite merits." "I, for one, have been enormously impressed that, in spite of the current difficulties, the economy is still very much afloat. We are hurting, indeed, but far from dead." By mid-1984, it was becoming clear that banknotes arbitrage, thought to be the stabilising force of the Linked Exchange Rate system as designed in 1983, was not working as smoothly as expected. Continual exchange market and money market intervention had been needed to stabilise the exchange rate. A senior government official said in July of that year, nine months after the introduction of the system: "Recent events have persuaded me once again that we cannot continue to ignore the question of enhancing our monetary armoury." "The aim of any set of reforms would be to give government control over the ultimate availability of Hong Kong dollars, in terms of quantity and interest cost, to the banking system." "I feel strongly that exploratory work on a system of this sort should proceed, sooner rather than later." Getting quite frustrated, a senior government official wrote in April 1985: "I hope that I have made clear my belief that the monetary framework could and should be enhanced; but, like others before and, I fear, after me, I bow out with my fingers crossed but the job hardly begun." The New Accounting Arrangements, which eventually gave government indirect control over the Monetary Base, were introduced in July 1988, after obtaining agreement from all concerned (of whom there were many). I hope readers will find these quotes, and the light they shed on developments in our Linked Exchange Rate system, as interesting as I do. Joseph Yam
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