For the past 28 years, Hong Kong has pegged its currency, the Honk Kong dollar, to its US counterpart. One greenback buys around 7.8 HK dollars. That means Hong Kong imports its monetary policy from America. But while the US Fed’s current near-zero interest-rate policy might suit the weak US economy, the worry is that Hong Kong may be overheating. The property market is red hot and inflation is at a 16-year high of almost 8%. But, because of the peg, Hong Kong can’t let its currency rise to temper inflation. So some observers are betting that the peg is unsustainable and will be abandoned so the city state can curb inflation and property prices.
Don’t count on it, says The Economist. For starters, a flexible exchange rate doesn’t necessarily bring stability. Both growth and inflation swung wildly in 1974-1983, when the currency floated freely. Moreover, the exchange rate may be fixed, but Hong Kong’s wages and prices “are famously flexible – in both directions”. So the economy can adjust to the dollar’s ups and downs without changing the peg. For instance, consumer prices fell between 1998 and 2004, a period of deflation that was shorter but deeper than Japan’s. In other words, the peg is less of a constraint than it looks.