Unlike a fixed exchange rate system, the government or central bank does not actively interfere in the foreign exchange market by controlling supply and demand of the currency in order to influence the exchange rate. The exchange rate is instead stabilized by an exchange mechanism, whereby the Hong Kong Monetary Authority (HKMA) authorises note-issuing banks to issue new banknotes provided that they deposit an equivalent value of US dollars with the HKMA. The Government, through the HKMA, authorises three commercial banks to issue banknotes:
Notes (HK$10 only) are also issued by the HKMA itself because of the continuing demand for small value notes among the public.
History
HKD/USD exchange rate since 1990
As a response to the Black Saturday crisis in 1983, the linked exchange rate system was adopted in Hong Kong on October 17, 1983 through the currency board system.[1] The redemption of certificates of indebtedness (for backing the banknotes) were sent out by note-issuing banks to peg the domestic currency against the US dollar at an internal fixed rate of HK$7.80 = US$1.[2]
The Hong Kong Monetary Authority (HKMA), Hong Kong's de facto central bank, authorised note-issuing banks to issue banknotes. These banks are required to have the same amount of US dollars to issue banknotes. The HKMA guarantees to exchange US dollars into Hong Kong dollars, or vice versa, at the rate of 7.80. When the market rate is below 7.80, the banks will convert US dollars for Hong Kong dollars from the HKMA; Hong Kong dollar supply will increase, and the market rate will climb back to 7.80. The same mechanism also works when the market rate is above 7.80, and the banks will convert Hong Kong dollars for US dollars.
The Hong Kong dollar is backed by one of the world's largest foreign exchange reserves, which is over 7 times the amount of money supplied in circulation or about 48% of Hong Kong dollars M3 at the end of April 2016.[3]
Strengthening of Currency Board Arrangements
Since 5 September 1998, the HKMA has provided an explicit convertibility undertaking to all licensed banks in Hong Kong to convert Hong Kong dollars in their clearing accounts into US dollars at the fixed exchange rate of HK$7.75 to US$1.[4] Starting from 1 April 1999, the convertibility rate in respect of the Aggregate Balance moved from 7.75 by 1 pip (i.e. $0.0001) per calendar day. It converged with the convertibility rate applicable to the issuance and redemption of Certificates of Indebtedness at 7.80 on 12 August 2000.[5]
The HKMA announced three refinements on 18 May 2005 to remove uncertainty about the extent to which the exchange rate may strengthen under the Linked Exchange Rate System:
the introduction of a strong-side Convertibility Undertaking by the HKMA to buy US dollars from licensed banks at 7.75;
the shifting of the existing weak-side Convertibility Undertaking by the HKMA to sell US dollars to licensed banks from 7.80 to 7.85, so as to achieve symmetry around the Linked Rate of 7.80. This shift was achieved in a gradual manner over five weeks by moving the exchange rate of the weak-side Convertibility Undertaking by 100 pips on every Monday starting with 7.81 on 23 May 2005 until it reached 7.85 on 20 June 2005;
within the zone defined by the levels of the Convertibility Undertakings (the "Convertibility Zone"), the HKMA may choose to conduct market operations consistent with Currency Board principles. These market operations shall be aimed at promoting the smooth functioning of the Linked Exchange Rate System, for example, by removing any market anomalies that may arise from time to time.[6]
A currency is a standardization of money in any form, in use or circulation as a medium of exchange, for example banknotes and coins. A more general definition is that a currency is a system of money in common use within a specific environment over time, especially for people in a nation state. Under this definition, the British Pound Sterling (£), euros (€), Japanese yen (¥), and U.S. dollars (US$) are examples of (government-issued) fiat currencies. Currencies may act as stores of value and be traded between nations in foreign exchange markets, which determine the relative values of the different currencies. Currencies in this sense are either chosen by users or decreed by governments, and each type has limited boundaries of acceptance; i.e., legal tender laws may require a particular unit of account for payments to government agencies.
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Joseph Yam Chi-kwong, GBM, GBS, CBE, JP is a Hong Kong statistician, economist and civil servant. He was the first Chief Executive of the Hong Kong Monetary Authority, Hong Kong's de facto central bank, holding the position for 16 years. In 2011 Yam was elected to a member of the board of directors of the Swiss Bank UBS AG. In 2014, following UBS AG's restructuring, he was appointed to the board of directors of the UBS Group AG and served in the position till May 2017. He has been a member of the Corporate Culture and Responsibility Committee and the Risk Committee of the UBS Group AG since 2011 and a non-official member of the Executive Council of Hong Kong since 2017.
In macroeconomics and modern monetary policy, a devaluation is an official lowering of the value of a country's currency within a fixed exchange-rate system, in which a monetary authority formally sets a lower exchange rate of the national currency in relation to a foreign reference currency or currency basket. The opposite of devaluation, a change in the exchange rate making the domestic currency more expensive, is called a revaluation. A monetary authority maintains a fixed value of its currency by being ready to buy or sell foreign currency with the domestic currency at a stated rate; a devaluation is an indication that the monetary authority will buy and sell foreign currency at a lower rate.
Foreign exchange reserves are cash and other reserve assets such as gold held by a central bank or other monetary authority that are primarily available to balance payments of the country, influence the foreign exchange rate of its currency, and to maintain confidence in financial markets. Reserves are held in one or more reserve currencies, nowadays mostly the United States dollar and to a lesser extent the euro.
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The issue of banknotes of the Hong Kong dollar is governed in the Special Administrative Region of Hong Kong by the Hong Kong Monetary Authority (HKMA), the governmental currency board of Hong Kong. Under licence from the HKMA, three commercial banks issue their own banknotes for general circulation in the region. Notes are also issued by the HKMA itself.
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The Exchange Fund of Hong Kong is the primary investment arm and de facto sovereign wealth fund of the Hong Kong Monetary Authority. First established in 1935 in order to provide backing to the issuance of Hong Kong dollar banknotes, over the years the role of the Fund has continually expanded to now include management of fiscal reserves, foreign currency reserves, real estate investments, and private equity.
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