CONFIDENTIAL
must prepare to cover their own positions by diversifying
into other assets". As for her external reserves, Hong Kong
has also threatened to diversify at least 50 per cent of these
into currencies other than sterling if the Sterling Agreement
is not renewed, as "public opinion would not permit us to do
less than this" (telegram No 817 of 26 July). The question
to be considered, therefore, is whether we can, or even wish
to, prevent both or either of these things happening.
It would not seem in our interests to go on guaranteeing
the banks' sterling ad infinitum since, for one thing, the
Hong Kong Bank derives a special, and profitable, position as
a result. The most desirable solution to the banks' problems
would be the setting up of a local money market capable of
absorbing the commercial banks' sterling. This would take
the form of an issue of local paper, together with proper
rediscounting facilities, so that the banks' Hong Kong dollar
liabilities would then be matched in the same currency. The
Government would then take into the Colony's official reserves
their foreign exchange holdings and any subsequent accruals
surplus to the banks' working requirements.
Such a course of
action was recommended to Hong Kong in February this year
(Keeble's letter of 16 February) but no reply has been received.
If these propositions are accepted, it is possible to
envisage the outline of a package deal which we might offer to
Hong Kong: we would offer an "attractive" guarantee (say the
current rate) for their sterling if in return, and over an
agreed period, they moved towards a more desirable banking
structure. Coupled with this would be a gradual phasing out
of banks' sterling from the total guaranteed
with the